On October 16, 2023, the Securities and Exchange Commission’s Division of Examinations released its 2024 examination priorities to inform investors and registrants of the key risks, examination topics, and priorities that the Division plans to focus on in the upcoming year. This year’s examinations will prioritize areas that pose emerging risks to investors or the markets in addition to core and perennial risk areas.

“The Division of Examinations plays a critical role in protecting investors and facilitating capital formation,” said SEC Chair Gary Gensler. “In examining for compliance with our time-tested rules, the Division helps registrants understand the rules as well as ensures that markets work for investors and issuers alike. The Division’s efforts, as laid out in the 2024 priorities, enhance trust in our ever-evolving markets.”

“Continuing to make our examination priorities public increases transparency into the examination program and encourages firms to focus their compliance and surveillance efforts on areas of potentially heightened risk to retail investors,” said Division of Examinations’ Director Richard R. Best. “We hope that aligning the publication of our examination priorities with the beginning of the SEC’s fiscal year will provide earlier insight to registrants, investors, and the marketplace of adjustments in our areas of focus year to year.”

The Division conducts examinations and inspections of SEC-registered investment advisers, investment companies, broker-dealers, transfer agents, municipal advisors, securities-based swap dealers, clearing agencies, and other self-regulatory organizations. The Division prioritizes examinations of certain practices, products, and services that it believes present potentially heightened risks to investors or the integrity of the U.S. capital markets. It uses a risk-based approach to fulfill its mission to improve compliance, prevent fraud, monitor risk, and inform policy.

The published priorities are not exhaustive of the focus areas of the Division in its examinations, risk alerts, and outreach. The scope of any examination includes analysis of an entity’s history, operations, services, products offered, and other risk factors.

As it relates to broker-dealers, the Division of Examinations will focus on:

• Regulation Best Interest, with an emphasis on (1) recommendations with regard to products, investment strategies, and account types; (2) disclosures made to investors regarding conflicts of interest; (3) conflict mitigation practices; (4) processes for reviewing reasonably available alternatives; and (5) factors considered in light of the investor’s investment profile, including investment goals and account characteristics. Examinations will focus on products s that are: (1) complex, such as derivatives and leveraged ETFs; (2) high cost, such as variable annuities; (3) illiquid, such as nontraded REITs and private placements; (4) proprietary; and (5) microcap securities. Examinations may also focus on recommendations to certain types of investors, such as older investors and those saving for retirement or college.
• Form CRS, including how broker-dealers describe (1) the relationships and services that it offers to retail customers; (2) its fees and costs; and (3) its conflicts of interest, and whether the broker-dealer discloses any disciplinary history.
• Financial Responsibility Rules, including the Net Capital Rule and the Customer Protection Rule.
• Trading Practices, with an emphasis on : (1) Regulation SHO, including the rules regarding aggregation units and locate requirements; (2) Regulation ATS, and whether the operations of alternative trading systems are consistent with the disclosures provided in Forms ATS and ATS-N; and (3) Exchange Act Rule 15c2-11.

The collaborative effort to formulate the annual examination priorities starts with feedback from examination staff who are uniquely positioned to identify the practices, products, services, and other factors that may pose risk to investors or the financial markets. The Division also gathers input and advice from the Chair and other Commissioners, staff from other SEC divisions and offices, other federal financial regulators, investors, and industry groups.

Herskovits PLLC represents broker-dealers, investment advisors, and registered individuals in SEC and FINRA examinations. Feel free to contact us for a consultation (212) 897-5410.

On September 19, 2022, the SEC’s Division of Examination issued a Risk Alert concerning the new investment adviser marketing rule, Advisors Act Rule 206(4)-1 (“the Marketing Rule”). In connection with the Marketing Rule, the Commission also amended the Books and Records Rule, Advisors Act Rule 204-2 and the Form ADV. The Marketing Rule became effective on May 4, 2021 but firms were given an 18-month transition period. Thus, firms must be compliant with the Marketing Rule by November 4, 2022.

According to the Staff’s announcement, examinations will focus on four areas: a) Policies and Procedures, b) the Substantiation Requirement, c) Performance Advertising Requirements, and d) Books and Records

With regard to policies and procedures, the Commission’s noted that the Marketing Rule Adopting Release, stated that firms must adopt procedures that, “include objective and testable means” of preventing violations of the Marketing Rule. Examples of such means are:

• internal pre-review and approval of advertisements,
• reviewing a sample of advertisements based on risk, or
• pre-approving templates.

As discussed in more detail below, many of the Marketing Rule restrictions are inherently subjective thus, it remains to be seen how supervisory reviews or even pre-approved templates can ever be “objective and testable.”

The next area of examination, the Substantiation Requirement is a perfect example of the subjective nature of many parts of the Marketing Rule. The Marketing Rule prohibits advertisements that “[i]nclude a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the Commission.” (emphasis added). The Staff advises firms to make contemporaneous records with each advertisement demonstrating the basis for their belief that a fact was accurate. They also advise firms to draft policies and procedures to address how the requirement is met. Ultimately, however, a violation of the Substantiation Requirement hinges upon the subjective element of “reasonable” belief.

Many Performance Advertising Requirements present similar subjective judgements while some are objectively straightforward. For instance, firms may not present gross performance in an advertisement unless they also present net performance. Similarly, firms may not advertise performance results unless they specify the time-period. Let us examine, however, three prohibitions listed by the Staff that are not so black and white.

• to the extent an advertisement includes the performance of portfolios other than the
  portfolio being advertised, performance results from fewer than all portfolios with
  substantially similar investment policies, objectives, and strategies as the portfolio being
  offered in the advertisement.

This prohibition requires a firm to make a very subjective determination as to which portfolios have “substantially similar investment policies, objectives, and strategies” to the portfolio being advertised. It is not hard to imagine that a firm and the SEC Staff may disagree on what makes a portfolio “substantially similar.”

Firms are prohibited from including hypothetical performance in an advertisement:

• unless the adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the likely financial situation and investment objectives of the intended audience.

This prohibition contains the seemingly impossible subjective test of determining if the hypothetical performance would be “relevant to the likely financial situation and investment objectives of the intended audience.” The use of the word “likely” here is tantamount to making a good guess.

As a final example, firms cannot include predecessor performance in an advertisement:

• unless the personnel primarily responsible for achieving the prior performance manage accounts at the advertising adviser and the accounts that were managed by those personnel at the predecessor adviser are sufficiently similar to the accounts that they manage at the advertising adviser.

First, in this prohibition there is the subjective question of which personnel were “primarily responsible” for the prior performance. This is a question that no examiner could ever objectively answer. Second, the prohibition requires a determination that the predecessor accounts were “substantially similar” to the accounts being advertised. Again, an entirely subjective question.

Finally, the SEC’s announcement states that exams will focus on firm’s books and records. The SEC amended Advisors Act Rule 204-2 in connection with the new Marketing Rule. Firms are required to maintain certain advertising related records, “such as records of all advertisements they disseminate, including certain internal working papers, performance related information, and documentation for oral advertisements, testimonials, and endorsements.”

Despite the Staff’s instructions that firm’s policies and procedures must have “objective and testable means” of preventing Marketing Rule violations, the fact remains that compliance with new Marketing Rule requires a slew of subjective judgements. The words “reasonable”, “reasonably” and “likely” appear 13 times in the Marketing Rule. The word “material,” the definition of which also contains the word “reasonably,” appears no less than 12 times in the Marketing Rule. Unfortunately, as with so many other rules, “reasonable” is likely to be in the eye of the examiner.

Herskovits PLLC has a nationwide practice defending RIAs with inquiries from the SEC or state securities regulators. Feel free to call us for a consultation. (212) 897-5410.

On September 6, 2022, the SEC issued an order instituting administrative and cease-and-desist proceedings against Perceptive Advisors LLC (“Perceptive”) a New York based investment adviser. In anticipation of the institution of the proceedings, Perceptive and the SEC entered into a Settlement.

