Securities Industry Commentator by Bill Singer Esq

September 22, 2021
Sometimes you break a rule that you didn't know existed. Sometimes you don't think you did anything wrong and it's not clear that you even broke a rule, but a regulator argues that you did and it's cheaper to just settle the case and pay a small fine than hire an expensive lawyer. Sometimes no matter what you do, it seems like you're going to get in trouble on Wall Street. A recent FINRA regulatory settlement alleges that a newbie rep engaged in an outside business activity without having first submitted prior, written notice to his firm. All of this while we were in the midst of the Covid pandemic. Which makes you wonder about FINRA's priorities and its agenda. Yeah, you're right, the rep agreed to the settlement, so, what the hell, why even raise a stink about it. Well, that's what our publisher Bill Singer does.
As set forth in part in the Treasury Press Release:

As part of the whole-of-government effort to counter ransomware, the U.S. Department of the Treasury today announced a set of actions focused on disrupting criminal networks and virtual currency exchanges responsible for laundering ransoms, encouraging improved cyber security across the private sector, and increasing incident and ransomware payment reporting to U.S. government agencies, including both Treasury and law enforcement. Treasury's actions today advance the United States government's broader counter-ransomware strategy, which emphasizes the need for a collaborative approach to counter ransomware attacks, including partnership between the public and private sector and close relationships with international partners.
. . .
Today's actions include the Department of the Treasury's Office of Foreign Assets Control's (OFAC) designation of SUEX OTC, S.R.O. (SUEX), a virtual currency exchange, for its part in facilitating financial transactions for ransomware actors. SUEX has facilitated transactions involving illicit proceeds from at least eight ransomware variants. Analysis of known SUEX transactions shows that over 40% of SUEX's known transaction history is associated with illicit actors. SUEX is being designated pursuant to Executive Order 13694, as amended, for providing material support to the threat posed by criminal ransomware actors.

Virtual currency exchanges such as SUEX are critical to the profitability of ransomware attacks, which help fund additional cybercriminal activity. Treasury will continue to disrupt and hold accountable these entities to reduce the incentive for cybercriminals to continue to conduct these attacks. This action is the first sanctions designation against a virtual currency exchange and was executed with assistance from the Federal Bureau of Investigation.
Jeffrey Jedlicki pled guilty in the United States District Court for the Middle District of Florida to conspiracy to commit wire fraud. As alleged in part in the DOJ Release:

[J]edlicki and his co-conspirators operated international boiler rooms in Panama and elsewhere that used high-pressure sales techniques to defraud individuals who invested substantial amounts of money in what they believed were regulated financial products or markets, such as options in commodities and stocks. The majority of the victims that the boiler rooms targeted were located in Canada, the United Kingdom, Australia, and New Zealand.

Jedlicki and his co-conspirators then transferred fraud proceeds generated by the boiler rooms through several money laundering rings, and then on to overseas accounts, with the launderers receiving a percentage of the funds they had moved. Jedlicki himself received a 2% referral fee for referring victims' funds to a money laundering ring.  Jedlicki used the funds to perpetuate the conspiracy, and for his own personal enrichment. In total, Jedlicki and his co-conspirators wired or caused to be wired approximately $3,244,592 (U.S. Dollars) in victims' funds to money laundering accounts in furtherance of the wire fraud conspiracy.
The United States District Court for the Southern District of New York entered final final judgment against Daniel B. Kamensky, whom the SEC had previously charged with abusing his position as co-chair of the unsecured creditors committee in the Neiman Marcus Group Ltd. LLC Chapter 11 bankruptcy proceedings. Kamensky was permanently enjoined against future violations of certain antifraud provisions of the federal securities laws; and the SEC barred him from appearing or practicing before the Commission. As alleged in part in the SEC Release:

[A]s co-chair of the unsecured creditors committee, Kamensky acted as a fiduciary to all unsecured creditors. The SEC's complaint further alleged that Kamensky sought to take advantage of his role on the committee to manipulate a bidding process to benefit the portfolio he managed, and at the expense of the unsecured creditors. According to the complaint, in his role as fund manager, Kamensky sought to purchase securities being distributed as part of the Neiman Marcus bankruptcy proceedings and coerced a competing bidder into withdrawing its bid, which was higher than Kamensky's own bid and would have led to a larger distribution to the unsecured creditors. When his actions came to light, Kamensky allegedly attempted to cover-up his misconduct by trying to persuade the other bidder not to describe Kamensky's conduct as a threat.

