Securities Industry Commentator by Bill Singer Esq

FINRA Arbitrators Award $1 In Response to $1 Million In Damages Sought (Sort of)  (BrokeAndBroker.com Blog)

Operating Partner of Oil and Gas Maintenance Business Sentenced to Prison for Wire Fraud (DOJ Release)

Falling Further Back - Statement on Chair Gensler's Regulatory Agenda (Statement by SEC Commissioner Hester M. Peirce and SEC Commissioner Elad L. Roisman)

Pueblo Cattle Investment Operator Sentenced to Federal Prison for Wire Fraud and Money Laundering (DOJ Release)

Rat Farms and Rule Comments - Statement on Comment Period Lengths (Statement by SEC Commissioner Hester M. Peirce)

Trader Indicted for Commodities Insider Trading Scheme (DOJ Release)

CFTC Charges Puerto Rico Resident and His Firm for Misappropriation of Nonpublic Information and Fictitious Trading (CFTC Release)

SEC Charges Three Canadians with Securities Fraud (SEC Release)

[T]hompson entered into a business partnership with the victim to operate a company called DACK Energy Services, LLC ("DACK"), which conducted maintenance services for oil and gas companies in Colorado and surrounding areas.  The defendant acted as the operating partner.   In that role, Thompson was solely responsible for managing work production, hiring employees, procuring equipment, and establishing contracts.  The victim, in turn, provided investment capital for the business.

From January 2014, to January 2016, the defendant submitted invoices to the victim,  The invoices purportedly represented work performed by DACK.  The victim relied on these invoices, believing they reflected accounts receivables and future income for DACK.  However, many of these invoices were completely fabricated and did not represent any future income the company would receive.  Often, the defendant had not established any business relationship with the companies identified in the fabricated invoices.  In total, more than $1.4 million in fabricated invoices were presented by the defendant.  Based on the false information provided by the defendant, the victim borrowed $1.25 million and invested that money into the company.

In addition to creating false invoices, the defendant funneled proceeds from the company into an account that he controlled.  Thompson used these monies for his personal benefit.  In addition, he ensured friends and family members were on DACK's payroll, but these individuals performed little, if any, actual work.  Instead, they would perform personal services for the defendant and his immediate family.

While Chair Gary Gensler's newly released regulatory agenda[1] is ambitious in scope, we are disappointed with its content. It fails to include any items intended to facilitate capital formation and misses opportunities to foster fair, orderly, and efficient markets and further investor protection. Instead the agenda is brimming with plans to redo recently completed rules, add new regulatory obligations, and constrain investor choice.

I. Facilitating Capital Formation

The Regulatory Flexibility Agenda ("Agenda") neglects to include a single item designed to help companies raise capital. Indeed, several items listed are poised to do the exact opposite.

One example is the proposal to alter the thresholds at which an issuer is required to register a class of securities with the Commission.[2] In 2012, Congress enacted the bipartisan Jumpstart Our Business Startups (a.k.a., the JOBS Act),[3] which, among other provisions aimed at improving capital access for newer companies, specifically raised these thresholds in order to allow companies greater flexibility in deciding whether and when to go public. This provision has been especially important for pre-IPO companies that use equity as part of their employee compensation arrangements and for startups in industries with high initial capital requirements. Lowering these thresholds may both contradict the express will of Congress and potentially undermine our mission to facilitate capital formation. A likely unintended consequence of lowering thresholds will be to limit the opportunity of employees, smaller investors, and other non-institutional investors to invest in promising businesses.

A second example is the proposed changes to Form D.[4] Federal law includes an exemption from registration for non-public offerings because Congress acknowledged that certain offerings do not require disclosure to the public or to the SEC. Smaller and younger companies often have legitimate business reasons to be discreet about early capital raising efforts. Investors in private companies already receive more information than is included on Form D. While it might be helpful for the SEC to have more information about these offerings, it is odd to consider imposing new requirements on small businesses which are trying to survive in a time of great uncertainty caused by COVID-19, labor shortages, supply chain disruptions, and inflation.

II. Maintaining Fair, Orderly, and Efficient Markets

The Agenda abandons two important endeavors crucial to maintaining fair, orderly, and efficient markets, which had been in progress during the prior administration.

