The Wall Street Legal & Regulatory Feed

Securities Industry Commentator by Bill Singer Esq

January 27, 2022
















http://www.brokeandbroker.com/6253/jpm-tro-solicitation/
It's another day and, not surprisingly, another erstwhile wirehouse brokerage firm asks a court for a temporary restraining order ("TRO") against one of its former employees. In today's iteration, we got J.P. Morgan Securities ("JPMS") alleging that Timothy Logsdon needs to be restrained from disclosing confidential information and soliciting the firm's clients. 

https://brokeandbroker.com/PDF/LIBOR2CirOp220127.pdf
As set forth in the 2Cir's Syllabus:

Appeals from judgments entered in the United States District Court for the Southern District of New York following a jury trial before Colleen McMahon, then-Chief Judge, convicting defendants of wire fraud in violation of 18 U.S.C. § 1343 and conspiracy to commit wire fraud and bank fraud in violation of 18 U.S.C. § 1349,  in connection with the London Interbank Offered Rate ("LIBOR"), and sentencing  them principally to time-served and supervised release, including various periods in home confinement, and imposing monetary fines. On appeal, defendants contend principally that the trial evidence was insufficient to prove the falsity, materiality, or fraudulent intent elements of the offenses of which they were convicted.

Cross-appeals by the government to challenge the sentences imposed, contending principally that the district court failed to determine the availability of adequate monitoring for one defendant's home confinement and that that failure could result in punishment inadequate to reflect the court's assessment of the defendants' relative culpability. 

Finding that the evidence was insufficient as a matter of law to permit 16 a finding of falsity, we reverse the judgments of conviction and remand to the district 17 courtfor entry of judgments of acquittal. The government's cross-appeals with regard 18 to sentencing are thus moot.

Judgments reversed; cross-appeals dismissed as moot.


In summing up its findings, 2Cir noted in part that:

In sum, the government sought to prove falsity on the premise that the BBA LIBOR Instruction required DB to submit a particular interest rate, that such a rate was generated automatically by a DB pricer, and that LIBOR submissions that were influenced by requests from DB derivatives traders were false because those submissions were not the numbers automatically generated by the pricer. However, - the government's main fact witnesses at trial, the LIBOR submitters, testified that there were numerous ways in which the pricer did not generate such numbers automatically because those witnesses regularly altered pricer data and spreads manually; that the LIBOR submitters regularly deviated from the pricer output--even as affected by the submitters' manual adjustments--in order to make LIBOR submissions that reflected interest rate estimates they had received from independent brokers; and that the LIBOR submitters engaged in all of these practices even on days when they had no requests from DB derivatives traders.

The government failed to produce any evidence that any DB LIBOR submissions that were influenced by the bank's derivatives traders were not rates at which DB could request, receive offers, and accept loans in DB's typical loan amounts; hence the government failed to show that any of the trader-influenced submissions were false, fraudulent, or misleading. While defendants' efforts to take advantage of  DB's position as a LIBOR panel contributor in order to affect the outcome of contracts to which DB had already agreed may have violated any reasonable notion of fairness, the government's failure to prove that the LIBOR submissions did not comply with the BBA LIBOR Instruction and were false or misleading means it failed to prove conduct that was within the scope of the statute prohibiting wire fraud schemes.
 
at Pages 53 - 54 of the 2Cir Opinion
 
https://www.sec.gov/litigation/litreleases/2022/lr25319.htm
In response to a Complaint filed in the United States District Court for the District of New Jersey, Aleksandr Milrud consented to the entry of a judgment permanently enjoining him from violating the antifraud provisions of Section 17(a) of the Securities Act and Sections 9(a)(2) and 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder and ordering him liable for disgorgement of his ill-gotten gains, which will be deemed satisfied by the order of forfeiture entered against Milrud in a related criminal action. In that criminal case, Milrud pled guilty to conspiracy to commit securities fraud, and he was sentenced to five years of probation and ordered to forfeit $285,000. As alleged in part in the SEC Release:

In its complaint, filed on January 13, 2015, the SEC alleged that Aleksandr Milrud, of Ontario, Canada, engaged in a manipulative trading practice known as "layering," in which a trader places orders solely to trick others into buying or selling stocks at artificially inflated or depressed prices. As alleged in the complaint, Milrud recruited online traders chiefly based in China and Korea and shared in the profits the traders made from manipulative trading in U.S. securities markets. According to the complaint, Milrud provided the traders with access to trading accounts and technology and instructed them on how to avoid regulatory scrutiny while engaging in layering strategies.

