Securities Industry Commentator by Bill Singer Esq

[In]Securities Guest Blog: And So This Is Christmas by Aegis Frumento Esq (BrokeAndBroker.com Blog)

Former CEO And Former Employee Of Broker-Dealer Charged With Falsifying Books And Records, Submitting False Reports To The Securities And Exchange Commission, And Making False Statements To SEC Staff (DOJ Release)

SEC Cites "Filter Team" In Denying Whistleblower Claim. In the Matter of the Claim for Award in connection with Redacted Redacted  Notice of Covered Action Redacted (Order Determining Whistleblower Award Claim)

Three Bay County Men Sentenced For Operating Sweepstakes Scam Targeting Elderly Victims (DOJ Release)

FINRA, Cboe, Nasdaq, NYSE and Affiliated Exchanges Fine Credit Suisse Securities $6.5 Million for Supervision and Market Access Rule Violations (FINRA Release)

SEC ALJ Discusses Inability-to-Pay Standards. In the Matter of Retirement Surety LLC, Crescendo Financial LLC, Thomas Rose, David Leeman, and David Featherstone (SEC ALJ Initial Decision;

Court Sentences Alleged Fraudster to Nine Years in Prison in Parallel Criminal Case (SEC Release)

At all relevant times, SEIDEL was the CEO of Seidel & Co., a Manhattan-based inter-dealer broker registered with the SEC.  MEKAWAY was a Seidel & Co. employee.  As an inter-dealer broker, Seidel & Co. acted primarily as an intermediary between institutional broker-dealers trading bonds of various types. 

SEC regulations required Seidel & Co. to maintain net capital reserves of the greater of $100,000 or six and two-thirds percent of its aggregate indebtedness.  If Seidel & Co.'s net capital fell below the required threshold, the Firm was required to notify the SEC of that fact the same day.  Once a broker-dealer falls out of its net capital requirement, it becomes subject to the suspension or revocation of its registration.

In order to ensure, among other things, that a broker-dealer maintains adequate net capital, SEC regulations require broker-dealers like Seidel & Co. to maintain books and records reflecting each expense incurred relating to their business and any corresponding liability.  Seidel & Co. was also required to file monthly reports with the SEC summarizing information concerning its financial and operational status, including its current net capital position.

Beginning at least in or about late-2016, SEIDEL and MEKAWAY caused Seidel & Co. to maintain inaccurate books and records regarding its net capital position and to submit false reports to the SEC regarding Seidel & Co.'s net capital position.  In particular, in monthly reports filed with the SEC reflecting Seidel & Co.'s financial position for the months of October 2016 and November 2016, SEIDEL and MEKAWAY caused Seidel & Co. to falsely represent that it had the requisite net capital to meet its regulatory requirements for those months.  In fact, as SEIDEL and MEKAWAY well knew, the net capital of Seidel & Co. fell far below the requisite amount in both months.  Specifically, in its filings for month-end October 2016, Seidel & Co. fraudulently represented that its net capital exceeded the minimum amount by: (i) failing to account for a debt of approximately $104,000 that the firm owed to its landlord, and (ii) falsely inflating the balance of a Firm brokerage account, for which MEKAWAY submitted a forged bank statement to the external financial operations entity the Firm engaged to prepare and submit reports to the SEC.  Subsequently, in order to falsely represent that Seidel & Co. met its capital requirements in its filing for November 2016, Seidel & Co. falsely recorded as a capital contribution a $1 million loan that should have been recorded as a liability.

When, in December 2016, the SEC began to examine Seidel & Co.'s true net capital position, SEIDEL made false statements to the SEC's exam staff regarding the $1 million loan.  SEIDEL initially claimed on multiple occasions that the loan was a capital investment.  When the SEC sought verification of this assertion, SEIDEL acknowledged that the money was in fact a loan but claimed, falsely, that he believed it might be converted to a capital investment. 

Subsequently, in or about August 2018, MEKAWAY sought to obstruct an investigation by the SEC's Division of Enforcement into the misconduct at Seidel & Co. by failing to produce relevant documents and emails in response to a subpoena for records and falsely denying that he was in possession of Seidel & Co. records.

[B]ecause Claimant's tips appeared to contain potentially privileged information, the tips were referred to a privilege filter team (the "filter team"), which was completely separate from the Enforcement staff responsible for the Covered Action. In Redacted, the filter team had a call with Claimant in an effort to determine whether the information submitted by Claimant was privileged. Although the filter team redacted from the tips information it believed to be privileged, Enforcement staff responsible for the Covered Action determined not to review Claimant's tips, including in redacted form, because the investigation had been ongoing for a significant period of time and the staff did not want to risk compromising the investigation by reviewing potentially privileged information. The Enforcement staff also had no communication with Claimant.

Claimant's information did not cause the Commission staff to open the investigation, as it was opened 21 months before the Commission received any information from Claimant. Nor did Claimant's information significantly contribute to the success of the Covered Action as Enforcement staff responsible for the Covered Action determined not to review Claimant's tips out of concern that they contained potentially privileged information, and had no communications with Claimant before or during the investigation of the Covered Action.

