1. Misalignment of Interests: While RIAs are held to a fiduciary standard by the Investment Advisers Act of 1940, this does not entirely eliminate the risk of self-interest affecting an RIA’s advice. For instance, RIAs might favor only those investment products from firms that are paying significant commissions to the RIA for selling that product. This means there is a significant potential conflict of interest causing an RIA to recommend the same small set of investment products to every potential client.
2. Limited Product Offering: Many RIAs have a limited range of investment products due to affiliations with certain investment companies. This could mean you may not have access to the full spectrum of investment options that might be more suitable for your retirement needs.
3. Lack of Transparency: Even though RIAs are required to disclose all material facts to their clients, the complexity of the investment products such as annuities and life insurance products may result in you not fully understanding certain investments, the adviser’s commission for selling a specific product, or the risks involved in an investment strategy recommended by the RIA.
4. Qualifications and Experience: RIA’s expertise and experience can vary significantly. While some have extensive experience and hold multiple qualifications, others might be newer to the industry and less experienced. A less qualified RIA might not provide the best advice or understand the intricacies of complex investment strategies. Further, it is important to check your adviser at brokercheck.org and investigate their history. There are plenty of RIAs who are and RIA because they are unable to be a stockbroker (yes, there is a huge difference.)
5. Costs: RIAs usually charge a fee based on a percentage of assets under management, which might be higher than what you’d pay if you managed your investments independently or did not invest in annuities or life insurance products. Additionally, some RIAs may have hidden costs or might charge additional fees for specific services on top of the percentage fees they charge.
6. Poor Communication: In some cases, you might find that your RIA does not communicate effectively or regularly. This could leave you feeling uninformed about your investment decisions and progress toward your retirement goals.
7. Inadequate Personalization: Some RIAs might use a one-size-fits-all approach to investment strategies, which could result in your retirement assets not being fully able to meet your specific goals, risk tolerance, and timeline to, or in, retirement.
8. Limited Accessibility: Depending on the RIA, you may face issues regarding the accessibility of your adviser. If they manage a large number of clients, they might not be available when you need them, impacting your ability to make timely decisions. This applies to the investment products that RIAs may recommend to you because the investment products often have significant penalties for early ‘surrender’ and withdrawals, or even have no option to gain access to your money.
9. Risk Management: Not all RIAs are skilled in managing risk effectively. A failure to appropriately assess and mitigate risk could potentially result in substantial losses for your retirement portfolio.
10. Lack of Oversight: While RIAs are regulated by either the Securities and Exchange Commission (SEC) or state regulators, this does not guarantee that your investments are safe. If the oversight body does not effectively regulate the RIA’s practices, your retirement assets could be at risk. Another oversight issue is that many RIA’s have no insurance to provide coverage to you for the RIA’s potential negligent or fraudulent handling of your account.

Despite these potential problems, it’s important to remember that many RIAs provide excellent service and can significantly contribute to the growth and protection of your retirement assets. The key is doing your due diligence in selecting an adviser. Check their qualifications, regulatory records, and references. Understand their fees, services offered and their investment philosophy. Good communication is essential, so ensure you feel comfortable discussing your needs and goals with them. Finally, always remember that it’s your retirement – stay informed and involved in the management of your assets.

Retirement planning can be a complex process, but knowing the potential pitfalls of entrusting your retirement assets to an RIA can help you make an informed decision that aligns with your retirement goals and financial situation.

A margin account is a type of investment account that allows investors to borrow funds from their broker-dealer to purchase securities. With a margin account, investors are able to leverage their trades by borrowing against the value of their portfolio. This means that investors can potentially earn larger returns on their investments but also exposes them to increased risk.

Broker-dealers have a number of responsibilities when it comes to margin accounts. One of their primary responsibilities is to ensure that investors understand the risks associated with trading on margin. This includes providing investors with a detailed explanation of how margin accounts work, the potential risks and benefits, and any costs or fees associated with trading on margin.

Another important responsibility of broker-dealers is to ensure that investors meet the eligibility requirements for trading on margin. These requirements may vary depending on the broker-dealer, but typically include factors such as an investor’s financial standing, trading history, and investment objectives. Broker-dealers must also maintain appropriate documentation to demonstrate that investors meet these requirements.

Once an investor has been approved for a margin account, broker-dealers are responsible for monitoring the account to ensure that the investor is maintaining sufficient collateral to cover any potential losses. This is known as a margin call. If the value of the investor’s portfolio falls below a certain level, the broker-dealer may issue a margin call, requiring the investor to deposit additional funds or securities to maintain the required level of collateral.

Broker-dealers should clarify for investors that the broker-dealer has almost unfettered control over the margin account. The broker-dealer, in the face of a ‘margin call,’ can raise money to meet the margin call by selling stocks from an investor’s account without first asking the investor. The broker dealer can even sell out the entire account without the client’s authority to protect the broker-dealer.

Broker-dealers are also subject to the Financial Industry Regulatory Authority’s (FINRA) rules regarding margin accounts. These rules require broker-dealers to provide investors with a risk disclosure statement outlining the risks associated with trading on margin. Broker-dealers must also provide investors with regular statements outlining the status of their margin accounts, including the amount of margin used and any potential margin calls. Additionally, broker-dealers must also comply with all applicable laws and regulations governing their conduct, including the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940.

Another important responsibility that broker-dealers have is the responsibility to ensure that all investors are treated fairly and with integrity. This includes providing investors with accurate and timely information about their margin accounts, as well as ensuring that any fees or charges associated with trading on margin are reasonable and transparent. Broker-dealers must also have adequate safeguards in place to protect investors’ assets and prevent unauthorized access or theft.

Margin accounts offer investors the opportunity to potentially earn larger returns on their investments, but such accounts also come with increased risk. Broker-dealers have a number of important responsibilities when it comes to margin accounts, including ensuring that investors understand the risks and benefits of trading on margin, monitoring accounts to ensure sufficient collateral, preventing illegal trading practices, and complying with applicable regulations. As an investor, it’s important to work with a reputable broker-dealer who is committed to transparency, fairness, and integrity when it comes to margin accounts.

Along with the sharing his viewpoint that the majority of crypto tokens and cryptocurrency intermediaries are subject to federal securities laws and regulations, Gensler also shared a quote from the first SEC Chairman, Joseph Kennedy: “No honest business need fear the SEC.” [1] Gensler’s repeated reference to this quote supported his overarching message that regulatory oversight of crypto tokens and intermediaries should be viewed as a positive for the market rather than a negative.

In first speaking on crypto tokens themselves, Gensler noted that the purchase and sale of these tokens are subject to federal securities laws so long as the tokens meet the statutory definition of a security. Gensler cited Congressional purpose and history as well as the Supreme Court’s “Howey Test” in support of his view. [1]

Gensler pointed out that Congress intended a broad scope for the definition of a security, citing Justice Thurgood Marshall’s statement that “Congress’ purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called.” [1]

Gensler then turned to the Supreme Court’s “Howey Test,” which sets forth the factors that comprise one form of security: an “investment contract.” [1] In line with the Howey Test, Gensler concluded that, because crypto investors buy and sell crypto tokens with the expectation of “profits derived from the efforts of others in a common enterprise,” the tokens are indeed investment contracts; thus, they are securities subject to federal securities laws.