Perceptive provides investment advisory advice to pooled investment vehicles and according to its March 31, 2022 Form ADV it had approximately $10.36 billion in assets under management. One of Perceptive’s investment vehicles is the Perceptive Life Sciences Master Fund, Ltd. (the “PSLM Fund”).

The gravamen of the SEC’s order revolves around Perceptive’s activities concerning special purpose acquisitive companies (“SPACs”). A SPAC is generally a publicly-traded, shell company which raises money, through an IPO, for the purpose of acquiring other, privately held companies. SPAC’s have “sponsors” that launch the IPO and generally manage the business of the SPAC, including the process of acquiring target companies. The sponsor is typically compensated on a percentage (often 20% to 25%) of the SPAC’s initial public offering proceeds (in the form of discounted shares and, at times, warrants). This compensation is sometimes referred to as the sponsor’s “promote” or “founder shares,” and it is received upon completion of a SPAC’s acquisition of a target company.

In 2018, Perceptive formed a SPAC and the sponsor was 100% owned by THE PSLM Fund. Subsequently, Perceptive formed three additional SPACs; however, unlike the first SPAC, five of Perceptive’s “supervised persons” took an ownership interest in the sponsors (20% for two of the funds and 30% for the last).

The order goes on to explain how this ownership interest by Perceptive personnel creates conflicts of interest for Perceptive. For example, because the five individuals only earn their compensation as sponsor owners’ when a SPAC makes an acquisition they had an incentive to engage in business combination even though transaction was not necessarily in the best interest of their advisory clients.

The order also noted that Perceptive’s conflict could, and apparently did, cause Perceptive to cause the PSLM Fund to make an investment that would assist the SPAC in completing their acquisitions. The order notes the PSLM Fund purchased stock of two of the SPACs on the open market just prior to closing business combinations.

According to the Commission, Perceptive failed to disclose this conflict to the board of directors of the PSLM Fund. In addition, Perceptive made material misstatements and omissions concerning the SPAC to investors in the PSLM Fund by failing to disclose that Perceptive personnel owned an interest in the sponsor. In a July 28, 2020 email communication, Perceptive stated that the PLSM Fund does not participate in the SPAC outside of the sponsor shares when in fact, at that point in time, the PSLM Fund had already engaged in two PIPE transactions to support acquisitions by the SPACs.

Among other things, the Commission found that Perceptive, “willfully violated Section 206(2) of the Advisers Act, which makes it unlawful for any investment adviser, directly or indirectly, to ‘engage in any transaction, practice or course of business which operates as a fraud or deceit upon any client or prospective client.’” The SEC also found the Perceptive violated Advisors Act Section 206(4) which makes it unlawful for any adviser to a pooled investment vehicle to, “make any untrue statement of a material fact or to omit to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading . . . .” The Commission noted that only a finding of negligence is required to show a violation of Section 206(2) and Section 206(4) of the Advisors Act.

For the conduct described above, Perceptive agree to pay a civil, monetary penalty of $1.5 million along with the usual order to cease-and-desist from committing or causing future violations of the same Advisers Act and Exchange Act Rules.

Herskovits PLLC has a nationwide practice defending companies and individuals subjected to SEC investigations. Feel free to contact us at (212) 897-5410.

What is a securities dealer? The answer is more complicated than people might think. On August 2, 2022, the SEC announced that it had reached a settlement with a Long Island firm, Crown Bridge Partners, LLC (“Crown Bridge”) and the two brothers who owned the firm Soheil and Sepas Ahdoot, for failing to register as a dealer. As part of the settlement, the Defendants agree to pay disgorgement and prejudgment interest of $8,390,601.27 and a civil penalty of $810,307, and to a five-year penny stock bar.

According to the SEC’s complaint, Crown Bridge purchased approximately 250 convertible notes from approximately 150 penny stock issuers. In all, during the Relevant Period, Crown Bridge sold into the public markets approximately 35 billion shares of unrestricted, post-conversion shares of penny stock issuers, for millions of dollars in profits. Soheil and Sepas initially found companies interested in issuing convertible notes by reviewing OTCMarkets.com, a website that includes a news feed of SEC filings and press releases from penny stock issuers. They used the website to identify issuers that appeared to need or had expressed a need for financing. They then cold called the issuers directly. Over time, as Crown Bridge grew its business and became known in the industry, issuers, brokers, and finders reached out directly to Soheil and Sepas to seek funding.

Absent their apparent failure to register Crown Bridge as a Dealer under Exchange Act Section 15(a) [15 U.S.C.§ 78o(a)], Soheil and Sepas executed what appears to have been a very shrewd and successful business plan. Crown Bridge purchased convertible notes directly from penny stock issuers. They negotiated the terms of the notes that led to millions of dollars in profits when the notes were converted into shares of stock. The notes typically contained terms that were highly favorable to Crown Bridge and reduced Crown Bridge’s exposure to market risk such as a conversion discount ranging from 25% to 50% to the prevailing “market price,” a term the notes typically defined as the lowest trading price, or lowest closing bid price, of the issuer’s common stock during the 10 to 25 days on or before the date of the conversion notice. Also critical was Crown Bridge’s right to convert the notes in increments, enabling Crown Bridge to convert what it could sell immediately, while shielding the remaining balance from exposure to market price movements.

Crown Bridge typically held the notes for six months, or until such time as it could claim the SEC Rule 144 exemption from registration [17 C.F.R. § 230.144]. SEC Rule 144 allows non-affiliates who acquire restricted stock directly from the issuer in a private transaction to resell it free of restriction into the market after observing a holding period, among other requirements.

The SEC’s complaint very specifically points out that Crown Bridge converted the notes with an eye toward distributing the underlying shares into the public markets for a profit based on the spread between the market price and the discounted acquisition price, as opposed to holding the shares for appreciation. The SEC noted that, “[t]his limited exposure to market risk is a common attribute of a securities dealer. It derived those profits principally from the discounted acquisition price, not from appreciation in the market price of the issuer’s common stock.” The SEC also stated that, “[t]his limited exposure to market risk is a common attribute of a securities dealer.”

Section 3(a)(5) of the Act generally defines a “dealer” as, “any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise . . . .” The SEC’s website states, that “[t]raders are excluded from the definition of a dealer” because while they may buy and sell securities for their own account, the do so “not as part of a regular business.” So what does it mean to be “in the business” of buying and selling securities versus being a common investor? What if a substantial part of someone’s income comes from day trading? Does it matter, as noted above, that the profits derived by Crown Bridge were not from appreciation in the price of the stock? What if Crown Bridge held the securities for longer and were exposed to more market risk but still made a profit from the discounted acquisition price?

The SEC’s “Guide to Broker-Dealer Registration” provides the following guidance regarding whether someone is a dealer:

• a person who holds himself out as being willing to buy and sell a particular security on a continuous basis;
• a person who runs a matched book of repurchase agreements; or
• a person who issues or originates securities that he also buys and sells.

Here are some of the questions you should ask to determine whether you are acting as a dealer:

• Do you advertise or otherwise let others know that you are in the business of buying and selling securities?
• Do you do business with the public (either retail or institutional)?
• Do you make a market in, or quote prices for both purchases and sales of, one or more securities?
• Do you participate in a “selling group” or otherwise underwrite securities?
• Do you provide services to investors, such as handling money and securities, extending credit, or giving investment advice?
• Do you write derivatives contracts that are securities?

It seems that the brothers Ahdoot could credibly answer “no” to all of these questions and also state that the first three bullet points do not describe their business model. Yet, the SEC deemed them to be dealers rather than traders based almost solely on the fact that they had limited exposure market fluctuations.

The SEC seems to understand that there is some ambiguity in the current statutory definition of dealer. In March 2022, the SEC has proposed a new rule that further defines the phrase “as part of a regular business” as used in the definition. The new rule is primarily aimed at market participants who are not registered dealers and yet “engage in a routine pattern of buying and selling securities for their own account that has the effect of providing liquidity.” With the sale of 35 billion shares in the market over four years, it certainly seems that Crown Bridge squarely falls under the definition of a dealer if regularity of trading and having the effect of providing market liquidity are the key factors.

