Securities Industry Commentator by Bill Singer Esq

[C]reates a transparent, efficient, and comprehensive process for a registered security-based swap dealer or major security-based swap participant, collectively known as SBS Entities, to apply to the Commission for relief from the statutory disqualification prohibition found in Exchange Act Section 15F(b)(6). Rule of Practice 194 also provides an exclusion for an SBS Entity from the prohibition in Exchange Act Section 15F(b)(6) with respect to associated persons entities, consistent with the Commodity Futures Trading Commission's (CFTC) approach with respect to the statutory prohibition for swap entities.

Today's release addresses a critical question: how can we best deter market participants from engaging in misconduct in our security-based swap markets? We have a wide range of tools for doing so,4 but none nearly as powerful as disqualification. The reason, of course, is that nothing is as valuable to security-based swap traders as access to the deepest and most liquid capital markets in the world. So when market participants consider engaging in wrongdoing, the prospect that they will be barred from the marketplace if they're caught looms large in their calculus regarding the costs of harming investors.

That's why Congress empowered this Commission to oversee whether, and how, bad actors could reenter these markets. As in other areas, the prospect of having to prove to our thoughtful, exacting Staff that past wrongdoing does not pose future risk to investors provides a powerful ex ante deterrent for wayward traders.

Today's release sets forth a process for individuals who have been disqualified to seek waivers from the Commission. But the rule also partly cedes that oversight to others by allowing disqualified entities to stay in our markets when another regulatory body has previously given its approval.  Our Staff's perspective on these questions is unique and important. I cannot see why independent review by this agency should not be required before bad actors can pursue the privilege of continuing to trade with American investors.

More generally, I do not understand the economic case for smoothing bad actors' path to readmission. There is no free lunch in financial markets. If we fail to deter bad actors, investors will have to pay to protect themselves. I cannot see why we should ask investors to bear those costs rather than provide the more meaningful deterrence that Congress envisioned in Dodd-Frank.

Moreover, if there's a market in which we should rely on investors, rather than the Commission, to deter bad actors, this isn't it.  In order to protect themselves, investors need information and competition. Information allows investors to identify potential wrongdoers, imposing high reputational costs that serve as a deterrent. And competition allows investors to impose the ultimate penalty when market participants misbehave: taking their business elsewhere.

But the security-based swaps market offers investors little of either. As to information, this market is famously opaque, making it especially costly for investors to find out whether, and how, a bad actor might harm them in the future.  And as to competition, this market is among the most concentrated of those we oversee. As the release notes, in 2017 the top five dealer accounts engaged in over 55% of transactions in this market -- leaving aggrieved investors few ways to vote with their feet.  So this market is especially ill-suited for reliance on other regulators and investors when it comes to deterring bad actors. Accordingly, I cannot support the choices reflected in today's final rule.

I am deeply grateful for the Staff's hard work on this rule. Although I cannot support today's recommendation, meeting our statutory mandate under the Dodd-Frank Act should be a top priority for the Staff and the Commission -- and I very much look forward to future recommendations that will bring the agency into compliance with that landmark law.

First, today's rule will give preferential treatment to companies that have committed fraud or were convicted of crimes. It would allow them to participate in buying, selling, trading, or effectuating security-based swap transactions-no questions asked. The rule will provide an automatic exception for a company that committed fraud, or engaged in the wholesale theft of assets and allow it to continue to participate in the securities swap market. There will be no application for a waiver, no hearing, no weighing of the factors, and no affirmative decision by the Commission. Companies will be automatically cleansed and be considered good actors in one procedure-less swoop.

My second concern is that the rule grants the power to waive bad actor bars concerning individuals to a host of regulators and non-regulators-- the Commodity Futures Trading Commission ("CFTC"), the National Futures Association ("NFA"), the Financial Industry Regulatory Authority ("FINRA"), and any national securities exchange.

Indeed, I am reminded of the colossal regulatory failures during the financial crisis, when regulators pointed to one another each disclaiming responsibility. By making everyone responsible, then no one is responsible. 

My concerns are not theoretical. As the release acknowledges, fraudsters, felons, and other wrongdoers to whom a bad actor bar would apply pose a real risk to both counterparties and the market. Employees with prior misconduct are five times as likely to engage in new misconduct. In addition, approximately a third of employees with misconduct in their past engage in repeated misconduct. Further, the release also notes that weaknesses in a firm's compliance culture can contribute to future misconduct: an employee is 37 percent more likely to engage in misconduct if they have co-workers with a history of misconduct.

There has been a vigorous debate about the collateral consequences for both companies and individuals incurred as a result of misconduct. Should companies lose privileges as a result of associating with others who have demonstrated misconduct? Or are certain firms too important to lose privileges? Are they too-big-to-bar?

