Securities Industry Commentator by Bill Singer Esq

February 11, 2019

Regulation: A View from Inside the Machine by SEC  Commissioner Hester Peirce (Remarks at Protecting the Public While Fostering Innovation and Entrepreneurship: First Principles for Optimal Regulation / University of Missouri School of Law)
In the latest thought-piece from SEC Commissioner Peirce, we have some provocative musings about the often uneasy relationship between regulators and those they regulate. In her introductory comments, Commissioner Peirce posits that:

Entrepreneurship and innovation do not have the happiest of relationships with regulation. Regulators get used to dealing with the existing players in an industry, and those players tend to have teams of people dedicated to dealing with regulators. Entrepreneurs trying to start something new are often much more focused on that new thing than on how it fits into a regulator's dog-eared rulebook. Regulators, for their part, tend to be skeptical of change because its consequences are difficult to foresee and figuring out how it fits into existing regulatory frameworks is difficult.

Society, however, often pushes regulators to accept change. After all, society benefits from entrepreneurs' imaginative approaches to solving problems and willingness to go out on a limb with a new idea. Society welcomes innovations that make our lives easier, more enjoyable, and more productive. In many sectors, therefore, entrepreneurship and innovation evoke overwhelmingly positive responses.

In the financial industry, entrepreneurship and innovation do not always face such a warm reception. Financial innovations, for example, were fingered by some as the cause of the last financial crisis. . . .

Wall Street professionals and serious investors should set side time to read Peirce's speech. In arguing her case for more enlightened regulation, the Commissioner asks some questions that some may find unsettling but other would say are long overdue:

[C]an we, for example, look for ways for unaccredited investors to pool their resources to invest in private companies? Can we change rules that mandate the use of outdated technology in, for example, our recordkeeping rules so that financial institutions can incorporate new technology and thus lower the costs of the services they provide? Can we allow more experimentation in the way that funds and investment advisers communicate with investors? Can we reexamine our assumptions about the types and methods of disclosure we require in light of the enormous changes in communication technology that have occurred since the federal securities laws were written in the 1930s? Can we permit more issuer communication with investors, which perhaps could open the door to a back-and-forth style of disclosure facilitated by online chats and message boards? These and other innovations in the capital markets often require regulatory approvals or regulatory forbearance, both of which my agency historically has been slow to provide.

As she has demonstrated in the past, Peirce is not averse to her role as agent provocateur, and she seems to relish in prodding and probing those who would cling to quaint notions of what must be regulated and how that effort is to be undertaken; for example [Ed: footnotes omitted]:

Blockchain-based networks offer a new way of coordinating human action that does not fit as neatly within our securities framework. Satoshi Nakamoto, in the white paper that introduced bitcoin to the world, envisioned a "network [that] is robust in its unstructured simplicity." Uncoordinated nodes work together toward a common end "with little coordination." Other blockchain projects likewise seek to build networks that operate organically, without a central organizer. Some projects seek to facilitate various forms of authentication to replace traditional recordkeeping transactions or to allow individuals to interact without using trusted intermediaries. The objective of many of these blockchain projects is to build networks that run on diffuse contributions, rather than to create centralized entities that run networks. In the end, there may not be anyone steering the ship.

Yet many of these projects begin in a centralized manner that looks about the same as any other start-up. A group of people get together to build something and they need to find investors to fund their efforts so they sell securities, sometimes called tokens. The SEC applies existing securities laws to these securities offerings, which means that they must be conducted in accordance with the securities laws or under an exemption. When the tokens are not being sold as investment contracts, however, they are not securities at all. Tokens sold for use in a functioning network, rather than as investment contracts, fall outside the definition of securities.

After she sets out the test for the existence of a "security" as enunciated in the seminal SEC v. Howey, 328 U.S. 293 (1946), Peirce then pursues an interesting dissection of what is viable from that seven-decade-old Supreme Court case when it comes to the 21st Century digital world; for example [Ed: footnotes omitted]::

Our interactions with cryptocurrencies are not limited to questions about the regulation of token sales and disclosures. Closely linked to the question of whether tokens are securities is the question of how the platforms on which tokens trade should be regulated. Some of these platforms want to register with us, and I am eager to make progress on this front. There are features of crypto trading platforms that may differ from exchanges or alternative trading systems designed for traditional securities. To identify how regulation may need to change to accommodate these differences we will need to improve our understanding of how the platforms operate.