On February 3, 2021, Kamensky pleaded guilty to criminal conduct related to certain matters charged in the SEC's complaint. Kamensky was sentenced to six months imprisonment, six months supervised release, and ordered to pay a $55,000 criminal fine.

In the SEC's matter, Kamensky consented to the entry of a judgment permanently enjoining him from further violating the anti-fraud provisions of Section 17(a) of the Securities Act of 1933. Separately, the SEC instituted proceedings against Kamensky forthwith barring him from appearing or practicing before the SEC under Commission Rule of Practice 102(e). In addition, the SEC has also instituted proceedings against Kamensky to determine what other remedial sanctions may be appropriate.

As previously reported in the Securities Industry Commentator on May 10, 2021
After pleading guilty in the United States District Court for the Southern District of New York, Daniel Kamensky, former founder/manager of Marble Ridge Capital, was sentenced to six months of supervised release on home confinement and ordered to pay a fine of $55,000. As alleged in part in the DOJ Release:

DANIEL KAMENSKY was the principal of Marble Ridge, a hedge fund with assets under management of more than $1 billion that invested in securities in distressed situations, including bankruptcies.  Prior to opening Marble Ridge, KAMENSKY worked for many years as a bankruptcy attorney at a well-known international law firm, and as a distressed debt investor at prominent financial institutions.

The Neiman Marcus Bankruptcy

Neiman Marcus, an American chain of luxury department stores with stores located across the United States, filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the Southern District of Texas (the "Bankruptcy Court") in May 2020.  At the outset of the bankruptcy, Marble Ridge, through KAMENSKY, applied to be on the Official Committee of Unsecured Creditors (the "Committee") and was thereafter appointed to be a member of the Committee.  As a member of the Committee, KAMENSKY had a fiduciary duty to represent the interests of all unsecured creditors as a group.

During the bankruptcy process, the Committee had negotiated with the owners of Neiman Marcus to obtain certain securities, known as MyTheresa Series B Shares (the "MYT Securities"), and ultimately, the Committee was successful in coming to a settlement to obtain 140 million shares of MYT Securities for the benefit of certain unsecured creditors of the bankruptcy estate.  In July 2020, KAMENSKY was negotiating with the Committee for Marble Ridge to offer 20 cents per share to purchase MYT Securities from any unsecured creditor who preferred to receive cash, rather than MYT Securities, as part of that settlement.

Kamensky's Fraudulent Scheme 

On July 31, 2020, KAMENSKY learned that a diversified financial services company headquartered in New York, New York (the "Investment Bank"), had informed the Committee that it was interested in bidding a price between 30 and 40 cents per share - substantially higher than KAMENSKY's bid - to purchase the MYT Securities from any unsecured creditor who was interested in receiving cash.

That afternoon, KAMENSKY sent messages to a senior trader at the Investment Bank ("IB Employee-1") telling him not to place a bid, and followed those messages up with a phone call with IB Employee-1 and a senior analyst of the Investment Bank ("IB Employee-2," and collectively the "Employees").  During that call, KAMENSKY asserted that Marble Ridge should have the exclusive right to purchase MYT Securities, and he threatened to use his official role as co-chair of the Committee to prevent the Investment Bank from acquiring the MYT Securities.  KAMENSKY also stated that Marble Ridge had been a client of the Investment Bank in the past but that if the Investment Bank moved forward with its bid, then Marble Ridge would cease doing business with the Investment Bank.

The Investment Bank thereafter decided not to make a bid to purchase MYT Securities and informed the legal adviser to the Committee of its decision.  The Investment Bank further told the legal adviser it made that decision because KAMENSKY - a client of the Investment Bank - had asked them not to.