Herskovits PLLC has a nationwide practice defending against SEC investigations and litigation. Feel free to call us for a consultation. (212) 897-5410.

In April 2018, the SEC proposed a new regulation that would govern the standard of conduct that applies when broker-dealers make recommendations to retail customers. Specifically, the proposal sought to established an express best interest obligation that would require all broker-dealers and associated persons to act in the best interests of their retail customers at the time a recommendation is made without placing the financial or other interests of the broker-dealer or associated person ahead of the interests of the retail customer.

At the time, the Commission received over 6,000 comments on the proposed rule. Ultimately, in July 2019, the SEC adopted Rule 15l-1(a) of the Securities Exchange Act of 1934 (“Reg BI”). On June 15, 2022, the SEC filed the first complaint for a violation of Reg BI since it was enacted. The SEC filed a complaint against Western International Securities, Inc. (“Western”) and five of its registered representatives for violating Reg BI in connection with the sale of high risk, illiquid and unrated debt securities known as L Bonds issued by GWG Holdings, Inc. (“GWG”).

Compliance with Reg BI consists of four components: the Disclosure Obligation, the Care Obligation, Conflict of Interest Obligation, and the Compliance Obligation. Registered representatives must comply with the Disclosure Obligation and the Care Obligation, which include:

1. The Disclosure Obligation requires a written disclosure to the customer at the time a recommendation is made of all the material facts relating to the investment including, among other things, all costs and fees that may apply to the customer’s account.
2. The Care Obligation requires that the firm’s registered representatives exercise reasonable diligence, care, and skill to understand the product being recommended including risks, reward and costs.
3. The Conflict of Interest Obligation requires a firm to identify and disclose all conflicts of interest that may exist in connection with a particular investment recommendation.
4. The Compliance Obligation is the most straightforward of the four obligations as it simply requires a firm to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest

Between July 2020 and April 2021, Western’s registered representatives sold approximately $13.3 million L Bonds to their retail customers. The Commission’s complaint faults Western for not establishing any criteria or thresholds for a customers’ financial resources before investing in L Bonds. The Commission also noted that Western’s Chief Compliance Officer reviewed a due diligence report on the L Bonds but did not distribute the report to Western’s registered representatives. The most significant issue it seems from reading the SEC’s complaint is that the registered representatives did not understand the product. In particular, Western’s registered representatives actually took a training course on the L Bonds but were not aware of a significant change to GWG’s business model that made the 2020 issuance of L Bonds very different in terms of their risk profile from the L Bonds issued in previous tranches.

The SEC concluded that L Bonds might be appropriate for “certain customers willing to accept a substantial degree of risk” but the registered representatives recommended L Bonds to customers who did not fit that profile. This “mismatch” meant that the registered representatives did not “demonstrate reasonable diligence, care or skill in determining that the L Bonds were in their customer’s best interests.”

The SEC also found Western’s policies and procedures were insufficient with regard to Reg BI. Interestingly, Western’s procedures were “substantially copied” from a Small Entity Compliance Guide that was published by the SEC. As such, the SEC found the policy too generic and not tailored to Western’s business. The policy also lacked an enforcement mechanism. The SEC’s prayer for relief included a request for an injunction, disgorgement of commissions earned and a civil penalty in an unspecified amount.

Perhaps most significantly, despite the financial industries’ understandable interest in Reg BI, it is hard to discern a significant difference between the obligations of Reg BI and the existing suitability obligations that have existed for years under FINRA Rule 2111. The SEC recitation of alleged wrongdoing by Western and its employees could just have easily amounted to a finding that they sold L Bonds that were not suitable for their clients in violation of FINRA Rule 2111. Based upon the SEC first invocation of Reg BI, It is not clear what Reg BI adds to the existing regulatory enforcement scheme.

Herskovits PLLC has a nationwide practice defending against investigations and actions filed by the SEC. Feel free to call us for a consultation at (212) 897-5410.

“Defendant understands and agrees to comply with the [SEC]’s policy ‘not to permit a defendant . . . to consent to a judgment or order that imposes a sanction while denying the allegation in the complaint . . . .’ 17 C.F.R. § 202.5. In compliance with this policy, Defendant agrees not to take any action or to make or permit to be made any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis. If Defendant breaches this agreement, the [SEC] may petition the Court to vacate the Final Judgment and restore this action to its active docket. Nothing in this paragraph affects Defendant’s: (i) testimonial obligations; or (ii) right to take legal or factual positions in litigation in which the [SEC] is not a party.”

Language to this effect is in every consent agreement with the SEC. The CFTC and FINRA also place substantively identical injunctions regarding what defendants can say about their cases once they settle.

Now, almost 20 years later, Mr. Romeril is tired of staying silent and is seeking to have his case heard by the Supreme Court. Romeril’s primary argument is that the judgment which incorporated his consent agreement with the SEC should be voided because it constitutes a prior restraint that infringes his First Amendment rights and that it violated his right to due process.

So far, Romeril has lost at the district court level and lost his appeal to the Second Circuit and is now seeking a writ of certiorari to take this case to the Supreme Court. While Romeril’s case is interesting in its own right, it is also interesting to note the various individuals and institutions that have filed amicus briefs in support of his arguments. The list includes Mark Cuban and Elon Musk who have famously and publicly clashed with the SEC in recent years. Cuban and Musk make the interesting argument that the SEC’s gag orders run contrary to the agency’s mission of market transparency. The amicus brief highlights the SEC’s supposed hypocrisy in insisting on the silencing of settling defendants while at the same time demanding full transparency for settlements between private parties. Their amicus brief notes that,

“[t]he SEC regularly brings enforcement actions against individual and companies based, at least in part, on their failure to provide the investing public sufficient information about their settlements or litigation.”

Musk, in particular, has had a very public bout with the SEC over his First Amendment rights. Musk settled a 2018 case with the SEC in which he was accused of making false and misleading statements about Tesla through his twitter account. Part of the settlement required Musk to have his tweets vetted by a securities lawyer before posting them. Musk has since unsuccessfully sought to overturn his 2018 settlement and has accused the SEC of trying to “muzzle and harass” him.

The Supreme Court has discretion as to when it will grant certiorari and for writs filed by attorneys the success rate of having a case heard is only 6% (the rate is much lower if ­you include pro se applicants). There is some statistical evidence however, that amicus briefs filed at the certiorari stage considerably increase the odds of certiorari being granted.

Presumably, if Mr. Romeril wins the CFTC and FINRA will have to take similar gag orders out of their settlement agreements. In 2015, a study showed that the average cost for a company to respond to an SEC formal investigation was north of $4 million[2] and that is before any litigation has commenced! Surely many innocent companies and executives have decided to settle with the SEC rather than endure the frustration and expense of an SEC investigation and litigation. Maybe someday those same people and companies can settle with the SEC and still publicly proclaim their innocence.

Herskovits PLLC maintains a nationwide practice defending SEC investigations and litigation. Call us for a consultation at (212) 897-5410.

“Enforcement staff responsible for the Covered Action confirmed that they did not receive any information from Claimant 2, nor did they have any communications with Claimant 2, before or during the investigation.”

Claimant 2’s theory, we learn, is that his tip did not have to be communicated directly to the Enforcement Staff responsible for the Covered Action. It turns out that Claimant 2 provided information about a company to Enforcement Staff in an entirely different regional office. An investigation was commenced and Enforcement Staff was unable to substantiate Claimant 2’s claims. The investigation was closed without commencement of an enforcement action. The Commission pointedly defines the redacted company as the (“Unrelated Company”) and the investigation as the (“Unrelated Investigation”).