Beyond discrete crypto tokens, Gensler also stated that the intermediaries, which host the exchange of crypto tokens, must also likely register with the SEC in order to comply with federal securities laws. Crypto intermediary platforms “match orders in crypto security tokens of multiple buyers and sellers using non-discretionary methods,” and this meets the legal test for regulatory oversight.

While Gensler views the majority of crypto tokens and cryptocurrency intermediaries as subject to regulation and oversight by the SEC, his remarks sought to underscore the merits of such regulation for all market participants.

He noted that those offering crypto tokens or operating crypto intermediary platforms should have open dialogues with the SEC to help ensure that any token or platform which legally requires registration with the SEC may avoid potential legal issues in the future.

Gensler also emphasized the important investor protections offered by SEC oversight of crypto tokens and intermediaries. In concluding his remarks, Gensler highlighted his view that crypto simply offers a new technology for the issuance and trading of securities, and the adoption of a new technology should not deprive the investing public of the critical benefits offered by required disclosures and registration with the SEC.

Although Gensler’s remarks are not representative of official guidance from the SEC, they shed light on the importance of regulating crypto markets, specifically as they expand in popularity and adoption by the general public. With regulatory oversight under existing federal securities laws, crypto investors gain important assurance of the legitimacy and safety of their investment portfolios.

Source:

[1] https://www.sec.gov/news/speech/gensler-sec-speaks-090822

The ruling by Judge Cecilia Altonaga of the U.S. District Court for the Southern District of Florida denied Robinhood’s motion to dismiss shareholder allegations of market manipulation. The allegations stem from Robinhood’s actions in the wake of the meme stock frenzy of early 2021. [1] In the lawsuit, Robinhood shareholders allege that Robinhood engaged in tactics aimed at artificially lowering the prices of nine stocks at the center of the frenzy. These stocks included GameStop, Bed Bath & Beyond, and AMC. [1]

The meme stock frenzy took place in January 2021 when social media users stirred extraordinary investment interest in several unexpected stocks. The outpour of interest in these stocks was not founded on each stock’s actual performance, but rather on the prospect of triggering a short squeeze on the stocks.

Retail investors organized via social media to begin buying these stocks in droves, thus sending their prices skyward. As stock prices skyrocketed, the meme stock investors reasoned that hedge funds who had shorted the stocks stood to lose vast sums of money.

The meme stock investors were, in many cases, correct. One hedge fund, Melvin Capital Management, lost more than $1 billion per day during the height of the January 2021 frenzy as a result of its bets against stocks like Gamestop. [2]

While the meme stock frenzy posed clear challenges for hedge funds like Melvin, it also posed a thorny problem for Robinhood – that of maintaining required cash reserves as meme stock prices rose.

Robinhood’s online securities trading platform was one of the major vehicles through which retail investors purchased these so-called meme stocks. Further, as a securities broker, Robinhood is required by the National Securities Clearing Corporation to maintain a certain amount of cash available to clearinghouses. [1] During the height of the frenzy, Robinhood’s clearinghouse cash requirement rose to over $3 billion, an obligation which Robinhood struggled to meet. [1]

Thus, in an effort to meet its clearinghouse cash requirement, Robinhood temporarily froze its user’s ability to buy certain stocks, while placing limits on the number of shares users could purchase of other stocks. [1] Robinhood users allege that these actions and others, including cancellation of purchase orders and liquidation of some customers’ shares, amounted to market manipulation by Robinhood, as well as a violation of federal securities laws. [1]

While Robinhood continues to “vigorously defend” itself from these allegations, maintaining that their actions were “appropriate and necessary to protect and support [their] customers,” Judge Altonaga noted in her August 11 ruling that the case presents “interesting legal questions” which are only complicated by the infancy of the app-based securities trading industry. [3]

As a result, the eventual decision on the merits of this case will likely be foundational to the future of online securities trading regulation in the United States. As the case develops, important updates here can be found here on the Savage Villoch Securities Fraud Lawyers Blog.

Sources:

[1] https://www.reuters.com/markets/us/robinhood-must-face-us-market-manipulation-claims-over-meme-stock-rally-judge-2022-08-11/

[2] https://www.wsj.com/articles/melvin-plotkin-gamestop-losses-memestock-11643381321

[3] https://www.forbes.com/sites/dereksaul/2022/08/11/class-action-suit-moves-forward-against-robinhood-over-halting-meme-stock-trading/?sh=5ed1ded564b3

Before sharing his view of the SEC’s role in crypto markets, Chairman Gensler first compared the technology to that of the dotcom bubble in 2000 and subprime lenders leading up to the 2008 financial crisis. His message: the flurry of attention on crypto and related innovations does little to vouch for its long-term viability or success. Instead, as was borne out in 2000 and again in 2008, cryptocurrency could indeed be a technology destined for failure.

The SEC’s role then, in Gensler’s view, is to protect investors from the potential financial blowback of such a failure. While Gensler lauded the spirit of entrepreneurship common in the United States, he also argued that the SEC should approach crypto regulation in a “technology neutral” way. In so doing, the SEC could carry out their mission to protect investors, facilitate capital formation, and maintain fair, orderly, and efficient markets, while still allowing crypto markets to flourish.

Gensler chose to focus on three discrete areas in which the SEC might appropriately step in with a regulatory scheme: crypto trading and lending platforms, stablecoins, and crypto tokens.

First, on the topic of crypto trading and lending platforms, Gensler noted the importance of these platforms being registered, thus allowing regulation in a similar manner to regulation of traditional securities exchanges. Gensler argued that in light of the functional similarities between “traditional regulated exchanges” and crypto platforms, investors on crypto platforms deserve similar regulatory protections. Such investor protections, Gensler noted, in turn promote investor confidence, which allows markets to work.

According to Gensler, stablecoins, which can be likened to bank deposits or money market funds, pose their own differing set of potential policy considerations. Stablecoins are rarely used in commerce, are not a legal tender, and are not issued by any central government.

As a result, stablecoins may impact monetary policy and financial stability within larger markets, may facilitate illicit activity, and may put U.S. investors at risk of losses created by unique conflicts of interest. Such conflicts arise because many of the platforms on which stablecoins are traded also physically own the stablecoins they trade.

Finally, Gensler approached the topic of the SEC’s regulation of all other crypto tokens. Most notably, Gensler stated that most crypto tokens are “securities” or “investment contracts” under U.S. law, thus necessitating registration by the SEC pursuant to existing federal securities laws.

The U.S. Supreme Court has held that an investment contract, or security, exists “when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Gensler noted that many crypto tokens are being sold by entrepreneurs who are looking to raise money from the public. This use-case places crypto tokens squarely within the definition of security or investment contract, and thus, submits crypto tokens to federal oversight. Regulation of crypto markets in this way safeguards not only crypto investors, but also the broader stability of the economy.

While Gensler emphasized that the views in his speech were his own and not representative of the SEC, his perspective will likely impact the SEC as it moves forward with enforcement policy. In the interim, Savage Villoch attorneys are available to consult on your cryptocurrency investment questions or concerns!

Sources: [1] https://www.investopedia.com/tech/question-why-should-anyone-invest-crypto/#:~:text=Another%20common%20reason%20to%20invest,dilute%20their%20value%20through%20inflation.