SEC Settles Case Against Gary Pryor and Two Arizona-Based Financial Technology Companies (SEC Release)
https://www.sec.gov/litigation/litreleases/2022/lr25317.htm
Without admitting or denying the allegations in an Amended Complaint, ZipRemit, Inc. and Lendaily, Inc., and their founder/Chief Executive Officer Gary Pryor consented to the entry of judgments in the United States District for the District of Arizona  https://www.sec.gov/litigation/litreleases/2022/judgment25317-lendaily.pdf permanently enjoining them from violating the antifraud provisions of Section 17(a) of the Securities Act and Sections 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, ordering a conduct-based injunction against Relief Defendant Rebecca Pryor, and ordering:

(i) Pryor to pay disgorgement of $2,666,705 (of which $180,519 would be joint and several with Relief Defendant Rebecca Pryor), with prejudgment interest of $753,137 (of which $13,508 would be joint and several with Relief Defendant Rebecca Pryor), and a civil penalty of $2,666,705;
(ii) ZipRemit to pay disgorgement of $1,564,534, with prejudgment interest of $426,917, and a civil penalty of $975,230; and
(iii) Lendaily to pay disgorgement of $311,615, with prejudgment interest of $52,388, and a civil penalty of $975,230. 

Relief defendant, Rebecca Pryor, consented to the entry of a judgment
https://www.sec.gov/litigation/litreleases/2022/judgment25317-pryor.pdf ordering her to pay, on a joint and several basis with Pryor, disgorgement of $180,519 with prejudgment interest of $13,508. 

As alleged in part in the SEC Release: 

The SEC's complaint, filed on September 14, 2020 in the United States District for the District of Arizona, alleged that from at least 2013 through 2019 Pryor, founder and CEO of ZipRemit, Inc. and Lendaily, Inc., private companies that claimed to offer merchant branded consumer credit at the point-of-sale, raised at least $4.3 million from investors while repeatedly misrepresenting the companies' technological capabilities and revenues. According to the complaint, Pryor allegedly falsely told investors that ZipRemit and Lendaily earned revenue from interest and loan origination fees and that the companies had several large nationally-recognized brands including Keurig and Bridgestone/Firestone as customers. Pryor allegedly repeatedly misrepresented that his companies had developed proprietary software that had been tested, approved, and launched, or was about to be launched, with customers, when, in fact, the companies had not generated any revenue and no customers had ever used their software, as it was not fully developed. In addition, Pryor allegedly diverted at least $1.2 million of investor funds for his own personal use.

https://www.sec.gov/litigation/litreleases/2022/lr25318.htm
In a Complaint filed in the U.S District Court for the Middle District of Tennessee
https://www.sec.gov/litigation/complaints/2022/comp25318.pdf, the SEC charged David J. C. Bolton with violations of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. As alleged in part in the SEC Release:

[B]olton formed a company, Millennia Shares, LLC, to launch and maintain exchange-traded funds. The complaint alleges that ten investors invested approximately $800,000 in Millennia Shares between August 2018 and May 2019, and that Bolton solicited investors for the venture with written disclosures stating that he would receive a specified monthly salary. The complaint further alleges that Bolton misappropriated for his personal use at least $215,000, over a quarter of the investor-contributed funds, in excess of his disclosed salary.

Ex-UBS broker spent a family's millions on his lovers: SEC (Financial Planning by Tobias Salinger)
https://www.financial-planning.com/news/ex-ubs-broker-german-nino-charged-with-5-8m-fraud
A comprehensive take by top industry reporter Tobias Salinger on this tragi-comedy of failed Wall Street supervision. After the regulatory and criminal cases are resolved, the troubling questions remain as to how this happens, how this keeps happening, and where the hell is the industry's compliance staff and regulators? 

https://www.sec.gov/news/press-release/2022-10
The SEC proposed rules to place Alternative Trading Systems ("ATS") that trade Treasuries and other government securities under the regulatory umbrella by extending Regulation ATS https://www.sec.gov/rules/proposed/2022/34-94062.pdf to include systems that offer the use of non-firm trading interest and provide protocols to bring together buyers and sellers for trading any type of security. These Communication Protocol Systems would be required to either register as exchanges or register as broker-dealers and comply with Regulation ATS. As set forth in part in the SEC Release:

