Senior Investors / FINRA Adopts Amendments to FINRA Rule 2165 / Effective Date: March 17, 2022 (FINRA Regulatory Notice 22-05 / February 15, 2022)L.A. Man Sentenced to 20 Years in Federal Prison for $650 Million Ponzi Scheme that Falsely Claimed to License Foreign Film Rights (DOJ Release)Arrest in California on Hawaii Indictment Charges Investment Fraud of Over $2 Million (DOJ Release)SEC Director Calls Awkward Football Audible During Wall Street Gamification Bowl (BrokeAndBroker.com Blog)
On June 5, 2019, the SEC adopted Form CRS and required SEC-registered investment advisers and SEC-registered broker-dealers to file their respective Forms CRS with the SEC, begin delivering them to prospective and new retail investors by June 30, 2020, and deliver them to existing retail investor clients or customers by July 30, 2020. The SEC also required firms to prominently post their current Form CRS on their website, if they had one. According to the SEC's orders, each of the firms charged today missed those regulatory deadlines. In addition, the orders find that certain firms failed to include information and language specifically required for Form CRS.The SEC's orders find that the investment advisers violated Section 204 of the Investment Advisers Act of 1940 and Advisers Act Rules 204-1 and 204-5, and that the broker-dealers violated Section 17(a)(1) of the Securities Exchange Act of 1934 and Exchange Act Rule 17a-14. Without admitting or denying the findings, each of the firms agreed to be censured, to cease and desist from violating the charged provisions, and to pay the following civil penalties:
- Arthur Zaske & Associates, LLC, a Bingham Farms, Michigan-based investment adviser, has agreed to pay a $15,000 civil penalty.
- Banyan Securities, LLC, a Greenbrae, California-based broker-dealer, has agreed to pay a $10,000 civil penalty.
- Church, Gregory, Adams Securities Corporation, a Decatur, Georgia-based broker‑dealer, has agreed to pay a $10,000 civil penalty.
- Gutt Financial Management, LLC, an Atlanta, Georgia-based investment adviser, has agreed to pay a $25,000 civil penalty.
- Hinsdale Associates, Inc., a Hinsdale, Illinois-based investment adviser, has agreed to pay a $25,000 civil penalty.
- J.K. Financial Services, Inc., a Norco, California-based broker-dealer, has agreed to pay a $10,000 civil penalty.
- N.V.N.G. Investments, Inc., a Kalamazoo, Michigan-based investment adviser, has agreed to pay a $15,000 civil penalty.
- Personal Financial Planning, Inc., a Deerfield, Illinois-based investment adviser, has agreed to pay a $25,000 civil penalty.
- Stone Run Capital, LLC, a New York, New York-based investment adviser, has agreed to pay a $25,000 civil penalty.
- The Winning Edge Financial Group, Inc., a Clifton, New Jersey-based broker-dealer, has agreed to pay a $10,000 civil penalty.
- Wall Street Access, a New York, New York-based broker-dealer, has agreed to pay a $97,523 civil penalty.
- Watermark Securities, Inc., a New York, New York-based broker-dealer, has agreed to pay a $25,000 civil penalty.On July 26, 2021, the SEC announced settlements with 27 other financial firms for similar failures to timely file and deliver their Forms CRS to their retail investors. https://www.sec.gov/news/press-release/2021-139. Three other investment advisers subsequently settled with the SEC in separate administrative proceedings: Disciplined Capital Management LLC; Lexicon Capital Management LP; and Newman Ladd Capital Advisors, LLC.
FINRA has adopted amendments to Rule 2165 (Financial Exploitation of Specified Adults) to permit member firms to: (1) place a hold on a securities transaction (in addition to the already-permitted hold on a disbursement of funds or securities) where there is a reasonable belief of financial exploitation; and (2) extend a temporary hold on a disbursement or transaction for an additional 30 business days, beyond the current maximum of 25 business days (for a total of 55 business days), if the member firm has reported the matter to a state regulator or agency, or a court of competent jurisdiction. The amendments to Rule 2165 become effective March 17, 2022.
[F]rom March 4, 2019 until today, BlockFi offered and sold BIAs to the public. Through BIAs, investors lent crypto assets to BlockFi in exchange for the company's promise to provide a variable monthly interest payment. The order finds that BIAs are securities under applicable law, and the company therefore was required to register its offers and sales of BIAs but failed to do so or to qualify for an exemption from SEC registration. Additionally, the order finds that BlockFi operated for more than 18 months as an unregistered investment company because it issued securities and also held more than 40 percent of its total assets, excluding cash, in investment securities, including loans of crypto assets to institutional borrowers.The order also finds that BlockFi made a false and misleading statement for more than two years on its website concerning the level of risk in its loan portfolio and lending activity.