First, Claimant contends that the staff attorney declarations supporting the Preliminary Determination are not sufficient because they "fail to provide an exhaustive representation that no one on the Redacted staff, including the taint team, used Claimant's information." We reject this argument and find that the staff declarations supporting the Preliminary Determination adequately demonstrate that the Covered Action investigative staff did not review or use Claimant's information in any way and had no communications with Claimant. We credit the sworn declaration from one of the primary Enforcement staff attorneys responsible for the investigation that she conferred with other staff on the investigation and no member of the staff responsible for the investigation reviewed any of the information that Claimant submitted or had any contact with Claimant. Further, supplemental declarations from Enforcement staff confirm and buttress the conclusion that Enforcement staff responsible for the Covered Action did not review or use Claimant's information in any way. The staff declarations demonstrate that it was the staff conducting the filter review-who were completely separate from the investigative staff responsible for the Covered Action-that interviewed Claimant in an effort to determine whether Claimant's information was privileged, and that the Enforcement staff on the investigation had no communications with either the filter team or Claimant. The Enforcement staff declarations further show that they did not learn of the Company's misconduct from Claimant, and none of Claimant's information was used to support the underlying charges in the Covered Action. Further, the record reflects that the filter team who reviewed Claimant's tips and who interviewed Claimant did not forward those tips to the Enforcement staff responsible for the Covered Action and did not relay the substance of their communications with Claimant to the Enforcement staff responsible for the Covered Action. 

Second, Claimant's surmise that staff disclosed Claimant's identity as a Commission whistleblower to the Company and then used that information to secure a more favorable settlement is contradicted by the record. As noted, the investigative staff responsible for the Covered Action never communicated with Claimant or accessed any of Claimant's information. Further, in a supplemental declaration, investigative staff confirmed that they did not disclose to the Company counsel directly, or indirectly, that Claimant was a Commission whistleblower or that Claimant had submitted tips to the Commission. Likewise, one of the filter team staff who interviewed Claimant also does not recall any contact with the Company or its counsel, and the documentary records of the filter team's work-which do not show any such contacts-further support this conclusion. As such, the fact that Claimant submitted tips to the Commission did not advance the staff's settlement negotiations with the Company or provide staff with any leverage in those settlement discussions. As reflected above, there is no evidence in the record that the Claimant's tips helped advance or were used in the investigation, including in the context of the staff's settlement discussions with the Company. And at no point during the settlement negotiations, did counsel for the Company indicate that it was willing to settle the case because of Claimant.

Since the late 1990s, telemarketers in Jamaica have been engaging in a scam in which they contact victims in the United States and falsely claim their targets have won large sweepstakes prizes.Victims, who are primarily elderly, are induced to send cash or cash equivalents in order to release their supposed prizes. The victims' funds are often transported by wire transfers and United States Postal Service packages.

Between 2014 and 2017, the defendants conspired together to receive wire transfers and packages mailed by victims. They then took a percentage of the funds for themselves before forwarding the remainder to co-conspirators in Jamaica. Multiple victims have been identified through wire transfer records and searches of the defendants' electronic devices.

Over the course of four years, 2010 to 2014, Credit Suisse offered its clients, which included broker-dealers and other institutional entities, some of whom were foreign unregistered entities, direct market access to numerous exchanges. The firm executed over 300 billion shares on behalf of its direct market access clients. During part of that time, certain of the firm's direct market access clients engaged in trading activity that generated over 50,000 alerts at FINRA and the Exchanges for potential manipulative trading, including spoofing, layering, wash sales and pre-arranged trading. Three of the firm's direct market access clients accounted for the majority of the 50,000 alerts for potentially manipulative activity. The same three clients at their peak accounted for about 20 percent of the firm's overall order flow.

FINRA and the Exchanges found that during most of the relevant time period, Credit Suisse did not establish a supervisory system, including written supervisory procedures, reasonably designed to monitor for potential spoofing, layering, wash sales and pre-arranged trading by its direct market access clients. As a result, orders for billions of shares entered the U.S. markets without being subjected to post-trade supervisory reviews for such potential manipulative activity. Moreover, Credit Suisse was put on notice of gaps in its surveillance system by correspondence with one of its direct market access clients and by an internal audit report.

In addition, Credit Suisse violated numerous provisions of the Market Access Rule, which requires broker-dealers that provide their customers access to an exchange or an alternative trading system to reasonably manage the financial and regulatory risks of providing such access. From 2011 to 2017, Credit Suisse violated the Market Access Rule's provisions related to the prevention of erroneous orders, the setting of credit limits and the firm's annual review of the effectiveness of its market access controls and supervisory procedures.