"In 2020, the Commission put out a request for comment on a proposal to enhance transparency and oversight over ATSs that trade government securities," said SEC Chair Gary Gensler. "Today's proposal includes the core elements of the 2020 proposal, including registration of certain interdealer brokers (IDBs) in the Treasury markets. It would bring Treasury trading platforms with significant volume under Regulation Systems Compliance Integrity (SCI), a rule that protects for the resiliency of technology infrastructure. It also would require these platforms to comply with the Fair Access Rule, which provides for fair access to platforms and would prohibit platforms from making unfair denials or limitations of access. Beyond that, today's amendments build upon the 2020 proposal and on feedback from the public."

With ATSs becoming increasingly important to government securities trading, the proposal would expand the investor protections of Regulation ATS to those that trade government securities or repurchase and reverse repurchase agreements on government securities. Additionally, the proposal would expand Regulation SCI to government securities to help increase investor protections and address technological vulnerabilities while improving the SEC's oversight of the core technology of key entities in the markets for government securities. 

Thank you Chair Gensler, and thank you to my fellow Commissioners for their thoughtful remarks.  I want to join my colleagues in thanking the staff of the Division of Trading and Markets, Division of Economic and Risk Analysis, and the Office of the General Counsel for the hard work that went into this release.  I'd also like to thank Sai Rao in the Chair's Office, and the other counsels, for all their assistance in getting the proposal to this open meeting.

When Congress amended the Exchange Act in 1975, it found it to be in the public interest to assure "fair competition . . . among exchange markets, and between exchange markets and markets other than exchange markets."[1] The Commission quoted that language when it adopted Regulation ATS in 1998, more than 20 years ago,[2] and has reiterated the principle in subsequent releases relating to alternative trading systems (ATSs).[3]  Assuring fair competition has been, and continues to be, an important objective for the SEC's regulation of exchanges and ATSs.

The amendments we are proposing today would advance that objective in two important ways.  First, fair competition requires entities performing similar functions to be regulated similarly.  However, under our current framework, there is a disparity among similar markets.[4]  Specifically, entities that offer the use of protocols and non-firm trading interest to bring together buyers and sellers of securities are not currently subject to our exchange regulatory framework, despite performing a similar function to ATSs and registered exchanges.  These trading venues have become increasingly popular for fixed income and government securities, and in the U.S. Treasury market in particular, account for approximately 50% of total electronic trading volume on multilateral trading venues.[5] This has both competitive effects and negative implications for investor protection, as these systems are not subject to SEC oversight or the SEC's requirements related to transparency or fair and orderly markets.

I am pleased that today we are proposing to address this disparity by bringing these Communication Protocol Systems under our exchange regulatory framework.[6]  We are proposing to do this by updating the definition of exchange to include systems that offer the use of non-firm trading interest and communication protocols to bring together buyers and sellers of securities.  This should help ensure that there is a level playing field for entities performing similar functions, as well as providing important investor protections, including requiring these entities to establish written safeguards and procedures to protect confidential subscriber trading information, meet the operational transparency requirements of Form ATS-N (for entities that trade National Market System (NMS) stocks or government securities or repos), and comply with fair and orderly markets provisions under the Fair Access Rule.[7]

Furthermore, as far back as 1998, the Commission was concerned that system providers might label trading interest that is firm in practice as non-firm, in order to avoid registering as an exchange or complying with Regulation ATS.[8]  This amendment would remove that potential loophole and ensure that the distinction between firm orders and non-firm trading interest is not used to evade our rules.   I look forward to hearing from commenters on the scope of these amendments, and whether they may be over- or under-inclusive.  However, as our former colleague Commissioner Roisman put it, the failure to regulate these significant venues is "obviously a gap,"[9] and I am pleased that today, we are taking steps to close it.

Turning to the second way in which this proposal helps advance the objective of fair competition, competition among venues requires customers to have the ability to evaluate and compare them in order to determine which best meets their needs.  However, ATSs trading government securities are not currently subject to the operational transparency rules that apply to ATSs that trade NMS stocks, including the obligation to file public disclosures.  In addition, ATSs that trade government securities are exempt from the Fair Access Rule and the requirements of Regulation SCI, and ATSs that trade only government securities are exempt from the requirements of Regulation ATS altogether.