To qualify for an award under Section 21F of the Securities Exchange Act of 1934 (“Exchange Act”), a whistleblower must voluntarily provide the Commission with original information that leads to the successful enforcement of a covered action. See Exchange Act Section 21F(b)(1), 15 U.S.C. § 78u-6(b)(1).6. Alternatively, if an investigation is already underway a Whistleblower can be eligible for an award where their information “significantly contributed to the success of the action.” Exchange Act Rule 21F-4(c)(2).

It the took the Commission little effort to deny a Whistleblower Award to a claimant who provided a tip about an entirely different company and a different investigation that never led to an enforcement action. As the Commission succinctly concluded.

That Claimant 2 made allegations with respect to the Unrelated Company does not mean that Claimant 2 is then eligible for every future enforcement action involving similar securities laws violations.

Herskovits PLLC has an active whistleblower practice and is one of a small number of law firm that have recovered a whistleblower bounty from the SEC. Feel free to call at 212-897-5410 for a consultation.

It has long been clear that the SEC opposes 12b-1 fees, the fees that funds use to compensate investment advisors for their sales and marketing efforts. For the past two decades, the SEC has embarked upon various attempts to repeal Rule 12b-1 or render it meaningless. The SEC, however, has never been able to build the political will to amend or repeal Rule 12b-1 and it remains the law.

The SEC’s latest attack on 12b-1 is a classic example of rule-making by enforcement. On February 12, 2018, the SEC issued a press release announcing its new Share Class Selection Disclosure Initiative (SCSD Initiative). The SCSD Initiative relies on Section 206 of the Investment Advisers Act of 1940 (the “Advisers Act”) which imposes a fiduciary duty on investment advisers to act in their clients’ best interests, including an affirmative duty to disclose all conflicts of interest. When an adviser receives 12b-1 fees from a mutual fund it presents a possible conflict of interest if a less expensive share class is available. Prior to the SCSD Initiative, the industry standard was to disclose this conflict of interest in a straight forward manner.

The SCSD Initiative and subsequent guidance put out through FAQs has effectively amended 12b-1 by requiring disclosure of:

• “The fact that different share classes are available”;

• “The fact that the adviser has financial interests in the choice of share classes that conflict with the interests of his clients”;

• “Whether there are any limitations on the availability of share classes to clients that result from the business of the adviser or the service providers that the adviser uses”;

• “Whether an adviser’s practices with regard to recommending share classes differs when it makes an initial recommendation to invest in a fund as compared to: (a) when it makes recommendations regarding whether to convert to another share class; or (b) when it makes recommendations to buy additional shares of the fund”;

• “The circumstances under which the adviser recommends share classes with different fee structures and the factors that the adviser considers in making recommendations to clients”; and

• “Whether the adviser has a practice of offsetting or rebating some or all of the additional costs to which a client is subject (such as 12b-1 fees and/or sales charges), the impact of such offsets or rebates, and whether that practice differs depending on the class of client, advice, or transaction.”

Under the SCSD Initiative, the Enforcement Division recommended standardized, “favorable” settlement terms to investment advisers that self-reported failure to disclose conflicts of interest associated with the receipt of 12b-1 fees to advisory clients when a lower-cost share class of the same mutual fund was available. Enforcement Division also required self-reporting advisers to disgorge fees to the allegedly harmed clients, but did not impose a civil monetary penalty. The press release also warned that the SEC expected to recommend stronger sanctions against any investment advisers that failed to self-report. As the Co-Director of Enforcement put it: “we promise that if we find [an adviser] later we will punish [it] more severely.” S. Garmhausen, SEC to Advisors: Don’t Test Us, Barron’s (Mar. 2, 2018).

The SCSD Initiative was an extremely useful weapon in the SEC’s war on 12b-1 fees. Within a year, 79 investment advisers self-reported their disclosure “violations,” entered into settlements with the SEC, and refunded more than $125 million. To date, 95 firms have reached settlements and disgorged roughly $140 million.

The Initiative expired after 120 days—and that is when the Commission started to deliver on its promise to punish the holdouts more severely. Since the SCSD Initiative deadline for self-reporting passed in September 2019, the SEC has issued orders against two firms that were eligible to self-report pursuant to the initiative, but failed to do so. See Mid Atlantic Financial Management Inc. (ordered to pay $1,027,002 in disgorgement and prejudgment interest and a $300,000 civil penalty) and BPU Investment Management Inc. (ordered to pay $692,107 in disgorgement and prejudgment interest and a $235,000 civil penalty). In April 2020, the SEC announced that it had reached settlement with three firms that represented the last of the SCSD Initiative self-reporting advisers. Going forward, even firms that self-report insufficient 12b-1 disclosures should expect the SEC to demand disgorgement of those fees as well as a substantial civil monetary payment.

Herskovits PLLC has a nationwide practice defending against SEC investigations and adversarial proceedings. Feel free to call us at (212) 897-5410 for a consultation.

If you are the target of an investigation by the Securities and Exchange Commission, do not assume it will go away on its own. Instead, it may linger for months or years, all the while you face the possibility of fines, loss of license and your job or business, and the possibility of criminal charges if the SEC refers your matter to the Department of Justice. When this happens, the smart thing to do is to become aware of the investigation as soon as possible and hire legal representation. If you need to know more about SEC investigations, here are some important details to keep in mind, as well as how New York securities attorneys at Herskovits PLLC can help you navigate this complex process.

Tips and Referrals For an SEC investigation to begin, the agency usually relies on tips and referrals from various sources, such as:

–Tips from customers, coworkers, or whistleblowers –Congressional referrals where constituent has complained to Congressperson –Referral from state regulators

Once you find out any tips or referrals have been made, be proactive and contact an experienced attorney immediately.

Recognize the Signs of an Investigation Contrary to what you may believe, a company is not obligated to let you know an SEC investigation is underway. Because of this, it is crucial you recognize what to look for that will indicate the SEC is investigating. For example, if Human Resources personnel, outside law firms, or other similar organizations request your files or ask to interview you about specific business or financial transactions, you may be under SEC investigation.

Rather than be caught off-guard by an SEC investigation and its potentially serious consequences, contact the New York securities attorneys at Herskovits PLLC to ensure your legal rights are protected from start to finish. By doing so, you will have the peace of mind as well as legal experience needed to navigate these complex and stressful investigations.

If you exchanged an official email with any SEC employee recently, you have seen the banner for Howeycoins Travel Network. And if you like to get in on a profitable deal, you probably thought, “well, if the SEC is endorsing them, these guys must be legit.” Perhaps you clicked on the banner to see what it was all about. If so, you must have been surprised at what you found.

Pre-initial coin offering deals usually promise spectacular returns, and HoweyCoins are not the exception. The attractive website for the ICO shows alluring scenes from luxury travel destinations. As you scroll down, you will quickly find that HoweyCoins will yield returns of at least 1 percent daily.

If you are not sold yet, the HoweyCoins.com site quickly boasts, “The average registered coin return over a two month period in 2017 was an amazing 72%.”

However, all these marvels await only those who dare to click on the “Buy” button NOW. A countdown clock gives you only 14 days to receive a special 15 percent bonus. How could you say no?

You will go get your credit card, your bitcoin wallet, your grandma’s golden rings, and invest everything you got. After all, HoweyCoins are “officially registered with the U.S. government… will trade on an SEC-compliant exchange… can be exchanged for cryptocurrencies and cash,” according to the site’s claims.

The U.S. government wouldn’t be in on a scam, now, would it?

Alas, the U.S. government truly is out to deceive you, but only for your own benefit. If you click on the buy button, you will be redirected to Investor.gov, a SEC website, and greeted with the following message, “If you responded to an investment offer like this, you could have been scammed – HoweyCoins are completely fake!”

In reality, HoweyCoins.com is a concoction of the SEC, which created it in an attempt to warn investors about common types of fraud in the cryptocurrency space.

As the Commission explains to users redirected from HoweyCoins.com, “Every investment carries some degree of risk, which is reflected in the rate of return you can expect to receive. High returns entail high risks, possibly including a total loss on the investments. Most fraudsters spend a lot of time trying to convince investors that extremely high returns are guaranteed.”

