Securities Industry Commentator by Bill Singer Esq

FINRA's Restricted Firm Rule: Two SEC Commissioners Toast the Sinking of the Titanic (BrokeAndBroker.com Blog)

Statement on Investor Protection Related to Recent Developments in China by SEC Chair Gary Gensler

Prepared Remarks for National Whistleblower Day Celebration by SEC Chair Gary Gensler

SEC Charges Ernst & Young, Three Audit Partners, and Former Public Company CAO with Audit Independence Misconduct (SEC Release)

U.S. Promoter of Foreign Cryptocurrency Companies Pleads Guilty for Role in Multimillion-Dollar Securities Fraud Scheme (DOJ Release)

Former President and CEO of now bankrupt precious metals firm convicted of mail and wire fraud for Ponzi-type scheme / Defrauded more than 2500 customers of $25 million (DOJ Release)

Former Bank Branch Manager Sentenced for Fraud Schemes (DOJ Release)

Former Chief Financial Officer of Publicly Traded Company Convicted of Securities and Accounting Fraud (DOJ Release)

Recently, the government of the People's Republic of China provided new guidance to and placed restrictions on China-based companies raising capital offshore, including through associated offshore shell companies. These developments include government-led cybersecurity reviews of certain companies raising capital through offshore entities.

This is relevant to U.S. investors. In a number of sectors in China, companies are not allowed to have foreign ownership and cannot directly list on exchanges outside of China. To raise money on such exchanges, many China-based operating companies are structured as Variable Interest Entities (VIEs).

In such an arrangement, a China-based operating company typically establishes an offshore shell company in another jurisdiction, such as the Cayman Islands, to issue stock to public shareholders. That shell company enters into service and other contracts with the China-based operating company, then issues shares on a foreign exchange, like the New York Stock Exchange. While the shell company has no equity ownership in the China-based operating company, for accounting purposes the shell company is able to consolidate the operating company into its financial statements.

For U.S. investors, this arrangement creates "exposure" to the China-based operating company, though only through a series of service contracts and other contracts. To be clear, though, neither the investors in the shell company's stock, nor the offshore shell company itself, has stock ownership in the China-based operating company. I worry that average investors may not realize that they hold stock in a shell company rather than a China-based operating company. 

In light of the recent developments in China and the overall risks with the China-based VIE structure, I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective. In particular, I have asked staff to ensure that these issuers prominently and clearly disclose:

• That investors are not buying shares of a China-based operating company but instead are buying shares of a shell company issuer that maintains service agreements with the associated operating company. Thus, the business description of the issuer should clearly distinguish the description of the shell company's management services from the description of the China-based operating company;
  
  
• That the China-based operating company, the shell company issuer, and investors face uncertainty about future actions by the government of China that could significantly affect the operating company's financial performance and the enforceability of the contractual arrangements; and
  
  
• Detailed financial information, including quantitative metrics, so that investors can understand the financial relationship between the VIE and the issuer.

Additionally, for all China-based operating companies seeking to register securities with the SEC, either directly or through a shell company, I have asked staff to ensure that these issuers prominently and clearly disclose:

• Whether the operating company and the issuer, when applicable, received or were denied permission from Chinese authorities to list on U.S. exchanges; the risks that such approval could be denied or rescinded; and a duty to disclose if approval was rescinded; and
  
  
• That the Holding Foreign Companies Accountable Act, which requires that the Public Company Accounting Oversight Board (PCAOB) be permitted to inspect the issuer's public accounting firm within three years, may result in the delisting of the operating company in the future if the PCAOB is unable to inspect the firm.

In addition to this specific guidance, we will continue to hold all companies to the securities laws' high standards for complete and accurate disclosure.

Further, I also have asked staff to engage in targeted additional reviews of filings for companies with significant China-based operations.

I believe these changes will enhance the overall quality of disclosure in registration statements of offshore issuers that have affiliations with China-based operating companies. This work builds on the SEC's Division of Corporation Finance's previous guidance on disclosure considerations for companies based in or with significant operations in China.[1]

I believe such disclosures are crucial to informed investment decision-making and are at the heart of the SEC's mandate to protect investors in U.S. capital markets.

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[1] See CF Disclosure Guidance: Topic No. 10, "Disclosure Considerations for China-Based Issuers" (Nov. 23, 2020), available at https://www.sec.gov/corpfin/disclosure-considerations-china-based-issuers.

I believe deeply in whistleblower programs and look forward to building on the work of past Chairs to ensure the continued strength of the SEC's program.

I have asked staff to examine whether and how the program could be further strengthened to ensure that misconduct within the remit of the SEC is identified, addressed, and stopped.

We must ensure that whistleblowers are empowered to come forward when they see misbehavior; that they are appropriately compensated according to the framework established by Congress; and that those who report wrongdoing are protected from retaliation.