The first is the proposed exemption from Exchange Act Rule 15c2-11 for certain publications of broker-dealer quotations on an expert market.[5] The Commission recently amended Rule 15c2-11 to enhance the requirements a broker-dealer must satisfy before it initiates or resumes the quotation of a security in the over-the-counter ("OTC") market.[6] While we supported the important investor protections these changes brought, we also cautioned-as did many commenters-that the amendments could have unintended adverse consequences for certain investors of companies that choose not to make disclosures.[7] A key reason we supported these rules was the Commission's explicit willingness to use exemptive relief for an expert market to ensure that investors in these companies would still be able to sell their shares. We are disappointed that the agency is no longer considering this exemption,[8] despite the overwhelming support of commenters and the adverse consequences investors now are experiencing.[9] Nor does the Agenda include plans to prevent Rule 15c2-11 from being misapplied to fixed-income securities. A rulemaking tailored to fixed income securities would make a lot more sense than trying to shoehorn these securities into a rule designed for equity securities.

Second, the Agenda abandons the much-needed effort to amend Investment Company Act Rule 17a-7, which governs cross-trading by investment companies. In December 2020, with our support, the Commission adopted a new rule addressing investment company valuation practices.[10] Commenters cautioned us that the rule's definition of "readily available market quotations" risked disrupting investment companies' ability to trade fixed income securities, which do not often have readily available market quotations, with affiliated funds.[11] To assuage these concerns, the Division of Investment Management issued a request for comment "on ways to enhance the regulatory regime governing investment company cross trading."[12] Commenters have been nearly unanimous in conveying the importance of funds' ability to trade fixed-income securities across affiliated funds.[13] Many commenters also have recommended conditions to ensure the protection of fund investors. The Commission's Spring 2021 rulemaking agenda stated that the "Division [of Investment Management] is considering recommending that the Commission propose amendments to rule 17a-7[.]"[14] Yet now, despite the demonstrated need for such amendments, the Agenda simply drops the planned rewrite of Rule 17a-7. As a consequence, we will not fix a problem of which we are aware-the impending inability of funds to cross-trade fixed-income securities-and we will miss a chance to modernize an outdated rule.

III. Furthering Investor Protection

The Agenda also comes up short on furthering the investor protection prong of our mission by failing to provide more clarity on digital assets. First, the Agenda makes no mention of any regulation with respect to digital assets. In the last several years, this sector has grown in size, complexity, diversity, and investor interest. Rather than taking on the difficult task of formulating rules to allow investors and regulated entities to interact with digital assets, including digital asset securities, the Agenda-through its silence on crypto-signals that the market can expect continued questions around the application of our securities laws to this area of increasing investor interest. Such silence emboldens fraudsters and hinders conscientious participants who want to comply with the law.

Second, the Agenda fails to prioritize action on data security amendments for the Consolidated Audit Trail ("CAT"),[15] which will collect and store information about every trade in our markets and the people who make those trades. The Commission proposed these amendments more than a year ago,[16] had planned to finalize them last spring but instead deferred them.[17] Now, this Agenda again defers action for another six months. The CAT database will be massive in size and irresistible to cyber-criminals. Slowing down the adoption of protections around the sensitive CAT data leaves investors' data vulnerable.

IV. Undermining Precedent

The Agenda makes plenty of room for rulemakings to undo rulemakings that the Commission only recently completed.[18] These include proposals to further amend our rules on proxy solicitation and shareholder proposals;[19] the Resource Extraction Payments Rule;[20] the rules pertaining to the accredited investor definition and the private offering exemption integration framework;[21] as well as our whistleblower rules.[22] Not only are the Commission's most recent amendments to each of these rules barely or less than a year old; none have been effective for more than a few months. As we said when we initially raised these concerns, we have not seen any new information that would warrant opening up any of these rules for further changes at this time.[23] So, why the rush to revisit them?

We urge the Commission to apply our scarce resources toward better uses than undermining recent precedent and depriving the markets and investors of these rules' benefits.

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[1] See Securities and Exchange Commission, Agency Rule List (Fall 2021), available at (hereinafter "Fall 2021 Agenda"), Agency Rule List - Fall 2021 (reginfo.gov).

[2] See id (Revisions to the Definition of Securities Held of Record).

[3] Pub. L. No. 112-106, 126 Stat. 306 (Apr. 5, 2012).

[4] See Fall 2021 Agenda (Regulation D and Form D Improvements).

[5] Notice of Proposed Conditional Exemptive Order Granting a Conditional Exemption from the Information Review Requirement of Amended Rule 15c2-11(a)(1)(i) and the Recordkeeping Requirement of Amended Rule 15c2-11(d)(1)(i)(A) under the Securities Exchange Act of 1934 for Certain Publications or Submissions of Broker-Dealer Quotations on an Expert Market, Exchange Act Release No. 90769 (Dec. 22, 2020), https://www.sec.gov/rules/exorders/2020/34-90769.pdf (hereinafter "Proposed Expert Market Order").