[2] https://www.sec.gov/news/speech/gensler-remarks-crypto-markets-040422

While the driving factors behind this downturn are many, the impact of the pandemic is undeniable. As an at-home exercise equipment company with the ability to connect users from their homes across the world via real-time classes, it’s no wonder the company and its stock soared through 2020’s COVID-19 lockdowns. Less clear, as of now, is Peloton’s staying power as consumer demand wanes, leading the company to hire consultants at McKinsey & Co. to review finances and to halt production on several of its models. [2]

In light of Peloton’s precipitous fall, some have turned their attention to massive stock sales undertaken by Peloton insiders before the downturn began. SEC filings from late 2020 and into 2021 show that insiders at Peloton sold approximately $500 million in stock before the price began to plummet. [3]

Among these insider sales were that of Peloton’s CEO and co-founder, John Foley, as well as the company’s president, William Lynch. First, in November 2020 Foley sold shares worth $119 million as part of a selling plan for “personal financial management purposes.” [3] Then, Lynch sold over $105 million in stock during 2021, the majority of which was sold in February 2021 at an average price of $144. [3]

While the timing of these Peloton insider trades might appear “lucky” in hindsight, the well-timed insider trades certainly were not unique. In fact, 2021 saw a new record for insider selling, which reached $170 billion, up from $94 billion in 2020. [3] As Daniel Taylor, associate professor at the Wharton School of Business succinctly explained, “[o]ne of the most well-accepted facts from decades of research on insider trading is that corporate insiders buy near bottoms and sell near peaks.” [3]

Given this well-established pattern of insider trading, two questions emerge: first, when does insider trading cross the line from legal to illegal; and second, how might everyday investors use knowledge about insider trades to their own investing advantage?

To start, insider trading crosses the threshold into illegality when company insiders trade securities when they have access to material information that the public does not. [4] Such illegal insider trading can be committed by anyone who has material and nonpublic information about a company – whether it be the CEO, a broker, or even an employee’s family or friend. [4]

Conversely, insiders may lawfully trade securities so long as they adhere to trading restrictions which lay out specific timing and other conditions for when trading is legal. [4] As a result, insider trading like that of Peloton and other executives throughout 2021 is both routine and legal, unless shown otherwise.

But how can these trades help individual investors? As described, insiders often sell stock when the price is high. At a base level, this may serve as a signal to investors with a short-term investment plan to consider selling their positions as well, while the stock is still high.

Furthermore, research has shown that executive’s insider trading activities can be extrapolated out to broader trends in the market. A company’s stock tends to outperform the broader market when executives of the company buy shares, and a company’s stock tends to underperform the broader market when executives sell. [4]

Helpfully for individual investors, the SEC requires that all corporate insiders report their stock sales or purchases within two business days of each transaction. [4] This information can then be accessed by the public either on Yahoo! Finance or on the SEC’s EDGAR Database.[4]

With more attention on insider trading as its volume rises, more individual investors may have their sights set on learning from these trades to inform their own investment decisions. When doing so, it is critical to remember that data on insider trades may not always tell the full story. A corporate insider may indeed have different motivations relating to other financial considerations, such as taxes, than would the average investor. Thus, it is possible to view insider trades as a guidepost, but investors should continue to exercise their own due diligence in making personal investment decisions.

Sources:

[1] https://www.google.com/finance/quote/PTON:NASDAQ?sa=X&ved=2ahUKEwivmo7qi8n1AhUSTd8KHYinAHIQ3ecFegQIERAc

[2] https://www.cnbc.com/2022/01/20/peloton-to-pause-production-of-its-bikes-treadmills-as-demand-wanes.html

[3] https://www.cnbc.com/2022/01/19/peloton-insiders-sold-nearly-500-million-in-stock-before-its-big-drop-.html

[4] https://www.investopedia.com/articles/02/061202.asp

At the heart of the decision to pivot in this manner has been a focus on steadily rising inflation, which some policymakers fear the pandemic’s longevity will only amplify. [1] This fear stems from the fact that in large part, populations are learning to coexist with the virus.

As time passes and each new wave appears, is studied, and spreads toward dominance, people become generally better equipped to deal with the pandemic’s impacts – economic and otherwise. Whether because of rising vaccination rates or better overall caution and awareness, many now agree that the largest current threat to the economy is inflation rather than COVID-19. [1]

This is, of course, not to say that COVID-19 doesn’t continue to significantly impact the global economy, as it has since it was first discovered about two years ago. When news of the most recent Omicron strain was released near Thanksgiving, stocks and energy prices took a significant dive, with the Dow Jones Industrial Average falling 2.5% for its steepest one-day percentage downturn in over a year. [2] In the several weeks following Omicron’s emergence, however, the stock market has largely rebounded.

Given the many remaining questions surrounding Omicron, including existing vaccines’ ability to effectively protect against the strain, as well as the severity of infection, further economic impacts may certainly come to fruition. As details continue to fill in, however, it is a fitting time to carefully consider some of the myriad market impacts already ushered in by the COVID-19 pandemic.

One of these market impacts has been the meteoric rise in retail investing, fueled by app-based securities trading platforms like Robinhood and Stash, aimed for use by the average main street investor. These platforms empower retail investors to participate in the stock market by facilitating trades on fractions of shares, all from the convenience of a smart phone. The use of these apps also facilitated the “meme stock” frenzy, wherein retail investors gathered over social media and stoked intense interest in stocks like GameStop and AMC – sending their share prices flying.

While these app-based platforms have empowered more investors than ever to enter the market, they’ve also posed potential financial pitfalls along the way. One such pitfall involves margin investing, wherein investors may supercharge their potential gains in the market by investing not only their own money, but also money they’ve borrowed. While the rewards of margin investing may be great, the risks are potentially even greater. [3]

Specifically, investor’s trading with margin are subjected to a minimum balance in their accounts. If their balance falls below this minimum – as can very well happen during a sudden market downturn or sell-off like the one effectuated by the news of Omicron in late November – the investor may be subjected to a margin call. When a margin call is issued, the investor is required to deposit additional money into their account in order to meet their required minimum balance.

Furthermore, many equate excessive levels of margin investing with “euphoric” behavior in the market – which can often be a sign of a serious impending market downturn. [3] As of now, the market does not appear to have reached dangerous levels of such market euphoria. [3] But as inflation continues to rise and COVID-19 continues to impact our lives in new ways, investors should exercise caution, as always, when making decisions about margin investing.

Sources:

[1] https://www.wsj.com/articles/central-banks-worry-omicron-could-sustain-inflation-11639909805

[2] https://www.wsj.com/articles/global-stock-markets-dow-update-11-26-2021-11637901748?mod=article_inline

[3] https://www.wsj.com/articles/black-friday-rout-shows-dangers-of-margin-borrowing-11638100800

By way of a brief overview, in January 2021 a group of about 100 stocks experienced monumental price and trading volume fluctuations. These stocks, many of which were consumer-centered companies with high brand awareness, gained rapid attention over social media platforms like Reddit and YouTube.

While the SEC’s report addresses the events and impacts of the meme stock phenomenon broadly, it focuses the bulk of its analysis around GameStop Corp (“GME”), arguably the most famous of the meme stocks.

The report notes that five factors – large price moves, large volume changes, large short interest, frequent Reddit mentions, and significant mainstream media coverage – all converged around GME in late January 2021.

