Securities Industry Commentator by Bill Singer Esq

SEC Slaps Generic, Non-Specific Whitewash Over Database Scandal (BrokeAndBroker.com Blog)

Former Mckinsey Partner Sentenced To 24 Months In Prison For Insider Trading Scheme / Defendant Puneet Dikshit Was a Lead McKinsey Partner Advising Goldman Sachs on Its Acquisition of GreenSky (DOJ Release)

SEC Proposes Rules for the Registration and Regulation of Security-Based Swap Execution Facilities

Statement on Rules Relating to Security-Based Swap Execution and Registration and Regulation of Security-Based Swap Execution Facilities by SEC Commissioner Caroline A. Crenshaw

FINRA Arbitrators Publish Impressive Rationale in Dismissal of Schwab Customer's Claims

James E. Novak, Claimant, v. Charles Schwab & Co., Inc., HFR Investment Advisory Services, and Herbert F. Reilly, III, Respondents (FINRA Arbitration Award)

FINRA Censures and Sanctions National Securities Corporation For Pre-IPO Private Placement Offering

In the Matter of National Securities Corporation, Respondent (FINRA AWC)

FINRA Bars Rep For Converting Checks from Senior Customers

In the Matter of Marianne O'Shee Smith, Respondent (FINRA AWC)

FINRA Sued in the Wrong Place At the Wrong Time (BrokeAndBroker.com Blog)

3Cir Considers Absolute Privilege For Alleged Form U5 Defamation (BrokeAndBroker.com Blog)

GreenSky was a publicly traded financial technology company that provided technology to banks and merchants to make loans to consumers for home improvement, solar, healthcare, and other purposes.  GreenSky's common stock traded under the symbol "GSKY" on the NASDAQ.

Between November 2019 and July 2020, and again between April 2021 and September 2021, Goldman Sachs, the investment bank, engaged McKinsey, the management consulting firm, to provide services related to the potential acquisition of GreenSky by Goldman Sachs and the post-acquisition integration of GreenSky.  DIKSHIT was one of the McKinsey partners leading these engagements.  In that role, he had access to material nonpublic information, which he misappropriated and, in violation of the duties that he owed to Goldman Sachs and McKinsey, used to trade GreenSky call options. 

DIKSHIT engaged in this trading between July 26 and September 15, 2021 - at the same time he was leading the McKinsey team that was advising Goldman Sachs about its potential acquisition of GreenSky.  At various times between July 26 and September 13, 2021, DIKSHIT purchased and sold relatively small numbers of GreenSky call options, which had expiration dates weeks or months from the time of purchase.  However, in the two days before the September 15, 2021, public announcement that Goldman Sachs would be acquiring GreenSky, DIKSHIT sold all of these longer-dated GreenSky call options and purchased approximately 2,500 out-of-the-money GreenSky call options that were due to expire just a few days later, on September 17, 2021.  After the deal to purchase GreenSky was announced on September 15, 2021, DIKSHIT sold these options and realized profits of approximately $450,000.

"This proposal would increase the transparency and integrity of the traditionally opaque over-the-counter security-based swap market, fulfilling a mandate under the Dodd-Frank Act of 2010 to register and regulate the platforms that trade these instruments," said SEC Chair Gary Gensler. "Among other things, today's proposal would create a framework for the registration of security-based swap execution facilities, based upon the 14 core principles for these entities spelled out in the Dodd-Frank Act. This framework would harmonize with the swap execution facility framework promulgated by our sibling agency, the Commodity Futures Trading Commission."

If adopted, today's proposal would implement the Exchange Act's trade execution requirement for security-based swaps and address the cross-border application of that requirement; implement Section 765 of the Dodd-Frank Act to mitigate conflicts of interest at SBSEFs and national securities exchanges that trade security-based swaps; and promote consistency between proposed Regulation SE and existing rules under the Exchange Act.

In developing this proposal, the Commission sought to harmonize as closely as practicable with parallel rules of the Commodity Futures Trading Commission (CFTC) that govern swap execution facilities (SEFs) and swap execution generally. The Commission seeks to obtain regulatory benefits comparable to those under the CFTC regime while minimizing costs imposed on SBSEFs and their members.

The Commission previously proposed rules regarding SBSEFs in three separate releases between 2010 and 2013. Given the length of time that has passed since they were issued and the significant market changes that have taken place in the interim, the Commission is withdrawing all previously proposed rules, rule amendments, and interpretations regarding SBSEFs.

Thank you, Chair Gensler, and thank you to my fellow Commissioners.