As Commissioner Lee noted, it is hard to overstate the importance of the government securities markets, and the U.S. Treasury market in particular, to the U.S. and global economies.  Recent disruptions, such as the flash rally of October 2014, the sudden spike in repo rates in September 2019, and the Covid-related market disruption in March 2020 triggered extensive interventions by the Federal Reserve and are a reminder of how critical these markets are to the financial system.  And ATSs and Communication Protocol Systems together represent over half of the trading activity in those markets.[10] The proposed extension of Regulation SCI and the Fair Access Rule to those venues is an important and overdue step that should enhance market stability, resiliency, and integrity.[11] 

Additionally, and critically, we are proposing to extend certain operational transparency requirements to ATSs that trade government securities.[12] If adopted, these amendments will provide more transparency to market participants about the operations of these ATSs, including how trading interests are handled, fee structures, the ATS's interaction with related markets, liquidity providers, activities the ATS undertakes to surveil and monitor its market, and any potential conflicts of interest that might arise from the activities of the broker-dealer operator or its affiliates. This should enhance competition among these ATSs by allowing investors to compare different venues using standardized, publicly available information, and to choose the one that best suits their trading objectives.  Additionally, it would help shrink the disparity between the regulation of ATSs and exchanges by requiring a greater share of ATSs to make public disclosures related to their operations, which would be subject to the Commission's review and effectiveness process.

Finally I want to highlight that in this release, we are soliciting comment on other ways to improve the ATS framework.  For example, we are soliciting comment on the possibility of extending the operational transparency requirements of Rule 304 to all categories of ATSs, including ATSs that trade corporate debt securities, municipal securities, and equity securities other than NMS stocks.  Many of the same concerns that motivate the proposal to extend transparency requirements to government securities ATSs are present in these other markets, which have also become increasingly electronic.  Extending these transparency requirements to all ATSs, and making them subject to the Commission's review and effectiveness process, may present another opportunity to advance the objective of fair competition, as well as the protection of investors and market transparency, resiliency, and stability.  We are also soliciting comment on whether to prohibit certain practices that present potential conflicts of interest, including the disclosure of confidential subscriber information and trading by the broker-dealer operator and its affiliates in the ATS.  I look forward to hearing commenters' views on these issues, other potential reforms to the ATS regulatory structure, and all aspects of the proposal.

Thank you again to the staff for all your hard work.  I am pleased to support the proposal.

 
[1] 15 U.S.C. 78k-1(a)(1)(C)(ii).

[2] See Regulation of Exchanges and Alternative Trading Systems, Securities Exchange Act Release No. 40760 (December 8, 1998).

[3] See Regulation of NMS Stock Alternative Trading Systems, Securities Exchange Act Release No. 76474 (November 18, 2015) at 11; Regulation of NMS Stock Alternative Trading Systems, Securities Exchange Act Release No. 83663 (July 18, 2018) at 52-53.

[4] Several commenters highlighted this disparity in response to the 2020 concept release regarding electronic trading in the fixed income markets. See Letter from Robert Laorno, General Counsel, ICE Bonds Securities Corporation, dated March 15, 2021 at 2-4; Letter from Stephen John Berger, Managing Director, Global Head of Government and Regulatory Policy, Citadel, dated March 1, 2021 at 2; Letter from Jennifer W. Han, Chief Counsel & Head of Regulatory Affairs, Managed Funds Association, dated March 1, 2021 at 6.

[5] Letter from Stephen John Berger, Managing Director, Global Head of Government and Regulatory Policy, Citadel, dated March 1, 2021 at 1-2.

[6] Amendments to Exchange Act Rule 3b-16 Regarding the Definition of "Exchange"; Regulation ATS for ATSs That Trade U.S. Government Securities, NMS Stocks, and Other Securities; Regulation SCI for ATSs That Trade U.S. Treasury Securities and Agency Securities, Securities Exchange Act Release No. 34-94062 (January 26, 2022) ("Release").