In 2020, GME’s stock price swung substantially, starting the year at around $6 per share before falling to $3 in April and then rebounding to reach about $20 per share by the end of the year. [1]

Then, when Ryan Cohen, the co-founder of the popular pet-focused e-commerce company, Chewy, Inc., announced he would be joining GameStop’s board of directors on January 11, 2021, the stock took off. While GME traded at $20.65 per share that day, its rose to a high of $347.51 per share by January 27^th. Along with these price increases came similar increases in volume. Trading volume from January 23-29 averaged 100 million shares trader per day, more than 1,400% higher than average daily trade volume during 2020. [1]

As this market volatility unfolded, perspectives on its driving force into two main camps – those who touted GME as a prudent, even undervalued, investment because of its potential to break into the e-commerce market, and those who felt short interest was fueling the moves. [1] As social media users focused their attention on short interest from large institutional investors like hedge funds, a “short squeeze” on GME was triggered. The Reddit retail investors viewed themselves as fueling GME’s price increases, forcing hedge funds to close out their short positions at significant losses.

However, as GME and other meme stocks skyrocketed, some app-based trading platforms popular among retail investors placed temporary restrictions on trading in these stocks. The platforms cited various reasons for these restrictions, including margin calls from clearing agencies to cover increased risk. Conversely, retail investors believed that the restrictions were put in place in response to pressure from hedge funds with short positions at risk of losing money – claims that made their way to a Congressional hearing in February.

The SEC’s report ultimately provides a few important takeaways for the investing public. First, the report notes that it was “positive sentiment” about GME – whether a legitimate belief in GME’s fundamentals or a desire to profit from a rise in price – that fueled the sustained appreciation of GME’s stock price, not short-sellers who were “buying-to-cover.” [1] In fact, the report quite succinctly noted that “[s]taff believes that hedge funds broadly were not significantly affected” by the run on GME. [1]

Furthermore, the report also briefly touched on the rationale behind trading restrictions enacted by broker-dealers like Robinhood, noting that it had found evidence that clearing agencies had indeed demanded to be paid billions in additional margin by their member firms to account for volatility risks. [2]

The report concluded with four areas targeted for further study and consideration, noted as the following:

1. Forces that may cause a brokerage to restrict trading
2. Digital engagement practices and payment for order flow
3. Trading in dark pools and through wholesalers
4. Short selling and market dynamics. [1]

Each of these areas falls squarely within the ambit of SEC Chairman Gary Gensler’s already stated policy goals, inherent in his aim of promoting a more “fair, orderly, and efficient” market in the United States. [3] While the report did not outline specific improvements to be made, it serves as an important starting point for potential policy changes for protecting retail investor interests moving forward.

Sources:

[1] https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf

[2] https://www.latimes.com/business/technology/story/2021-10-18/sec-gamestop-report-debunks-conspiracies-backs-commission-chiefs-plan

[3] https://www.barrons.com/articles/sec-report-changes-what-we-know-about-januarys-gamestop-frenzy-51634590024

The SEC’s order concerns a period of time from 2016 through 2019, during which the SEC alleged that respondents made material misrepresentations and omissions about their oil and gas securities offerings. [1] The order states that neither Powell nor Toth were registered nor even associated with a registered broker-dealer during the relevant time period as they sold unregistered securities to investors. [2]

RCP is described as a private equity firm that “gives smart investors access to beyond-Wall Street assets, such as oil and gas wells” by creating, and then offering, oil and gas debt and equity investment vehicles for oil and gas wells. [2] In so doing, RCP relies on Homebound to identify and purchase these oil and gas wells. [2] During the relevant time period, Thomas Powell owned RCP while Stefan Toth owned and managed Homebound. [2]

Some of the several material misrepresentations and omissions highlighted in the SEC’s order include:

• Circulating offerings materials which falsely stated that respondent’s oil and gas securities were sold by FINRA-member broker-dealers who were registered with the SEC.
• Publishing “one-pager” documents for investors that contained “insufficiently supported oil well production projections.” These projections did not vary by region and projected that three separate wells would produce 510 barrels/day while actual production at these wells landed at only 3-5 barrels/day.
• Failing to take reasonable steps to ensure that investors were accredited, resulting in the sale of unregistered securities to approximately 200 non-accredited investors
• Misleading retirement account investors by advertising the potential tax benefits of oil & gas investments without stating that these benefits were not available to retirement account investors. [2]

Although Powell and Toth neither admitted to nor denied the charges, they have each agreed to pay a civil penalty of $75,000. Homebound and RCP have each agreed to pay a civil penalty of $225,000. The respondents also face several other consequences as part of the settlement, including a two-year prohibition on participating in any unregistered oil and gas related offerings, and a requirement that the SEC’s order be linked on all of their websites for the next three years.

Respondents must also hire an “Independent Compliance Consultant” at their own expense to review their policies and procedures as they relate to federal securities law, as well as to certify that respondents are indeed in compliance with said policies and procedures prior to any offering of securities. [2]

These punitive measures are designed with investor protection and the public interest in mind, as the SEC aims to reduce the instance of similar violations not only by respondents, but also by other equity firms and broker-dealers in the United States. The order also serves as an important reminder for investors to partner closely with trusted professionals in making informed investment decisions, especially in a volatile market like oil and gas.

Sources: [1] https://www.sec.gov/news/press-release/2021-193?utm_medium=email&utm_source=govdelivery [2] https://www.sec.gov/litigation/admin/2021/33-10987.pdf

The complaint alleges that Garcia has been operating a Ponzi scheme in which she has taken upwards of $70 million from over 2,000 investors under the guise that the investments funded Merchant Cash Advances (MCAs) for small businesses in need. Instead, the complaint alleges, the investments are being used in a “classic Ponzi scheme fashion” not to fund MCAs, but to pay the “returns” of investors before them. [2]

While MJ Taxes has been in existence since 2016, MJ Capital Funding was formed in June 2020, after the COVID-19 pandemic had already taken hold. From June until October 2020, MJ Taxes solicited six-month investments which typically promised a 10% monthly return, extrapolated out to substantial 120% annual returns. MJ Capital took over in October 2020, continuing to advertise as a source for MCAs while promising investors large and consistent returns.

MCAs provide small businesses who may not otherwise be able to obtain loans with quick access to needed funds. The MCA provides a set amount of money to the small business in exchange for a percentage of their daily income over a stipulated period of time. Considering the difficulties posed by the COVID-19 pandemic on small businesses, MJ Capital’s investors may well have represented a sympathetic group, hoping to offer a hand to small businesses in need while benefiting from exorbitant returns for themselves.

The SEC’s complaint alleges that MJ Capital has funded only a minimal number of MCAs since June 2020, instead using its investors money to both pay off existing investors and to pay for marketing and sales agents which advertise the company’s purported operations.

Situations like this one pose a unique danger to retail investors, one that the SEC is well aware of and has pledged to diligently investigate. While the SEC was granted emergency relief following the filing of their complaint, they are also seeking permanent injunctions and a civil penalty from the defendants, among other forms of relief. The complaint alleges eight federal counts against the defendants – five violations of the Securities Act and three violations of the Exchange Act. [1]

Florida has long been a hotspot for Ponzi schemes, and its important for all interested investors to keep a careful eye on how their hard-earned money is being invested. To protect yourself from potential Ponzi schemes, there are a few factors to be aware of. Typically, when an investment sounds too good to be true, i.e. offering very high and consistent returns, it likely is too good to be true. Be wary of such investment offers and consider soliciting advice from a trusted and unbiased professional.

It is also important to be on the lookout for investment opportunities that promise to make a lot of money without properly explaining how that money will be made. These situations may be another red flag of a potential Ponzi scheme and warrant careful consultation with your trusted advisor or attorney.

