Securities Industry Commentator by Bill Singer Esq

August 21, 2018

File this one under a DOJ press release headline you don't see everyday (thankfully): Ohio Man Pleads Guilty, Sentenced For Ruckus At Peace Bridge Port Of Entry (DOJ Press Release) WARNING!!! In the United States District Court for the Western District of New York it is now a federal crime to create a "ruckus." And "no," I am not providing any details about this idiocy of a case because if the Department of Justice actually thinks that it's okay to publish a press release that asserts that there is some crime in the federal criminal code that prohibits ruckusing then I will invite my readers to click on the link and satisfy their curiosity as to just what the hell constitutes the time-honored jurisprudence of the crime of ruckus. I do not consider a "failure to obey a lawful order by a U.S. Customs and Border Protection officer" to be a  "ruckus."  Such a characterization makes light of what was, in fact, a more serious scenario as presented in the press release.
Without admitting or denying the findings, Merrill Lynch, Pierce, Fenner & Smith consented to an SEC Order, which finds that the firm was negligent in violating the antifraud and policies and procedures provisions of the Investment Advisers Act of 1940 when the firm failed to disclose a conflict of interest. Merrill agreed to pay over $4 million in disgorgement, $806,981 in prejudgment interest, and a more than $4 million penalty, and to be censured and to cease and desist from further violations..  READ the FULL TEXT SEC Order As explained in part in the SEC Order:

Merrill put new investments into these products on hold due to pending management changes at the third party, and Merrill's governance committee planned to vote on a recommendation to terminate the products and offer alternatives to investors. According to the order, the third-party manager sought to prevent termination and contacted senior Merrill executives, including making an appeal to consider the companies' broader business relationship. Following those communications, and in a break from ordinary practices, the governance committee did not vote and chose to defer action on termination. The governance committee later lifted the hold and opened the third-party products to new Merrill accounts. The SEC's order found that Merrill failed to disclose to its clients the conflicts of interest in Merrill's decision-making process. 

In the Matter of Interactive Brokers LLC, Respondent (AWC 2014042022401, August  17, 2018).
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Interactive Brokers LLC submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In accordance with the terms of the AWC, FINRA imposed upon Interactive Brokers LLC a Censure and $5.5 million fine. READ the FULL TEXT AWC.

As set forth in the "Summary" portion of the AWC:

The Securities and Exchange Commission adopted Regulation SHO to address concerns regarding persistent failures to deliver and potentially abusive "naked" short selling, e.g., the sale of securities that an investor does not own or has borrowed. Regulation SHO imposes certain requirements with respect to short sales of equity securities in order to promote market stability, preserve investor confidence, and increase short sale transparency, including Rule 201's short sale price test circuit breaker and Rule 204(a)'s close-out requirement. When the close-out requirement is not satisfied, Rule 204(b) -- the "penalty box" provision -- restricts short selling unless additional requirements are met. 

From July 2012 through June 2015 (the "Relevant Period"), Interactive failed to establish, maintain, and enforce a supervisory system, including written supervisory procedures, reasonably designed to achieve compliance with the requirements of Regulation SHO. Interactive also repeatedly ignored red flags - including internal audit findings and recommendations, multiple internal warnings from members of the Firm's clearing and compliance departments, and its own annual risk assessments - indicating to the Firm that its Regulation SHO supervisory systems and procedures were unreasonable. Even when the Firm learned of deficiencies in its systems, the Firm failed to act timely to remediate those issues, resulting in short selling activity that violated Rules 201 and 204 of Regulation SHO ("SEC Rule 201" and "SEC Rule 204"). 

For example, in 2011 and 2012, the Firm's Compliance Technology Department advised senior management that the Firm's systems should be amended to implement supervision for SEC Rule 201's short sale price restrictions. Similarly, in 2012, 2013 and 2014, the Firm's Clearing and Compliance Technology Departments observed and communicated that the Firm's systems failed to account for existing segregation deficits when determining whether the Firm needed to make additional borrows or purchases for purposes of SEC Rule 204(a). In 2013, the Firm's Compliance Technology Department noted to senior management that its systems had no automated procedures designed to enforce SEC Rule 204(b)'s penalty box provision. In 2014, Interactive's Internal Audit Department reported that the Firm had no systems or procedures specifically relating to SEC Rule 204(b) and (c), and no supervision over SEC Rule 201.

In 2014, the Internal Audit Department also advised senior management that the WSPs may not reflect the Firm's actual supervisory processes and controls for Regulation SHO. In fact, during the Relevant Period, Interactive's WSPs did not accurately reflect the supervisory reviews conducted by Firm personnel, or the tools used to conduct those reviews. The WSPs also did not specify when issues with the Firm's systems or open FTDs should be escalated for further review, or how and by whom those issues should be resolved. During the Relevant Period, the WSPs also contained no supervisory tasks, reviews or reports that tested the Firm's compliance with SEC Rule 204(b) and SEC Rule 204(c). 

Although the Firm was aware of these supervisory deficiencies, Interactive did not revise its supervisory systems and WSPs relating to SEC Rule 201 and SEC Rule 204 until the middle of 2015. As a result of its failure to establish and maintain reasonable supervisory systems and procedures, Interactive: (i) did not timely close-out FTDs on at least 2,329 occasions in violation of SEC Rule 204(a); (ii) routed and/or executed short sales in securities for which they had open FTDs approximately 28,000 times in violation of SEC Rule 204(b); and (iii) did not issue notice to clients placing short sale orders in a security with an existing open FTD that a pre-borrow was required, as required by SEC Rule 204(c). Additionally, the Firm permitted the execution or display of short sale orders of a security subject to a price restriction, at a price less than or equal to the current national best bid, on at least 4,709 occasions, in violation of SEC Rule 201. 