[7] The Fair Access Rule currently applies to entities that meet specified volume thresholds in NMS stocks, equity securities that are not NMS stocks and for which transactions are reported to an SRO, municipal securities, and corporate debt securities.  See 17 CFR 242.301(b)(5).  The proposal would extend the Fair Access Rule to platforms that meet certain thresholds in government securities. Release at 102.  In addition, registering as a broker-dealer would subject a Communication Protocol System to Commission and Financial Industry Regulatory Authority ("FINRA") oversight. As a FINRA member, a Communication Protocol System would also be subject to FINRA's investor protection and examination and market surveillance programs and would be required to comply with FINRA's trade reporting rules. Release at 27.

[8] See Regulation of Exchanges and Alternative Trading Systems, Securities Exchange Act Release No. 40760 (December 8, 1998).

[9] Commissioner Elad L. Roisman, Remarks at U.S. Treasury Conference (September 29, 2020).

[10] Release at 377-78, 392 (noting that ATSs accounted for approximately 32 percent of U.S. Treasury Securities trading volume in the first half of 2021, and that Communication Protocol Systems account for approximately 30 to 40 percent of the total trading volume in U.S. Treasuries).

[11] The proposal would apply the Fair Access Rule and Regulation SCI to platforms that exceed certain volume thresholds. Release at Sections III.B.4, Section III.C.

[12] The requirements would apply to current ATSs that trade government securities as well as Communication Protocol Systems that register as ATSs as a result of the amendments to the definition of exchange. These requirements currently apply only to ATSs that trade NMS stocks.


Thank you, Chair Gensler.

Events in the U.S. Treasury market (as well as the related repo market) over the past several years strongly suggest that the market for government securities suffers from inadequate levels of intermediation, liquidity, and transparency that in times of stress can dramatically decrease its ability to function properly and significantly increase risks to market participants.[1]  Commentators have suggested a number of possible reforms,[2] and, although I am skeptical of some of these suggestions, I agree that the Commission should be considering carefully how it might use its authority to make changes that could relieve some of these pressures and help ensure that the market continues to perform its vital functions in the U.S. and global economy.

Careful consideration of fundamental issues of market structure is particularly important in the government securities market.  It performs a central role in fiscal and monetary policy, as well as in our financial markets more broadly.  The market is enormous, with over $22 trillion in U.S. Treasuries outstanding as of December 2021 and with over $600 billion in average daily trading volume.[3]  Any efforts to reform this market must take into account the potentially cataclysmic risks of inadvertently making things worse through sloppy or rushed rulemaking that introduces uncertainty for market participants or that deprives the public and the Commission of the opportunity to devote careful attention to thinking through the full implications of the proposed rules.

The proposal we are considering today is certainly not sloppy, but at the same time it is too wide-ranging and, given its length, too unwieldy to facilitate careful consideration.  The document weighs in at a hefty 650 pages, contains over 220 separate comment requests (with many requests containing multiple questions), and addresses about a dozen significant issues, several of which affect trading venues of all types (including currently unregulated communication protocol systems).  And the release goes well beyond government securities, or even fixed-income securities; key parts of the proposal affect trading venues that make any type of security available for trading. 

Notwithstanding the literal and figurative bulk of this release, the Commission has determined that it is appropriate to provide the public with 30 days to read, understand, consider, consult, identify, model, assess, and discuss these rules and how they are likely to affect trading venues for every type of security that is traded in our markets.  It would have been an irresponsible abdication of our role as the primary overseer of the U.S. capital markets to limit the public to a 30-day comment period on fundamental changes to the $22 trillion Treasury market; it is unconscionably reckless to do so for a proposal the effects of which will reverberate through all of the markets that we regulate, in ways that we cannot foresee. 

I cannot comprehend why we insist on blindfolding ourselves, rather than embracing the notice-and-comment process that has been so valuable in unearthing issues for our consideration. Our self-imposed unrealistic time constraint will prevent us from thinking seriously about the possible effects-intended and otherwise-of our rules by refusing to give the public sufficient time to provide us with informed comment.  We face no emergency in these markets that compels us to limit comments to 30 days; indeed, the Commission's precipitous rush to plow through the comment period-almost as if it were a mere formality in our process-presents a greater immediate risk to the market than any of the issues that have led to this recommendation.