There is also great interest in exchange-traded products based on bitcoin or other cryptocurrencies. As I have mentioned in the past, I am concerned that our approach with respect to such products borders on merit-based regulation,[29] which means that we are substituting our own judgment for that of potential investors in these products. We rightfully fault investors for jumping blindly at anything labeled crypto, but at times we seem to be equally impulsive in running away from anything labeled crypto. We owe it to investors to be careful, but we also owe it to them not to define their investment universe with our preferences.

In a Complaint filed in the United States District Court for the Southern District of New York, Robert Alexander was charged with one count of securities fraud and one count of wire fraud. As alleged in part in the Complaint:

Beginning in at least 2013 and continuing through in or about 2017, ALEXANDER engaged in a scheme to defraud investors in the Company.  Specifically, ALEXANDER solicited and maintained investments in the Company through numerous false representations, including concerning his own professional background, the Company's financial condition, expected returns on investment, and assurances to investors that their investments would be used solely for the Company's business purposes.  

Also in furtherance of his scheme and contrary to representations made to investors, ALEXANDER used more than approximately $1.3 million of the funds he obtained from investors for his own personal expenses instead of for the Company's business purposes.  For example, ALEXANDER used investor funds to make payments toward his personal credit cards, to fund his gambling excursions to multiple casinos, to make rental payments for his personal residence, and to make car payments for a luxury car purchased for one of ALEXANDER's family members.
Wall Street's regulations, rules, policies, and protocols often appear as a challenge for some stockbrokers. It's not that brokers don't understand the meaning of "NO." They do; however, they may smile at you and shrug, and then freely admit that they knew that they weren't supposed to do what they did but . . . It's that "but" that often alters a droll regulatory fine or suspension into a fascinating tale of misplaced human ingenuity and an epic example of one individual's unbridled but misdirected passion for finding short-cuts and detours in life and business. In today's featured FINRA regulatory settlement, we come across a Merrill Lynch iconoclast who aspired to fly beneath his firm's compliance radar. Sadly, his second-rate stealth protection failed and he was shot down by his firm's detection system --  plummeting back to earth in flames. A once bright career now in smoking ruins. The old crash and burn.
The United States District Court for the Eastern District of New York permanently enjoined Niket Shah and his company, Spark Trading Group LLC, from violating the antifraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 thereunder. The Court's final judgment held Shah and Spark Trading jointly and severally liable for disgorgement of $299,229 plus interest of $24,742; and also ordered Shah to pay a civil penalty of $370,944.  The Court found that Shah and Spark Trading had falsely claimed that the firm was SEC-registered; that their investments were profitable; that investors' funds were guaranteed; and that defendants received $250,000 in start-up capital, including $200,000 that Shah deposited into a binary options trading account.

Training Accounts Used To Defraud Customers
In the Matter of Christopher Eikenberry, Respondent (Order Instituting Administrative Proceedings, Making Findings, And Imposing Remedial Sanction; '34 Act Release No. 85077; Admin. Proc. File No. 18992 / February 8, 2019) (the "Order"). In anticipation of the institution of proceedings by the SEC but without admitting or denying the findings, Romano Brothers & Company submitted an Offer of Settlement, which the federal regulator accepted.In accordance with the Order, Eikenberry was barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization; and from participating in any offering of a penny stock, including: acting as a promoter, finder, consultant, agent or other person who engages in activities with a broker, dealer or issuer for purposes of the issuance or trading in any penny stock, or inducing or attempting to induce the purchase or sale of any penny stock. As set forth in part in the OIP:

1. Eikenberry, age 49, is a resident of Birmingham, Michigan. Eikenberry held multiple securities licenses and was associated with a number of registered broker-dealers between 1991 and 2015, including during the time when he worked with others to develop and execute a fraudulent scheme to issue training accounts instead of real ones to certain customers of Nonko Trading ("Nonko"), an unregistered broker-dealer, and to pocket those customers' deposits. 

