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Securities Industry Commentator by Bill Singer Esq

August 29, 2022









https://www.brokeandbroker.com/6636/kovack-securities-finra/
Something does not seem right here. There is a gap between when FINRA knew or should have known of compliance deficiencies at one of its member firms and when FINRA settled its charges via an August 2022 AWC. Was FINRA's investigation influenced by its awareness that an executive from that firm sat on its Board of Governors? We don't know. We should. Ultimately, that's the most troubling issue: FINRA's lack of TRANSPARENCY. 

California Man Arrested for $7 Million Securities Fraud (DOJ Release)
https://www.justice.gov/usao-ma/pr/california-man-arrested-7-million-securities-fraud
In a Complaint filed in the united States District Court for the District of Massachusetts, Joseph A. Padilla, 53, was charged with one count of securities fraud. As alleged in part in the DOJ Release:

[P]adilla is a one-time stockbroker who was barred from the securities industry in 2012 by the U.S. Securities and Exchange Commission. It is alleged that, between February and April 2021, Padilla participated in a sophisticated and lucrative pump-and-dump fraud scheme involving the shares of Charlestowne Premium Beverages Inc., a thinly-traded microcap company that traded under the stock ticker symbol FPWM. As part of the scheme, Padilla is alleged to have orchestrated the fraudulent inflation (or "pump") of Charlestowne's stock price using his brokerage account and the accounts of several other individuals. He then allegedly facilitated the sale (or "dump") of millions of Charlestowne's shares at pumped up prices to unsuspecting investors in Massachusetts and throughout the United States.

https://www.justice.gov/usao-sdfl/pr/caretaker-senior-couple-sentenced-stealing-hundreds-thousands-elderly-couple-s-bank
Sherri Lynn Smith, 52, pled guilty in the United States District Court for the Southern District of Florida to bank fraud and aggravated identity theft, and she was sentenced to 51 months in prison plus four years of supervised release and ordered to pay $168,895.92 in restitution and a $288,865.92 forfeiture. As alleged in the DOJ Release:

From 2016 to 2019, Smith worked as a caretaker for an elderly couple in Broward County.  As part of her duties, Smith had access to the victims' bank accounts to assist them with paying their monthly bills.  Smith used her access to the victims' finances to embezzle approximately $300,000 out of the victims' accounts without their knowledge or consent.  She accomplished this by writing and forging the victim's signature on checks made payable to herself, her family members, and her creditors; initiating Zelle electronic money transfers from the victims' accounts to her own bank account; and making electronic payments from the victims' accounts to her and her husband's numerous credit card accounts.

https://www.justice.gov/usao-edny/pr/latvian-individual-extradited-securities-fraud-and-wire-fraud-cryptocurrency-scheme
In an Indictment filed in the United States District Court for the Eastern District of New York, Ivars Auzins was charged with wire fraud, securities fraud, and conspiracies to commit wire fraud and securities fraud in connection with the operation of eight companies that purported to offer, invest in or mine digital assets. As alleged in part in the DOJ Release:

[A]uzins, using aliases to conceal his identity, operated a series of entities the "Auzins Entities" that advertised through email campaigns, social media and websites dedicated to cryptocurrencies.  The Auzins Entities purported to offer valuable investment opportunities, solicited investments and then effectively disappeared.  Some of the Auzins Entities - Denaro and Bitroad Limited - purported to raise funds from investors through initial coin offerings (ICOs).  Other Auzins Entities - Impressio Estate Ltd., Broi Investments Ltd., also known as Bankroi, ChangePro Pty Ltd., Gemneon Investments Limited and Lycovest Ltd. - purported to be cryptocurrency investment platforms that provided investors with different investment plans and profit rates.  Another Auzins Entity - Innovamine - purported to offer investments in mining a number of cryptocurrencies, including Bitcoin and Ether.

As alleged, Auzins and co-conspirators induced investors to invest in the Auzins Entities through a series of material misrepresentations and omissions about the products and services that the Auzins Entities claimed to provide, the profits that investors would earn by investing in the Auzins Entities and the individuals who operated the Auzins Entities.  For example, in its marketing materials, Denaro stated that its Chief Executive Officer, "Ron Ramsey," previously was an executive at a technology company based in Ohio, its Chief Financial Officer, "Jeremy Boker," obtained a degree from a university in Kentucky, and that it issued debit cards associated with a credit card company based in New York.  These representations were false.  After soliciting investors in its ICO, Denaro stopped its public advertising campaign, its website became publicly inaccessible, and its investors lost their investments.