[6] See Publication or Submission of Quotations without Specified Information, Exchange Act Release No. 89891 (Sept. 16, 2020), https://www.sec.gov/rules/final/2020/33-10842.pdf.

[7] See Commissioner Hester M. Peirce, "Statement on the Adoption of Amendments to Exchange Act Rule 15c2-11" (Sept. 16, 2020), https://www.sec.gov/news/public-statement/peirce-statement-adoption-amendments-rule-15c2-11; Commissioner Elad L. Roisman, "Statement on Adoption of Amendments to Rule 15c2-11" (Sept. 16, 2020), https://www.sec.gov/news/public-statement/roisman-statement-adoption-amendments-rule-15c2-11.

[8] See Division of Trading and Markets Staff, "Staff Statement on the Proposed Expert Market" (Aug. 2, 2021), https://www.sec.gov/news/public-statement/proposed-expert-market.

[9] Comments on the Proposed Expert Market Order, supra note 5 are available here: https://www.sec.gov/comments/s7-23-20/s72320.htm.

[10] SeeGood Faith Determinations of Fair Value, Investment Company Act Release No. 34128 (Dec. 3, 2020), https://www.govinfo.gov/content/pkg/FR-2021-01-06/pdf/2020-26971.pdf.

[11] See Division of Investment Management Staff, "Staff Statement on Investment Company Cross Trading" (Mar. 11, 2021), https://www.sec.gov/news/public-statement/investment-management-statement-investment-company-cross-trading-031121 (hereinafter "Staff Cross-Trading Statement").

[12] See id. See also Commissioner Elad L. Roisman, "Statement on Fixed Income Trading and Investment Company Act Rule 17a-7" (Mar. 11, 2021), https://www.sec.gov/news/public-statement/roisman-statement-rule-17a7-031121.

[13] Comments on the Staff Cross-Trading Statement, supra note 11, can be found here: https://www.sec.gov/investment/engaging-investment-company-cross-trading.

[14] See Securities and Exchange Commission, Agency Rule List (Spring 2021), available at https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202104&RIN=3235-AM69.

[15] See Fall 2021 Agenda (deferring the date for the Amendments to NMS Plan for the Consolidated Audit Trail-Data Security from October 2021 to April 2022).

[16] See Proposed Amendments to the National Market System Plan Governing the Consolidated Audit Trail To Enhance Data Security, Exchange Act Release No. 89632, available at https://www.sec.gov/rules/proposed/2020/34-89632.pdf.

[17] See Securities and Exchange Commission, Agency Rule List (Fall 2020), available at https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202010&RIN=3235-AM62 (providing action date of May 2021 for finalization of rule).

[18] See Commissioners Hester M. Peirce and Elad L. Roisman, "Moving Forward or Falling Back? Statement on Chair Genlser's Regulatory Agenda" (June 14, 2021), https://www.sec.gov/news/public-statement/moving-forward-or-falling-back-statement-chair-genslers-regulatory-agenda ("Joint Statement on Spring Agenda").

[19] SeeFall 2021 Agenda (Proxy Voting Advice and Rule 14a-8 Amendments). See also Exemptions from the Proxy Rules for Proxy Voting Advice, Rel. No. 34-89372 (July 22, 2020),https://www.sec.gov/rules/final/2020/34-89372.pdf; Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8, Rel. No. 34-89964 (Sep. 23, 2020),https://www.sec.gov/rules/final/2020/34-89964.pdf.

[20] SeeFall 2021 Agenda (Disclosure of Payments by Resource Extraction Issuers). See also Disclosure of Payments by Resource Extraction Issuers, Rel. No. 34-90679 (Dec. 16, 2020),https://www.sec.gov/rules/final/2020/34-90679.pdf.

[21] SeeFall 2021 Agenda (Exempt Offerings). See also Accredited Investor Definition, Rel. No. 33-10824 (Aug. 26, 2020),https://www.sec.gov/rules/final/2020/33-10824.pdf; Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, Rel. No. 33-10884 (Nov. 2, 2020),https://www.sec.gov/rules/final/2020/33-10884.pdf.

[22] SeeFall 2021 Agenda (Amendments to the Commission's Whistleblower Program Rules). See also Whistleblower Program Rules, Rel. No. 34-89963 (Sep. 23, 2020),https://www.sec.gov/rules/final/2020/34-89963.pdf.

[23] See Joint Statement on Spring Agenda, supra note 14.