By virtue of the foregoing, during the Relevant Period, Interactive violated Rules 201, 204(a), 204(b) and 204(c) of Regulation SHO, NASD Rule 3010(a) and (b) (for conduct from July 1, 2012 through November 30, 2014), FINRA Rule 3110(a) and (b) (for conduct from December 1, 2014 through June 30, 2015) and FINRA Rule 2010. 

In re: Arctic Glacier International, Inc., et al. (Debtors in a Foreign Proceeding) (Opinion, United States Court of Appeals for the Third Circuit, 17-2522 / August 20, 2018)
In response to a Motion to Dismiss, 3Cir summarizes the appeal as follows:

Buying shares in a bankrupt company can be perilous business. Here, shareholders were on notice of Arctic Glacier's bankruptcy proceedings, were represented throughout those proceedings, and voted overwhelmingly to confirm the company's reorganization Plan. So their shares were subject to its benefits (its dividend-distribution scheme) as well as its burdens (its implementation particulars and releases of claims relating to the Plan). When appellants, the Brodskis, bought their shares from those shareholders, they stepped into their shoes. So the Brodskis bought shares subject to the Plan's terms, including the terms that governed post-confirmation acts taken to carry out the Plan. 

The Brodskis argue that the Plan's releases of liability do not apply to them because they are not transferees and because due process forbids releasing their claims. But the Plan came along with the shares, and the Brodskis were on notice. So we will hold them, like all buyers, to the terms of their bargain.

SEC Charges Unregistered Brokers Who Sold Woodbridge Securities to Main Street Investors (SEC Press Release 2018-157)
In a Complaint filed in the United States District Court for the Southern District of Florida, the SEC charged Barry M. Kornfeld, Ferne Kornfeld, Lynette M. Robbins, Andrew G. Costa, Albert D. Klager, Costa Financial Insurance Services, Corp., Atlantic Insurance & Financial Services, Inc., and Knowles Systems, Inc. for unlawfully selling securities of the now bankrupt Woodbridge Group of Companies LLC to retail investors.  Previously, the SEC had charged the Woodbridge Group, its owner, and others with operating a $1.2 billion Ponzi scheme. In the instant SEC Complaints, the defendants allegedly reaped millions of commission dollars on their sales of Woodbridge securities even though they were not registered as broker-dealers and were not permitted to sell securities. Allegedly, Barry Kornfeld also violated a prior SEC order which barred him from acting as a broker.  Robbins and her company, Knowles Systems Inc., agreed to settle the SEC's charges in a separate action without admitting or denying the allegations and return more than $1 million of allegedly ill-gotten gains plus interest; and she agreed to pay a $100,000 civil penalty and to an industry and penny-stock bar. READ the FULL TEXT: 
Kornfelds et al. Complaint 
Robbins Complaint
Without admitting or denying the allegations , Michael B. Rothenberg and his advisory firm Rothenberg Ventures LLC agreed to settle charges in an SEC Complaint filed in the United States District Court for the Northern District of California. In part, Rothenberg agreed to be barred from the brokerage and investment advisory business with a right to reapply after five years. The Complaint alleged that Rothenberg's funds had nearly 200 investors and more than $64 million in assets, and over a three-year period, Rothenberg and his firm misappropriated millions of dollars from the funds, including an estimated $7 million of excess fees, which Rothenberg used to support personal business ventures he claimed were self-funded and to pay for private parties and events at high-end resorts and sporting arenas.READ the FULL TEXT Complaint
In a Complaint filed in the United States District Court for the Northern District of Illinois, the SEC filed an emergency action against Jerome H. Cohen and Shaun D. Cohen and their companies, Equitybuild, Inc. and Equitybuild Finance, LLC, with violating the antifraud provisions of Section 17(a) of the Securities Act of 1933, and Section 10(b)(5) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and the registration provisions of Sections 5(a) and 5(c) of the Securities Act. The SEC's Complaint also seeks injunctions against future securities laws violations, disgorgement of the defendants' ill-gotten gains, and civil penalties. READ the FULL TEXT Complaint The SEC obtained a temporary restraining order enjoining the defendants from raising any additional funds from investors, and an order appointing a receiver to secure the real estate and other assets obtained with investor proceeds for the benefit of the defrauded investors. As set forth in the SEC Release:

[S]ince 2010, the defendants have sold promissory notes to at least 900 investors throughout the country. The defendants raised these funds by falsely promising safe investments fully secured by income-producing real estate. According to the SEC's complaint, the defendants took 15-30% of investors' funds as undisclosed fees, hiding the fees by reporting inflated acquisition costs. The complaint also alleges that, contrary to defendants' representations, the real estate did not earn enough to pay the double-digit returns promised to investors. As a result, the defendants could only pay earlier investors by raising funds from unwitting new investors.

According to the SEC's complaint, the defendants recently admitted in a video recording to earlier investors that the companies are in financial distress, can no longer afford to make payments to investors, and are cutting staff to a "skeleton crew." Despite these disclosures, the defendants have continued to solicit new investors for various real estate funds, again offering double-digit returns but failing to disclose the companies' dire financial condition.