Between approximately November 2017 and July 2019, individuals in the United States and elsewhere transferred at least $7 million in digital assets to the Auzins Entities.  Shortly after receiving these investments, the Auzins Entities disappeared without providing their promised services. 

[C]oncluding that "the evidence demonstrated that defendants abused their 'gatekeeper' role," the District Court also ordered injunctive relief as to Island Stock Transfer and the two individuals, and imposed penny stock bars against Spartan Securities, Dilley and Eldred, prohibiting them from participating in the issuance, trading, offer or sale of a penny stock.

In July 2021, after a three week trial, a jury returned a unanimous verdict finding Spartan Securities, Island Stock Transfer, Dilley and Eldred liable for fraud by violating Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), and Rule 10b-5(b) thereunder. Evidence at trial showed that Spartan Securities, Dilley and Eldred, made misrepresentations and omissions in the filing of 15c2-11 applications and submissions with Financial Industry Regulatory Authority (FINRA) to publicly list the companies' common stock and ultimately enable the shares to become free-trading and available to public investors. The evidence also showed that Island Stock Transfer and Dilley, its President, made misrepresentations and omissions regarding the designation of the securities as free trading and when effectuating the bulk issuance and transfer of securities, including stock certificates without restrictive legends. The evidence also revealed that Spartan Securities, Island Stock Transfer and Dilley initiated and provided false information for applications filed with the Depository Trust Company (DTC), including misrepresenting the shell status of issuers.

The relief awarded against defendants was decided by the District Court after a two-day evidentiary hearing on July 20-21. The Court ordered permanent injunctive relief against Island Stock Transfer, and 5-year injunctions against Dilley and Eldred. The Court declined to order injunctive relief against Spartan Securities because it was defunct and faced a substantial capitalization barrier. However, the Court imposed a permanent penny stock bar against Spartan Securities and 10-year penny stock bars against Dilley and Eldred. As for monetary relief, the court imposed civil money penalties in the amount of $250,000 each for Spartan Securities and Island Stock Transfer, $150,000 each against Dilley and Eldred, and ordered Island Stock Transfer to pay disgorgement and prejudgment interest in the amount of $154,394.05.

https://www.sec.gov/news/press-release/2022-151
The SEC adopted two amendments to its whistleblower program rules
https://www.sec.gov/rules/final/2022/34-95620.pdf; and, as asserted in part in the SEC Release:

Specifically, the SEC amended Rule 21F-3 to allow the Commission to pay whistleblower awards for certain actions brought by other entities, including designated federal agencies, in cases where those awards might otherwise be paid under the other entity's whistleblower program. The amendments allow for such awards when the other entity's program is not comparable to the Commission's own program or if the maximum award that the Commission could pay on the related action would not exceed $5 million.

Further, the amendments affirm the Commission's authority under Rule 21F-6 to consider the dollar amount of a potential award for the limited purpose of increasing the award amount, and it would eliminate the Commission's authority to consider the dollar amount of a potential award for the purpose of decreasing an award.

On the Consequences of an Inconsequential Rulemaking: Statement Regarding Amendments to Whistleblower Program Rules by SEC Commissioner Hester M. Peirce (SEC Release)
https://www.sec.gov/news/statement/peirce-statement-whistleblower-program-082622

I did not support the proposal to amend the Commission's whistleblower rules, and cannot support the amendments adopted today.[1] The Commission's whistleblower program is successful, increasingly so in recent years.[2] Today's amendments, although themselves inconsequential and unlikely to inhibit that success, nonetheless carry harmful consequences both for the whistleblower program and for the Commission's rulemaking processes.

Inconsequential Amendments

The amendments adopted today closely track those proposed in February, and continue to be solutions in search of a problem. Indeed, the adopting release indicates that the Rule 21F-3(b)(3) amendments adopted today are inconsequential. According to the economic analysis, if this amended version of Rule 21F-3(b)(3)-the "Multiple-Recovery Rule"-had been in effect since July 2010, "it would have resulted in an additional total payout [to whistleblowers] of less than $10.5 million."[3] The Commission's whistleblower program has paid out more than $1.1 billion since 2010.[4] A 1% increase in the total payouts is not much of an "additional incentive[] to encourage individuals to report potential violations of the federal securities laws."[5] Granted, past awards are not perfectly predictive, but the adopting release provides no data or analysis to indicate that future related action awards will be different in type or amount from past awards. Instead, the release cites to "economic literature" of no apparent relevance that leads the Commission "to believe that changes such as these that increase whistleblowing incentives should have a positive effect on the frequency of whistleblowing activity."[6]