The SEC actually riddled the HoweyCoins offering with red flags. They wanted to make the site as phoney as possible, so that people would realize how careless they had been once they realized the ICO was fake.

On Investor.gov/howeycoins, would-be HoweyCoins investors will learn that, “many online trading platforms appear to investors as SEC-registered and regulated marketplaces when they are not… Although some of these platforms claim to use strict standards to pick only high-quality digital assets to trade, the SEC does not review these standards or the digital assets that the platforms select.”

HoweyCoins.com reproduces many features of well-known ICO schemes: it lists a non-existent group of executives (diverse and millennial-friendly, based on the posted photos) and features a number of ‘celebrity endorsements.’

Perhaps, HoweyCoins will do more to educate ICO investors than any other media campaign could, as people who click through the fake site to get a piece of the action will probably think twice before pouring their hard-earned cash into a hot ICO deal with little to offer aside from a bunch of wild claims and an elegant website.

Rob Herskovits is a New York based securities law expert with a nationwide practice. Connect with Rob

Wells Fargo will pay $480 million to resolve fraud and insider trading allegations brought in a class action in California.

According to the plaintiffs, top executives at the bank engaged in insider trading after employees were directed to create millions of accounts under customer names, without the customers’ consent.

While litigation in California state court continues, the settlement will end the federal lawsuit.

In a statement, Wells Fargo’s CEO said,

“We are pleased to reach this agreement in principle and believe that moving to put this case behind us is in the best interest of our team members, customers, investors and other stakeholders… We are making strong progress in our work to rebuild trust, and this represents another step forward.”

In 2017, Wells Fargo paid $142 million to resolve a related lawsuit. The bank has faced media scrutiny and endured significant losses in connection with this and other misconduct. Back in 2016, following a media expose about the unauthorized accounts, the bank faced $185 million in civil penalties, courtesy of the Office of the Comptroller of the Currency, the Consumer Financial Protection Bureau, and the Los Angeles City Attorney’s Office.

When the penalties were made public, Wells Fargo’s shares experienced a 9 percent plunge. The class action that the bank just settled was actually brought by all the investors who purchased stock over a two and a half year period leading up to September 2016, when the sanctions were announced.

According to the shareholders’ complaint, Wells Fargo prided itself in securing new business from existing customers, by getting them to sign up for additional products like credit cards and retirement accounts; but in reality, many of those sign-ups were unauthorized and thus, fraudulent.

Last February, Wells Fargo’s defense fought aggressively to have the class action dismissed, to no avail. Defendants in the case include the bank’s former and current CEOs, John Stumpf and Tim Sloan, respectively, and its CFO, John Shrewsberry. At the time, the appointed judge allowed the plaintiffs to move forward with nearly all of their claims.

Originally, Wells Fargo was being charged with creating about 2.1 million fraudulent accounts, but that number rose to over 3.5 million last August when a third-party review left the bank no choice but to acknowledge that it was potentially liable for more than a million additional violations.

Initially, investigators had looked at accounts opened between mid-2011 and mid-2015. The number of “phony” accounts rose dramatically when the probe’s scope was expanded to cover a period between early 2009 and late 2016.

The Federal Reserve has mandated a growth cap for Wells Fargo, which will not be allowed to grow above $1.95 trillion until the bank clearly demonstrates that it has learned from its mistakes and will no longer put customers at risk. A difficult challenge for the scandal ridden financial institution.

Securities lawyer Rob Herskovits is New York based with a national securities-focused practice. To connect with Rob: 212.897.5410 or CONNECT ONLINE

Jehu Hand, a California-based attorney has been found guilty of securities fraud and is now awaiting sentencing. Following his trial, which took place in Boston, the defendant could be facing up to eight years in prison.

The federal jury found that Hand conspired with his two brothers to run a pump-and-dump scheme by falsifying documents. According to the evidence presented during trial, the defendant and his co-conspirators fraudulently obtained $1.5 million through the scheme.

Hand and his brothers allegedly misrepresented Greenway Technology Inc. as a company with tremendous potential, which was about to acquire lucrative gay-friendly hotels in California and Nevada.

According to its Bloomberg listing, Greenway Technology “intends to operate as Andalusian Resorts and Spas with properties located in Palm Springs, California and Las Vegas, Nevada. It focuses on providing luxury boutique hotel and resort chain catering to the various alternative lifestyles of men and women.” Greenway Technology is now defunct.

In the case of Crown Marketing LLC, the defendant misrepresented to potential investors that it owned rights to a lucrative technology in the controlled drug field.

Bloomberg states that Crown, “focuses on developing its controlled release technology (CDDT) and marketing nutraceutical products. The company intends to license CDDT to pharmaceutical companies, as well as to develop proprietary applications.”

The role of Hand in the plot to inflate the prices of Greenway and Crown shares was to falsify documents and write opinion letters with false information to be sent out to stockbrokers, misrepresenting the ownership and legitimacy of both ventures.

Hand allegedly used made-up investors to make fake stock purchases, using this and other strategies to conceal the fact that he alone controlled the companies.

Through these tactics, Hand and others managed to sell a large number of shares at inflated prices, causing massive losses to the purchasers once the stock plummeted.

The trial was a nasty affair, as Hand and one of his brothers tried to claim innocence and blame each other. Lured by the promise of a more lenient sentence, Learned Jeremiah Hand accused his brother Jehu of being the schem´s mastermind.

“When he was on the stand, did you see how, again and again, he tried to plunge the dagger in his brother’s back?” Jehu Hand´s attorney said of Learned Jeremiah during the trial. His pleading, however, did not move the 12-person jury, which found Jehu guilty after a couple of hours of deliberation.

Pump and dump schemes involve promoters trying to boost the price of a certain company´s shares by making false statements about its prospects. As soon as the stock has reached a sufficiently high price, the fraudsters dump their own (cheaply acquired) shares into the market to make sizable profits.

The way schemers get buyers for the stock is by claiming they have inside information about the prospects of a certain company, which will positively affect the stock´s pricing in time.

After the fraudsters get rid of their stock at a profit, prices plummet, and investors incur massive losses.

Rob Herskovits is a 20+ year New York securities lawyer with a national practice. Focused, along with the other Herskovits PLLC lawyers exclusively on securities law, Rob helps financial industry participants head off anticipated problems and minimize or eliminate the regulatory consequences for those targeted for enforcement action. 212.897.5410 or CONNECT ONLINE

In a complex and shifting global scenario, the financial industry faces numerous challenges relating to anti-money laundering (AML) compliance. In a rapidly changing regulatory environment, within an unstable geopolitical context, financial institutions have to adapt to new technologies and innovative operating models.

As regulators worldwide coordinate to increase transparency and target wrongdoers, AML has taken center stage when it comes to compliance programs.

The 2017 Global Anti-Money Laundering and Sanctions Compliance Survey by AlixPartners shed light on many observable industry trends. A survey of 361 financial institutions, the report is a valuable tool for anyone trying to understand the industry’s current perceptions and expectations.

Through online and in-person interviews, AlixPartners surveyed board members, compliance, risk-management and legal executives, as well as C-level executives from the top global banks, broker-dealers, insurance companies, and other financial institutions, and obtained the following results.

Findings of the AML and Sanctions Compliance Survey 2017

• 20 percent of the surveyed institutions acknowledged that their boards do not receive any training in AML and sanctions compliance, and that it is unclear whether board members are up-to-date regarding the current regulatory framework. For financial institutions outside the U.S., the number of boards at fault exceeds 20 percent.
• 63 percent of respondents said they had experienced some form of de-risking (closing high-risk accounts). While this leads to a reduction in correspondent banking relationships, certain financial institutions have substituted them for relationships with non-traditional counterparts, which involve higher money-laundering risks.
• 32 percent of respondents deemed their firms’ AML and sanctions compliance budgets either “inadequate” or “severely inadequate.”
• 54 percent said AML and sanctions compliance monitoring systems are at the top of their investment priorities for the next one/two years.
• 92 percent stated that their firms have formal AML compliance programs in place
• 35 percent acknowledged that their firms fail to perform independent or benchmarking reviews of their AML compliance programs.

