Securities Industry Commentator by Bill Singer Esq

May 16, 2019

CFTC's Division of Market Oversight Issues Statement on the Certification of ICE Futures (CFTC Release)
The CFTC Release provides the following background in part [Ed: footnotes omitted]:

On February 1, 2019, ICE Futures U.S., Inc. (ICE or Exchange) self-certified an amendment to ICE Rule 4.26 (Order Execution) (ICE Rule) that would allow ICE to implement a new functionality, named Passive Order Protection ("POP functionality" or "functionality") (Submission). The POP functionality creates a delay or "speed bump" in the processing of incoming "aggressive" orders that would otherwise execute against "resting" or "passive" orders, but does not delay the processing of passive orders or their cancellations or modifications. The POP functionality is designed to reduce the impact of latency (or speed) advantages among a segment of higher speed traders through the asymmetric delay as described above. The Submission (but not ICE Rule 4.26) provides that the POP functionality will initially be implemented for ICE's Gold Daily and Silver Daily futures markets, and the delay period will be set at three milliseconds. ICE Rule 4.26 states that "Passive Order Protection may be activated for those Exchange Futures Contracts and contract months as determined by the Exchange from time to time in its discretion."

This is the first time a designated contract market has certified a rule that would implement speed bump functionality..Following DMO Staff's review of the amendment and upon its recommendation against CFTC objection, CFTC certified the effectiveness of the rule. In part, the CFTC Release offers the following commentary [Ed: footnotes omitted]:

DMO staff believes that speed bump functionalities have the potential to significantly impact futures markets' function and quality, both negatively and positively, in a number of ways. For example, the implementation of speed bump functionalities, in particular an asymmetric speed bump like the POP functionality, raises concerns regarding the potential impact on fairness and competition between market participants and exchanges. Additionally, market participants have commented that liquidity providers are being given an extended ability to cancel or modify their resting orders and therefore liquidity displayed in the market data feed may be inaccessible. On the other hand, ICE's Gold Daily and Silver Daily futures markets currently have little or no order book trading. Moreover, these markets are not primary price discovery markets. Thus, the speed bump functionality may foster liquidity and trading volume in these markets by certain liquidity providers by slowing down high-speed traders engaged in latency arbitrage.

In light of these factors, DMO staff believes the application of the POP functionality to ICE's Gold Daily and Silver Daily futures contracts may be useful to evaluate the impact of speed bump functionality on, among other things, futures market liquidity, price discovery, competition, and the potential for manipulation and abusive trading practices. Accordingly, DMO staff intends to monitor and analyze the impact of the POP functionality on an ongoing basis in light of the applicable statutory and regulatory requirements. DMO intends to coordinate with the Commission's Office of the Chief Economist and Office of Data and Technology in this regard. The impact of the POP functionality in ICE's Gold Daily and Silver Daily futures markets may serve to inform the Commission's analysis of other speed bump functionality proposals.

DMO staff does not view the certification of the ICE Rule as establishing a precedent with respect to the legal and policy merits of speed bump functionalities generally. Rather, DMO staff will consider any proposed speed bump functionality on its own merits based on all of the relevant facts under applicable statutory and regulatory requirements.

Furthermore, DMO staff emphasizes that the implementation of speed bump functionality for any product, or a change to a speed bump's functionality, for example, an adjustment to a time delay period, requires a separate rule submission with the Commission. Section 40.1(i) of the Commission's regulations broadly defines the term "rule." Thus, the application of a speed bump to any product, regardless of prior certification of the functionality by the same DCM with respect to another product, or adjustments to a speed bump's functionality, would constitute a "rule" and require separate certifications or approvals under CEA Section 5c(c) and part 40 of the Commission's regulations. Therefore, notwithstanding the broad language of the ICE Rule, the future implementation of the POP functionality for any ICE contract other than the Gold Daily and Silver Daily contracts, or a change to the three millisecond delay period, among other changes to the POP functionality, would require ICE to file a new rule submission in accordance with CEA Section 5c(c) and part 40 of the Commission's regulations.