I would have supported a rule that permitted a person or entity subject to a statutory disqualification to apply to the Commission for a waiver.[7] There are occasions when it makes sense to waive such bad actor provisions. And since I have been at the Commission, I have been advocating for the establishment of fair and transparent processes for those seeking such waivers. Fair and transparent processes provide clarity to market participants, level the playing field between businesses big and small, and focus the Commission on its investor protection duties.

As I said previously, the Commission abrogating its authority, for little reason other than to carve out wrongdoers from having to obtain waivers from the Commission is a loophole that I cannot sign onto.

Simply put, it's our mission to use all the regulatory tools in our toolbox to ensure market integrity and to protect investors. This means that we must ensure that wrongdoers -whether they are companies or individuals-do not pose a threat to the system or our investors. In my view, this rule does not adequately protect against such a threat. It is for this reason that I cannot support today's rule. . .

The Tucker Payday Lending Scheme

On October 13, 2017, Scott Tucker and his attorney, Timothy Muir, were convicted after trial in the United States District Court for the Southern District of New York of racketeering, wire fraud and money laundering for their roles in perpetrating a massive payday lending scheme.  As the jury found, from in or about the late 1990s through in or about 2013, through various companies that he owned and controlled (the "Tucker Payday Lenders"), Tucker extended short-term, high-interest, unsecured loans, commonly referred to as "payday loans," to individuals around the country at interest rates as high as 700% or more and in violation of the usury laws of numerous states, including New York.  Tucker sought to inoculate himself against applicable usury laws by entering into a series of sham relationships with certain Native American tribes (the "Tribes") in order to conceal his ownership and control of the Tucker Payday Lenders and gain the protection of tribal sovereign immunity - a legal doctrine that generally prevents states from enforcing their laws against Native American tribes.  To effectuate his scheme, Tucker assigned nominal ownership of his payday lending companies to certain corporations created under the laws of the tribes (the "Tribal Companies").

CSCM's Willful Failure to File a SAR in Violation of the BSA

CSCM failed to follow its written customer identification procedures and did not act upon red flags prior to opening investment accounts for the Tribal Companies, which were in fact controlled by Tucker.  CSCM discussed opening these accounts exclusively with Scott Tucker and his brother Blaine (the "Tuckers").  Although CSCM received account opening documents signed by tribal officials granting only Blaine Tucker authorization over the accounts, CSCM routinely dealt with and took direction from Scott Tucker concerning the management of funds in the Tribal Companies' accounts based solely on Scott Tucker's oral assertions that he was a "consultant" to the Tribes.  At no point did CSCM obtain written verification of Tucker's authority over the accounts.

CSCM also disregarded red flags that were known prior to opening the accounts.  In March 2012, Tucker explained to the CEO that he was involved in the payday lending business and that he had approached certain Native American tribes to operate the payday lending business in order to take advantage of the tribes' sovereign immunity.  Tucker further explained that the payday lending business had generated large cash reserves and that he was approaching CSCM because the business's existing bank, a small bank based in Florida (the "Florida Bank"), had asked Tucker to move excess accumulations of cash because of certain regulatory requirements it was unable to meet.  Neither the CEO, nor anyone at CSCM, attempted to verify this explanation.

Shortly thereafter, CSCM also became aware of additional red flags concerning the Tuckers and the Tribal Companies.  Specifically, CSCM learned that Tucker had been convicted of fraud in 1991 and, separately, found news reports from as early as 2011 alleging that the Tuckers were engaging in a "rent-a-tribe" scheme in which the Tribal Companies were used by the Tuckers to claim ownership and control over the payday lending businesses in order to exploit the Tribal Companies' ability to assert sovereign immunity as a defense to charges that the payday lending business violated state usury laws.  CSCM also became aware of an action brought by the Federal Trade Commission ("FTC") against the Tuckers and the Tribal Companies, among others, for engaging in unfair business practices, which included allegations that the Tribal Companies were not protected by sovereign immunity.  CSCM, including its CEO, did not act upon these red flags because Tucker assured CSCM that the FTC action would soon be resolved and all challenges brought by state regulators had been unsuccessful due to sovereign immunity.

In addition to ignoring these various warning signals, CSCM failed to monitor any transactions using Actimize, the AML tool provided to CSCM for that purpose.  Between December 2011 and December 2015, Actimize generated 103 alerts, but CSCM never checked any of the alerts, made any attempt to customize Actimize's default parameters, or undertook a review to ensure that this tool was sufficient for its specific monitoring needs or was being appropriately utilized.  Further, although the Clearing Firm furnished CSCM with the ability to generate a report reflecting, among other things, the identities of third parties transferring funds via wire transactions to CSCM account holders, CSCM never generated such reports.

Numerous suspicious transactions went undetected and unreported by CSCM.  For example, between December 21, 2012, and March 13, 2013, 18 wire transfers totaling $40,518,000 were sent from accounts at the Florida Bank in the names of Tribal Companies to Tucker's personal CSCM account.  The transfers were in even dollar amounts, and on several occasions two different Tribal Companies, associated with different tribes, transferred the same dollar amounts, on the same day, to Tucker's personal CSCM account.  CSCM never asked Tucker or the Tribal Companies about any of these transactions.

