Securities Industry Commentator by Bill Singer Esq

Young professionals risk financial burnout as they weather their first big crisis (CNBC by Lorie Konish)

Petition for Rulemaking of Financial Services Institute, American Securities Association, Competitive Enterprise Institute, and New Civil Liberties Alliance, Petitioners (Petition for Rulemaking to End the Securities and Exchange Commission's Backdoor Regulation of 12b-1 Fees)

SEC Charges Husband and Wife in Insider Trading Scheme (SEC Release)

SEC Settles with Former Top Finance Executives of Oil and Gas Company (SEC Release)

SEC Obtains Final Judgments Against Defendants in Snack Company Investment Scam (SEC Release)

SEC Files Settled Charges Against Small Business Lender Related to Undisclosed Practices Concerning Asset-Backed Securitization (SEC Release)

FINRA Censures, Fines and Orders Restitution in Suitability Settlement (BrokeAndBroker.com Blog)

FINRA Imposes Fine and Suspension for Rep's Role With Minor League Soccer Team.

In the Matter of Michael B. Mountjoy, Respondent (FINRA AWC)

FINRA Imposes Fine and Suspension for Rep's Hiding of Study Materials in Testing Center Restroom 

In the Matter of Spencer Sullivant, Respondent (FINRA AWC2019064078501)

This petition is about the Securities and Exchange Commission's thirty-year effort to effectively outlaw Rule 12b-1 fees, and the concerted campaign of subregulatory sabotage upon which it embarked when it could not get its way through the proper channels. 

It is no secret that the Commission has long opposed Rule 12b-1 fees-the fees that mutual funds use to compensate financial advisers for ongoing sales and marketing assistance. The agency has tried to repeal or otherwise undo the Rule for the better part of a decade. See infra pp. 7-10. But the Rule remains important to the broader investment community, accounting for nearly $10 billion a year in economic activity. E.g., Mutual Fund Distribution Fees, Securities Act Release No. 9128, Exchange Act Release No. 62,544, Investment Company Act Release No. 29,367, 75 Fed. Reg. 47,064, 47,070 (Aug. 4, 2010). And the Commission has never been able to garner the political will needed to repeal it. So Rule 12b-1 is, and remains, the law. See 15 U.S.C. § 80a-12(b); 17 C.F.R. § 270.12b-1 (Rule 12b-1). 

On paper, that is. 

Although federal law requires agencies to conduct rulemaking in a transparent manner and to seek public input, agencies often overlook these mandates and impose their rulemaking through the backdoor. The Commission's actions here are a prime example of these practices. Having failed to repeal or seriously refashion Rule 12b-1 through conventional means, the Commission has turned to "guidance," coupled with "voluntary" self-reporting programs for those in violation of the "guidance," and punitive enforcement actions for those who refuse to turn themselves in. So with a few speeches, "initiatives," "frequently asked questions," and the like, the Commission has achieved what, through rulemaking, it could not-the effective repeal of Rule 12b-1. The law, however, does not countenance such guerilla governance.

Why does this matter? Yes, there are policy concerns. Rule 12b-1 helps funds to grow their asset base, lowering investors' average costs; it offers investors flexible payment options, and it helps to compensate intermediaries for valuable services. There is, in fact, abundant literature on the benefits of Rule 12b-1 that the Commission has ignored. See infra pp. 5-6. But more is at stake than policy. 

This is about the rule of law. In this country, there is law that governs the government. For good reason. Agencies like the Commission wield massive power. They promulgate binding regulations. And they bring enforcement actions against private citizens. But their leaders are not elected, nor are they fully accountable to anyone who is. So we at least demand that these agencies act in the open and in accordance with the law. People who will have to comply with a new rule can bring their knowledge and experience to the table in shaping and improving a proposed rule. Congress can monitor the agency's actions. And, most important, the people can see the rules for themselves-and try to comply-before the agency initiates an enforcement action. This is fundamental, and it is the policy of the current Administration: "Regulated parties must know in advance the rules by which the Federal Government will judge their actions." Executive Order No. 13,892, 84 Fed. Reg. 55,239, 55,239 (Oct. 15, 2019).

None of that has happened here. In its latest guidance documents, the Commission announced a brand-new, detailed disclosure regime that the agency had previously failed to discern in existing law, was never mentioned in any rule, and which, presumably, the entire investment adviser industry has been violating for decades. Worse still, the Commission has used its newly minted standards, not only to impose obligations going forward (without notice-and-comment), but also to retroactively punish scores of firms for conduct that no one knew, or even could have known, was supposedly unlawful. That is not how the rule of law works. 

The Commission's actions here go well beyond permissible "guidance." Its pronouncements do not merely "clarify or remind" investment advisers of their "preexisting duties." Mendoza v. Perez, 754 F.3d 1002, 1022 (D.C. Cir. 2014). Far from it. Here, the Commission's edicts "supplement" the existing regulatory regime "by imposing specific," newly minted "duties" on an entire industry, id.- duties that cannot fairly be traced to any "existing document," id. at 1021, and that are backed by the threat "of significant . . . civil penalties," Army Corps of Eng'rs v. Hawkes Co., 136 S. Ct. 1807, 1815 (2016). Accordingly, these pronouncements should have been promulgated through notice and comment, should have been transmitted to Congress for review, and should have been discussed with the Office of Information and Regulatory Affairs. And in no event should the Commission have attempted to apply the guidance retroactively. 