A lot of securities lawyers will nod, "Yes, I saw this coming," in response to today's settlement with BlockFi Lending LLC ("BlockFi"). A company taking in crypto from a wide range of investors and promising returns could implicate the securities laws in several ways. Today's settlement tags that arrangement as both an investment contract under Howey and a note under Reves. On top of that, the settlement deems BlockFi an unregistered investment company. Lurking behind the legal analysis, however, is an important question: Is the approach we are taking with crypto lending the best way to protect crypto lending customers? I do not think it is, so I respectfully dissent.As an initial matter, it is difficult to understand how the civil penalty will protect investors. BlockFi will pay the SEC $50 million, and will pay another $50 million in connection with state settlements for the same conduct. While penalties this size are intended to deter bad conduct, here there is no allegation that BlockFi failed to pay its customers the money due them or failed to return the crypto lent to it. BlockFi's misrepresentations about over-collateralization are serious, but the combined $100 million penalty nevertheless seems disproportionate.The piece of the settlement aimed at getting important information to customers is more understandable from a retail protection standpoint. Customers who lend crypto assets to a company in exchange for a promised return should get the information they need to assess the risks against the rewards. A company offering crypto lending services could offer that information voluntarily as a way to gain and retain customers. For those companies that do not provide the information on their own, a self-regulatory or government regulatory framework might make sense. Securities law is one regulatory framework through which one could force transparency. This settlement seeks to do just that. The Order Instituting Proceedings states that BlockFi's parent company has announced that it "confidentially submitted a draft registration statement on Form S-1." If this registration statement becomes effective, it will afford BlockFi customers helpful transparency. But it is still worth asking whether a framework other than the securities regulatory framework might be better suited to getting customers transparency around the terms and risks of crypto lending products.Applying the securities regulatory framework has consequences, some of which may be unfortunate. Rather than forcing transparency around retail crypto lending products, today's settlement may stop them from being offered to retail customers in the United States. BlockFi will not be allowed to take in any additional crypto from retail investors until the company has registered a new crypto lending product on Form S-1. Getting an S-1 to the point where staff will declare it effective is often a months-long, iterative process. When crypto is at issue, the timeframe is likely to be longer than it would be for more traditional filings.Even assuming BlockFi perseveres and prevails in the S-1 registration process, before it can restart its lending program, it has to leap through another regulatory hoop-the Investment Company Act. The Commission has found that BlockFi operated as an unregistered investment company. Yet BlockFi cannot register as an investment company since it issues debt securities, and so it needs an exemption or exclusion from registration. The Order Instituting Proceedings also specifically discusses the market intermediary exclusion. If BlockFi seeks refuge in this rarely used exclusion, it has a challenging path to prove that it qualifies, particularly with the Commission staff's typical heightened scrutiny for crypto companies. The Commission's lack of experience with the market intermediary exclusion combined with the nature of BlockFi's business suggests that the sixty-day timeframe (even if extended an additional 30 days) allocated for BlockFi to "provid[e] the Commission staff with sufficient credible evidence that it is no longer required to be registered under the Investment Company Act" is extremely ambitious.More importantly, what ends does this Investment Company Act exercise serve? The Form S-1 already should satisfy the information disclosure objective at the heart of this settlement. Finding a way not to be subject to the Investment Company Act would not seem to serve an additional protective purpose. If the Commission believes that additional protections are needed to make up for not being covered by the Investment Company Act protections, then we could work with BlockFi under our Section 6(c) exemptive authority to craft a bespoke set of conditions that make sense in this context. The Section 6(c) process also lends itself better to public input, which seems appropriate given that today's settlement will reverberate beyond just the settling entity and will affect competing crypto lenders and their customers as well.We often tell companies wanting to offer products that could implicate the securities laws to "come in and talk to us." To make that invitation meaningful, however, we need to commit to working with these companies to craft sensible, timely, and achievable regulatory paths. Working with an earnest desire to reach a prudent, properly calibrated regulatory outcome is important for a number of reasons. First, these products matter to people. A program that allows people-and not just affluent people-to keep their crypto assets, while still earning a return is valuable to many Americans, as evidenced by the programs' popularity in the United States to date. The investor protection