Securities Industry Commentator by Bill Singer Esq

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

Several sentenced in $50M pump-and-dump scheme (DOJ Release)

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

SEC Cites Failure to Exhaust Administrative Remedies in Dismissing Appeal by Rep Barred for Failure to Respond to FINRA Document/Information Demands

In the Matter of the Application of Shad Nhebi Clayton for Review of Disciplinary Action Taken by FINRA (SEC Opinion)

SEC Dismisses Untimely Appeal by Rep Barred for Failure to Respond to FINRA Testimonial Demands

In the Matter of the Application of Shlomo Sharbat for Review of Disciplinary Action Taken by FINRA (SEC Opinion)

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

Previously, Judge Gilmore ordered Farmer to serve a sentence of 72 months. Brotherton, Grob and Massey were ordered to serve 60 months, 12 months and three years of probation, respectively, while Eddie Austin and Sieck both were ordered to serve 36-month terms of imprisonment.

All seven must also pay restitution the victims of their scheme. Farmer and Sieck were each ordered to pay $8 million, while Eddie Austin must pay $6.6 million. The court ordered Grob and Massey to pay $4.5 and $1 million, respectively while Brotherton must pay $6.2 million. The court held open the amount of restitution Carolyn Austin will be required to pay to enable the parties to submit an agreed upon amount.

Farmer, Eddie Austin, Sieck, Brotherton and Grob were further ordered to forfeit additional funds to the United States in amounts ranging from $242,907 to $6 million.

The defendants admitted to their involvement in a conspiracy to commit fraud in microcap securities. During the course of the conspiracy, they obtained control of the stock of numerous companies, then "pumped up" the price of the stock through false and misleading press releases and fraudulent trading techniques. They then "dumped" their shares of stock onto the market for a significant profit.

[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.

Shad Nhebi Clayton, who was formerly associated with a FINRA member firm, appeals from a FINRA action barring him from association with any FINRA member firm for failing to respond to FINRA's requests for information and documents. FINRA moves to dismiss Clayton's application for review because he failed to exhaust his administrative remedies before FINRA and his application is untimely. Clayton opposes FINRA's motion. For the reasons explained below, we grant FINRA's motion and dismiss Clayton's application for review. 

We find, and Clayton does not dispute, that he failed to exhaust his administrative remedies before FINRA. The Pre-Suspension and Suspension Notices described the administrative process for avoiding imposition of a suspension or bar: (1) "tak[ing] corrective action" by providing the information FINRA requested prior to the Suspension Date; (2) "requesting a hearing" in response to the Pre-Suspension Notice; or (3) "fil[ing] a written Request for Termination of the Suspension on the ground of full compliance" with the Pre-Suspension Notice. Clayton does not assert that he did any of these things. We have previously stated that applicants who do not avail themselves of FINRA's administrative processes thereby forfeit any future challenge to FINRA's actions before the Commission. 

Clayton asserts that he "was completely unaware of all attempts by FINRA to contact [him]," because an "unamicable situation" between Clayton and his then-wife required Clayton to "refrain from occupying or entering [his] primary address"-that is, his address of record in CRD, which Clayton acknowledges to have been his "official address" on file with FINRA. Clayton further asserts that, given various factors causing him mental or physical duress in 2011, "it never occurred to [him] to update [his] U4 or notify FINRA" that he may not be able to receive correspondence at his CRD address. But we have emphasized repeatedly that it is the registered individual's obligation to keep the CRD address current. That is because FINRA's rules permit it to serve a natural person by personal service, U.S. Postal Service mail, or courier service at the person's last known residential address as reflected in the CRD. Service by courier or express delivery is complete upon delivery, and service by mail is complete upon mailing. FINRA's rules do not require it to confirm receipt. As a result, a person generally cannot avoid the exhaustion requirement "by failing to receive or claim mail properly sent to [his] address." 

Shlomo Sharbat, who was formerly associated with a FINRA member firm, seeks review

of a FINRA default decision barring him from association with any FINRA member firm

because he failed to respond to FINRA's requests for testimony. FINRA moves to dismiss Sharbat's application for review because he failed to exhaust his administrative remedies before FINRA and his application is untimely. Sharbat opposes FINRA's motion. For the reasons explained below, we grant FINRA's motion and dismiss Sharbat's application for review.

Sharbat does not contest the validity of our administrative-exhaustion requirement. He admits that he was aware of FINRA's disciplinary proceeding against him and Enforcement's motion for entry of a default decision and that he decided to default. Sharbat failed to appeal the default decision to the NAC or file a motion with FINRA to set aside the default decision.

Nonetheless, Sharbat argues that he should be excused from the exhaustion requirement on the ground that he did not receive the default decision from FINRA. But a person cannot avoid the exhaustion requirement "by failing to receive or claim mail properly sent to [his] address." Here, FINRA properly sent the default decision and notice of default decision to Sharbat. Under FINRA's rules, when a default decision imposes a bar, "FINRA shall serve the decision on a Respondent by courier, facsimile or other means reasonably likely to obtain prompt service." Sending the default decision via FedEx to Sharbat's Tel Aviv address met this standard because FedEx is a courier and Sharbat had apparently signed for at least three FedEx shipments from Enforcement to his Tel Aviv address. 

Contrary to Sharbat's claim, the record lacks any evidence that FINRA knew that Sharbat failed to sign for the default decision sent to his Tel Aviv address. Regardless, FINRA rules did not require it to confirm that Sharbat received the default decision.Because FINRA properly served the default decision on Sharbat, he had constructive notice of the default decision.

Sharbat also suggests that FINRA should have sent the default decision to Sharbat's email address and to his attorney at the time, as Enforcement had done when serving documents on Sharbat. But FINRA rules did not require it to use email to serve the default decision, or to serve Sharbat's attorney because he failed to file a notice of appearance. Sharbat has not cited any precedent or FINRA rule suggesting that the Hearing Officer was required to use these service methods simply because Enforcement had used them. 

 As discussed above, sending the default decision to Sharbat's Tel Aviv address via FedEx was reasonable given that Sharbat had previously signed for FedEx shipments from FINRA at that address. To the extent Sharbat wanted the Hearing Officer to serve him by other means, he never informed the Hearing Officer of his preferred service methods. To the contrary, he admits that he knew Enforcement was seeking a default decision and that he chose not to respond.

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.

= = =

[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.

• Securities Industry Commentator
• Bill Singer