To correct these myriad errors, the Financial Services Institute, American Securities Association, Competitive Enterprise Institute, and New Civil Liberties Alliance petition the Commission to initiate a rulemaking to promulgate regulations to bring the Commission's guidance into compliance with applicable law. See 5 U.S.C. § 553(e); 17 C.F.R. § 201.192(a). Corrective rulemaking is imperative, as the Commission-in the words of its Co-Director of Enforcement-is "not resting on the success of" its misguided effort to regulate Rule 12b-1 fees out of existence; far from it, the Commission has just as improperly turned its attention to the longstanding, widespread, and previously uncontroversial practice of revenue sharing. Stephanie Avakian, Co-Director, Div. of Enforcement, U.S. SEC, What You Don't Know Can Hurt You: Keynote Remarks at the 2019 SEC Regulation Outside the United States Conference (Nov. 5, 2019), https://www.sec.gov/news/speech/speech-avakian-2019-11-05. This expanding effort to regulate without rulemaking must stop. The Commission should comply with its legal obligations and with the policy of this Administration-not open a new frontier. Indeed, if there were ever a time for the Commission to recommit itself to promoting regulatory certainty, this is it-a time when the financial services industry is fighting to regain its footing as the nation pulls itself out of the current crisis and gears up for the impending recovery

[H]ong and Jiang generated profits of approximately $8.5 million by trading in the securities of Sagent in advance of a July 11, 2016 announcement about the company's acquisition. The complaint alleges that the couple obtained confidential information about the acquisition directly or indirectly from a friend and neighbor whose company competed in the bidding process to acquire Sagent. According to the complaint, Hong and Jiang, who resided in California at the time of the trading but are now in China, attempted to evade detection by trading through accounts held in the names of relatives living in China. Between November 2015 and June 2016, these newly opened trading accounts amassed more than 1 million shares of Sagent stock. On multiple occasions, the defendants' purchases made up greater than 20% of the total trading volume in Sagent stock on that trading day, which they sold immediately following the acquisition announcement.

[F]rom 2012 through 2014, Penn West Petroleum, Ltd., now doing business as Obsidian Energy Ltd., improperly classified certain operating expenses as capital expenses in order to lower a key publicly reported metric concerning the cost of oil extraction and processing. As alleged, this fraudulent practice was not disclosed to the company's external auditor and caused the company's financial statements to be materially inaccurate. In September 2014, the company publicly reported that it would restate its financial statements from 2012 to the first quarter of 2014 and that its historical financial statements and related audit reports could no longer be relied upon. The company and Waldemar Grab, a former operations controller at Penn West, previously settled the Commission's fraud claims.

Lisa Bershan and Barry Schwartz, of California, and Joel Margulies, of Tennessee, falsely claimed that Starship Snack Corp. was developing and ready to mass produce its own caffeinated snack, and that investors would receive a one-to-one exchange of Starship shares for Monster or Coca-Cola shares after Starship was acquired by those companies. The SEC's complaint further alleged that Starship had no agreement with Monster Energy or Coca-Cola, and that Bershan and Schwartz used investor funds as their own personal piggy bank, spending them to rent and decorate a New York City apartment and on travel, meals, and other personal expenses.  Investors were defrauded out of more than $2.3 million.

securitization of a revolving pool of merchant cash advances and small business loans. The complaint alleges that CAN Capital disclosed to investors that it was required to maintain a minimum amount of receivables in the revolving pool, which included writing off delinquent accounts and replacing them with performing assets. According to the complaint, however, CAN Capital failed to disclose its practice of granting forbearance, known as grace days, to certain accounts unable to make loan payments. The complaint alleges that these accounts often remained as collateral for the securitization, even as they became non-performing. By November 2016, CAN Capital's collateral for the securitization allegedly contained millions of dollars of non-performing assets that should have been removed from the securitization, which resulted in losses to investors.

Beginning in April 2014 and continuing until November 2017, Mountjoy solicited investors, consisting of friends and business associates, to purchase interests in an LLC formed to invest in a minor league professional soccer team based in Louisville, Kentucky. He failed to provide the Firm with prior notice or obtain the Firm's advance approval. Mountjoy solicited a total of $378,000 in investments in the LLC from four individuals. Among other things, Mountjoy provided investors with the subscription agreement and other written materials and communicated with them verbally and by email to inform them about and encourage them to purchase interests in the LLC. Mountjoy did not receive any compensation for soliciting the investments, nor did he represent or otherwise suggest that the investments had been approved by the Firm. By virtue of the foregoing, Mountjoy violated NASD Rule 3040 and FINRA Rules 3280 and 2010. 

Mountjoy also failed to provide written notice to the Firm prior to engaging in two outside business activities. Beginning in 2013 and continuing until his termination from LPL in 2018, Mountjoy was a member and treasurer of an LLC that owned and leased real estate; and, also a co-owner and board member of another LLC that owned a fund created to promote foreign investments in Indiana and Kentucky. Mountjoy failed to disclose either outside business activity on his annual compliance questionnaires, despite a question asking him whether he had disclosed all outside business activities. By virtue of the foregoing, Mountjoy violated FINRA Rules 3270 and 2010. 

• Securities Industry Commentator
• Bill Singer