objective of today's settlement will be poorly served if retail investors are ultimately shut out from participation in these products. Second, our process speaks volumes about our integrity as a regulator. Inviting people to come in and talk to us only to drag them through a difficult, lengthy, unproductive, and labyrinthine regulatory process casts the Commission in a bad light and thus makes us a less effective regulator. Third, a company that tries to do the right thing should be met across the table by a regulator that tries to get to a sensible result in a reasonable timeframe. For the sake of the American public, our own reputation, and the companies that heed our call to come in and talk to us, we need to do better than we have so far at accommodating innovation through thoughtful use of the exemptive authority Congress gave us. SEC v. W. J. Howey Co., 328 U.S. 293 (1946). Reves v. Ernst & Young, 494 U.S. 56 (1990). BlockFi Lending LLC, Order Instituting Proceedings, ¶¶ 40, https://www.sec.gov/litigation/admin/2022/33-11029.pdf. BlockFi Lending LLC, Order Instituting Proceedings, ¶¶ 24-29. See Section 18 of the Investment Company Act of 1940, 15 U.S.C. § 80-18 (restricting registered investment companies from issuing "senior securities" which is defined to include "any bond, debenture, note, or similar obligation or instrument constituting a security and evidencing indebtedness"). See BlockFi Lending LLC, Order Instituting Proceedings, ¶¶ 38-39. Even if it did not issue debt securities, the assets the company holds include digital assets, which the Commission staff does not like to see in fund portfolios. See Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings (Jan. 18, 2018), https://www.sec.gov/divisions/investment/noaction/2018/cryptocurrency-011818.htm (identifying a series of questions under five broad topic headings and concluding that "[u]ntil the questions identified above can be addressed satisfactorily, we do not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products"). See also Staff Statement on Funds Registered under the Investment Company Act Investing in the Bitcoin Futures Market (May 11, 2021), https://www.sec.gov/news/public-statement/staff-statement-investing-bitcoin-futures-market (acknowledging the growth of the Bitcoin futures market and stating that the staff intends to "closely monitor" any mutual fund investments in Bitcoin futures). BlockFi Lending LLC, Order Instituting Proceedings, ¶ 43.b. Section 6(c) of the Investment Company Act, 15 U.S.C. § 80-6(c), provides that the Commission may conditionally or unconditionally exempt any person, security or transaction, or any class or classes of persons, securities or transactions, from any provision or provisions of the Investment Company Act, or any rule or regulation thereunder, if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Investment Company Act.
For more than five years, Horwitz raised millions of dollars from investors, many of whom were personal friends, based on false claims that their money would be used to acquire film distribution rights, which then would be profitably licensed to online platforms such as Netflix and HBO.But the whole business was a lie. In reality, Horwitz's company neither acquired film rights nor entered into any distribution agreements with HBO or Netflix. The purported copies of film licensing agreements and distribution agreements were fake.Instead of using the funds to acquire films and arrange distribution deals, Horwitz operated 1inMM Capital as a Ponzi scheme, using victims' money to repay earlier investors and to fund his own lavish lifestyle, including the purchase of his $6 million Beverlywood residence, luxury cars, and travel by private jet, according to the government's sentencing memorandum.Horwitz defrauded five major groups of private investors, but he knew these entities derived funds from individual investors. Throughout the scheme, Horwitz raised at least $650 million from more than 250 individuals who invested directly or indirectly in 1inMM Capital. By late 2019, 1inMM Capital began defaulting on all of its outstanding promissory notes. To date, Horwitz, through 1inMM Capital, remains in default to investors on a total outstanding principal of approximately $230 million and his scheme has caused substantial financial hardship to dozens of investors.Horwitz's scheme began in 2014 and lasted until the FBI arrested him in April 2021. During that time, Horwitz, through his company, 1inMM Capital, entered into hundreds of six- and 12-month promissory notes with investors. The funds supplied under each note were supposed to provide money for 1inMM Capital to acquire the rights to a specific film, and each note was supposed to be repaid using the profits from licensing those film rights to Netflix or HBO. The promissory notes guaranteed repayment on a specified maturity date, as well as the amount to be paid at maturity, which included investment returns ranging from 25 percent to 45 percent.To give investors a sense of security, Horwitz furnished them with purported film license agreements between 1inMM Capital and sales agents for production companies, as well as purported distribution agreements with Netflix and HBO.Investors started to complain after 1inMM Capital began defaulting on notes in 2019. In response, Horwitz falsely reassured investors that any missed payments on promissory notes were caused by the streaming platforms, and that payment on the notes would resume. To support these false excuses, Horwitz sent the investors fabricated emails and text messages using the identities of actual employees of HBO and Netflix.