FINRA Enforcement Loses Dramatic NAC Appeal. FINRA Department of Enforcement, Complainant, v. Austin Wayne Morton, Respondent (OHO Hearing Panel Decision, Financial Industry Regulatory Authority, Office of Hearing Officer, Disciplinary Proceeding No. 2016052347901 / March 14, 2018)
%20OHO%20Decision%20sl.pdf, provides the following analysis in its "Introduction" [Ed: Footnotes omitted] :

Department of Enforcement filed a Complaint against Respondent Austin Wayne Morton consisting of two causes of action. The first cause of action alleges that, on two separate occasions in September and October 2016, Morton converted a total of $36,000 from "GR" in violation of FINRA Rule 2010. The Complaint alleges that the first conversion occurred when Morton allegedly took possession of $20,000 cash that GR had withdrawn from his bank account. The Complaint further alleges that the second conversion occurred when Morton obtained, filled out, and cashed a check signed by GR for $22,000, when GR had intended the check to be for $6,000. At the time of the alleged conversions, GR was 82 years old and had been diagnosed with dementia. He had been a customer of Morton's at FINRA member Edward D. Jones & Co until mid-September 2016.

The second cause of action alleges that Morton was compensated in the amount of $2,000 cash for assisting GR in locating and cashing out a variable annuity and thereby engaged in an undisclosed outside business activity in violation of FINRA Rules 3270 and 2010.

A hearing was held in Fayetteville, Arkansas on December 5-6, 2017. A majority of the Hearing Panel concludes that Enforcement failed to meet its burden of proving the two causes of action: conversion of funds from GR and receipt of compensation in the amount of $2,000 cash for an alleged undisclosed outside business activity.

Having lost via a majority decision, FINRA's Department of Enforcement appealed the OHO Decision to the National Adjudicatory Committee ("NAC") In the Matter of FINRA Department of Enforcement, Complainant, v. Austin Wayne Morton, Respondent (FINRA NAC Decision; Complaint No. 2016052347901 /  May 15, 2019)
%20Austin%20Wayne%20Morton%20CRD%205538108%20NAC%20jm.pdf  The NAC Decision offers us a bit more color as to the underlying OHO Hearings:

On April 24, 2017, Morton filed an answer in which he denied engaging in any misconduct. The Hearing Panel held a two-day hearing on December 5 and 6, 2017. Six witnesses testified during the hearing.1 Morton testified both during Enforcement's case and in his defense. He testified concerning his long-standing relationship with GR and the events in September and October 2016, which mostly only he and GR witnessed, that are at issue in this case. Morton, consistent with his answer, denied all allegations of wrongdoing. 

Two witnesses testified about their interactions or conversations with GR and Morton concerning the transactions that are at issue in this case. The first witness, KF, is GR's daughter. She testified about the assistance Morton provided GR with locating and surrendering an annuity; her claim that Morton admitted taking $2,000 from GR as compensation for providing that service; and a written complaint that she filed on GR's behalf with Edward Jones, the FINRA member with which Morton was registered at the time of the events at issue. 

The second witness, Katherine Ferguson ("Ferguson"), is an Edward Jones compliance investigator and investigated KF's written complaint. She testified about interviews she conducted with GR, KF, and Morton and the decision of Edward Jones to terminate Morton for accepting a loan from GR. 

The final three witnesses who testified at the hearing included RH, GR's friend and neighbor; Shalene Woods ("Woods"), Morton's branch office assistant; and Sean FitzPatrick ("FitzPatrick"), an Enforcement case manager who testified about Morton's financial condition in 2016, evidence of which Enforcement put forward to suggest that Morton possessed the motive to steal from GR.
Footnote 1: GR did not testify. As we discuss below, infra Part II.B., two doctors diagnosed GR with vascular dementia in 2012, and he entered an assisted-living facility in November 2016. GR, who at the time of the hearing was 83 years old, possessed little or no recollection of the happenings that resulted with Enforcement filing a disciplinary action against Morton.  