In this administrative proceeding, the Securities and Exchange Commission alleged that Respondents David Featherstone, David Leeman, and Thomas Rose sold securities in violation of the registration requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934. The parties agreed to a partial settlement which included findings of fact and a finding of liability on a no-admit, no-deny basis. I partially granted the Division of Enforcement's motion for summary disposition and found that Featherstone, Leeman, and Rose should pay disgorgement and prejudgment interest. This initial decision resolves the remaining issues. I conclude that Featherstone, Leeman, and Rose did not act with scienter, first-tier civil penalties are in public interest, and the disgorgement to be paid by Featherstone and Leeman but not Rose should be reduced due to a demonstrated inability to pay. 

David Featherstone: $60,380; 

David Leeman: $24,343.50; and

Thomas Rose: $297,360

Featherstone

Although Featherstone reported significant assets on his statement of financial condition, review of that document shows that his net assets are not as significant as they appear. ¹⁵¹ Since he submitted that statement, his income has decreased substantially and he has an additional adult dependent. Featherstone's income is now insufficient to cover his monthly expenses, and his long-term earning potential is low. 

I previously determined that Featherstone should disgorge $120,760. While I did not calculate prejudgment interest, it is likely to be significant- more than $13,000. Comparing this amount to Featherstone's current financial condition, he has established an inability to pay the entire amount. Turning to the second part of the inquiry, while the violations are serious,  Featherstone's conduct was not egregious. As discussed, he did not act with scienter. It is appropriate to credit his inability to pay. 

Because Featherstone's monthly cash flow is negative and not likely to increase in the future, and because of the economic challenges he faces resulting from the fact he must provide long-term, continuous care for two dependents, it is appropriate to discount his disgorgement amount. But because of the importance of Section 5 and Section 15, and because of the manner in which Respondents held themselves out as financial advisors and accepted and repeated Schantz's claims, I cannot waive the entire disgorgement amount. I will discount it by half, for a final disgorgement figure of $60,380, plus prejudgment interest. 

Leeman 

Leeman reported a net worth of about $240,000, most of which is equity in his home. His monthly household expenses exceed his monthly household income, and this income is likely to decrease in the future considering his significant medical condition and his and his wife's age. I previously determined that Leeman should disgorge $243,435, and prejudgment interest is likely to exceed $26,000. I find that Leeman has established an inability to pay. Leeman did not act with scienter, and his conduct was not otherwise egregious. I will credit his inability to pay. 

Leeman's financial condition is precarious and unlikely to improve in the future. Nevertheless, Leeman is not impecunious, and the seriousness of the violations and his behavior requires that some monetary sanction be imposed. Balancing these factors with Leeman's health, income, and expenses, I reduce  the disgorgement amount to $24,343.50, or 10% of the determined total, plus prejudgment interest.

Rose

Rose is the youngest of the Respondents and in the best financial condition. Although he reported that his expenses currently exceed his household income, he has the highest prospects for increasing income in the future. Rose owns two homes with a combined value of about $650,000, he and his wife have over $1,000,000 in total assets and about $320,000 in total liabilities. I previously determined that Rose should disgorge $297,360 and prejudgment interest is likely to exceed $31,000.159 Comparing this amount to Rose's financial condition, I find that he has not demonstrated an inability to pay. 

Although Rose reported negative monthly cash flow, his net worth is significant, and it appears likely that his household income will increase (or his expenses will decrease) in the future. He and his wife have not yet reached retirement age. For these reasons, I find that Rose can pay the amount of the disgorgement ordered, plus prejudgment interest. ¹⁶⁰ 

= = = = =

Footnote 151: In his May 2017 statement of financial condition, Featherstone declared that his net worth exceeded $1 million. Resp'ts' App. at 1012-13. His largest asset, however, was identified as the "Cash Surrender Value of Insurance." Id. at 1012. But in his explanation of assets, Featherstone stated that his insurance policies were "beneficial to [his] family as stated in the policy," and "[b]oth are term, not permanent life." Id. at 1013. Featherstone's next biggest asset is his home, but it is partially encumbered by a mortgage and is the home for two dependents who depend on him to provide constant care. Id. at 1012- 13. One of Featherstone's dependents is also the beneficiary of a trust that, in 2017, provided annual income of about $3,000. Id. at 1419-20.

. . .

Footnote 160: Cf. Robert L. Burns, Advisers Act Release No. 3260, 2011 WL 3407859, at *12 (Aug. 5, 2011) (holding that, where a respondent's net worth exceeded the total amount of disgorgement, penalties, and interest, the respondent had not shown an inability to pay).

In the parallel civil action, filed in June 2016, the SEC charged Connerton and his company, Safety Technologies LLC, with making false and misleading statements to investors about potential business deals and misappropriating investor fund for his personal use.  The victims of Connerton's alleged scheme included several women Connerton met through an online dating website.  When the SEC filed its case it stopped the ongoing fraud and froze Connerton's assets.  In early 2017, Connerton and Safety Technologies agreed to settle the SEC's charges and pay more than $1.89 million in disgorgement, interest, and civil penalties.  They also consented to a lifetime ban on participating in the issuance, purchase, offer, or sale of any security.

• Securities Industry Commentator
• Bill Singer