[B]eginning in June 2008, and continuing into May 2015, Sears defrauded investors through a cattle investment program to develop a breed of cattle - Rocky Mountain Romangus - that did not then exist.  For a set "entry fee," Sears claimed he would purchase a specific number of cows for the investor's benefit.  Sears claimed he would then "leaseback" the cattle for a set period of time and be responsible for paying all costs related to the cattle.  Sears further agreed to pay the investors an annual "cash return" or "leaseback payment" of 10 percent and to repurchase the cows for no less than the original purchase price at the end of the lease period. 

Initially, Sears made some leaseback payments, thereby lulling investors into believing the investment was successful and operating consistent with their agreements.  In 2011, Sears stopped purchasing cattle, yet continued to solicit new investors.  At the same time, he misrepresented the true number of cows in his possession.  By September 2013, Sears knew he was unable to meet his obligations but he continued to solicit investors, obtaining over $800,000 from the later investors.  Sears used a portion of investor funds to pay personal debts unrelated to the cattle program. 

As the Securities and Exchange Commission embarks on an active period of rulemaking, we ought to do all we can to elicit broad-ranging public comment. Carefully delineating the nature of the changes we are proposing helps commenters to respond with helpful suggestions for improving the rules. Asking lots of questions, something we routinely do in our rulemaking releases, points the public to particular questions we have. Identifying the problem we are trying to solve, offering potential alternative solutions, setting forth the costs and benefits of the proposed and alternative solutions, and laying out the assumptions and data underlying our economic analysis together enable commenters to offer thoughtful responses. Essential to facilitating substantive input from a wide variety of interested parties is giving people enough time to comment.

The notice and comment process is intended to be a dialogue. The regulatory conversation flows only when the Commission affords the commenting public sufficient time both to review and analyze proposals thoroughly and to formulate fully articulated opinions and suggestions. Analyzing a multi-hundred page rulemaking in the context of intricate markets and an already complicated set of securities and other relevant laws is not an easy task. Such analysis takes time. Thirty days is typically not enough time to get feedback on a rule proposal. In fact, "a comment period . . . should generally be at least 60 days."[1] For complicated rulemakings or at times when we have many rulemakings outstanding simultaneously, 90-day comment periods are likely more appropriate. Short comment periods are particularly problematic when they coincide with holidays, end-of-year operational obligations, or other periods in which commenters' staff are likely to be unavailable or occupied with other time-sensitive obligations.

Public commenters help the Commission to look at rules in light of their unique experiences. They bring a broad range of perspectives, technical expertise, and deep, personal experience to their comments. In so doing, they help us to see things we otherwise would not. Sometimes they identify better ways to tackle a problem or point out flaws with rules that we might not have found on our own.

Rules can have unintended, negative consequences. Such unintended consequences sometimes overwhelm the rules' worthy objectives. Consider an example offered by historian Michael Vann.[2] The French administrators of Hanoi at the beginning of the 1900s faced an overwhelming rat population, which had exploded thanks to the newly installed sewer system. To supplement its on-staff exterminators, the colonial government offered people a bounty for each rat tail turned in. Vann explains the unintended consequence of this program-more rats:

After some perplexity, the authorities realized that less-than-honest but quite resourceful characters were catching rats, but merely cutting off the tails and letting the still-living pests go free (perhaps to breed and produce more valuable tails). . . . [M]ore enterprising but equally deceptive individuals were actually raising rats to collect the bounty. One can only imagine the frustration of the municipal authorities, who realized that their best efforts at dératisation had actually increased the rodent population by indirectly encouraging rat-farming.[3]

A shrewd commenter, given sufficient time, could have foreseen how people would game the rat bounty system and how the rat population would expand as a result of this gamesmanship.

The more eyes allowed to peruse a rule carefully, the more likely we are to identify potential bad consequences ahead of time. I hope the Commission will allow enough time for people to comment so that our policy objectives are not overwhelmed by unintended consequences.

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[1] Executive Order 13563, Improving Regulation and Regulatory Review (Jan. 18, 2011), 76 Fed. Reg. 3821 (Jan. 21, 2011). See also Executive Order 12866, Regulatory Planning and Review (Sept. 30, 1993), 58 Fed. Reg. 51735 (Oct. 4, 1993) ("each agency should afford the public a meaningful opportunity to comment on any proposed regulation, which in most cases should include a comment period of not less than 60 days"); Memorandum for the Heads of Executive Departments and Agencies, Modernizing Regulatory Review (Jan. 20, 2021), 86 Fed. Reg. 7223 (Jan. 26, 2021) ("This memorandum reaffirms the basic principles set forth in [Executive Order 12866] and in Executive Order 13563 of January 18, 2011 (Improving Regulation and Regulatory Review), which took important steps towards modernizing the regulatory review process. When carried out properly, that process can help to advance regulatory policies that improve the lives of the American people.").