Over the last year, we have taken a number of important steps toward fulfilling the agency's Dodd-Frank mandate to establish a comprehensive regulatory framework for security-based swaps.  We took the final steps to implement our security-based swap entity registration and reporting rules, which should give the SEC improved oversight of, and visibility into, the security-based swap market.[1]  We re-proposed rules designed to prevent fraudulent, manipulative, and deceptive behavior in connection with security-based swaps, and we proposed new rules prohibiting undue influence over the Chief Compliance Officers of security-based swap dealers and major security-based swap participants, and requiring the disclosure of large security-based swap positions.[2]  We also proposed electronic recordkeeping requirements for security-based swap dealers and major security-based participants.[3] 

The security-based swap market was at the center of the events that precipitated the 2008 financial crisis, and it remains a multi-trillion dollar market. [4]  Its size, interconnected nature, and global reach means that events in that market have the potential to echo throughout the financial system.  I am pleased that the agency has made so much progress toward finalizing our Title VII framework, and I congratulate the staff on these significant accomplishments. 

Today, we are considering whether to propose rules that would create a regime for the registration and regulation of security-based swap execution facilities (SBSEFs).[5]  Among the proposed requirements are provisions addressing conflicts of interest involving SBSEFs and security-based swap exchanges, as required by Title VII of the Dodd-Frank Act.[6]

A guiding principle behind the proposal we are considering today is harmonization with the CFTC's regulatory regime for swap execution facilities (SEFs), which has been effective for a number of years.[7]  As noted in the release, most, if not all entities that we expect to register with the SEC will also be registered as SEFs with the CFTC.[8] Harmonizing with the CFTC to the extent possible, as proposed in the release, should help minimize the costs of compliance for those entities.

However, the security-based swap market is distinct from the swap market, including among other things, a swap that is based on a cash equity, a crypto/digital asset security, or a security option.  And I'll note that as I understand it, the term "crypto/digital asset security," as used in this proposal, has the same meaning as the term "digital asset security," which we have used in past publications, such as the Commission's 2020 statement on the custody of digital asset securities by special-purpose broker-dealers.[9]  Given that these are distinct markets, there may be instances where differences in the SEC's statutory authority or differences in the SBS market relative to the swap market may necessitate differences between the Commission's rules and the CFTC's. There may also be instances where the benefits of deviating from the CFTC's rules justify the costs associated with imposing different or additional requirements.  I hope commenters will share their views on whether the proposed approach goes too far, or not far enough, in harmonizing with the CFTC's regime.

One important aspect of the CFTC's regime that we are proposing to harmonize with is the use of the Legal Entity Identifier, or LEI, to identify execution facilities.  The LEI is a code that provides a single, unique, international identifier for legal entities.[10]  As such, it facilitates the reliable, consistent identification of entities within and across data sets - such as, for example, the data sets collected by the CFTC and SEC on swap execution facilities. I believe we should leverage the benefits of the LEI by incorporating it into our forms and filings wherever appropriate, and I'm glad that we are proposing to do so here.

Thanks as always to the staff for all of your hard work on this proposal, and your continued work to stand up the Title VII regime.  In particular, I want to join my colleagues in thanking the staff of the Division of Trading and Markets, the Division of Economic and Risk Analysis, and the Office of the General Counsel.  Today's proposal, if adopted, should bring improved transparency and oversight to the security-based swap market, and I am pleased to support it.

= = =

 

[1] See Commissioner Allison Herren Lee and Commissioner Caroline Crenshaw, Statement on the Registration Deadline for Security-Based Swap Dealers (November 1, 2021).

[2] See Prohibition Against Fraud, Manipulation, or Deception in Connection with Security-Based Swaps; Prohibition against Undue Influence over Chief Compliance Officers; Position Reporting of Large Security-Based Swap Positions, Release No. 34-93784 (December 15, 2021)

[3] See Electronic Recordkeeping Requirements for Broker-Dealers, Security-Based Swap Dealers, and Major Security-Based Swap Participants, Release No. 34-93614 (November 18, 2021).

[4] See Commissioner Caroline Crenshaw, Statement on Re-Proposed Prohibition Against Fraud, Manipulation, or Deception in Connection with Security-Based Swaps (December 15, 2021).

[5] See Rules Relating to Security-Based Swap Execution and Registration and Regulation of Security-Based Swap Execution Facilities, Release No. 34-94615 (April 6, 2022) (the "Release").

[6] Proposal at 1.

[7] Proposal at 14-15.  Most aspects of the CFTC's regime were adopted in 2013. See CFTC, Core Principles and Other Requirements for Swap Execution Facilities, 78 FR 33476 (June 4, 2013); CFTC, Process for a Designated Contract Market or Swap Execution Facility To Make a Swap Available to Trade, Swap Transaction Compliance and Implementation Schedule, and Trade Execution Requirement Under the Commodity Exchange Act, 78 FR 33606 (June 4, 2013).

[8] Proposal at 386.

[9] See Custody of Digital Assets by Special Purpose Broker-Dealers (December 23, 2020).

[10] See Commissioner Caroline Crenshaw, The Lessons of Structured Data (November 10, 2021).

The claim that Respondent Schwab negligently referred Respondents HFR and Herbert F. Reilly, III, and that they acted in breach of contract and unjustly enriched themselves, was denied by the Panel because Claimant failed to prove his allegations by a preponderance of the evidence. 