The adopting release is equally unconvincing when it comes to explaining why we needed to amend Rule 21F-6(d). The amendment "cabin[s] the Commission's use of its statutory authority to consider the dollar amount of an award when setting an award" by "restrict[ing] the Commission from considering the dollar amount of a potential award . . . to decrease a potential award." The adopting release includes precisely one sentence stating the Commission's rationale for disavowing a substantial portion of its statutory authority to set appropriate award amounts: "For the reasons set forth in the proposing release and supported by the comments received on this proposal, this amendment will help strengthen the whistleblower program by encouraging high-quality tips from insiders and others who have original information relating to potential securities law violations."[7] This confident and conclusory assertion coexists rather uneasily with the economic analysis, which admits that the Commission "cannot determine with any reasonable degree of certainty if the revisions to Rule 21F-6 will affect a whistleblower's willingness to report a potential securities law violation."[8] In any event, the Commission's disavowal of authority that it never used is inconsequential to whether whistleblowers will or will not continue to submit tips.[9] This conclusion coexists rather easily with the fact that the Commission received more tips the year the 2020 rule amendments were in effect than it received in any other year.[10]

Harmful Consequences

Although the changes to the rules are inconsequential because they are not logical solutions to any existing problems, they nonetheless further complicate the already byzantine rules governing our whistleblower program. The amendments to Rule 21F-3(b)(3) are particularly troubling because they introduce a needlessly complex analysis that rests on poorly defined terms. The key term, "comparable whistleblower award program," includes four criteria, two of which are reasonably clear.[11] The two unclear criteria relate to the award potentially available from the non-Commission award program. Specifically, Rule 21F-3(b)(iv)(A)(2) states that a comparable whistleblower award program must not "have an award range . . . that is meaningfully lower (when assessed against the maximum and minimum potential awards that program would allow) than the award range that the Commission's program could yield (i.e., 10 to 30 percent of collected monetary sanctions)." Rule 21F-3(b)(iv)(A)(3) states that a comparable award program must "not have a cap that could operate in a particular action to yield an award for a claimant that is meaningfully lower than the maximum award the Commission could grant for the action (i.e., 30 percent of collected monetary sanctions)." The latter appears to be a subset of the former-a statutory cap that is "meaningfully lower" than the 30% the Commission is authorized to award necessarily sets an "award range" that is "meaningfully lower" than the 10-30% the Commission is authorized to award. If the second prong is not a subset of the first, then what does it mean? Redundant criteria complicate an already overly complicated rule.

Further confounding the analysis of what constitutes a "comparable whistleblower award program" is the ambiguity that the release introduces around whether the "award range" or "award" is "meaningfully lower." The most natural reading of the rule text ties the inquiry to the terms of the relevant statute-a comparable whistleblower award program is "meaningfully lower" when the award amounts available under the governing statute are meaningfully less than what the Commission's program would pay out. Yet the discussion in the adopting release seems inconsistent with this straightforward reading of the rule. The release instead states that "meaningfully lower" is a "flexible standard" under which a "whistleblower might argue that the Commission should consider the particular whistleblower's own economic situation at the time that the individual reported the securities-law violation."[12] Tethering the question of what constitutes a "meaningfully lower" award to the whistleblower's individual circumstances transforms what could be a reasonably objective analysis into a purely subjective assessment of each claimant's personal facts and circumstances. While this result may end up working in favor of whistleblowers with legal representation to assist them in crafting the most effective narrative, whistleblowers who valiantly try to navigate our rule-maze on their own will not fare so well.

Finally, today's adoption of the whistleblower rule is yet another installment in the Commission's rule rewriting series. The whistleblower rules join the proxy advisor rules, shareholder proposal rules, and perhaps the resource extraction rules in being reopened even though the ink was barely dry on the last set of amendments.

Despite my concerns about the substance and process of the course the Commission has chosen, I am grateful to the staff in the Office of Whistleblower, Office of General Counsel, and Division of Economic and Risk Analysis for their work on this rulemaking and their unflagging commitment to rewarding whistleblowers for their valuable contributions to the integrity of the securities markets.

[1] Statement on Proposal to Revisit Recently Adopted Rule Amendments, https://www.sec.gov/news/statement/peirce-statement-adopted-whistleblower-rule-amendments-021022. I do not object to the technical amendments to Rule 21F-4(c) and Rule 21F-8(e).

[2] Whistleblower Program Rules, Rel No. 34-95620, at 29-30 ("Adopting Release"), available at https://www.sec.gov/rules/final/2022/34-95620.pdf. As I noted in my dissenting statement when these amendments were proposed, supra n.1, the whistleblower program had its most successful year ever, as measured by number of tips, claims, and total payouts, while the rules now being revised were in effect.