According to a spokesperson for Alixpartners, “success in AML and sanctions preparation hinges on having clear support from senior management and the board… If you want to create a culture of compliance, the tone and expectations need to be set at the top and supported by ongoing education and training.”

To foster a true culture of AML and sanctions compliance, firms must:

• Have an integrated approach to compliance that ensures consistency organization-wide
• Establish adequate incentives for compliance goals
• Have a holistic view of compliance across international borders
• Maintain geographically integrated reporting systems and technology
• Frequently update their compliance programs to reflect changes in the regulatory framework

In a competitive global market where banks and other financial institutions are increasingly interconnected, only those who devote sufficient resources to ensuring AML and sanctions compliance will thrive.

Financial firm facing AML sanctions on compliance issues? Herskovits PLLC can help. For 20+ years we have focused exclusively on helping securities industry firms and professionals defend themselves in regulatory actions. We have a great track record of successful outcomes. Call us early in the process to avoid pitfalls and assure your best defense. 212.897.5410 OR CONNECT ONLINE

Last week, federal prosecutors charged Delaney Equity Group with participating in a fraudulent scheme involving the sale of bogus shell company shares. The Florida-based broker-dealer allegedly conspired to sell shares of fraudulent microcap companies to investors at a profit. The Department of Justice has accused the defendant of “unlawfully” selling “unregistered securities” between late 2009 and mid 2013.

According to prosecutors, Delaney Equity Group recruited individuals to pose as CEOs for shell companies which were used to fraudulently register securities with the SEC. In order to be able to market shares of the shell companies, Delaney and the straw CEOs allegedly submitted numerous fraudulent documents to government agencies. Among other falsehoods, the documents stated that the ‘CEOs’ owned a control block of restricted shares in their respective companies.

Delaney Equity Group could be fined up to $500,000 or double the proceeds from the misconduct. The case has been assigned to Miami District Judge Cecilia M. Altonaga.

The shell companies mentioned by prosecutors in a recent criminal information were actually controlled by Steven Sanders, Daniel McKelvey, and Alvin S. Mirman, rather than by the nominal CEOs.

A criminal information is a formal criminal charge detailing the existing allegations against the defendants.

According to the DOJ, to elude anti-insider trading rules, Delaney also recruited shareholders to “make it appear that… shares were owned by persons unaffiliated with the company. These shares would later be classified as unrestricted or ‘free trading.’”

The principals would later “sell the companies to criminal actors who would secretly obtain the control shares and the purported ‘free trading’ shares… This would allow the buyers to engage in stock manipulation schemes using the purported ‘free trading’ shares,” the DOJ said in a press release.

The sham CEOs and shareholders were compensated with a set payment and fixed returns, respectively.

The criminal information also states that Delaney, which focuses on penny stocks markets, created nine fraudulent shell companies, secretly facilitating acquisition of their shares by criminal actors. Allegedly, the defendant also filed fraudulent documentation in order to secure FINRA’s authorization to trade shares of the bogus companies electronically and facilitated the acquisition of fraudulent shares by the investing public.

There have already been several prosecutions and convictions in connection with the alleged scheme.

The convicted defendants include John Ahearn, Andrew Wilson, Yelena Furman, David Lubin, Sheldon Rose, Ian Kass, Steven Sanders, Alvin S. Mirman, Daniel McKelvey, and Jeffrey Lamson.

Known as the “Shell Factory” case, the DOJ’s investigation, which began in 2016, has already resulted in several years of prison-time for some of the defendants mentioned above. Daniel McKelvey is serving six months, Jeffrey Lamson is serving seven, Steven Sanders has been put away for 16 months, Sheldon Rose for 40 months, and Ian Kass for 30. David Lubin, a New York-based securities lawyer will be serving one to three years in prison.

Herskovits PLLC, New York securities lawyers with a nationwide practice, helps financial firms and advisers defend against SEC, FINRA and other enforcement actions. CALL US 212.897.5410 OR CONNECT ONLINE

The over 80 subpoenas recently issued to companies in the cryptocurrency sector have provided a logical corollary to the agency’s many warnings about ICOs potential violations of security laws.

The time for warnings is over. Now, the SEC’s intentions have evolved into enforcement actions, forever changing the scenario for new cryptocurrency initiatives.

In late 2017, Bitcoin’s spectacular rise in value lured both would-be cryptocurrency developers and new investors with the promise of returns higher than 2,000 percent. Although the digital currency’s value eventually stabilized, these price fluctuations and the surge in ICO initiatives raised alarm among regulators, who pointed to issues of valuation, liquidity, and arbitrage.

One of the main concerns for CFTC and SEC regulators is the lack of transparency that is inherent to blockchain.

While the heads of both agencies have publicly expressed their optimism about the future of financial technology, they have clearly advised companies raising capital through ICOs to take “appropriate steps to ensure compliance with the federal securities laws.”

As per the U.S. Supreme Court’s Howey test to determine what constitutes a security, ICO activities fit the bill: they involve the investment of money with a reasonable expectation to obtain profits resulting from the entrepreneurial/managerial efforts of others. In other words, the sector’s semantic attempts to dodge SEC scrutiny have failed.

The recently issued SEC subpoenas demanded a variety of documents from cryptocurrency companies, from marketing materials, to establish if there has been false advertising, to investor information, and details about organizational structure.

Recent SEC and CFTC Enforcement Actions

• April, 2018 – SEC complaint filed against Centra Tech, a company that used celebrity endorsements and fake CEO bios to lure investors. Their ICO involved a cryptocurrency-funded debit card supposedly backed by Visa and Mastercard. Three executives were arrested.
• April, 2018 – Over $27 million in fintech trading proceeds were frozen after the SEC filed a complaint accusing Delaware-based Longfin of causing a surge in stock prices as a result of the sale of restricted shares and subsequent acquisition of a “purported cryptocurrency business” that had “no ascertainable value.”
• January 2018 – Texas-based AriseBank received a court order halting an offering of its cryptocurrency AriseCoin. According to the SEC, the bank lied to investors when it said it was in the process of acquiring a federally insured bank. Endorsed by sports stars, the ICO was viewed by the SEC as an “outright scam;” one that managed to raise $600 million in barely two months.
• January, 2018: The CFTC filed a complaint against Las Vegas-based My Big Coin Pay, a company that secured $6 million from investors in a virtual currency, through various misrepresentations, and used customer funds for the owners’ personal expenses.
• January, 2018 – The CFTC accused Colorado-based Dillon Michael Dean and his UK-registered company, The Entrepreneurs Headquarters Limited, of engaging in a Ponzi scheme by securing Bitcoin investments, which were subsequently used to pay earlier investors in a commodity pool.
• January, 2018: Patrick K. McDonnell and his New York-based company CabbageTech were charged with “fraud and misappropriation in connection with purchases and trading of Bitcoin and Litecoin.” The CFTC alleges that the defendants “used their fraudulent solicitations to obtain and then simply misappropriate customer funds.”
• December 2017 – $15 million ICO launched by Munchee Inc. halted by the SEC. The California-based restaurant review company was told it should have registered its endeavor as a securities offering.

2018 Outlook

Since the issuing of the subpoenas and the creation of the SEC’s Cyber Unit, it has become clear that the agency will continue to scrutinize the sale, exchange, and marketing of digital currencies during the rest of the year and beyond.

Regulatory efforts will likely expand, as the SEC appears to be preparing to crack down on a large number of cryptocurrency-focused private fund managers. Disclosures about risk and potential conflicts of interest are likely to become the main targets of the agency’s scrutiny.

Ensuring compliance with federal securities laws is going to be one of the keys to ICO survival. Cryptocurrency entrepreneurs should also keep track of state legislation, as it has been known to define digital tokens in a way that may impact their categorization as securities.