The sole allegation against Schwab was that it made a negligent referral of HFR from the Schwab Advisor Network ("SAN"). However, Claimant did not present evidence to satisfy the elements of a legally cognizable cause of action for negligence. In New York, the elements of a negligence case are: duty, breach of duty, causation, and damages. The evidence showed that the SAN referral of HFR was appropriate given Claimant's investment profile and his own requirements. Moreover, nearly twelve months elapsed between when Schwab introduced Claimant to and when he engaged their investment management services, and approximately 3 months after Claimant's attendance at a three-hour dinner hosted by HFR where it explained its investment philosophy. As such, Claimant's allegation that he was pressured by Schwab's representative to hire HFR fails. Furthermore, Claimant testified that from the commencement of his relationship with HFR on July 5, 2016 until January 31, 2018, the relationship was "uneventful". Claimant's case against Schwab rests on losses that occurred over a nine-day period (Jan 31- Feb 8, 2018) during the eighteen months HFR managed Claimant's two discretionary accounts. Notably, Schwab had no involvement in managing Claimant's HFR accounts pursuant to enforceable investment agreements Claimant made with all three Respondents, which Claimant testified he understood. Therefore, Claimant's testimony coupled with the documentary evidence supports a finding that no breach of duty occurred. Lastly, Claimant failed to establish that he realized any losses. Rather, the evidence revealed that Claimant's accounts managed by HFR were profitable overall and consistent with the terms of the SAN referral. Accordingly, Claimant's complaint against Schwab is denied. 

Claimant testified and the record supports that he is an experienced investor with an extensive business background, and prior to engaging HFR's services he managed his own portfolio. Yet on or about July 5, 2016, he entered into two enforceable HFR Investment Advisory Services Investment Management Agreement(s) (the "Agreement"). The Agreement identified Claimant's investment objectives as "growth" with a "30% downside risk" (up to 100% equities) chosen and managed at HFR's discretion. From the inception of the Agreement, the equities in Claimant's accounts reflected typical market fluctuations and on balance the accounts were profitable. Sometime in January 2018, Claimant became concerned about global events and testified he raised the possibility that he might want to convert both accounts to all cash, but the record is clear that he never directed HFR to do so- either directly or indirectly. Also, contrary to Claimant's assertion, HFR had no incentive not to convert Claimant's holdings to cash inasmuch as fees were based on the value of the account. Indeed, credible testimony indicated that two of HFR's 100+ customers did just that. Moreover, during said nine-day period, when Claimant alleges the breach occurred, the record indicates the market did decline, as did Claimant's HFR accounts, albeit by a smaller percentage than the downside risk Claimant accepted in the Agreement. Not only did the Agreement provide HFR with discretionary authority to manage the accounts according to its philosophy and policies of "prudent growth" it plainly stated that HFR does not engage in market timing. Claimant provided no facts or authority to support his theory that any decline in an investment account on any given day is a recoverable loss. Moreover, the record shows Claimant continued to hold many of the MFR positions after the relationship ended. Therefore, inter alia, the allegation that HFR breached the terms of the Agreement is without merit. Likewise, Claimant's allegation that HFR unjustly enriched itself by charging Claimant $5,254.00 in fees in 2017 is baseless for a myriad of reasons including (i) credible testimony and records showing that prior to January 31, 2018, he was satisfied with HFR's services; (ii) during the eighteen month relationship he had accepted periodic market volatility affecting the performance of his portfolio, and (iii) HFR refunded a prorated amount of the February 2018 fees collected in advance ($587.00). Consequently, both claims against HFR are dismissed.

In December 2017 and January 2018, NSC sold a "pre-IPO" private placement offering managed by its affiliated investment adviser. In connection with that offering, NSC deceived investors by offering interests in a private company ("Company A") at a price not to exceed $9.75 per share, even though the firm had failed to locate shares available at that price. The offering eventually purchased shares in Company A at more than double the maximum price listed in the offering documents. The firm's conduct contravened Section 17(a)(3) of the Securities Act of 1933. As a result, the firm violated FINRA Rule 2010. 

NSC also failed to reasonably enforce its written procedures concerning the offering of "pre-IPO" shares and failed to reasonably supervise the head of its private share business. As a result, the firm violated FINRA Rules 3110 and 2010.  

Between January 3 l, 2018, and February 27, 2021, three Cetera Advisors customers gave Smith ten checks totaling $45,100 made payable to a mutual fund company affiliated with the firm. The customers, all of whom were senior citizens, directed Smith to use the checks to fund their mutual fund investments. Smith instead used the customer checks, without their prior knowledge or consent, to purchase mutual fund shares for a family member of Smith. On each customer check, Smith wrote her .family member's mutual fund account number and the fund ticker symbol and sent the check to the mutual fund company to be credited to the family member's account. After discovery of Smith's misconduct, the customers were reimbursed in full. 

• Securities Industry Commentator
• Bill Singer