Securities Industry Commentator by Bill Singer Esq

June 6, 2019

In part the SEC Release states:

Under Regulation Best Interest, broker-dealers will be required to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.  Regulation Best Interest will enhance the broker-dealer standard of conduct beyond existing suitability obligations and make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer when making recommendations.

The Form CRS Relationship Summary will require registered investment advisers and broker-dealers to provide retail investors with simple, easy-to-understand information about the nature of their relationship with their financial professional.  While facilitating layered disclosure, the format of the relationship summary allows for comparability among the two different types of firms in a way that is distinct from other required disclosures.  Form CRS will also include a link to a dedicated page on the Commission's investor education website,, which offers educational information about broker-dealers and investment advisers, and other materials.

The Commission also issued an interpretation to reaffirm and, in some cases, clarify the Commission's views of the fiduciary duty that investment advisers owe to their clients under the Advisers Act.  The interpretation reflects how the Commission and its staff have applied and enforced the law in this area, and inspected for compliance, for decades.  By highlighting principles relevant to the fiduciary duty, investment advisers and their clients will have greater clarity about advisers' legal obligations. 

Finally, the Commission issued an interpretation of the "solely incidental" prong of the broker-dealer exclusion under the Advisers Act, which is intended to more clearly delineate when a broker-dealer's performance of advisory activities causes it to become an investment adviser within the meaning of the Advisers Act.  This interpretation confirms and clarifies the Commission's position, and illustrates the application in practice in connection with exercising investment discretion over customer accounts and account monitoring. 

Division of Corporation Finance Frequently Requested Materials
Final Rules
SEC Chair Clayton states in part:

Specifically, we are considering the adoption of four separate but complementary staff recommendations: 
  • Regulation Best Interest, which will substantially enhance the broker-dealer standard of conduct beyond existing suitability obligations, requiring broker-dealers, among other things, to act in the best interest of their retail customers when making a recommendation, including not placing their financial or other interests ahead of the interests of the retail customer. The standard of conduct draws from key fiduciary principles and cannot be satisfied through disclosure alone;
  • Form CRS, which will require registered investment advisers and broker-dealers to deliver to retail investors a relationship summary providing succinct, plain English information about the relationships and services the firm offers, the fees, costs, conflicts of interest and required standard of conduct associated with those relationships and services, and whether the firm and its financial professionals have reportable legal or disciplinary history;
  • An interpretation reaffirming-and in some instances clarifying-the fiduciary duty investment advisers owe to their clients under the Investment Advisers Act of 1940 ("Advisers Act"); and
  • Finally, an interpretation of the "solely incidental" prong of the broker-dealer exclusion under the Advisers Act, which is intended to delineate more clearly when a broker-dealer's performance of advisory activities causes it to become an investment adviser within the meaning of the Advisers Act.
. . .

I'd like to say just a few words about some of the potential criticism you may hear about our rulemaking package-criticism that I believe is clearly misguided. 
  • You may hear that Regulation Best Interest does not truly enhance the broker-dealer standard of conduct beyond existing suitability obligations, that it can be satisfied by disclosure alone, or that we are doing a disservice to investors by calling it a "best interest" standard. This is simply not true-you will hear from the Division of Trading & Markets specifically how the rule goes significantly beyond existing broker-dealer obligations. To be clear, Regulation Best Interest cannot be satisfied through disclosure alone.
  • You may hear that our Relationship Summary will confuse retail investors, will not accomplish its goals, or should have been subject to further testing. This criticism misses the point of how much an improvement the Relationship Summary will be for retail investors over existing disclosures. No existing disclosures provide the level of transparency and comparability that the Relationship Summary will provide. The criticism also ignores the extensive amount of investor testing and other information our staff considered in developing the final recommendation, leveraging their considerable expertise with investor disclosures.
  • Finally, you may hear that our Fiduciary Interpretation weakens the existing fiduciary duty that applies to investment advisers-also not true. The interpretation reflects how the Commission and its staff have applied and enforced the law in this area, and inspected for compliance, for decades.

Statement on Final Rules Governing Investment Advice (SEC Commissioner Robert J. Jackson Jr.)
SEC Commissioner Jackson states in part:

[R]ather than requiring Wall Street to put investors first, today's rules retain a muddled standard that exposes millions of Americans to the costs of conflicted advice. Even worse, contrary to what Americans have heard for a generation, the Commission today concludes that investment advisers are not true fiduciaries. Today's actions fail to arm Americans with the tools they need to survive the Nation's retirement crisis. Accordingly, I respectfully dissent.