This was recently the case in Wyoming, where “utility tokens” are not deemed to be securities, and Massachusetts, a state that is aggressively enforcing the notion that they are.

On the other hand, the creation of the cross-agency “Distributed Ledger Technology (DLT) Working Group,” which includes the SEC, the CFTC, U.S. Attorney’s Offices, and the Treasury points to continued coordinated efforts to increase and improve regulatory efforts targeting ICOs and other cryptocurrency initiatives.

In the words of a former SEC Commissioner, “there is going to be a ton of enforcement activity.”

If you are facing SEC or CFTC enforcement activity on cryptocurrency or ICO issues, we can help. At Herskovits PLLC we focus exclusively on regulatory defense with specific attention to ICO and cryptocurrency charges. Call early in the process and we might be able to head off an intrusive investigation. 212.897.5410 OR CONNECT ONLINE

Hip-hop star Shawn Carter, aka Jay-Z, has just received a subpoena to appear in court after he failed to testify in connection with the SEC’s probe into Iconix Brand Group’s accounting practices.

Iconix acquired intangible assets from Jay-Z’s clothing brand Rocawear in 2007, which boasted $700 million in annual sales at the time. The agreement was that Carter and Iconix would work on the joint development of new brand opportunities following the sale. But Iconix went on to announce two write-downs of Rocawear, one in 2016, of $169 million, and another one of $34 million earlier this year.

Iconix, which describes itself as, “the world’s premier brand management company and owner of a diversified portfolio of strong global consumer brands across fashion, sports, entertainment, and home,” markets retail brands such as Joe Boxer, Candie’s, Bongo, Pony, Umbro, and Material Girl.

One of America’s top-selling artists of all time, Jay-Z built an empire around his brand. His Roc-A-Fella conglomerate includes a record label, a talent agency, a production company, and even an investment arm.

Once famous for writing a song called, “99 Problems,” in light of the SEC’s subpoena, the musician could well change that title to, “100 Problems.”

So far, however, the SEC has made it clear that Carter is not a suspect of securities violations, and that the subpoena is “appropriate where the information sought from the witness is relevant to the investigation.”

The first time the SEC issued a subpoena for Carter to testify in the Iconix case was in November.

Then, in February, he was summoned again. He failed to appear on both occasions.

The SEC said in a statement that, “Carter failed to appear as required by the subpoenas and, through his counsel, Carter has declined to provide any additional dates on which he will agree to appear for investigative testimony.”

According to a spokeswoman for the hip hop mogul, he is “aware that the SEC is seeking information on Iconix’s financial reporting,” but, “Mr. Carter had no role in that reporting or Iconix’ s other actions as a public company. Mr. Carter is a private citizen who should not be involved in this matter.”

The SEC initiated its ongoing investigation into Iconix Brand Group’s accounting practices in December 2015. The agency is specifically seeking evidence of securities laws violations relating to financial reporting.

A judge has now ordered Carter to appear in court on May 8. At that time, he will have a chance to explain why he believes he should not be required to testify before the Securities Exchange Commission.

SEC subpoena? Call us, we can help. Herskovits PLLC focuses exclusively on defending people and firms in regulatory enforcement actions. 212.897.5410 ORCONNECT ONLINE

Celebrity endorsements add an element of trust for investors who are just entering the ICO market. But the strategy did not turn out well for Centra Tech, as a third arrest has just been made in connection with the SEC’s allegations that the company defrauded investors out of over $25 million.

Earlier this year, I reported on the charges brought against Sohrab Sharma and Robert Farkas, and the public exposure of the alleged fraud.

Sharma, Farkas, and now Raymond Trapani have been charged with falsely advertising their ICO as having links with Visa, and Mastercard, which they claimed were backing their cryptocurrency-funded debit card, “Centra Card.”

Trapani was Centra Tech’s COO. According to the DOJ’s allegations, he co-conspired with Sharma and Farkas to deceive investors by posting a fake CEO bio on Centra Tech’s website and advertising non-existent agreements with established credit card companies.

The SEC’s original complaint against Centra Tech, Sharma, and Farkas has just been amended to include Trapani.

The three defendants, who used to run a luxury car rental company in Florida, enticed investors to entrust millions of dollars to a company that was supposedly run by “Michael Edwards” and “Jessica Robinson,” two executives with an impressive track record; the problem is that neither one of them existed.

The Centra Tech website and its social networks also echoed claims that Visa and Mastercard were backing Centra Card.

Evidence that was instrumental for Trapani’s arrest was found in private communications among the defendants, which were cited by prosecutors in their complaint. For example, on the day the SEC announced it was investigating REcoin, another ICO endeavor, Sharma wrote to Trapani and Farkas: “[The SEC] just shut down REcoin… Read the article… We gotta clean up every single thing that we can’t do… And can’t offer today.”

On another occasion, when a major bank referenced in Centra Tech ads sent them a cease-and-desist letter, Sharma wrote to his partners, “we gotta get that shit removed everywhere and blame freelancers lol.”

Trapani also wrote to Sharma asking him to “cook up” a false document that would enable him to list Centra’s digital tokens in an exchange. To this request, Sharma replied, “Don’t text me that shit lol. Delete.”

According to the criminal charges against Trapani, he “conspired with his co-defendants to lure investors with false claims about their product and about relationships they had with credible financial institutions.”

Deputy U.S. Attorney Robert Khuzam concluded that, “While investing in virtual currencies is legal, lying to deceive investors is not.”

The fact that SEC investigations into fraudulent ICOs are leading to arrests should serve as a cautionary tale for the numerous companies currently making wild claims about their cryptocurrency ventures. In the current ICO and cryptocurrency scenario, sound legal advice is key.

Trapani could face up to 20 years in prison.

Are you part of a team planning an ICO or plan to take investment in your cryptocurrency venture? Herskovits PLLC can help. As securities lawyers exclusively for more than two decades, we know the rules and realities of SEC requirements and how they apply in the new cryptocurrency landscape. 212.897.5410

A new proposed SEC regulation vows to “enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers.”

If “Regulation Best Interest” is finally implemented, broker-dealers will be required to “act in the best interest” of their retail customers whenever they recommend any securities transactions or investments.

Following numerous penalties in cases where broker-dealers recommended investments to their retail customers for the sake of personal gain, the proposed regulation is designed to deter financial advisers from this type of behavior, in the SEC’s words, “to make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer in making recommendations.”

Under Regulation Best Interest, registered broker-dealers would have to disclose fees as well as any conflicts of interest that may arise. An Obama-era regulation that was overturned on appeal last March proposed similar terms, and the new SEC regulation is viewed by some as a timely replacement, and extension, for it.

Promulgated by the Department of Labor under the umbrella of the Employee Retirement Income Security Act, and partially implemented during the second half of 2017, the Obama-era rule required brokers offering advice relating to retirement accounts to act without regard to their personal financial interests.

President Trump had already initiated a strategy to obtain a repeal of the rule, when the U.S. Court of Appeals for the 5th Circuits in New Orleans overturned it. This means that, once more, the interests of the SEC and those of our current President appear to be diametrically opposed.

One of the main aspects of the SEC’s proposed regulation relates to the interpretation of what investment advisers’ fiduciary duty to their clients entails.

The goal is to clarify this relationship and an adviser’s legal obligations to retail investors. In practice, this will be, in part, achieved thanks to the implementation of a new disclosure document summarizing all aspects of that relationship: the Client Relationship Summary (CRS). The CRS would inform clients in detail and in simple language about the nature of their relationship with their adviser.

Under the new regulation, certain client communications would require that the broker disclose their registration status with the SEC, and unregistered brokers would not be allowed to use the term “adviser” or “adviser” in their title when communicating with investors.

The SEC’s Chairman, Jay Clayton, who has made repeated efforts to enhance investor protections, said in a press release that he believes the Commission,

“can increase investor protection and the quality of investment services by enhancing investor understanding and strengthening required standards of conduct.” He also emphasized the fact that the SEC does not want this type of rules to restrict “investors’ access to a range of products and services at a reasonable cost.”