[3] Adopting Release at 33.

[4] Whistleblower Program: 2021 Annual Report to Congress, 1-2 and 10-12 (2021), https://www.sec.gov/files/2021_OW_AR_508.pdf.

[5] Adopting Release at 14-15.

[6] Id. at 33.

[7] Id. at 25-26.

[8] Id. at 35.

[9] See The Commission's Whistleblower Program Rules, Rel. No. 34-94212, 87 Fed. Reg. 9280, 9290 (Feb. 18, 2022) (noting that the Commission historically only considered dollar amounts to increase awards and had "not considered the dollar amount to lower any awards since the rule was amended").

[10] Whistleblower Program: 2021 Annual Report to Congress, 1-2.

[11] See Adopting Release at 41 (Rules 21F-3(b)(iv)(A)(1) and (4)).

[12] Id. at 18.

https://www.sec.gov/news/statement/uyeda-statement-whistleblower-program-082622
Aug. 26, 2022

The Whistleblower Program was created by Congress to provide monetary incentives for individuals to come forward and report possible violations of the federal securities laws to the Commission.[1] Today, the Commission is adopting final rules amending the Whistleblower Program rules. Specifically, the final amendments (1) expand the scope of related actions eligible for an award under the Commission's Whistleblower Program, and (2) amend the rules so that the Commission may use its statutory authority to consider the dollar amount to increase, but not decrease, the award.[2] While I support the important work of the staff in the Office of the Whistleblower in their efforts to arrive at an appropriate result in evaluating claims, I am unable to support today's amendments.

This past July, I expressed disagreement with the Commission's decision to revisit recently adopted rules governing the practices of businesses providing proxy voting advice.[3] This objection was rooted in a belief that the decision to revisit recently adopted rules risks creating a regulatory seesaw. In contrast, administrative "best practices" should promote long-term reliance and confidence by market participants in the stability of important areas of securities regulation.[4] Today, I have similar concerns. The Commission is revisiting rules that were finalized a little over a year and a half ago.[5] Reversing rules shortly after adoption, in the absence of a regulatory weakness or failure,[6] sets a bad precedent, risks eroding the Commission's regulatory credibility, and increases costs for market participants by requiring frequent reevaluations of compliance obligations.

To the extent that data points to a regulatory weakness or failure, it may be necessary to revisit an existing regulatory framework-whether that framework is decades old, or newly adopted. Robust evidence should, however, underpin decisions to revisit recently adopted rules. Absent such evidence, the Commission should monitor the effectiveness of recently adopted rules, with a view to refining any aspects that require adjustments, while avoiding destabilizing wholesale revisions.

Today's amendments are not aimed at remediating any known or identified weaknesses with the current whistleblower rules. Indeed, the Adopting Release acknowledges that "[w]histleblower programs, including the SEC's whistleblower program, have been studied by economists who report findings consistent with award programs being effective at contributing to the discovery of violations."[7] As the economic analysis points out, the total amount of awards, and number of recipients, increased significantly since 2019. From 2020 to 2021, the total awards more than tripled, while the number of recipients also almost tripled.[8] These increases, reflected in the table below, suggest that the existing Whistleblower Program framework is properly incentivizing claimants.

SEC Whistleblower Program Annual Award Activity[9]

Year Total Awards Number of Recipients

2021 $564 million 108
2020 $175 million 39
2019 $60 million  8


The incremental improvements to the whistleblower rules from today's amendments, if any, are unclear. The Adopting Release concedes that "[t]he benefits and costs . . . are difficult to quantify. For example, we do not have a way of quantitatively estimating the extent to which the final rules could affect our enforcement program by altering whistleblowing incentives."[10] As would be expected, with certain evaluations based on behavioral economics, "the discussion of economic effects of the final amendments is qualitative in nature."[11] As such, there is neither a negative trend for claims and awards justifying amendments nor clear benefits resulting from the revisions. Given that the prior amendments were only recently adopted, the Commission should have continued to monitor the whistleblower rules, rather than revise them without corresponding data substantiating the need for such amendments.

High-quality tips from whistleblowers represent an important tool in the Commission's enforcement program. To the extent that the Commission seeks to improve the Whistleblower Program and its rules, it should perhaps consider promoting greater visibility into its claims and award determinations, and increasing the number of high-quality tips from unrepresented persons. Such a review could also evaluate the role played by lawyers representing whistleblowers on a contingency fee basis and how they present tips to the Commission.[12]

The Whistleblower Program has come under increasing scrutiny from some on the basis that it operates with a lack of transparency.[13] These concerns are understandable, given that the Whistleblower Program has paid out more than $1.1 billion in awards since inception from funds that would have otherwise benefitted taxpayers.[14]

While I am unable to support today's amendments, I acknowledge the efforts of the staff in the Office of the Whistleblower, the Division of Economic and Risk Analysis, and the Office of the General Counsel for their work on these amendments.