At Pages 2 - 3 of the NAC Decision

Enforcement did not appeal the portion of the OHO majority's decision dismissing the claim that Morton took $2,000 from GR; and, accordingly, the NAC did not consider that issue. The NAC found that Enforcement did not prove by a preponderance of evidence that Respondent Morton had engaged in conversion, and, thereby affirmed the OHO Decision and dismissed the case. The NAC stated that:

In summary, Enforcement failed to prove the amount of the undocumented loan GR gave to Morton, and we are left unable to find that Morton, more likely than not, converted any sum of money from the $22,000 check that GR signed on October 9, 2016. We thus affirm the Hearing Panel majority's findings that Enforcement did not prove, by a preponderance of the evidence, that Morton converted $16,000 from GR's $22,000 check.  

At Pages 22 - 23 of the NAC Decision

In explaining the rationale for its dismissal, the NAC noted in part that [Ed: Footnotes omitted}:

In reaching this conclusion, we highlight first that there is no direct evidence that Morton took or exercised ownership of any of portion of the $22,000 in cash that GR withdrew from his bank account on September 13, 2016. Although Enforcement asserts in its opening appeal brief that GR departed Morton's company that day without the cash he withdrew from the bank, and that GR told Ferguson, the Edward Jones compliance investigator, Morton took it, these claims find no support in the record. Morton testified consistently, and without contradiction, both during Edward Jones's investigation and in this matter, GR departed Morton's car possessing all of the cash GR withdrew from the bank on September 13, 2016. Moreover, far from claiming that Morton took his cash, the evidence instead shows that GR, when asked about the $22,000 cash withdrawal in October and November of 2016 by both KF and Ferguson, had no recollection of it, or "even going to the bank." 

Unable to produce direct evidence of Morton's alleged conversion, and confronted with Morton's consistent denials of any wrongdoing, Enforcement argued to the Hearing Panel that several pieces of circumstantial evidence proved Morton stole $20,000 from the $22,000 in cash GR withdrew from the bank on September 13, 2016. Of course, circumstantial evidence is permissible in FINRA disciplinary proceedings. See John D. Audifferen, Exchange Act Release No. 58230, 2008 SEC LEXIS 1740, at *12 n.9 (July 25, 2008) ("[T]he Supreme Court has held  that circumstantial evidence can be more than sufficient to satisfy the burden of proof in civil actions." (internal quotation marks omitted)). Nevertheless, "the probative value of circumstantial evidence depends entirely on the strength of the inferences that can be drawn from the proven circumstances." Mosier v. Stonefield Josephson, Inc., 815 F.3d 1161, 1171 (9th Cir. 2016). 

The Hearing Panel majority concluded that the circumstantial evidence Enforcement presented in support of its claims was unpersuasive and the inferential connections Enforcement drew from the evidence were "tenuous." In this appeal, Enforcement argues that the Hearing Panel majority failed to give sufficient weight to circumstantial evidence showing Morton's "motive and opportunity" to steal. We disagree. Like the Hearing Panel majority, we find that the circumstantial evidence Enforcement mustered does not lead to a conclusion that it was more likely than not that Morton took $20,000 from GR on September 13, 2016. . . .

Pages 17 - 18 of the NAC Decision

Bill Singer's Comment: Very thoughtful and comprehensive OHO and NAC Decisions, which I urge all serious industry participants to read. I do not fault FINRA for bringing its charges given the seriousness of the allegations and the presence of a vulnerable customer. On the other hand, there are were many gaps in the necessary elements of proof, which prompts alternative theories as to who did or didn't do various acts. Finally, Respondent Morton was zealously represented by Jon-Jorge Aras, Esq., a rising star among the FINRA regulatory defense bar.
By all indications, we may eventually have to give up beef, not from vegan sensibilities, but simply because it will become too expensive. The grain now fed to livestock could feed almost a billion people, and those people may soon need it. Not to worry. The hottest IPO of the month was not Uber, which went from bang to whimper with little wait time. It was Beyond Meat, which was priced at $25, scooted up to $80 in its first trading day, and has stayed there despite tariffs and other scares to date. On its heels is competitor Impossible Foods, which raised $300 million in private financing and will itself go public soon. Both those companies are developing foods from plant-stuff that taste sort of like beef. It's not quite the real thing yet, but I'm confident that in a quarter century we won't be able to tell the difference. 