As it is customary, the public now has 90 days to comment on the proposed rule, counting from April 18.

The proposal’s highlights, as published by the SEC, are reproduced below.

SEC Proposal’s Highlights

Regulation Best Interest

A broker-dealer making a recommendation to a retail customer would have a duty to act in the best interest of the retail customer at the time the recommendation is made, without putting the financial or other interest of the broker-dealer ahead of the retail customer.

A broker-dealer would discharge this duty by complying with each of three specific obligations:

• Disclosure obligation: disclose to the retail customer the key facts about the relationship, including material conflicts of interest.
• Care obligation: exercise reasonable diligence, care, skill, and prudence, to (i) understand the product; (ii) have a reasonable basis to believe that the product is in the retail customer’s best interest; and (iii) have a reasonable basis to believe that a series of transactions is in the retail customer’s best interest.
• Conflict of interest obligation: establish, maintain and enforce policies and procedures reasonably designed to identify and then at a minimum to disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives; other material conflicts of interest must be at least disclosed.

Investment Adviser Interpretation

An investment adviser owes a fiduciary duty to its clients — a duty that the Supreme Court found exists within the Advisers Act. The proposed interpretation reaffirms, and in some cases clarifies, certain aspects of the fiduciary duty that an investment adviser owes to its clients.

Form CRS – Relationship Summary

Investment advisers and broker-dealers, and their respective associated persons, would be required to provide retail investors a relationship summary.

This standardized, short-form (4 page maximum) disclosure would highlight key differences in the principal types of services offered, the legal standards of conduct that apply to each, the fees a customer might pay, and certain conflicts of interest that may exist.

Investment advisers and broker-dealers, and the financial professionals who work for them, would be required to be direct and clear about their registration status in communications with investors and prospective investors.

Certain broker-dealers, and their associated persons, would be restricted from using, as part of their name or title, the terms “adviser” and “advisor” — which are so similar to “investment adviser” that their use may mislead retail customers into believing their firm or professional is a registered investment adviser.

Securities lawyer Rob Herskovits, founder of New York based Herskovits PLLC, helps advisers and broker-dealers nationwide accused of violating SEC regulations. Call 212.897.5410 or Connect Online

The SEC is effectively expanding its jurisdiction into the cryptocurrency and ICO market. Dozens of companies, possibly hundreds, are receiving SEC subpoenas, which I advise them to take very seriously.

High profile companies, including giants like TechCrunch’s cryptofund, are currently dealing with these subpoenas. One of the problems is that nobody knows exactly what is going on, and the market is eager for the SEC to clarify the rules.

Do securities laws apply to cryptocurrency? The SEC says they do, but it is yet to issue a detailed guide for compliance. That is why securities lawyers like myself are playing an increasingly important role in the digital currency space right now.

In fact, the current legal uncertainty has driven many companies to move offshore, in order to avoid SEC scrutiny.

In this context, it is important to be prepared in case your company should receive a subpoena. The most important thing is not to confront the SEC directly or claim that they do not have jurisdiction. Instead, you should seek counsel and have them inquire about the agency’s concerns.

The safest path to disaster would be to talk to SEC officials without advice from an experienced securities lawyer. This could lead to self-incrimination and involuntary admissions of guilt.

Basically, the SEC is looking to determine whether your company should be registered, if it is dealing in what the SEC considers securities, or if it is somehow exempt from registration. As usual, anything you say during an interview with SEC staff could be used against you.

SEC Going After SAFTs

After careful consideration as to which companies are receiving subpoenas, a clear pattern emerges: the SEC is systematically targeting ICO projects working under the simple agreements for future tokens (SAFTs) framework.

Under this framework, issuers simply offer coupons for future tokens, that will be available when their cryptocurrency platforms are completed.

An anonymous source recently told CoinDesk:

“The SEC is targeting SAFTs. The new approach of the SEC is to consider tokens as both utility and security at the same time, meaning a token can bring utility to a platform but at the same time can be considered as a security if you sold it to parties that mainly looked for profit on its increase in value.”

The problem now is that SAFTs were largely thought to be on the safe side of securities laws. Now, the SEC is issuing 25-page subpoenas asking issuers for everything under the sun. At this point, the best investment you can make is securing representation from a top securities law firm.

What the cryptocurrency market needs is a regulatory framework that protects investors while enabling innovation.

The SEC’s recent enforcement actions against cryptocurrency fraudsters were meant to send a message. But the agency seems to feel that was not enough. We are living in a time of constant shifts in the regulatory space.

As the market evolves, regulators will try to keep up with it. and years will probably go by before we have a clear and determined framework in place to govern the digital tokens trade.

One thing is certain, the SEC subpoenas are going to keep coming, and companies should start preparing for them right now.

If you or your company are in the ICO and digital currency space the SEC says you must comply with their rules or face heavy sanctions. It’s a new area of law, filled with pitfalls for non-lawyers. Herskovits PLLC lawyers have 20 years’ experience representing people and companies facing SEC subpoenas. Call to learn your options.

Call 212.897.5410 or Connect Online

The SEC has repeatedly warned cryptocurrency investors about the market’s vulnerability to large-scale fraud. Likewise, the agency has made it clear that cryptocurrency offerings that function as securities will be treated as such, and thus subjected to scrutiny.

Since SEC officials began making emphatic statements about its jurisdiction over the cryptocurrency space, many companies have been sued in connection with their ICO dealings.

According to estimates, the SEC is looking into the affairs of at least 80 crypticompanies, in search of a variety of violations.

Among the companies whose alleged fraudulent dealings have been exposed by the SEC were:

• PlexCorps, a company that raised $15 million from investors lured by the promise of “the next decentralized worldwide cryptocurrency,” which the SEC believes they never even started developing.
• Maksim Zaslavskiy and the companies he used to sell REcoin, advertised as “The First Ever Cryptocurrency Backed by Real Estate.” Zaslavskiy told potential investors he had raised over $4 million, when in reality, he had only raised $300,000.
• The blockchain-based food review service Munchee and its MUN token. The SEC found evidence of false advertising on Facebook, promising “199% GAINS.”
• AriseBank, a company that claimed to have raised $600 million in an ICO, in its efforts to “revolutionize banking” via cryptocurrency. The SEC alleged the company misled investors about its true activities and intentions, and concealed from them the fact that one of its founders had a criminal record.
• Jon E. Montroll and his platform BitFunder.com. According to evidence introduced by the SEC complaint, Montroll misappropriated funds from users of the platform, stealing over 6,000 bitcoins.

But companies need not have incurred these type of violations to receive a SEC subpoena. The agency is currently making a sweeping effort to show it has jurisdiction over ICOs. It is looking for any companies that may be making misleading claims to attract investors, lying about the valuation of their assets or the amount of investor funds raised.

This should come as no surprise to players in the cryptocurrency space. The SEC has given ample warnings about its areas of concern.

A defense based on the argument that ICOs are not securities will not fare well in the current scenario.

Above all, companies developing and marketing ICOs need to be prepared to hear a knock on the door, compliments of SEC regulators. SEC subpoenas need to be taken seriously. Considering the shocking cases of fraud the agency has already exposed, where investors have been defrauded out of millions of dollars, its regulatory efforts and blanket probes are unlikely to stop.

Companies that receive an SEC subpoena or even an informal inquiry, must be ready to respond with crucial assistance from a cryptocurrency-savvy securities lawyer. A legal professional can obtain specific information as to what the SEC is looking at, and devise a plan to respond efficiently to any concerns regulators may have.

This is still largely uncharted territory for both regulators and cryptocurrency companies, and legal counsel is key to minimize risks.

Facing an SEC subpoena over ICO activities? Cryptocurrency firms should have an experienced securities lawyer interfacing with the SEC to avoid mischaracterization of their attempts to explain ICO related conduct. Herskovits PLLC focuses exclusively on securities law. Nationwide practice. Call 212.897.5410 or Connect Online