I also believe we should look for opportunities to continue to reduce processing times in SEC whistleblower award determinations. . . .

admitted that he conspired with others to defraud investor victims by inducing them to invest in their companies, "Start Options" and "B2G," based on materially false and misleading representations. Start Options purported to be an online investment platform that provided cryptocurrency mining, trading and digital asset trading services. B2G was purportedly an "ecosystem" that would allow users to trade B2G tokens, provide digital wallet staking and trade digital and fiat currencies "on a secure, comprehensive platform." Both Start Options and B2G, however, were fraudulent. 

As part of the conspiracy, in approximately December 2017, DeMarr and others began offering securities in the form of investment contracts to U.S. and international investors through the Start Options website. Investments were accepted in Bitcoin, U.S. dollars or Euros. To participate, investors had to deposit their funds for a specified contract period, after which they were told that they could withdraw their money at a significant profit. 

According to court documents, DeMarr and others falsely claimed that investor funds would be invested in digital asset mining and trading platforms that would earn them massive profits. In truth, however, the money was never invested and was instead diverted to accounts controlled by DeMarr and others and used for various personal expenditures, including the purchase of a Porsche, jewelry, and to remodel DeMarr's home in California. 

Similarly, Start Options also claimed to feature celebrity endorsements to promote its securities offerings. For example, Start Options falsely represented that a professional athlete had endorsed Start Options when, in fact, the athlete was not involved with Start Options and his name and likeness were used without his consent. Based on this and other fraudulent promotional materials, investors sent millions of dollars' worth of Bitcoin, Ethereum, and fiat currency to financial accounts, including cryptowallets, controlled by DeMarr and others in the U.S. and abroad. 

In late January 2018, rather than permitting Start Options investors to withdraw money from their accounts after the requisite time period, DeMarr and others required investors to roll over their accounts into an unregistered "initial coin offering," or ICO, of B2G, the second of the two fraudulent companies in which DeMarr was involved. Among other fraudulent misrepresentations, DeMarr and others falsely told investors that the ICO would raise capital for the company to build an "ecosystem" that would allow users to trade B2G tokens, provide digital wallet staking, and trading. In truth, investors never actually received any digital tokens, and funds from the offering were not used to develop the B2G platform.

As part of the conspiracy, DeMarr and others also paid various promoters, including an actor famous for martial arts films made in the 1980s and 1990s, to serve as a promoter and celebrity spokesperson, falsely claiming that B2G could generate an "8000%" return for investors within one year, and that he was a participant in the ICO. DeMarr and others also created false press releases and whitepapers about B2G, fabricated B2G account statements and refused to allow investors to withdraw their money. 

Northwest Territorial Mint (NWTM) operated both a custom business that involved the manufacturing of medallions and other awards, and a bullion business that involved the selling, buying, exchanging, storing, and leasing of gold, silver, and other precious metals.  The company had offices in Federal Way and Auburn, Washington, but declared bankruptcy on April 1, 2016. 

According to records in the case and testimony at trial, Hansen and Erdmann defrauded NWTM customers in a variety of ways. The evidence at trial showed that Hansen and Erdmann lied about shipping times for bullion, used customer money to expand the business to other states, and used customer money to pay their own personal expenses.  In this way the company lacked enough assets to fulfill customer orders and used new customer money to pay off older customers in a Ponzi-like scheme.  In total, over 2500 customers paid for orders, or made bullion sales or exchanges, that were either never fulfilled or never refunded.  The total loss to these customers was more than $25,000,000.  

In closing arguments, Assistant United States Attorney Benjamin Diggs told the jury "They tried to make this company look solid - like the metals they sold - but in fact it was a house of cards."

In addition to the bullion customer fraud, the evidence at trial demonstrated that Hansen and Erdmann defrauded customers who paid NWTM to safely and securely store bullion in the NWTM vaults.  Evidence and testimony at trial showed that Hansen and Erdmann used this bullion that was supposed to be in secure storage to fulfill other orders.  In April 2016, the NWTM vaults were inventoried and all or part of the stored bullion for more than 50 customers was missing.  The missing bullion was worth more than $4.9 million.  

devised two separate fraud schemes. Fruits' s bank fraud scheme targeted customers of the Brownsburg, Indiana bank where she served as branch manager. Fruits admitted in court that between 2017 and 2020, she perpetrated a scheme to withdraw money from customers' Certificate of Deposit (CD) accounts without their knowledge. She digitally signed for the customers without their authorization, effectively forging their signatures, and then approved the withdrawals using her position as branch manager. In total, she stole more than $180,000 from the bank's customers using this scheme.

Fruits mail fraud scheme targeted three children for whom she served as guardian and trustee of their inheritance. Fruits admitted that in mid-2015, one of Fruits' s close friends died, leaving trust accounts for the friend's three children. Fruits was named the trustee for the accounts, each of which had more than $50,000 in them. Over the course of eight months, Fruits spent all the money in the children's accounts on unauthorized purchases.

To conceal her thefts, she created and mailed false bank statements purporting to show that the children's accounts still had thousands of dollars in them. The three trust accounts had zero dollars left because Fruits had spent all the money.

Between the two schemes, Fruits admitted to stealing more than $315,000. 

• Securities Industry Commentator
• Bill Singer