If you have any questions or think your investments may have been impacted by a Ponzi scheme, our attorneys are here to advise. Please reach out for a consultation.

Sources:

[1] https://www.sec.gov/litigation/complaints/2021/comp-pr2021-151.pdf

[2] https://www.sec.gov/news/press-release/2021-151

Robert Jackson, a professor at NYU School of Law and former SEC Commissioner, and John Morley, a Yale Law School professor, recently filed three suits against high-profiles SPACs in New York federal court. The suits argue that each SPAC is operating as an unregistered investment company, and under the Investment Company Act of 1940 (the “Act”), compensation paid to the SPAC’s sponsors and directors was illegal and void under the Act. However, in the decades-long history of SPACs, these entities have never been classified as investment companies under the Act, nor has the SEC purported that they should.

At the center of this debate lie two secondary, though potentially even more important, questions: what is a SPAC, and what is a SPAC’s primary purpose? The answer to these questions determines whether SPACs should indeed be classified as investment companies under the Act, as Jackson and Morley contend, or whether SPACs may continue to operate independently of the Act, as the SPAC industry and a wide coalition of law firms believe.

A SPAC is a type of blank check company which operates with the aim of finding an existing company to merge with, thus taking that company public. Typically, a SPAC is founded by an institutional investor, or group of institutional investors, who raise capital to go public via a SPAC IPO. The SPAC’s sponsors typically must then find a company with which to merge within 18 to 24 months. While SPAC sponsors search for a merger target, investors’ dollars are typically placed in trust accounts which hold various securities. [1]

Because SPACs have no sales or operations of their own, investors face a considerable degree of risk when they choose to invest in a SPAC before a merger occurs. At the same time, the merging company reaps the benefit of bypassing rigorous and time-consuming financial disclosures which the traditional IPO process entails. Once a merger occurs, the company has automatically gone public.

Under the Investment Company Act of 1940, “an investment company that is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, o trading in securities.” [2] Jackson and Morley argue that because SPACs invest the proceeds from their IPOs in trust accounts while they search for a target to merge with, most SPACs are just this – entities who engage primarily in investing in securities.

SPAC industry players, including the group of over 60 large law firms in the United States, contest this view. The law firms quickly signed onto a statement which refutes the factual and legal basis of the lawsuits, arguing that the primary business of a SPAC is that of identifying and acquiring a company within a specific period of time. [2]

Their argument centers on a plain text analysis of the Act’s language, and states that so long as a SPAC engages in its primary business of acquiring a company, their short-term investments in their trust accounts do not make them an investment company under the Act. [2]

While this public refutation from some of the country’s leading law firms is noteworthy, its impact on the three lawsuits filed is attenuated. It is also important to note that some of these firms represent and receive earnings from SPAC dealings themselves. [1]

The outcome of each of these anti-SPAC cases will be interesting to track, particularly considering their potential impacts on the SPAC industry. One expert maintains that if a court were to determine that SPACs are investment companies subject to the Act, the decision would “wreak havoc in the industry, forcing sponsors to restructure their compensation and find new ways to safeguard investors’ capital.” [3] As these cases progress, please reach out to our attorneys with any questions you might have.

[1] https://www.reuters.com/legal/litigation/49-firms-72-hours-how-spac-bar-united-against-law-profs-splashy-lawsuits-2021-08-30/\

[2] https://www.jdsupra.com/legalnews/over-55-of-the-nation-s-leading-law-4944524/

[3] https://www.reuters.com/legal/litigation/49-firms-72-hours-how-spac-bar-united-against-law-profs-splashy-lawsuits-2021-08-30/

At the heart of the civil and criminal complaints against Nikola are allegations that as its CEO, Trevor Milton, regularly spread false and misleading information about the progress of Nikola’s EV products and technologies. Nikola’s focus is on manufacturing low- and zero-emissions trucks, and the complaints allege in part that under Milton, Nikola published a promotional video of a prototype truck which did not actually work, but appeared to only because the truck was set in neutral and rolled down a hill. [1]

Promotional videos like that one, along with Milton’s enthusiastic social media posts and numerous podcast and television appearances, all painted a picture of exciting and impressive forward progress at Nikola, which Federal prosecutors and SEC regulators allege was nothing more than an illusion. [2]

This illusion allegedly created by Milton came at a steep cost – and was seemingly targeted retail investors in particular. Nikola went public via a Special Purpose Acquisition Company (“SPAC”) in June 2020, and once it began trading publicly, the value of its shares increased by $7 billion. However, Nikola’s value dropped steeply once the public learned of ongoing federal investigations into the company and its operations, leading to huge losses borne by retail investors who had been misled. [1]

Of course, EV companies and their executives are in a unique position given the bounding public interest in, and relative infancy of, the EV market. When attempting to evaluate a new or existing EV company, projections into the future must be made, and no fool-proof roadmap for this technology currently exists.

However, these uncertainties pose a particularly risky situation for prospective retail investors who can be easily misled by companies making false claims about their highly complex products or technologies – especially when, as here, these claims are being shared rapidly over social media.

Here, Nikola’s non-traditional IPO process put unsuspecting retail investors at even greater risk. When a company goes public via a SPAC, the traditional “quiet period” after a company is publicly listed is not required. This allowed Milton to continue amplifying false claims about Nikola on social media just after going public, thereby attracting additional retail investors, and driving the stock price up further. [3]

In pursuing these securities fraud charges against Nikola, the SEC continues to signal its sharp focus on SPAC regulation in the interest of protecting investors. As we all navigate the rapid influx of SPACs along with the continued push for broad adoption of EVs, retail investors should continue to carefully research prospective investments by identifying concrete achievements such as milestones hit and actual sales or delivery figures to date, while steering clear of “bandwagon effect” investing. These careful considerations, along with continued scrutiny by regulators, are some of the best ways to protect your assets in the market.

Sources:

[1] https://www.marketwatch.com/story/nikola-electric-truck-prototypes-were-powered-by-hidden-wall-sockets-towed-into-position-and-rolled-down-hills-prosecutors-say-11627572394

[2] https://www.sec.gov/news/press-release/2021-141

[3] https://www.nytimes.com/2021/07/29/business/nikola-trevor-milton-fraud.html

The PRI is an independent network of investors who promote responsible and sustainable investing by incorporating ESG factors and considerations into their investment decisions. Although the PRI is not a part of the UN itself, the UN supports and partners with the group. In 2006, when the PRI was formed, it managed about $7 Trillion in assets, and in 2020, it managed over $100 Trillion. [1]

So why should you as an investor care about ESG investing? ESG factors and criteria empower investors to make “socially responsible” and sustainable investment decisions by providing important insight into a company’s operations, standard practices, and culture through the lens of Environmental, Social, and Governance considerations.

For example, a company might disclose Environmental factors such as their carbon emissions or water usage, aimed at conserving our natural world. Social factors place an emphasis on how a company treats both its employees and the public and include employee diversity statistics or human rights considerations. Finally, Governance factors focus on the way in which the company is led and include information like executive pay scales as well as political leanings. [2]

When an investor is equipped with meaningful – and truthful – ESG information, they can be confident in their monetary support of a company. As a result, ESG investing continues to be top of mind for investors and regulators in the United States. However, investor interest is not the only factor influencing ESG popularity. Sound ESG investing also yields relatively high returns when compared to conventional funds while providing relatively lower risk, according to a study by Morgan Stanley in 2019. [2]

While many companies voluntarily disclose ESG data, there is currently a gap in investor knowledge, as many ESG disclosures are not yet compulsory. One particular area in which this is true is with regard to climate change disclosures – which the SEC published guidance on in 2010 but have not been adjusted since then.

