Securities Industry Commentator by Bill Singer Esq

February 7, 2020

Running on Empty: A Proposal to Fill the Gap Between Regulation and Decentralization (Speech by SEC Commissioner Commissioner Hester M. Peirce)

ABN AMRO Clearing Chicago Charged With Improper Handling of ADRs (SEC Release)

FINRA Imposes Censure and Fine on Two-Rep Firm for Supervisory Issues. In the Matter of FIMCO Securities Group, Inc., Respondent (FINRA AWC)

FINRA OHO Panel Grants Summary Disposition in Rule 8210 Matter. FINRA Department of Enforcement, Complainant, v. Robert Juan Escobio, Respondent (FINRA OHO Decision)

Running on Empty: A Proposal to Fill the Gap Between Regulation and Decentralization (Speech by SEC Commissioner Commissioner Hester M. Peirce)
SEC Commissioner Peirce offers her vision for moving the SEC's regulatory agenda from the 20th to the 21st Century with a thoughtful yet provocative proposal for creating a safe harbor for digital tokens. Clearly, Peirce believes that commercialization of crypto has been "stymied by concerns that such efforts may fall within the ambit of federal securities laws." In part, Peirce asserts that:

Getting into the specifics of the proposal, the safe harbor would provide network developers with a three-year grace period within which they could facilitate participation in and the development of a functional or decentralized network, exempted from the registration provisions of the federal securities laws, so long as the conditions are met.  This objective is accomplished by exempting (1) the offer and sale of tokens from the provisions of the Securities Act of 1933, other than the antifraud provisions, (2) the tokens from registration under the Securities Exchange Act of 1934, and (3) persons engaged in certain token transactions from the definitions of "exchange," "broker," and "dealer" under the 1934 Act. 

The initial development team would have to meet certain conditions, which I will lay out briefly before addressing several in more depth.  First, the team must intend for the network on which the token functions to reach network maturity-defined as either decentralization or token functionality-within three years of the date of the first token sale and undertake good faith and reasonable efforts to achieve that goal.  Second, the team would have to disclose key information on a freely accessible public website.  Third, the token must be offered and sold for the purpose of facilitating access to, participation on, or the development of the network.  Fourth, the team would have to undertake good faith and reasonable efforts to create liquidity for users.  Finally, the team would have to file a notice of reliance.
In a recent FINRA Arbitration, an associated person Claimant sued his former firm and lost. On appeal to the federal courts, Claimant argues that two of the three FINRA arbitrators were wrongly characterized as "Public Arbitrators," and they should not have been allowed to sit (or remain) on his hearing panel. Frankly, it looks like the facts are on Claimant's side. Ahh . . . but so much for appearances. In the end, it all comes down to a question of timing.
The SEC issued an Order finding that ABN AMRO Clearing Chicago LLC:
  • improperly borrowed pre-released American Depositary Receipts ("ADRs") from other brokers when the firm should have known that those brokers did not own the foreign shares needed to support those ADRs; and
  • failed reasonably to supervise its securities lending desk personnel concerning the borrowing of pre-released ADRs from said brokers.
Without admitting or denying the SEC's findings, ABN AMRO agreed to return more than $326,000 of ill-gotten gains and ti pay a $179,353 penalty plus $80,970 in prejudgment interest. The SEC release asserts that its ABN AMRO Order constitutes the 15th enforcement action against a bank or broker arising from its investigation into abusive ADR pre-release practices; and that the federal regulator charged four individuals for their roles in the improper handling of pre-released ADRs -- allegedly, $432 million in monetary remedies were ordered for said cases. As alleged in part in the SEC Release:

The SEC's investigations revealed that misconduct by numerous industry participants had the effect of introducing "phantom" ADRs into the marketplace. At times of high demand for ADRs, or when supply from traditional lending sources was limited, a number of brokers sought pre-released ADRs from intermediary brokers, who obtained them from depositary banks.  Many of the brokers seeking the ADRs could not represent that they owned the underlying foreign shares to support a pre-release, and so they used intermediaries, which, in turn, obtained pre-released ADRs under false pretenses, including by providing false certifications. The depositary banks that issued the pre-released ADRs and the brokers who took custody of them should have known that under the circumstances, it was highly unlikely that anyone in the chain of transactions actually owned the requisite underlying foreign shares. The pre-released ADRs that were not backed by ordinary shares were often inappropriately used for trading strategies such as dividend arbitrage or short selling, which could not have otherwise occurred.

For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, FIMCO Securities Group, Inc submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC alleges that FIMCO Securities Group, Inc has been a FINRA member firm since 1992 engaged in subscription-only mutual funds, and the firm employs two registered represenatives through one branch office. The AWC alleges that FIMCO Securities Group, Inc "does not have any disciplinary history with the Securities and Exchange Commission, any state securities regulators, FINRA, or any other self-regulatory organization." In accordance with the terms of the AWC, FINRA found that FIMCO Securities Group, Inc had violated NASD Rule 3012 and FINRA Rules 3120, 3130, and 2010; and the self regulator imposed upon the firm a Censure and $5,000 fine (the fine reflects the consideration, in part, of the firm's revenues, resources, and ability to pay). In part the AWC asserts that:

From 2010 through 2018, FIMCO did not conduct the supervisory testing and verification required by NASD Rule 3012 and FINRA Rules 3120, or prepare an annual report documenting the results. Moreover, for eight of the nine years during the Relevant Period, FIMCO failed to prepare an annual certification attesting that the Firm had processes in place to ensure that its supervisory systems and WSPs were reasonably designed to achieve compliance with the laws, rules and regulations governing its business and the activities of its registered representatives. In fact, FIMCO's CEO completed only one annual certification for the year 2012; however, that certification was deficient because the Firm did not prepare an annual supervisory report for review. 