SEC Freezes Assets of Online Auction Portal and Its CEO Associated with $23 Million Offering Fraud (SEC Release)
In a Complaint filed in the United States District Court for the Southern District of New York the SEC charged Collector's Coffee d/b/a "Collectors Cafe" and Mykalai Kontilai with violations of the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act  and Rule 10b-5 thereunder. The Complaint seeks permanent injunctions, disgorgement plus prejudgment interest, and penalties; and the Court granted an an emergency asset freeze and other relief. As set forth in part in the SEC Release:

[C]ollectors Cafe and Kontilai, a New York resident, operated a fraudulent scheme that raised more than $23 million from at least 140 investors since April 2014. To entice investors, Collectors Cafe and Kontilai allegedly falsely stated that Collectors Cafe had hundreds of dealers signed up to sell billions of dollars of inventory. Additionally, Kontilai allegedly misrepresented the extent of Collectors Cafe's purported interest in two contracts signed by Jackie Robinson, the first African American to play for a major league sports team, by falsely claiming the company owned a $36 million asset with the Jackie Robinson contracts, when Collectors Cafe owned only a fraction of such asset. The SEC also alleges that Kontilai misappropriated at least $6.1 million of the $23 million raised in investor funds by funneling millions of dollars through his personal bank account, withdrawing millions in cash, and charging personal expenses and luxury items to Collectors Cafe credit and debit cards.  The SEC's complaint also alleges that Kontilai attempted to conceal this fraudulent conduct by producing fabricated documents to the SEC, including documents that purported to show that Kontilai loaned millions of dollars to Collectors Cafe.

Jury Rules in SEC's Favor, Finds Brokerage Firm and Two of Its Executives Liable for Fraud (SEC Release)

A jury in the United States District Court for the Southern District of New York found  Portfolio Advisors Alliance Inc. ("PAA"), Howard J. Allen  (PAA's indirect owner), and Kerri L. Wasserman  PAA's President) liable for violating the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act  and Rule 10b-5 thereunder; and further found that Allen and Wasserman aided and abetted PAA's violations; and that Wasserman aided and abetted Allen's violations; and that Allen and Wasserman were liable as control persons for PAA's violations. As set forth in part in the SEC Release, the SEC had charged PAA with:

fraud and related charges in connection with making material misrepresentations and omissions in American Growth Funding II LLC (AGF II)'s private placement offering. The SEC alleged that AGF II, which raised capital from investors to provide loans to businesses, and its owner, Ralph C. Johnson, promised investors 12 percent annual returns and falsely claimed in offering documents that its financial statements were being audited each year.  The SEC further alleged that PAA, Allen, and Wasserman knew the offering documents were inaccurate yet continued using them to solicit sales of AGF II securities. 

Earlier this year, the SEC obtained a final consent judgment against AGF II and Johnson, who were charged with lying to investors who purchased AGF II's high-yield securities.

Clarence Investment Advisor Sentenced For Bilking Clients Out Of Hundreds Of Thousands Of Dollars (DOJ Release)
Michael Giokas, a financial advisor and President of Giokas Wealth advisors was convicted in the United States District Court for the Western District of New York for his role in two schemes,which defrauded victims out $1,473,396.  Giokas was sentenced to 52 months in prison and ordered to pay restitution totaling $916,396. As set forth in part in the DOJ Release:

Between May 2017 and October 2017, the defendant persuaded certain clients to withdraw money from their investment accounts at Nationwide Mutual Insurance Company and invest the money in a company called Trinity Council, LLC. Giokas claimed that Trinity Council was a fund that invested in private corporations; that investments were guaranteed to earn interest between eight and nine percent per year; and that investment principal was guaranteed. The defendant also provided a fraudulent promissory note to one of his clients to convince the client that his investment in Trinity Council was legitimate.