At Wednesday’s PRI event, Commissioner Gensler focused in on the value and importance of climate change disclosures and provided a glimpse into the future of SEC regulation of the topic. In particular, Gensler emphasized that these disclosures must be “decision useful,” meaning that they include sufficient factual information to allow proper decision-making to take place.

Gensler also highlighted the intense interest modern investors have in the climate risks associated with stocks they purchase, likening the investor push for climate risk disclosure today to the push for disclosure of basic financial information decades ago. In response to this investor interest, Gensler announced that he has tasked his staff with developing a proposal for mandatory climate risk disclosures for review by the end of 2021. [3]

The transition from the SEC’s current climate risk guidance to mandatory SEC climate risk disclosures is monumental, and it will allow investors to compare “apples to apples” when analyzing climate risk data between companies.

Furthermore, Commissioner Gensler spoke about the possibility of requiring disclosure of carbon emissions data not only for the company itself, but for each member of the company’s value chain. Granular data like this will provide investors with a truly actionable and “decision useful” basis for making investment decisions by providing not just a piece of the puzzle, but instead the full picture of a company’s true impact on the environment.

As we enter the back half of 2021, investors should be on the lookout for additional remarks by Commissioner Gensler relating to climate risks and ESG disclosures. While we have only a blueprint now, support and demonstrated investor interest in ESG factors will encourage the SEC to continue its pursuit of meaningful regulation to benefit investors like you.

Sources:

[1] https://www.unpri.org/pri/about-the-pri

[2] https://www.nerdwallet.com/article/investing/esg-investing

[3] https://www.sec.gov/news/speech/gensler-pri-2021-07-28

Margin debt can be simply understood as debt taken on by an investor in order to extend their buying, and earning, power in the market. In essence, an investor borrows money to increase their initial investment and, hopefully, to supercharge their eventual profit.

For example, an investor might borrow $10,000 from their broker on margin in order to increase their initial investment from $20,000 to $30,000. If the shares they’ve purchased increase by 10%, the investor stands to make 50% more than they would have with only their own $20k.

Of course, taking on margin debt is also highly risky. When an investor’s balance falls below the minimum amount required by the broker, they may face a margin call. This margin call requires the investor to deposit more money or securities to maintain the broker’s minimum required value within the account.

Trading on margin is an attractive option when investors feel optimistic about the future of the security they’re investing in, or the overall market. However, this practice may have detrimental, rippling impacts within the market. Because borrowing on margin adds additional investment money into a particular stock or stocks, high levels of margin may actually begin to create a bubble. [2]

Excessive margin debt can be symptomatic of these speculative market bubbles, and eventual bursts, because it may signal overexuberant investor behavior, behavior that is not fully based in fact. As a result, several experts agree that exceedingly high levels of margin debt may signal an impending market drop.

In fact, sky-rocketing levels of margin debt have preceded both of this century’s extended economic downturns. Just before the dot-com bubble burst in 2000, margin debt was up more than 80%, and before the great recession in 2008, margin debt had risen by over 60%. [3] For context, margin debt is currently up more than 50% since this time last year and has risen 10.5% to date in 2021.

While high levels of margin debt are but one indicator of a potential market downturn, they are a critically important one to watch. In 2000 and in 2007, the S&P hit its own peak just a few months after margin debt peaked. Similarly, once margin debt hit its lowest point in 2009 following the recession, the S&P hit bottom just one month later. [4] The takeaway: the cyclical and relational nature of margin debt and overall market performance is not to be ignored.

The popularity of trading on margin has exploded, particularly in light of the newfound ease of doing so through popular app-based platforms like Robinhood. However, it is important for investors to keep in mind the broader market implications that an abundance of such trading may have, potentially in the near future.

Sources: [1] https://www.finra.org/investors/learn-to-invest/advanced-investing/margin-statistics [2] https://www.gobankingrates.com/money/economy/signs-of-market-bubble-crash-what-to-expect/ [3] https://www.fool.com/investing/2021/06/12/whos-ready-stock-market-crash-5-reasons-big-drop/ [4] https://www.advisorperspectives.com/dshort/updates/2021/07/20/margin-debt-and-the-market-up-2-4-in-june-continues-record-trend

FINRA noted three major violations from its investigation into Robinhood’s conduct and operations as a stock-trading app, each of which merited its own penalties.

First, FINRA found that Robinhood has pervasively and negligently provided false or misleading information to its customers. [1] This false information was circulated in spite of Robinhood’s core mission to “de-mystify finance for all” and “democratize finance,” and ranged from misrepresenting customer account balances and buying power, to erroneous communication about customers facing margin calls. [2]

As a result of Robinhood’s misrepresentations, FINRA is requiring the firm to pay over $7 Million in restitution to customers who suffered related losses. [1]

Second, FINRA found that Robinhood did not exercise proper due diligence in its options trading offerings. [1] Given the financially risky character of options trading, Robinhood improperly outsourced an algorithm powered by artificial intelligence to determine customer options trading eligibility. The technology was riddled with inconsistencies, causing eligibility decisions to be made based upon incorrect customer information, and allowing ineligible customers to engage in options trading. [1]

Finally, FINRA also uncovered issues with Robinhood’s technological supervision of its core business tenets. For example, Robinhood experienced a widespread outage of its platform in early March 2020, during which operations halted. Robinhood customers were unable to access their accounts for a period of two days, during which market volatility was incredibly high. This outage, which was only one of many similar situations, resulted in approximately $5 Million in customer losses, which Robinhood has now been ordered to pay in restitution. [1]

Beyond these three severe offenses, FINRA also found that Robinhood has violated several other rules as a brokerage firm in recent years. Robinhood has failed to report failures and customer complaints which are required by FINRA, and has also failed to show customers complete market data as they make sensitive decisions about securities trading.

Robinhood, for its part, responded to the charges by stating that they are actively improving their educational resources, customer support capabilities, and legal and compliance teams. [2] They are “glad to put his matter behind [them]” with a renewed focus on the continued democratization of finance for all. [2]

FINRA’s message through these sanctions is clear – violate brokerage industry rules, pay the price. Its Head of Enforcement, Jessica Hopper, added that “all FINRA member firms, regardless of their size or business model, must comply with the rules that govern the brokerage industry . . . to protect investors and the integrity of our markets.” [1][2]

Given Robinhood’s exploding popularity among retail investors, particularly during the pandemic, this settlement should be a reassuring sign to investors that FINRA is taking its duty to protect their interests seriously. On the same token, customers of platforms like Robinhood should remain diligent in their financial decisions and report any potential issues for assessment by either the firm or by FINRA itself.