[1] Pub. L. No. 111-203, § 922(a), 124 Stat. 1841 (2010).

[2] Whistleblower Program Rules, Release No. 34-95620 (Aug. 26, 2022) (the "Adopting Release").

[3] Mark T. Uyeda, Statement on Final Rule Amendments on Proxy Voting Advice (July 13, 2022), available at https://www.sec.gov/news/statement/uyeda-statement-amendments-proxy-voting-advice-071322.

[4] Id.

[5] Whistleblower Program Rules, Release No. 34-89963 (Sept. 23, 2020) [85 Fed. Reg. 70898 (Nov. 5, 2020)].

[6] By contrast, the Commission has not taken any steps to address potential unintended consequences with respect to the effects of recent amendments to Securities Exchange Act Rule 15c2-11 on the fixed income markets. Publication or Submission of Quotations without Specified Information, Release No. 34-89891 (Sept. 16, 2020) [85 Fed. Reg. 68124 (Oct. 27, 2020)], available at https://www.federalregister.gov/documents/2020/10/27/2020-20980/publication-or-submission-of-quotations-without-specified-information; see, e.g., Baker Botts LLP, New SEC Staff Interpretation of Rule 15c2-11 raises issues for Rule 144A market, Client Update (Mar. 16, 2022), available at https://www.bakerbotts.com/thought-leadership/publications/2022/march/new-sec-staff-interpretation-of-rule-15c2-11-raises-issues-for-rule-144a-market. To date, only Commission staff have addressed such concerns through no-action letters. See Letter to Racquel Russell, Financial Industry Regulatory Authority from the Division of Trading & Markets, SEC No-Action Letter (Dec. 16, 2021), available at https://www.sec.gov/files/fixed-income-rule-15c2-11-nal-finra-121621.pdf; Letter to Racquel Russell, Financial Industry Regulatory Authority from the Division of Trading & Markets, SEC No-Action Letter (Sept. 24, 2021), available at https://www.sec.gov/files/rule-15c2-11-fixed-income-securities-092421.pdf.

[7] Adopting Release at 30.

[8] Adopting Release at 29.

[9] Id.

[10] Adopting Release at 28.

[11] Id.

[12] See, e.g., Alexander I. Platt, The Whistleblower Industrial Complex (July 29, 2022) (preliminary draft), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4112398. 

[13] John Holland, Bloomberg Law, SEC Enriches Fraudsters, Lawyers as Secrecy Shrouds Tips Program (July 26, 2022) (noting that "SEC whistleblower decisions are inconsistent, cloaked in secrecy, often go to clients of agency ex-officials"), available at https://news.bloomberglaw.com/securities-law/sec-enriches-fraudsters-lawyers-as-secrecy-shrouds-tips-program.

[14] Securities and Exchange Commission, 2021 Annual Report to Congress: Whistleblower Program, at 1, available at https://www.sec.gov/files/owb-2021-annual-report.pdf.

In the Matter of the Arbitration Between Shlomo Salant, Claimant, v. Citigroup Global Markets, Inc., Respondent (FINRA Arbitration Award 19-00801)
https://www.finra.org/sites/default/files/aao_documents/19-00801.pdf
In a FINRA Arbitration Statement of Claim filed in March 2019, associated person Claimant Salant  asserted quantum merit and unjust enrichment; improper and illegal cancellation of awards; wrongful termination; and misconduct. As set forth in part in the FINRA Arbitration Award:

In the Statement of Claim, Claimant requested damages of a minimum of $1,000,000.00, with statutory interest thereon; damages emanating from Respondent's cancellation of awards on December 19, 2017 provided to Claimant as part of his incentive compensation, which as of December 19, 2017, had an aggregate value of $137,144.80, with statutory interest thereon; severance pay, with statutory interest thereon; punitive/ treble damages in a minimum of $3,000,000.00; and for such other and further relief as deemed just and proper, statutory interest, and the reimbursement of all FINRA fees.

Respondent Citigroup generally denied the allegations and asserted affirmative defenses. The FINRA Panel of Arbitrators found Respondent Citigroup liable and ordered it to pay to Claimant Salant $107,619.50 for cancelled deferred cash and stock benefits; and  $617,763.82 for cash bonus attributable to his employment in 2014.

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