Trinity Council was actually a shell company that engaged in no investment or business activity. Giokas was the sole member and only owner of Trinity Council, and the only person with signature authority on its bank accounts, which the defendant opened for the purpose of executing this scheme to defraud.

In a separate scheme, between 2015 and October 2017, Giokas prompted Nationwide to transfer money from his clients' Nationwide accounts to the defendant under the guise of "fee requests." Giokas claimed that he was entitled to the requested money as investment advisory fees, despite the fact that the requested amounts greatly exceeded what the defendant was entitled to pursuant to his fee agreements with his clients.

Bandimere Moves Forward at SEC. in David F. Bandimere, Petitioner, v. United States Securities and Exchange Commission, Respondent (Opinion, United States Court of Appeals for the Tenth Circuit, 15-9586 / December 28, 2016), upon considering Petitioner Bandimere's appeal, the Court of Appeals for the Tenth Circuit ("10Cir") preliminarily explained that:

When the Framers drafted the Appointments Clause of the United States Constitution in 1787, the notion of administrative law judges ("ALJs") presiding at securities law enforcement hearings could not have been contemplated. Nor could an executive branch made up of more than 4 million people, most of them employees. Some of them are "Officers of the United States," including principal and inferior officers, who must be appointed under the Appointments Clause. U.S. Const. art. II, § 2, cl. 2. In this case we consider whether the five ALJs working for the Securities and Exchange Commission ("SEC") are employees or inferior officers.

Based on Freytag v. Commissioner of Internal Revenue, 501 U.S. 868 (1991), we conclude the SEC ALJ who presided over an administrative enforcement action against Petitioner David Bandimere was an inferior officer. Because the SEC ALJ was not constitutionally appointed, he held his office in violation of the Appointments Clause Exercising jurisdiction under 15 U.S.C. §§ 77i(a) and 78y(a)(1), we grant Mr. Bandimere's petition for review.

Following its defeat at 10Cir, the SEC filed a Petition for Certiorari with the United States Supreme Court, which was denied on June 28, 2018. In the Matter of David F. Bandimere and John O. Young (SEC ALJ Order Concerning Division Production of Documents; Admin Proc. Rul. Rel. No. 6574; Admin. Proc. File No. 3-15124 / May 14, 2019) some 2 1/2 years after the 10Cir Opinion, Bandimere is back before another SEC Administrative Law Judge -- this time,  James E. Grimes. In response to an ongoing dispute between Bandimere and Enforcement about whether certain materials are entitled to protection as work-product, ALJ Grimes has ordered as follows:

Respondent David F. Bandimere has subpoenaed the notes taken by counsel for the Division of Enforcement during witness interviews. The parties disagree about the extent to which the work-product doctrine protects the notes from production. However, the Division has agreed to produce the factual portion of the notes, on the condition that the production will not be deemed a waiver of any privilege or protection. The parties agree to the following three points. 

1. The production of privileged or work-product protected documents, electronically stored information ("ESI") or information, whether inadvertent or otherwise, is not a waiver of the privilege or protection from discovery in this case or in any other federal or state proceeding. This order shall be interpreted to provide the maximum protection allowed by Federal Rule of Evidence 502(d). 

2. Nothing contained herein is intended to or shall serve to limit a party's right to conduct a review of documents, ESI or information (including metadata) for relevance, responsiveness and/or segregation of privileged and/or protected information before production.

3. Nothing contained herein is intended to or shall serve to limit a party's right to challenge claims of privilege or work product asserted to withhold documents or ESI.  

SEC Enforcement Activity: Public Companies and Subsidiaries (Midyear FY 2019 Update, Cornerstone Research / NYU Pollack Center for Law & Business) As set forth in part in the "Executive Summary" :

SEC enforcement activity remained at near-record levels in the first half of FY 2019, continuing a resurgence of activity that began in 2H FY 2018. The SEC filed 52 new actions against public companies and subsidiaries in 1H FY 2019 -- with nearly half of these new actions stemming from self-reporting related to the SEC's Share Class Selection Disclosure Initiative . . .