Bill Singer's Comment:
Okay, sure, I get it. FIMCO's supervisory testing was non-compliant for eight years -- and, clearly, that's a long time. Moreover, for eight of those nine years, the firm didn't prepare the requisite annual certification. On the other hand, where the hell was FINRA for much of that last decade? How the hell does Wall Street's self-regulatory-organization not detect that one of its member firms hasn't filed an annual certification for eight years? As in annual. As in eight years. To some extent, this mess is as much on FINRA as FIMCO because if the former had been diligently supervising this small-firm, then maybe an examiner might have warned the firm that it had been deficient for the first or second year rather than piling on with eight years of failed supervision. Seems like there is a lot of deficiency to go around for both the regulated and the regulator. 

As set forth in the "Background" section of the OHO Decision [Ed: footnotes omitted]:

Escobio became associated with Southern Trust Securities, Inc. ("Southern Trust"), a FINRA-registered firm, in June 2000.On August 29, 2016, a federal court in Florida entered a judgment against Escobio in an action the CFTC brought against him for allegedly engaging in a fraudulent commodities scheme. On September 7, 2016, FINRA notified Southern Trust and Escobio in writing that Escobio was deemed statutorily disqualified as a result of that judgment.

On July 27, 2017, the National Adjudicatory Council ("NAC") denied a Membership Continuance Application ("MC-400") filed by Southern Trust to allow Escobio to continue to associate with the firm. Two days later, on July 29, FINRA filed a Uniform Disciplinary Action Reporting Form ("Form U6"), reporting that Escobio was "subject to a statutory disqualification." On August 7, 2017, Southern Trust filed its Uniform Termination Notice for Securities Industry Registration ("Form U5") for Escobio, which stated that Escobio's voluntary termination with the firm occurred on July 27, the day the NAC denied the firm's membership continuance application. Almost two years later, on June 28, 2019, Southern Trust filed an amended Form U5 for Escobio, changing his date of termination to June 30, 2017.

Page 2 of the OHO Decision

In March 2019, Enforcement began an investigation into Escobio's possible post-July-2017 affiliation with Southern Trust. Through June 6, 2019, Enforcement sent to Escobio five Rule 8210 requests for information and documents, to which he failed to produce responsive information/documents. Thereafter, Escobio refused to appear for on-the-record testimony despite five Rule 8210 demands for such. On July 17, 2019, Enforcement filed a Complaint that charged Escobio with failing to respond to the ten Rule 8210 demands for documents, information, and testimony, and he requested a hearing. 

On December 18, 2019, Enforcement moved the OHO Panel for summary disposition. In part, Escobio argued that Enforcement's investigation was illegitimate because it solely sought to aid the CFTC's efforts to collect on its judgment. In his Second Amended Answer, Escobio raised the argument that FINRA lacked jurisdiction because the Complaint had been filed more than two years after his retirement. In addressing his argument about the two-year jurisdictional horizon, the OHO Decision states, in part, that [Ed: footnotes omitted]:

But Escobio's jurisdictional arguments are erroneous as a matter of law. FINRA's jurisdiction over Escobio is based not upon when he ended his employment or association with Southern Trust, but when his registration was terminated. Escobio's FINRA registrations were terminated on July 28, 2017, the day after the NAC denied Southern Trust's MC-400 application. FINRA filed a Form U6 for Escobio on the next day, July 29, 2017, reporting that Escobio was statutorily disqualified and that his MC-400 application had been denied. Southern Trust filed a Form U5 for Escobio on August 7, 2017, specifying that Escobio's association with Southern Trust ended on July 27, 2017. 

The fact that, two years later, Southern Trust amended the Form U5 to change Escobio's termination date to June 30, 2017, is irrelevant. What matters is when FINRA ended his registration. As the SEC has stated, "[a] person who becomes registered remains registered until FINRA (not the registered person) ends the registration based, among other things, on the Forms U5 it receives." Because Escobio's FINRA registration was not terminated until July 28, 2017, and the Complaint was filed within two years of that date, FINRA has jurisdiction over this proceeding.

Pages 6 - 7 of the OHO Decision 

In rejecting the balance of Escobio's various assertions, the OHO Panel found that summary disposition was appropriate on both causes of the Complaint, and found that he had violated FINRA Rules 8210 and 2010. Accordingly, OHO imposed upon Escobio a Bar from associating with any member firm in any capacity. 
Bill Singer's Comment: Compliments to FINRA for publishing an articulate and compelling OHO Decision.