Despite producing documents in connection with this Office's criminal investigation and its awareness of the indictment against Tucker, CSCM did not file a SAR until long after Tucker was convicted at trial. 

Goodman Complaint
https://www.sec.gov/litigation/complaints/2018/comp-pr2018-296-1.pdf

New, Knuth, and Synergy Complaint
https://www.sec.gov/litigation/complaints/2018/comp-pr2018-296-2.pdf

Davis et. al Complaint
https://www.sec.gov/litigation/complaints/2018/comp-pr2018-296-3.pdf

CFTC and State of Utah Amend Their Complaint Against Rust Rare Coin and Gaylen Rust to Charge Additional Defendants for Participating in $200 Million Salt Lake City Precious Metals Ponzi Scheme (CFTC Release)
https://www.cftc.gov/PressRoom/PressReleases/7856-18CFTC and the Utah Department of Commerce, Division of Securities filed an amended complaint alleging that Denise Gunderson Rust and Joshua Daniel Rust actively participated and aided and abetted, in a precious metals Ponzi scheme involving the purported pooling of some $200 million of investors funds into silver (the "Silver Pool") with defendants Gaylen Dean Rust and Rust Rare Coin, Inc. ("RRC"). The First Amended Complaint alleges that Denise Rust and Joshua Rust knew the Silver Pool was a fraudulent scheme; and that they signed checks issued to Silver Pool investors knowing that these checks were Ponzi payments involving money contributed by other investors.  Further, Denise Rust and Joshua Rust allegedly transferred Silver Pool funds to one or more of the relief defendants or to help fund RRC's other business activities. The United States District Court for the District of Utah entered a restraining order freezing the assets of the defendants and the relief defendants and permitting the CFTC and the State of Utah to inspect all relevant records of the defendants and the relief defendants. READ the Complaint 
https://www.cftc.gov/sites/default/files/2018-12/enfrustrarecomplaint120618.pdf

CFTC Charges Chicago-area Trader with Ongoing Forex and Commodity Fraud (CFTC Release)
https://www.cftc.gov/PressRoom/PressReleases/7857-18
In a Complaint filed in the United States District court for the Northern District of Illinois, the CFTC filed a civil enforcement action against Dro Kholamian and his company, Blue Star Trading, LLC. The Complaint charges that the Defendants fraudulently solicited clients to trade leveraged off-exchange foreign currency (Forex) and commodity futures contracts through accounts they would manage; however, the Defendants did not trade all of the clients' funds as represented and, instead, misappropriated those funds.  The Court entered a Statutory Restraining Order freezing the assets of Kholamian and Blue Star, and prohibiting the destruction of their books and records. Also, the parties agreed to a Consent Order for Preliminary Injunction whereby the Court continues the relief set forth in the Statutory Restraining Order and prohibits the Defendants from further violations of the provisions of Commodity Exchange Act and its Regulations alleged in the Complaint. As set forth in part in the CFTC Release:

[B]eginning in at least January 2013 and continuing to the present, the Defendants fraudulently solicited and accepted at least $775,000 from at least three individuals with whom Kholamian was acquainted through his local Armenian community, and overall possibly more than $1.9 million from more than 30 clients.  Kholamian, a long-time commodity trader and former floor broker, claimed that he would manage individual trading accounts for clients to trade forex and commodity futures contracts, generating for them a 10-20 percent profit on a $25,000 investment within one year, and that clients could withdraw their funds at any time, without penalty.  After his clients opened and funded their trading accounts, Kholamian assured them that that their investments were "doing well" and were on target to make the projected 20 percent return after one year.  In fact, Kholamian did not trade on their behalf as promised.  Instead, the Defendants misappropriated most of his clients' funds, using those funds to pay personal expenses such as medical bills and business expenses, to make cash withdrawals and to pay other clients in the manner akin to a Ponzi scheme.

As part of his scheme, when clients demanded to withdraw their funds, Kholamian ignored their demands and lied about trading conditions that purportedly prevented him from making disbursements, claiming, for instance that he was "tied up in trades."  Eventually, when confronted with persistent demands from clients for the return of their money, Kholamian issued two $25,000 checks from his Blue Star bank account to clients, knowing that they could not be paid due to insufficient funds.  

READ the Kholamian and Blue Star:

Complaint https://www.cftc.gov/sites/default/files/2018-12/enfdrokholamianandbluestartradingllcomplaint113018.pdf

Restraining Order  https://www.cftc.gov/sites/default/files/2018-12/enfdrokholamianandbluestartradingllcorder113018.pdf

Preliminary Injunction https://www.cftc.gov/sites/default/files/2018-12/enfkholamianbluestarorder121318.pdf

• Securities Industry Commentator
• Bill Singer