Advisers to the Committee informed counsel for Marble Ridge of their call with the Employees, and after speaking with KAMENSKY, counsel for Marble Ridge falsely informed the advisers that KAMENSKY had not asked the Employees not to bid, but instead had told them to place a bid only if they were serious.  Later that evening, KAMENSKY contacted IB Employee-1 and attempted to influence what IB Employee-1 would tell others, including the Committee and law enforcement, about KAMENSKY's attempt to block the Investment Bank's bid for the MYT Securities.  KAMENSKY said at the outset of the call, in substance, "this conversation never happened."  During the call, KAMENSKY asked IB Employee-1 to say falsely that IB Employee-1 had been mistaken and KAMENSKY had actually suggested that the Investment Bank bid only if it were serious, and made comments including the following:  "Do you understand . . . I can go to jail?"  "I pray you tell them that it was a huge misunderstanding, okay, and I'm going to invite you to bid and be part of the process."  "But I'm telling you . . . this is going to the U.S. Attorney's Office.  This is going to go to the court."  "[I]f you're going to continue to tell them what you just told me, I'm going to jail, okay?  Because they're going to say that I abused my position as a fiduciary, which I probably did, right?  Maybe I should go to jail.  But I'm asking you not to put me in jail."

During a subsequent interview with the Office of the United States Trustee, which was conducted under oath and in the presence of counsel, KAMENSKY stated that his calls to IB Employee-1 were a "terrible mistake" and "profound errors in lapses of judgment."

After this series of events, Marble Ridge resigned from the Committee and advised its investors that it intended to begin winding down operations and returning investor capital.

SEC Charges Crowdfunding Portal, Issuer, and Related Individuals for Fraudulent Offerings / Case is SEC's First Involving Regulation Crowdfunding (SEC Release)
In a Complaint filed in the United States District Court for the Eastern District of Michigan, the SEC charged  Robert Shumake, Nicole Birch Willard Jackson, and 420 Real Estate LLC with violating the antifraud and registration provisions of the Securities Act and Securities Exchange Act; and, further,  charged  registered funding portal TruCrowd and its Chief Executive Officer Vincent Petrescu with violating the crowdfunding rules of the Securities Act. As alleged in part in the SEC Releases:

[S]humake, alongside associates Nicole Birch and Willard Jackson, conducted fraudulent and unregistered crowdfunding offerings through two cannabis and hemp companies, Transatlantic Real Estate LLC and 420 Real Estate LLC.  Shumake, with assistance from Birch and Jackson, allegedly hid his involvement in the offerings from the public out of concern that his prior criminal conviction could deter prospective investors. The complaint alleges that Shumake and Birch raised $1,020,100 from retail investors through Transatlantic Real Estate, and Shumake and Jackson raised $888,180 through 420 Real Estate. Shumake, Birch, and Jackson allegedly diverted investor funds for personal use rather than using the funds for the purposes disclosed to investors. As alleged, TruCrowd Inc., a registered funding portal, and its CEO, Vincent Petrescu, hosted the Transatlantic Real Estate and 420 Real Estate offerings on TruCrowd's platform. Petrescu allegedly failed to address red flags including Shumake's criminal history and involvement in the crowdfunding offerings, and otherwise failed to reduce the risk of fraud to investors., one of Back to Green Mining LLC's two managing members, Manuel Portalatin offered to settle to permanent injunctions from future violations of the charged provisions and from participating in securities offerings not registered with the SEC, and to pay disgorgement of $605,462, plus prejudgment interest thereon in the amount of $64,312.25, and a civil penalty of $160,000. In addition to Portalatin, the Complaint charged Back to Green and managing member Jose Jimenez Cruz with violating the antifraud provisions of the federal securities laws, as well as with directly offering and selling securities in an unregistered offering. As alleged in part in the SEC Release:

[F]rom August 2016 until at least 2020, Back to Green, Jiménez, and Portalatin offered and sold to retail investors in Puerto Rico and at least five U.S. states the opportunity to share in the profits of a purported Colombian gold mining operation.  According to the SEC's complaint, the offering, which was not registered with the Commission, was part of a fraudulent scheme that raised approximately $2.7 million. Jiménez and Back to Green allegedly placed advertisements promising investors exorbitant returns and presented investors with materials that falsely stated that all permits necessary to mine in Colombia had been obtained. Subsequent to the provision of these materials, Portalatin allegedly signed contracts with investors when he knew that they had been misled.
In a Complaint filed in the United States District Court for the Western District of Texas, the SEC charged Leena Jaitley d/b/a Managed Option Trading and Options By Pros with violating the antifraud provisions of Section 17(a) of the Securities Act , Section 10(b) of the Securities Exchange Act  and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940; and further named as Relief Defendants: Taraben Patel and OTA LLC. As alleged in part in the SEC Release