I could have voted for this proposal had the Commission provided a period long enough to enable market participants and others to engage in a considered analysis of the proposed rules and their likely consequences.  Ninety days would have been a reasonable period, given the breadth of issues and the potential effects of the proposed rule.  Any shorter period would not be sufficient to give me the confidence that the Commission was receiving sufficient public analysis and comment to enable us to proceed to adoption in a manner consistent with our responsibilities to the market, to the law, or to the American people.

I regret this outcome.  Much of today's proposal, in its broad outlines, seems reasonable.  The staff has spent a lot of time thinking about how we might make incremental changes to the government securities market, and it shows.  The proposed rules would bring venues that facilitate the trading of government securities and repos within our regulatory ambit, effectively forcing venues that make these securities available for trading to become ATSs.  These ATSs would need to file an amended version of Form ATS-N, which should help market participants better understand where and how they can trade these securities.  The rules would also subject the larger ATSs to the Fair Access Rule, which could ensure access to liquidity for a larger proportion of market participants.  Because more venues would be operating as ATSs, trades executed on these venues would be reported to TRACE, which should increase transparency in the market.  Although I do not agree with every policy line that the proposal draws or every deadline that it sets, I could have supported this proposal if it allowed for careful consideration and informed comment that would have helped me evaluate whether the changes staff is recommending would work in the real world.

The staff is also recommending an amendment to the definition of "exchange" in Exchange Act Rule 3b-16.  Unexpectedly for me-and perhaps for many in the market-this proposed amendment goes far beyond the scope of the concept release that was issued with the initial September 2020 proposal.  What the staff is recommending for our consideration today is an expansion in the definition of exchange that would apply to any trading venue, including so-called communication protocol systems, for any type of security, not just for government or fixed-income securities.  This change could deter innovation and dissuade new entrants from entering into the market for trading venues and execution services, but communication protocol services have become more sophisticated and now play a significant role in the trading of certain types of securities.  I could have supported a proposal that allowed for careful consideration and informed comment on how this change would affect innovation and competition in this space.

The staff is also recommending a wholesale revision to Form ATS-N that will require all NMS Stock ATSs with currently effective forms to file amendments to the Commission.  This part of the proposal would likely impose significant burdens and could lead to a replay of some of the difficulties that ATSs and our staff encountered when we adopted Form ATS-N just a few years ago.  Many of these changes flow from the proposed amendments to the definition of exchange and thus are understandable, but it is unclear whether it is reasonable to expect these ATSs to repeat this process so soon after expending considerable resources on filing these forms in the very recent past.  Nevertheless, I could have supported a proposal that allowed for careful consideration and informed comment on how these revisions would affect these venues.

A final message to those who operate any service that is designed to facilitate any communication between potential buyers and sellers of any type of security:  Read this release.  Even if you have nothing to do with government securities or even fixed-income, or with traditional securities, read this release.  Preferably as soon as it is published on the Commission's website.  It covers a lot of ground, and you should not assume that it has nothing to do with you, because it probably does.

In closing, I would like to thank the staff in TM and DERA for the time-a lot of it-they spent on the phone with my counsel and with me, walking me through the many issues covered in the release and answering my many questions.  A special shout out to Tyler Raimo, who exhibited in our conversations his characteristic great patience and inexplicable good cheer.  I appreciate the team's hard work on this document and know that you will engage with the public proactively to make the most of this exceedingly short comment period.

[1] See, e.g., SIFMA, Improving Capacity and Resiliency in US Treasury Markets: Part I, March 24, 2021, available at https://www.sifma.org/resources/news/improving-capacity-and-resiliency-in-us-treasury-markets-part-1/. 

[2] See, e.g., Group of Thirty Working Group on Treasury Market Liquidity, U.S. Treasury Markets: Steps Toward Increased Resilience. Group of Thirty (2021), available at https://group30.org/publications/detail/4950; SIFMA, Improving Capacity and Resiliency in US Treasury Markets: Part II (March 30, 2021), available at https://www.sifma.org/resources/news/improving-capacity-and-resiliency-in-us-treasury-markets-part-2/; Nellie Liang and Patrick Parkinson, Enhancing the Liquidity of U.S. Treasury Markets Under Stress (Dec. 16, 2020), available at https://www.brookings.edu/research/enhancing-the-liquidity-of-u-s-treasury-markets-under-stress/.  