2. On December 11, 2018, a judgment was entered by consent against Eikenberry, permanently enjoining him from future violations of Section 17(a) of the Securities Act of 1933 and Sections 10(b) and 15(a)(1) of the Exchange Act and Rule 10b-5 thereunder in the civil action entitled Securities and Exchange Commission v. Jeffrey Goldman and Christopher Eikenberry, Civil Action Number 18-Civ-13550-KM-JBC, in the United States District Court for the District of New Jersey. 

3. The Commission's complaint alleged that, from late 2013 and through at least the summer of 2015, Eikenberry, with others, perpetrated a fraudulent scheme in which Nonko and its associated persons misappropriated certain of Nonko's customers' trading deposits and provided those customers with what the customers were led to believe were live securities trading accounts, but in reality were mere training accounts, operated by a trading simulator program. The Commission's complaint further alleged that Eikenberry provided knowing and substantial assistance in Nonko's unregistered brokerage operations, which often targeted United States investors.

What Part of "Demand" In "Demand Loan" Are You Not Getting?
In the Matter of the Arbitration Between David Yusupov, Claimant, v. TD Ameritrade, Inc., Respondent (FINRA Arbitration Decision Case 18-02533 / February 7, 2019)
In a FINRA Arbitration Statement of Claim filed in  July 2018, public customer Claimant Yusupov, representing himself pro se, assserted sale of shares due to margin call and sought $3,181 in compensatory damages. 
Respondent TD Ameritrade generally denied the allegations and asserted affirmative defenses. The sole FINRA Arbitrator denied Claimant's claim and offer this rationale -- which is merely the latest iteration of a well-worn explanation:

The client agreement which Claimant signed and which he acknowledged was binding on him, provides that, with respect to his margin account, Respondent can "immediately" sell securities "without notice to" Claimant. Respondent may so act "even if you have contacted me and provided a specific date by which I can meet a margin call". The actions of Respondent which Claimant contests were thus specifically authorized by him. 

In the Matter of Joseph S. Amundsen, CPA, Michael T. Remus, CPA, and Michael Remus CPA, Respondents. (SEC Order Instituting Administrative and Cease-and-Desist Proceedings; Acct. and Aud. Enf.  Rel. No. 4019;  '34 Act Rel. No. 85081; Admin. Proc. File No.3-18994) alleged in the "Summary" heading of the SEC Order:

1. These proceedings arise out of multiple violations of the auditor independence requirements in audits conducted of seven broker-dealers in both 2015 and 2016. Specifically, Amundsen, a certified public accountant who in 1983 was permanently enjoined from appearing or practicing before the Commission in any way, served as the Engagement Quality Reviewer ("EQR") on fourteen audits of certain broker-dealers for which Amundsen's daughter was the financial and operations principal ("FINOP"). The engagement partner on these audits, Remus, of Remus CPA, was aware of Amundsen's familial relationship and nevertheless engaged him as EQR on these fourteen audits, and directed the Firm to issue audit reports for each of these clients that falsely stated that they were conducted in accordance with standards of the Public Company Accounting Oversight Board ("PCAOB"). 

Federal Judge in Del Rio Sentences Three Men to Prison for Multi-Million Dollar Investment Scheme (DOJ Release)
In the United States District Court for the Western District of Texas, Kelly Ray Coronado and James Edward Cox pled guilty to one count of conspiracy to commit wire fraud; and Gordon Richard Moskowitz pled guilty to one count of conspiracy to commit money laundering. The Defendants preyed on vulnerable parties - most of whom operated international non-profits - by promising them large-scale financing in exchange for upfront payments. Using fake business entities, websites, and aliases, the Defendants collected over $5 million in upfront payments from their victims, then worked together to frustrate law enforcement detection and victim redress. Coronado, Cox, and Moskowitz were sentenced respectively to 51, 78, and 46 months in prison.