. . .

So the final Regulation Best Interest has, in these instances and many more, lowered the bar even from the standards we set in last year's proposal. But more fundamentally, I can't vote to support Regulation Best Interest for the same reason I can't vote for our guidance on investment advisers: neither requires Wall Street to put investor interests first. And for those who wonder whether language matters, the most compelling evidence comes from the finance industry's own advocates. They've argued in comments to us that "the assertion that an investment adviser must put clients' interest 'first' is very different from saying that they may not 'subordinate' or 'subrogate' clients' interests.". . .

. . .

Two things happened in States that extended fiduciary obligations to brokers. First, those brokers provided a better menu of investment options to clients.[21] Second, brokers sold those investors fewer variable annuities relative to fixed indexed annuities. And because variable annuities can be costly, the study shows that investors in those States saved significant sums. . . .

Regulation Best Interest requires a broker to have a more thorough understanding of the products and the accounts it could offer to a retail customer, including their costs, and refrain from making a recommendation if none of its products or accounts would meet this standard. Beyond this, and perhaps most importantly, when making a recommendation, a broker cannot place its own interest ahead of the retail customer's. This obligation applies not only during the process of a broker making a recommendation, but extends (through the Conflict of Interest Obligation) to the way a broker designs its product menus and compensates its personnel.

If Regulation Best Interest just stopped there, it would already be a greatly elevated set of obligations for brokers. But, the rule goes further; banning high-pressure product-specific sales contests, which can motivate associated persons to push customers toward investments for the broker's or associated person's own benefit. Regulation Best Interest also will impose heightened disclosure requirements about brokers, their investment offerings, and associated conflicts of interest in order to better inform retail customers about their service provider and investing options.
SEC Investor Advocate Rick Fleming states in part:

In summary, I believe Regulation Best Interest, while not as strong as it could be, is a step in the right direction because it is an improvement over the existing suitability standard for broker-dealers. However, what investors have gained in Reg BI has been undermined by what investors have lost in the Commission's interpretation of the fiduciary duty that applies to investment advisers. And while the new Form CRS relationship summary will provide useful information to investors about their particular financial professional and account, it likely will not achieve its original goal of preventing the financial harm that results from investor confusion about the differences between investment advisers and broker-dealers. Finally, while the interpretation of "solely incidental" presented an opportunity to sharpen the distinctions between broker-dealers and investment advisers, the interpretation merely serves to formalize the Commission's longstanding deference to broker-dealers who engage in conduct that is advisory in nature.
Perhaps had Mark Zuckerberg not dropped out of Harvard to become a billionaire, he might have paused long before uttering "domination" to describe his ambitions. Christ said that the love of money is the root of all evil, but that's not quite right. He wasn't crucified for profit. The love of money for its own sake doesn't make one evil; it makes one a pathetic miser. The root of all evil is something else.
In a Complaint filed in the United States District Court for the Northern District of Georgia, the SEC charged Peter Baker, Elizabeth Oharriz, and their companies, Prestige Global Trading, Ltd., Diversified Initiatives Consulting & Logistics, Inc., and Sienna Business Group, Inc., with violating the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Actand Rule 10b-5 thereunder; and Baker and Oharriz were further charged with violating the broker-dealer registration provisions of Section 15(a) of the Exchange Act. The SEC seeks permanent injunctions, disgorgement plus prejudgment interest, and civil penalties. Oharriz, Sienna, and Diversified have agreed to a bifurcated settlement where they will be permanently enjoined from violations of the charged provisions. Monetary relief will be determined by the court upon motion of the SEC. As set forth in part in the SEC Release:

[F]rom 2013 through 2017, Baker and Oharriz engaged in a scheme to sell fictitious prime bank instruments that raised over $2.3 million from unwitting investors. According to the SEC's complaint, Baker and Oharriz allegedly falsely told investors that their funds would be used to obtain instruments issued by well-known commercial banks and promised investors astronomical profits. The SEC further alleges that Baker and Oharriz falsely promised investors that they would return any advance payments the investors made if Baker and Oharriz could not secure these instruments. Contrary to their representations, however, Baker and Oharriz allegedly misappropriated substantially all of the funds invested, using them for their own personal expenses or transferring them to third parties. As alleged in the SEC's complaint, to prevent investors from uncovering their fraud, Baker and Oharriz gave investors fabricated bank instruments and other supporting documents.