[2] Michael G. Vann, Of Rats, Rice, and Race: The Great Hanoi Rat Massacre, an Episode in French Colonial History, 4 FRENCH COLONIAL HISTORY 191 (2003).

[3] Id. at 198 (footnote omitted).

worked as a natural gas trader for his own company, Omerta Capital LLC. Miller conspired with others to misappropriate material, nonpublic information and to engage in fraudulent, noncompetitive trades, including prearranged trades, in natural gas futures contracts for their own personal gain. Miller and his co-conspirators caused prices to be reported, recorded, and registered on designated commodities markets that were not true, bona fide prices. The profits from these fraudulent trades were split among Miller and his co-conspirators.

In four related cases, Marcus Schultz, 41, of Houston, Texas; John Ed James, 51, of Katy, Texas; Mathew Webb, 51, of Tiki Island, Texas; and Lee Tippett, 62, of Jacksonville, Florida, pleaded guilty on July 20, 2020, Feb. 1, 2021, June 15, 2021, and Aug. 17, 2021, respectively. Schultz pleaded guilty to a one-count information charging him with conspiracy to commit wire fraud and to violate various provisions of the Commodity Exchange Act. James pleaded guilty to a one-count information charging him with conspiracy to commit commodities fraud and wire fraud. Webb pleaded guilty to a one-count information charging him with conspiracy to commit commodities fraud and wire fraud and to violate various provisions of the Commodity Exchange Act. Tippett pleaded guilty to a one-count information charging him with conspiracy to commit commodities fraud and honest services wire fraud.

[F]rom August 2015 through December 2018, Miller received block trade order information that was disclosed by a trader employed by an energy company in breach of that trader's duty of trust and confidence to their employer. This trader disclosed this information to one of two energy brokers, who in turn passed this information on to Miller. Miller, through Omerta, traded on the basis of this information by (1) entering into non-arm's length, fictitious block trades in financially-settled natural gas futures contracts with the energy company and (2) entering into trades involving physically-delivered natural gas futures for the same quantity and contract month. Miller traded in this manner as part of a spread trading strategy in which he sought to profit from the relative movement in the prices of the two natural gas futures contracts. By trading on the basis of the energy company's information, Miller was able to obtain advantageous prices for his block trades and sequence his trading of the two contracts in a manner that maximized his ability to profit through this strategy. In total, Miller generated over $1.5 million in trading profits by trading in this manner. Miller shared a portion of these profits with both the energy company trader and the broker involved in the scheme.

[B]etween at least 2011 and 2016, Canadian citizens Jay Scott Kirk Lee, Geoffrey Allen Wall, and Benjamin Thompson Kirk were some of the more prolific clients of Frederick L. Sharp and his offshore platform, which was essentially a complete service provider for all the illicit needs of those dedicated to committing penny stock fraud. (Previously, the SEC filed an action against Sharp and associates of his for violations of the anti-fraud and registration provisions of the federal securities laws arising from their creation, maintenance and profiting from this platform. See SEC Press Release No. 2021-148 (Aug. 9, 2021) (https://www.sec.gov/news/press-release/2021-148)). Through this platform, Lee, Wall, and Kirk, were able to utilize a network of offshore front companies to conceal their control of shares in public companies, unload those shares on unsuspecting retail investors, and disburse to their various bank accounts throughout the world the proceeds of their fraud. They communicated with one another and with Sharp and his associates using encrypted communication devices and an encrypted communications system supplied by the platform, using handles and aliases to hide their behavior. For example, the complaint alleges that in 2013, Lee, Wall, and Kirk surreptitiously gained control of Nutranomics, Inc.'s free-trading stock, directed the distribution of shares of the company to offshore brokerage accounts under the Sharp platform, hired promoters to tout the company's stock, and then sold their secret large positions on the precipitous price rise, netting millions of dollars.

Key to the fraud was maintaining the appearance to the unknowing public that the shares of the public companies were disparately and unrelatedly owned when, in fact, they were under the control of the three defendants working together to dump them. To do this, Lee, Wall and Kirk's hid their control from brokers and transfer agents who serve as "gatekeepers" to assure that shares controlled by company affiliates (including those who control 5% or more of a company's shares) are not sold to the public without proper disclosure in a registration statement.

• Securities Industry Commentator
• Bill Singer