[H]eidi Royal's employer was registered with the U.S. Securities and Exchange Commission as an investment adviser. The firm provided investment advice and financial services to C.K., an elderly widow suffering from dementia.As the firm's Accounting Manager and Bill-Pay Supervisor, Royal had access to C.K.'s Social Security Number and the usernames and passwords for C.K.'s investment accounts and bank accounts. As part of her duties and responsibilities at the firm, Royal provided professional accounting services and bill-pay services to C.K. for more than 10 years. During that time, Royal gained C.K.'s trust and developed a close personal friendship with her. Royal even told a co-worker at the firm that C.K. was like a grandmother to her.As a person associated with an investment adviser, Royal owed a fiduciary duty to each of the firm's clients, including C.K., and Royal was required to act in C.K.'s best interests at all times. Royal was not permitted to pay her own debts and expenses with C.K.'s money.From approximately June 1, 2010, through March 17, 2021, however, Royal misappropriated approximately $800,000 of C.K.'s money and converted it to her own use.As part of the scheme, Royal stole C.K.'s annuity payments, wrote more than 200 fraudulent checks on C.K.'s bank accounts, forged C.K.'s endorsement on checks, withdrew cash from C.K.'s bank accounts and converted it to her own use, fraudulently used the electronic bill-pay feature associated with C.K.'s bank accounts to divert money to herself, used PayPal to make electronic payments to herself from C.K.'s bank accounts, impersonated C.K. in telephone conversations with financial institutions; and made false and misleading entries in C.K.'s financial records to make the fraud harder to detect.In addition, Royal fraudulently used C.K.'s name and Social Security Number to open a secret bank account for the purpose of concealing and disguising the fraud proceeds.In mid-March 2021, when the firm learned that checks drawn on C.K.'s bank accounts had been deposited into Royal's personal accounts, the firm immediately terminated Royal and reported the matter to law enforcement.
[B]eginning by at least in or around July 2015, the defendants participated in an "advanced payment scheme." One or more of the defendants solicited upfront payments from victim-investors that would purportedly be used to generate much larger sums of money for the victim-investors after a short period. The upfront payments were not invested and had no reasonable possibility of generating the promised return. To perpetuate the scheme, the defendants falsely represented that they were wealthy financial professionals, and that Patterson and Hill owned a financial institution that was properly registered in Switzerland. At times, Patterson used a fictitious alias, "Xavier Carter" and spoke with a fake accent.The indictment further alleges that upfront payments were divided amongst the defendants and used to pay the defendants' personal expenses, such as credit card bills, rent, entertainment expenses, and other expenses, none of which were investments and had no potential to earn the returns promised to the investors. During the course of the conspiracy, the defendants collectively solicited over $2.5 million in upfront payments from investors, and only returned approximately $163,000, some of which was derived from the payments of other victim-investors.
FINRA Censures and Fines First Manhattan for SupervisionFeist was Interactive Brokers' AMLCO from July 2006 through August 2018. The firm's written supervisory procedures vested Feist, as AMLCO, with "full responsibility" for Interactive Brokers' AML program, including its day-to-day operations, and required him to review one of each of the firm's surveillance reports every month to ensure that analysts "handled [them] in accordance with [the firm's] procedures."From January 2013 through August 2018, while he was Interactive Brokers' AMLCO, Feist failed to implement and monitor the firm's AML program.Feist failed to meaningfully familiarize himself with the firm's AML program as it was being implemented on a day-to-day basis. Feist did not supervise the firm's AML analysts or their supervisors (over whom he had "dotted line" supervisory responsibilities). Nor did Feist take other steps to understand how the firm was implementing its AML program. He failed to regularly perform the monthly review of at least one of the firm's surveillance reports, as set forth in the firm's written supervisory procedures, and failed to develop an understanding of the firm's AML risk profile. Feist also did not assess whether the firm's AML analysts were reviewing the firm's AML surveillance reports on a timely basis and he did not evaluate the adequacy of the firm's surveillance reports. Additionally, he did not take steps to determine whether the firm's AML investigations were adequate. Moreover, Feist failed to monitor other AML compliance activities at the firm, such as due diligence and enhanced due diligence for foreign financial institutions.Additionally, while he was AMLCO, Feist learned about, but failed to recognize the import of, facts that should have alerted him that Interactive Brokers' AML program was not reasonably designed to detect and cause the reporting of suspicious activity or to comply with Bank Secrecy Act regulations. For example, Feist was aware that Interactive Brokers received wire deposits from unknown remitters (known at the film as "no-data wires") and recognized that such wires posed AML risks to the firm. Many of those wires, which totaled hundreds of millions of dollars during the period that Feist was the firm's AMLCO, originated from countries with a heightened risk of money laundering. Rather than treat those wires as third-party wires and subject them to monitoring and review, Interactive Brokers chose to treat them as first-party wires, and firm analysts did not review, or contact customers to determine the origin of, no-data wires. Feist took no steps to investigate or address the firm's review of no-data wires for AML purposes.Finally, as AMLCO, it was Feist's responsibility to decide whether Interactive Brokers would file a Suspicious Activity Report (SAR). However, Feist incorrectly believed that the firm did not need to file a SAR concerning suspicious activity the firm first learned about from regulators or law enforcement agencies investigating that same conduct. From February 2014 to March 2016, for example, the firm filed only 3 SARs in response to 37 regulatory inquiries by FINRA and the SEC.