Sources: [1] https://www.finra.org/media-center/newsreleases/2021/finra-orders-record-financial-penalties-against-robinhood-financial [2] https://www.cbsnews.com/news/robinhood-finra-70-million-fine/

There are some situations in which FINRA arbitration is required, such as when a written agreement between the parties mandates it. In order to be eligible for FINRA arbitration, an investor must be seeking to file a claim stemming from the business activities of their broker or brokerage firm, and the event in question must have taken place within the last six years (in most states). [1]

Generally, FINRA arbitration allows an investor to seek either monetary or securities damages resulting from the business activities of their broker or brokerage firm. To get the filing process started, an investor must submit a Statement of Claim, a FINRA Submission Agreement, and related filing fees, all of which are available to view on FINRA’s website. [2]

The format and related fees for the arbitration itself vary based on the amount of money in controversy. When the amount in controversy is below $10,000, a hearing session will be conducted with just one arbitrator, and the session fee will be between $50 and $450. If the amount in controversy is above $10,000, a panel of three arbitrators may be used instead, and the hearing session fee will range from a minimum of $600 to a maximum of $1,575. [3]

Once FINRA receives all of the initial required documents, they analyze the claim and determine whether a one- or three-person arbitration panel will be used. A case number is created, and FINRA will notify the respondent – the party the investor has filed their claim against – about the case. So long as the respondent is registered with FINRA, they will be required to arbitrate.

The respondent then has 45 days to research the claim lodged against them and to respond. FINRA analyzes the response along with any counter claims or cross claims.

Next, the parties choose their arbitrators from a randomly generated list of names supplied by FINRA. FINRA arbitrators are not FINRA employees, instead they are contractors who are evaluated by FINRA on the basis of their employment, professional licenses, and education. They are chosen from diverse backgrounds and must take an oath to remain neutral and decide cases solely on the facts and meris.

Once arbitrators are chosen and agreed upon by both parties, there will be an initial pre-hearing conference, where investors are typically represented by an attorney. The arbitration hearing is scheduled, and discovery begins.

Discovery allows both parties to exchange documents and identify witnesses and is governed by rules within FINRA’s Discovery Guide. After discovery is completed, the arbitration hearing takes place.

The arbitration hearing takes place around a conference table, with arbitrators at the head of the table and the parties on each side. The claimant presents their side of the case first, complete with an opening statement, witnesses, and evidence, and is followed by the respondent. Objections are permitted, and the arbitrators determine whether or not they will accept evidence.

At the completion of the hearing, the arbitrator(s) will deliberate, and render their award, typically within 30 days. The award is legally binding on both parties, and FINRA offers no internal appeals process. While a party may choose to appeal an arbitration award in court, it should be noted that judges rarely overturn these awards.

From start to finish, FINRA arbitration cases that don’t settle before their hearing take approximately 16 months. The process allows for a streamlined and more private alternative to litigation in the courtroom, as FINRA arbitration documents are not made public like court documents. We invite you to contact us for details and support on your potential FINRA arbitration claim.

Sources: [1] https://www.finra.org/arbitration-mediation/arbitration-overview] [2] https://www.finra.org/sites/default/files/Education/p117486.pdf [3] https://www.finra.org/rules-guidance/rulebooks/finra-rules/12902]

Let’s consider an example of margin investing with Robinhood. An investor deposits $5,000 cash into a margin account, and Robinhood lends another $5,000 to allow the investor $10,000 worth of securities. The “margin” is the difference between the value of the securities and the loan from Robinhood. This type of investing increases both purchasing power and financial leverage. [1]

If the securities in the margin account increase in value, the investor has the opportunity for a higher profit than they would have had they invested $10,000 of their own.

On the other hand, if the securities decrease in value, the margin investor is at risk of losing more than they would have had they invested $10,000 of their own.

One of the most significant risks of margin investing stems from margin calls. Because securities purchased on margin are used as collateral against the loan Robinhood extends, Robinhood sets “margin maintenance requirements” on each margin account. These requirements are minimum portfolio values that must be maintained by the investor, and they help Robinhood protect the money they’ve loaned. [2]

So, if the market is volatile, as it has been recently, and the value of securities in a margin account falls too far, Robinhood will issue a margin call. The investor must then either deposit additional cash into their account to meet the margin maintenance requirement or close out their position(s).

However, per Robinhood’s Margin Account Agreement and Margin Disclosure Statement, when Robinhood issues a margin call, they also have the right to sell the account holder’s securities without notice nor consultation. [3],[4]

The language of the agreement specifically states that Robinhood is authorized to liquidate or sell the securities in a margin account to cover any margin deficiency, and that they are not required to notify the account holder before making such a sale. The agreement also stipulates that Robinhood has the sole authority to choose which securities are sold in order to satisfy a margin call, and that Robinhood’s margin maintenance requirements are subject to increase at any time, with no advanced written notice required. [3],[4]

Based on this agreement, which all Robinhood margin investors are required to sign, Robinhood has quite a bit of power over margin accounts. Understood in context, however, these stipulations are designed not to put the investor at risk, but instead to allow Robinhood to protect the money they’ve loaned to investors via immediate liquidation and/or covering losses by requiring additional cash deposits. [3],[4]

Margin investors should also be aware that Robinhood’s margin account agreement explicitly states that any disputes must be resolved via arbitration, so neither party to the agreement may sue one another in court. If a dispute arises, an arbitration case would be filed with the Financial Industry Regulatory Authority (FINRA) in order to reach a resolution or settlement. [3],[4] FINRA arbitration is designed to create a fair and expedited alternative to a traditional court case, but it’s important to understand the arbitration process before deciding to make the leap into margin investing.

So, depending on your risk tolerance, margin trading may or may not be an investment tool you want to use in your accounts.

In our next post, we’ll be sharing a start-to-finish overview of what you can expect from the FINRA arbitration process, particularly as it pertains to margin investing.

Sources: [1] https://www.investopedia.com/ask/answers/041315/why-purchasing-stocks-margin-considered-more-risky-traditional-investing.asp [2] https://robinhood.com/us/en/support/articles/margin-overview/ [3]https://cdn.robinhood.com/assets/robinhood/legal/RHS%20Customer%20Margin%20and%20Short%20Account%20Agreement.pdf [4]https://cdn.robinhood.com/assets/robinhood/legal/RHS%20Margin%20Disclosure%20Statement.pdf

Starting with the basics, what is a non-fungible token?

An NFT is a type of digital, cryptographic asset which exists on blockchain. Fungibility refers to interchangeability – assets like dollars, gold, and even Bitcoin, are fungible, because each unit is worth the exact same amount, and is thus readily interchangeable. On the other hand, each unit of a non-fungible asset has its own unique value and thus is not readily interchangeable – think of assets like property, artwork, and other collectibles. [1]

NFTs derive their value from their uniqueness. Each NFT has its own identification codes and related data within the blockchain to distinguish itself. It is impossible to replicate an NFT, which helps to create rarity among NFTs akin to that of traditional and tangible collectibles.

While there are several possible use cases for NFTs, the market is currently largely focused on collectibles. In particular, the popularity of digital artwork NFTs has skyrocketed in 2021. Artists are excited about this new market, as NFTs eliminate the need for intermediaries like art brokers, thereby increasing market efficiency. Artists can now post their artwork on digital marketplaces like OpenSea where anyone in the world can browse and purchase using blockchain-based cryptocurrencies, like Ethereum. [2]

But when you buy an NFT, what do you actually get? In the case of digital collectible NFTs, you are getting not only the digital piece of art, but also the NFT’s unique code and data on the blockchain. The value of the NFT comes from its unique identifiers. You are not, however, getting any intellectual property rights to the piece of art – those still belong to the artist.

Instead, much like physical pieces of art or baseball cards, you are paying to own an “original” or collectible item. For example, when Jack Dorsey sold an NFT of his first tweet, the buyer received a unique token on the blockchain that cannot be replicated. But that does nothing to change the fact that anyone with internet access can look at the tweet, screen shot it, or save a picture of the tweet on their phone.