[J]aitley operated two fraudulent websites called Managed Option Trading and OptionsbyPros. As alleged, clients would provide with the websites access to their on-line brokerage accounts and allow traders purportedly employed by the websites to trade options on their behalf, in return for a "start-up" fee and a percentage of the profit generated by those trades. The SEC alleges that to convince investors to subscribe for the services, Jaitley falsely claimed, among other things, that the websites used a unique, proprietary system designed to generate profits, had a long track record of successful investing, and employed scores of traders in New York with experience at large and reputable broker-dealers. Jaitley also allegedly solicited and published fake testimonials and positive reviews by supposed clients of the websites. According to the complaint, however, the only "traders" at the websites were Jaitley and, possibly, her now-deceased, 84-year-old father - neither of whom had any relevant education or experience or any unique, proprietary system for reliably producing trading profits from trading options. The SEC alleges that ultimately, the websites frequently lost all or most of the money in their clients' accounts, and when clients complained about the trading losses, Jaitley, using an alias and posing as a representative of the websites, often responded by email or text message to falsely disavow any responsibility and blame the client or someone else for her losing trades.
FINRA member firm and persons associated with firm appeal from a FINRA disciplinary proceeding finding that the firm was responsible for the unregistered sale of securities not subject to an exemption from registration in violation of Section 5 of the Securities Act of 1933; that the firm's owner engaged in conduct inconsistent with just and equitable principles of trade; and that the firm, its president, and its chief compliance officer failed to exercise reasonable supervision. FINRA imposed fines on the firm, the president, and the chief compliance officer, barred the owner from association with a member firm, and suspended the president and chief compliance officer from such association for two years. Held, FINRA's findings of violations and imposition of sanctions are set aside. 

By way of predicate for Scottsdale's appeal, the SEC Opinion offers this summary:

Scottsdale Capital Advisors Corporation ("Scottsdale"), John J. Hurry, Timothy B. DiBlasi, and D. Michael Cruz (together, "Applicants") appeal from a FINRA disciplinary action. FINRA found that (i) Scottsdale participated in the unregistered sale of securities not subject to an exemption from registration and thus violated Section 5 of the Securities Act of 1933 and FINRA Rule 2010; (ii) Hurry violated FINRA Rule 2010 by engaging in unethical conduct related to his creation, management, and control of a foreign broker-dealer; (iii) Scottsdale and DiBlasi violated NASD Rule 30101 and FINRA Rule 2010 by failing to establish and maintain supervisory systems, including written supervisory procedures ("WSPs"), that were reasonably designed to prevent the sale of unregistered, nonexempt securities; and (iv) Scottsdale and Cruz violated NASD Rule 3010 and FINRA Rule 2010 by failing to adequately supervise Scottsdale's due diligence process for accepting unregistered securities for deposit and sale. 

FINRA fined Scottsdale $1.5 million; barred Hurry from associating with any FINRA member firm in any capacity; and suspended DiBlasi and Cruz from associating with any FINRA member firm in any capacity for two years and fined them each $50,000. 

In shredding FINRA's case, the SEC notes, in part, that:

The NAC found that Scottsdale "violated FINRA Rule 2010 because the Firm acted in contravention of Section 5 of the Securities Act and sold millions of shares of unregistered microcap securities without the benefit of a registration exemption." Specifically, the NAC found that Scottsdale failed to establish either (1) that its customers' resales qualified for the Rule 144 safe harbor (and thus the exemption under Section 4(a)(1) of the Securities Act was available); or (2) that Scottsdale's facilitation of its customers' resales qualified for the exemption under Section 4(a)(4) of the Securities Act. In reaching this conclusion, however, the NAC failed to correctly state and apply the appropriate legal standards and thereby failed to "clearly explain the bases for its conclusions" in a manner that would allow us to "discharge properly our review function." Because of this, we are unable to discern whether FINRA has discharged its obligation of establishing a violation for which it can impose sanctions. Accordingly, we will set aside the Section 5 liability findings against Scottsdale and the resulting Rule 2010 violation.