First Manhattan's written supervisory procedures (WSPs) were not reasonably designed to avoid becoming a participant in the potential unregistered distribution of securities. Although the firm's WSPs mentioned control or restricted securities and the use of the safe harbor set forth in Securities Act Rule 144 (17 C.F.R. § 230.144), they did not include procedures regarding how to conduct a searching inquiry to determine whether a transaction complied with the registration requirements of Section 5. Instead, First Manhattan's WSPs only stated that Principal A should be consulted for assistance. Moreover, even though the firm, in practice, used a "pre-clearance form" in connection with its Section 5 reviews, the WSPs failed to even mention the pre-clearance form.First Manhattan's system for compliance with Section 5 relied entirely on a pre-clearance form, which representatives at the firm were required to complete "prior to the deposit or sale/transfer" of microcap shares. The pre-clearance form required the representative to provide certain information relevant to making a determination pursuant to Rule 144. The pre-clearance form, however, did not provide any guidance about what documentation the representative should review prior to the deposit or sale of any microcap security to verify the information set forth on the pre-clearance form. First Manhattan also did not have any process for ensuring that representatives completed the pre-clearance form, and as a result, from January 2012 through May 2020, First Manhattan accepted deposits of microcap securities without first having received a completed pre-clearance form from the customer's registered representative.For example, from May 2015 through May 2020, Customer A made 55 deposits of microcap securities, many of which involved issuers that had recently changed their names and lines of business. Frequently, Customer A deposited physical share certificates, sold the shares within days or weeks, and then immediately wired out the proceeds. Those red flags notwithstanding, First Manhattan accepted 25 of Customer A's 55 deposits even though no pre-clearance form had been completed and, therefore, the firm had no information to determine whether the securities were registered or exempt from registration. With respect to the remaining 30 deposits, although Principal A ostensibly submitted a pre-clearance form for each of those deposits to the firm, those forms were incomplete, lacking, among other things, specific details about Customer A's acquisition of the shares and Customer A's relationship, if any, to the issuer. The firm therefore lacked sufficient information to determine whether the transactions complied with Section 5.3Therefore, Respondent violated FINRA Rules 3110 and 2010.. . .First Manhattan's AML procedures did not provide guidance about how to identify or address red flags of suspicious trading in microcap securities. The procedures did not include a list of red flags identified in NTM 02-21 or RN 19-18 that was tailored to fit First Manhattan's business. The firm's procedures also failed to require that the firm monitor, for AML purposes, information collected during the firm's pre-clearance process for microcap securities. Therefore, even when customers deposited and quickly liquidated and wired out the proceeds of microcap securities, activity identified as a red flag in RN 19-18, the firm's procedures did not require the firm to review those transactions for potential BSA reporting.Additionally, First Manhattan did not have a reasonable system to identify suspicious trading in microcap securities. The firm's exclusive method for doing so was through the use of an exception report that only surveilled transactions of 50 million shares or more. As nearly all of the firm's customers' microcap activity involved fewer than 50 million shares per transaction, this exception report was not tailored to the firm's business. As a result, on more than 150 occasions during the relevant period, a small number of firm customers deposited fewer than 50 million shares of microcap securities, liquidated some or all of the securities, and withdrew the funds shortly thereafter-without the firm detecting or investigating that activity.As noted in the prior section, Customer A deposited large blocks of microcap securities (but never 50 million shares or more) on 55 separate occasions from May 2015 through May 2020. Often, Customer A liquidated the position shortly after deposit and then wired out the proceeds. Many of Customer A's transactions raised other red flags of money laundering or market manipulation, such as involving issuers with limited or no revenues or frequent name or business line changes. Moreover, on many occasions, Customer A's transactions comprised a significant proportion (or all) of the daily trading volume in the security, and, often, Customer A's sales were the initial public sales of the security. Because of the 50-million-share threshold for the firm's microcap trading exception report, Customer A's activity never appeared on the report and thus was never investigated by the firm as suspicious.5Therefore, First Manhattan violated FINRA Rules 3310(a) and 2010.= = = = =Footnote 5: First Manhattan has changed its AML policies and procedures since terminating Principal A's employment in May2020.