Securities Industry Commentator by Bill Singer Esq

[V]oya Investments LLC and Directed Services LLC served as investment advisers to certain insurance-dedicated mutual funds offered to annuity and life insurance customers through insurance companies affiliated with the advisers.  In order to generate additional income for the mutual funds and their investors, the Voya advisers lent securities held by the funds to parties looking to borrow the securities.  The Voya advisers recalled loaned securities before their dividend record dates so that the advisers' insurance company affiliates, who were the record shareholders of the funds' shares, could receive a tax benefit based on the dividends received.  But, as the order explains, the recall practice caused the funds and their investors to lose securities lending income without receiving any offsetting tax benefit.  The order found that the Voya advisers failed to disclose the conflict of interest to the funds' board of directors or in the funds' prospectuses.

From January 24, 2011 to August 18, 2011 Merrill violated the registration provisions of  the federal securities laws by effecting unregistered sales of almost 3 million shares of Longtop  Financial Technologies Limited's ("Longtop") securities for a customer. Longtop's securities were trading in the United States as American Depositary Shares ("ADSs"). Longtop's Chairman had obtained the 3 million unregistered shares from Longtop as one of its founders. In the summer of 2010, the Chairman purported to gift Longtop ordinary shares through a trust to existing and ex-employees  of Longtop, who were the purported beneficiaries of that trust. The related ADSs were then sold in about 68 transactions through an account at Merrill's Singapore branch office held in  the name of the trust's nominee ("Nominee").  

Section 5 of the Securities Act generally requires registration of securities offerings, or an  available exemption from registration, including for resales such as the sales through the Nominee  account at Merrill. Although brokers frequently rely on an exemption under Section 4(a)(4) of the  Securities Act, known as the brokers' transaction exemption, this exemption was not available to  Merrill for any of the Longtop ADS sales through the Nominee account. For this exemption to be available, Merrill was required, before selling securities on its customers' behalf, to engage in a reasonable inquiry into the facts surrounding the customers' proposed sales to determine if the customers were engaging in an unlawful distribution of securities. The amount of inquiry a broker must conduct as part of this reasonable inquiry varies with the facts and circumstances of each transaction. The requirement that a broker conduct a reasonable inquiry is not limited to penny stock transactions.  

Here, the Merrill team evaluating the proposed sales engaged in some inquiry before the  first sales that revealed red flags that Longtop, its management, and the Chairman maintained  control of the securities, thus indicating the purported gifts were not bona fide and the sales could  be part of an unlawful unregistered distribution by Longtop and its affiliates. Nevertheless, Merrill did not properly investigate, failed to inquire about the identities of the purported sellers and whether they were affiliates of Longtop, and instead allowed the sales to go forward.  

In January 2011, Merrill cleared a block of almost 1 million Longtop ADSs for future sales  through the Nominee account by unknown sellers. Merrill did not conduct any subsequent reviews when these ADSs were sold between January 24, 2011 and May 4, 2011. During this time, Merrill was presented with additional red flags that should have prompted the firm to conduct further inquiry and consider whether an exemption from securities offering registration was available. For instance, Merrill failed to perform any inquiry after an April 2011 online report accused Longtop  of financial fraud and questioned the legitimacy of the Chairman's gift of shares. 

Likewise, in early May 2011, when nearly 2 million more Longtop unregistered securities  were deposited into the Nominee account, Merrill failed to conduct any inquiry before effecting  additional sales of the Longtop ADSs. Even after learning of more red flags, including that  Longtop's auditor resigned in late May 2011, citing the Chairman's admissions of fraud, and  Longtop's securities were delisted by the NYSE in August 2011, Merrill still made no inquiry to  determine whether the ADSs could be sold without registration. 

Accordingly, Merrill did not perform a reasonable inquiry and was not entitled to rely on  the brokers' transaction exemption. Merrill engaged in an unregistered distribution through the Nominee account, generating approximately $38 million in proceeds for the benefit of Longtop  and its affiliates. Merrill wired the proceeds from the Nominee account to a Hong Kong bank account in the name of a different entity. This entity also was controlled by Longtop management.  Merrill received over $127,000 in commissions and fees during the relevant period. By virtue of its conduct, Merrill willfully violated Sections 5(a) and 5(c) of the Securities Act.

• Securities Industry Commentator
• Bill Singer