Defendant Allegedly Inflated Company's Revenue to Defraud Investors (DOJ Release)

In a  Complaint filed in the United States District Court for the Southern District of New York, the SEC alleged that Longfin Corp (which voluntarily delisted from NASDAQ in May 2018 and shut down in November 2018) and its Chief Executive Officer, Venkata S. Meenavalli, conducted a fraudulent public offering of Longfin shares in which they obtained qualification for a Regulation A+ offering by falsely representing in SEC filings that the company was principally managed and operated in the U.S. when, in fact, the company's operations, assets and management remained offshore. The fraudulent scheme was further by the distribution of over 400,000 Longfin shares to insiders and affiliates to meet certain Nasdaq listing criteria, without obtaining payment said shares. Further, the Complaint alleges that Longfin consultant Andy Altahawi misrepresented to Nasdaq the number of qualifying shareholders and shares sold in the offering. See the Amended Altahawi Complaint Also, the Complaint alleges that Longfin and Meenavalli  engaged in an accounting fraud, recording over $66 million in sham revenue, which represented about 90% of Longfin's reported 2017 revenue. 

In a prior action, the SEC alleged that Longfin and Meenavalli; and Andy Altahawi, Dorababu Penumarthi, and Suresh Tammineedi illegally distributed and sold more than $33 million of Longfin stock in unregistered transactions; and the SEC obtained a preliminary injunction freezing more than $27 million in allegedly illegal trading proceeds. Altahawi, Penumarthi, and Tammineedi agreed to settlements and have agreed to surrender the previously frozen funds towards paying monetary relief. Without admitting or denying the charges, Altahawi has agreed to settle the fraud charges and the prior charges of trading in unregistered securities; and he will be required to return $21 million of allegedly ill-gotten gains, pay a $2.9 million penalty, and surrender all his Longfin shares; and, further, he agreed to be barred from serving as a public company officer or director for five years, and to an industry bar to be issued in an administrative proceeding. Without admitting or denying the charges, Penumarthi and Tammineedi, agreed to settle all pending charges for trading in unregistered securities, and Penumarthi will be required to pay more than $1.7 million and Tammineedi to pay more than $241,000, in addition to injunctive relief. 

In an Indictment filed in the United States District Court for the District of New Jersey, Meenavali was charged with securities fraud. As set forth in part in the DOJ Release:

In 2017 and 2018, Meenavalli and others orchestrated a multimillion-dollar accounting fraud relating to Longfin Corp., a publicly traded company purportedly engaged in sophisticated commodities trading and so-called "cryptocurrency" transactions, including "blockchain-empowered solutions." In fact, Longfin did not engage in any revenue-producing cryptocurrency transactions, and did not use the blockchain to empower any solutions. Longfin reported as revenue millions of dollars of commodities transactions, which were actually sham events between Longfin and separate entities Meenavalli controlled, using phony bills of lading and other fraudulent documents.

Longfin fraudulently reported in its public filings with the U.S. Securities and Exchange Commission (SEC) more than $66 million of revenue that was never actually earned and should never have been recognized. By including this phony revenue in the company's public filings, Meenavalli and others made Longfin's shares more attractive to potential investors.

Longfin's 2017 Form 10-K (a required annual report to the SEC) claimed that its primary source of revenue was from "structured trade finance," including "the sale of physical commodities." Longfin falsely reported million in accounts receivable in purported physical commodity sales that never occurred. In fact, Meenavalli allegedly owned or controlled several entities that purportedly did business with Longfin, and did not disclose those relationships to Longfin's shareholders or the investing public.
In November 2018, the SEC issued a subpoena to Einstein Investments LLC for the production of documents but the company has failed to produce any responsive documents. Accordingly, the SEC filed in the United States District Court for the Central District of California a subpoena enforcement action against Einstein as part of the federal regulator's alleged ongoing investigation of a potential pump-and-dump scheme in the stock of microcap companies Cherubim Interests, Inc.; PDX Partners, Inc.; and Victura Construction Group, Inc., all of which were previously subject to trading suspensions. As set forth in part in the SEC Release:

The SEC's application provides that these microcap companies may have issued false public statements in January 2018 to "pump" their stock price, claiming that it had acquired hundreds of millions of dollars of "AAA-rated" assets, when each company purportedly had little to no assets. After the stock price and trading volume for each company increased, an entity associated with the companies - and possibly Einstein - may have "dumped" their overvalued shares for significant profits.