The concept may seem nebulous to some, but its not so different from physical collectibles. It’s widely accepted that certain early edition baseball cards have inherent value to collectors. If someone were to simply take a picture of one of these collectible cards, that would do nothing to decrease the value of the original card, and similarly, would not suddenly give value to the picture someone took of it.

Of course, rarity alone does not necessarily equate to value – actual interest within the market participants of owning the NFTs is also essential. But it is yet to be seen whether this is what makes NFTs such an interesting and risky investment opportunity.

Many people are currently buying NFTs speculatively, not to own them long-term, but rather with the aim of selling them at a profit sometime in the future. While some NFT purchasers have already made huge sums of money in this way, it remains to be seen whether the current NFT craze will endure, or whether this is a passing fad brought on by the uncertain and unprecedented circumstances we’re all currently under.

In sum, NFTs present an equally intriguing and risky investment opportunity. If you are interested in the market, you should approach the decision to invest with extra care as the NFT market continues to develop and additional use cases and capabilities are explored.

Sources: [1] https://www.investopedia.com/non-fungible-tokens-nft-5115211 [2] https://www.nytimes.com/2021/03/11/arts/design/nft-auction-christies-beeple.html

As defined by SEC Commissioner Allison Lee during her keynote speech at the PLI’s Annual Institute on Securities Regulation in November 2020, a systemic risk is “characterized by the following features: (1) ‘shock amplification’ or the notion that a given shock to the financial system may be magnified by certain forces and propagate widely throughout; (2) that propagation causes an impairment to all or major parts of the financial system; and (3) that impairment in turn causes spillover affects to the real economy.” [1]

Put more simply, a systemic risk is one with the potential to result in the downturn, or even collapse, of an entire market system. The ongoing COVID-19 pandemic is one recent example of such a risk, as we continue to see its economic impacts across every sector of the market. During her speech, Lee noted that although the SEC is not in a position to regulate and slow the actual drivers of climate change, it can – and should – address climate risks through standardization of the environmental, social, and governance (ESG) disclosures that financial institutions make.

The SEC’s interest in managing climate risk seems to be gaining momentum, as John Coates, the SEC’s acting Director of the Division of Corporation Finance, recently echoed Lee’s sentiments by recommending that the SEC take a leadership role in creating a standardized disclosure system for ESGs. [2] Coates commented that ESG disclosures are becoming “less voluntary” than they historically have been, as investor interest in this information has risen significantly. Investors are beginning to expect sustainability reports, and in turn, some form of standardization by the SEC will help protect and inform investors moving forward.

From an outside perspective, a June 2020 report by Ceres, titled “Addressing Climate as a Systemic Risk: a call to action for U.S. financial regulators” offers additional insight into the economic impacts of climate change, along with recommended actions for a slew of financial institutions like the SEC. [3]

The report states that some of the most significant risks inherent in climate change include economic losses and health risks stemming from extreme weather events, as well as the ripple of economic impacts from the eventual transition toward a low or zero-carbon economy.

As seen from this week’s tragic winter storm in Texas, the economic impacts of severe weather events are staggering, and these events are only getting more extreme and more common. Experts are expecting insurance claims from the storm to top $19 billion, the previous record for Texas’ most expensive storm set by Hurricane Harvey in 2017. [4] Not to mention the extensive costs borne by disrupted supply chains, among other market sectors.

Further, as our economy necessarily transitions toward net-zero carbon in order to reduce greenhouse gases that accelerate climate change, there is the potential for widespread disruption of critical industries like transportation and energy. When these multi-trillion-dollar industries suffer, the entire market does too.

While regulatory bodies like the SEC may not lead the charge in slowing climate change itself, they have the unique opportunity to prepare and stabilize the market as climate risks loom. Their recent prioritization of formalized ESG disclosures is a promising sign, but only time will tell whether measures like these will effectively protect the market from the extreme risks posed by climate change.

Sources:

[1] https://www.sec.gov/news/speech/lee-playing-long-game-110520

[2] https://www.reuters.com/article/us-climate-change-disclosures/secs-coates-says-agency-should-help-create-esg-disclosure-system-idUSKBN2AI2CG

[3] https://www.ceres.org/sites/default/files/2020-05/Financial%20Regulator%20Executive%20Summary%20FINAL.pdf

[4] https://www.dallasnews.com/business/2021/02/18/this-years-winter-storm-could-become-the-costliest-weather-event-in-texas-history/

The first cryptocurrency, Bitcoin, was introduced in 2009, and it has since been joined by over 1,900 competitors. Cryptocurrencies operate in a decentralized, purely digital block-chain network. Within the network, a supply cap on “coins” exists, and coin production is left in the hands of collective members of the system through a process known as “mining.” In Bitcoin’s case, there can only ever be 21 million coins mined, of which over 18 million have been mined thus far. Cryptocurrencies like Bitcoin derive their value largely from their limited supply, overall market demand, the cost to produce a bitcoin via mining, and competition from other cryptocurrencies.

Recently, Bitcoin’s price has been on the rise, stirring up a good deal of interest from prospective investors. As of February 6, 2021, one bitcoin is worth $39,255.90 –up about 300% year over year, and 34% year to date. But an investment in Bitcoin, or other cryptocurrencies like it, is unique in its risks. Experts caution that because cryptocurrency is a relatively new technology, and is not yet well understood by the public, prospective investors are at an increased risk of falling victim to fraudulent schemes.

From a regulatory standpoint, the SEC currently categorizes bitcoin as a security. However, bitcoin differs significantly from a traditional stock or bond because it does not represent shares of a corporation– it has no balance sheet, it is not impacted by government-imposed monetary policy or inflation rates, and its digital format makes it extremely difficult for regulators to access. As a result, cryptocurrencies like Bitcoin offer fraudsters a prime opportunity to engage in predatory behavior against investors.

This week, the US Department of Justice brought two recent cryptocurrency schemes to light. First, on February 1, 2021, a California man, John DeMarr, was charged with one count of conspiracy to commit securities fraud for soliciting investments in two companies he owned, which he misrepresented as highly profitable online cryptocurrency mining and trading platforms. DeMarr lured investors in with celebrity endorsements and fake press releases. But rather than investing his victims’ money in cryptocurrency technologies, DeMarr defrauded them of over $11 million, using the funds to furnish his lavish lifestyle instead.

On February 4, 2021, another cryptocurrency scheme unfolded as the 24-year-old founder of a cryptocurrency hedge fund pleaded guilty to one count of securities fraud. Stefan He Qin owned two cryptocurrency hedge funds which he told investors carried minimal risk because they were not impacted by volatile swings in cryptocurrency prices. Qin managed more than $90 million for his investors, which he used for personal expenses while providing his investors with falsified monthly investment performance reports.

These are just two instances of cryptocurrency fraud, but they are symptomatic of a growing trend in the cryptocurrency market. Eager investors looking to get involved in cryptocurrency and related technologies should exercise caution when making their investment decisions. The SEC has recently published an investor alert titled “Ponzi Schemes Using Virtual Currencies” which points out several red flags to be aware of, including investments touted as carrying little or no risk, unlicensed sellers, and investments requiring no minimum investor qualification.

While cryptocurrencies present an exciting investment opportunity for some, prospective investors should keep in mind their myriad risks, and regulators should continue to develop strategies for identifying and deterring fraudulent cryptocurrency schemes.