at Pages 11 - 12 of the SEC Opinion:

Further, the SEC criticizes the poor legal reasoning and rationale underpinning FINRA's case [Ed: footnotes omitted]:

FINRA incorrectly applied the legal standards. We find the NAC incorrectly applied these legal standards. The NAC conflated the analysis under Section 4(a)(1) and Rule 144 with the analysis under Section 4(a)(4). The NAC stated that Scottsdale "failed to conduct a searching inquiry that is required under Rule 144 and Section 4(a)(4)" and that "as a consequence . . . the Firm is unable to satisfy its burden of proof for the more technical aspects of Rule 144." But contrary to what the NAC stated, whether the sales satisfied the "technical" requirements of Rule 144 did not depend on whether a broke-rdealer conducted a "searching inquiry." "The purpose of Rule 144 is to provide objective criteria for determining that the person selling securities to the public has not acquired the securities from the issuer for distribution." Contrary to the NAC's analysis, Scottsdale could have met its burden to establish an exemption from registration by showing that its customers' sales satisfied the Rule 144 safe harbor without regard to the inquiry required under Section 4(a)(4). 

In its brief, FINRA attempts to justify the NAC's conflation of the Rule 144 and Section 4(a)(4) standards by noting that Rule 144(f) and (g) reference Section 4(a)(4) and the reasonable inquiry requirement. But the NAC's decision did not reference subsections (f) and (g) of Rule 144. And Rule 144(f) and (g) are inapplicable to sales by non-affiliates of the issuer and the execution of customer orders in furtherance of those sales, respectively. Although the applicability of the Rule 144 exemption may depend on whether the broker-dealer after reasonable inquiry is aware of circumstances indicating that the selling customer's part of the transaction is not exempt from Section 5 of the Securities Act, this is the case only where the customers are affiliates. Scottsdale submitted evidence, such as the beneficial ownership declarations, that its customers were not affiliates. The NAC did not explain the relevance of the reasonable inquiry or searching inquiry requirement to the Rule 144 analysis in light of this evidence. Instead, the NAC appeared to hold that the lack of a searching inquiry by Scottsdale was itself sufficient to show that Scottsdale's customers were not non-affiliates of the issuers- again confusing the Rule 144 and Section 4(a)(4) analyses. 

We have recognized, citing Exchange Act Section 15A(h)(1), that FINRA's "determination to impose a disciplinary sanction must be supported by a statement setting forth, among other things, the violative act or practice engaged in by the member or person and the sanction imposed and the reason therefore." Accordingly, it is important that FINRA clearly explain the basis for its conclusions. If FINRA fails to do so, applicants are impaired in their ability to defend themselves before us. Here, Scottsdale could not be expected to defend itself before us against FINRA's finding that it violated Section 5 in light of the NAC's flawed articulation of the standards governing the Rule 144 and Section 4(a)(4) exemptions. 

As a result, we conclude that it is appropriate to set aside FINRA's finding that Scottsdale violated Securities Act Section 5. In doing so, we make no finding as to whether the sales at issue qualified for an exemption from registration. Rather, we find that due to the manner in which FINRA applied the governing legal standards it failed to discharge its duty to fairly and adequately explain the basis for the finding that Scottsdale committed a violation. So, to be clear, nothing about this case alters our view about the role broker-dealers should play in preventing unregistered distributions or the need to prevent recidivism. We have long made combating abuses in the microcap market one of our top priorities, and we will continue to do so. But, on this record, we simply cannot sustain FINRA's finding of liability.

at Pages 14 - 15 of the SEC Opinion

Also read:
As set forth in part in the FINRA podcast notes:

As part of FINRA's Member Supervision Transformation, each firm was assigned a Single Point of Accountability - a senior leader in Member Supervision that helps firms navigate their experience with FINRA. 

Now that we are nearly two years into the new structure, we are joined on this episode by two SPOAs - Andrew McElduff and Brian Kowalski - to give us insight into their roles, how they interface with member firms, and how their positions have evolved since the new structure took effect in 2020.