[3] BNY Mellon, Future-Proofing the U.S. Treasury Market (2021), available at https://www.bnymellon.com/content/dam/bnymellon/documents/pdf/aerial-view/future-proofing-the-us-treasury-market.pdf.coredownload.pdf.

https://www.sec.gov/news/press-release/2022-9
The SEC proposed amendments to Form PF (used by SEC-registered investment advisers to private funds) https://www.sec.gov/rules/proposed/2022/ia-5950.pdf for the alleged purpose of enhancing the Financial Stability Oversight Council's ("FSOC") ability to assess systemic risk as well as to bolster the Commission's regulatory oversight of private fund advisers and its investor protection efforts in light of the growth of the private fund industry. As set forth in part in the SEC Release:

"Since the adoption of Form PF in 2011, a lot has changed," said SEC Chair Gary Gensler. "The private fund industry has grown in size to $11 trillion and evolved in terms of business practices, complexity of fund structures, and investment strategies and exposures. The Commission and Financial Stability Oversight Council now have almost a decade of experience analyzing the information collected on Form PF. We have identified significant information gaps and situations where we would benefit from additional information. Among other things, today's proposal would require certain advisers to hedge funds and private equity funds to provide current reporting of events that could be relevant to financial stability and investor protection, such as extraordinary investment losses or significant margin and counterparty default events. I am pleased to support it."

The proposed amendments would require current reporting for large hedge fund advisers and advisers to private equity funds. These advisers would file reports within one business day of events that indicate significant stress at a fund that could harm investors or signal risk in the broader financial system. The proposed amendments would provide the Commission and FSOC with more timely information to analyze and assess risks to investors and the markets more broadly.

The proposal also would decrease the reporting threshold for large private equity advisers from $2 billion to $1.5 billion in private equity fund assets under management. Lowering the threshold would result in reporting on Form PF that continues to provide robust data on a sizable portion of the private equity industry. Finally, the proposal would require more information regarding large private equity funds and large liquidity funds to enhance the information used for risk assessment and the Commission's regulatory programs. 

https://www.sec.gov/news/statement/lee-form-pf-20220126

Today's proposed amendments to Form PF contain key enhancements to investor protection for private fund investors as well as better tools for monitoring systemic risk. The private fund space continues to grow with the latest aggregated data from Form PF showing over 3300 reporting fund advisers, overseeing or managing over 37,000 funds, with an aggregate net asset value of $11.7 trillion that is more than double the amount from just seven years ago.[1] 

Form PF provides critical data to assist the Commission in understanding - both at the firm and industry-wide levels - significant information about this vast and growing market, such as overall size, investment concentration, leverage, liquidity, and counterparty exposures. This data may also serve to inform the work of the Financial Stability Oversight Council in monitoring for activities that may pose systemic risk to financial markets.[2] 

Today's proposed current reporting requirements, in particular, would further that goal by requiring certain advisers to timely report significant events such as deep losses, counterparty defaults or the inability to meet margin calls. These kinds of events raise not only investor protection concerns, but in some cases may also implicate systemic risks of the type that the FSOC was designed to address.

Form PF data has informed policy-making and delivered much-needed transparency in this area to the public.[3]  However, while we have worked to bolster our oversight program since the first filing requirements over a decade ago, we now know more tools are needed to effectively examine and monitor the private fund space.[4] 

Today's proposal would provide critical tools to help the Commission and the FSOC, including its reconvened Hedge Fund Working Group,[5] in making timely determinations as to whether certain events could pose systemic risks.[6]   

Monitoring for systemic risk is a key pillar of the FSOC's mission, and it is important to support that mandate.[7]  I hope the recent reinvigoration of the FSOC[8] will continue apace so that financial regulators can work together within our complex financial ecosystem to maintain a laser focus on financial stability for investors and the broader American economy.[9] Given the growth and complexity of private funds, ensuring we have the data we need in this space is an important component of that work.   

I'm happy to support today's proposal, and I'd like to thank the staff in the Division of Investment Management for their pragmatic and forward-looking approach to today's recommendations. I also want to thank staff in the Division of Economic and Risk Analysis and the General Counsel's office for their hard work. Thank you.

 
[1] Private Fund Statistics, First Calendar Quarter 2021, U.S. Securities and Exchange Commission: Division of Investment Management (Nov. 1, 2021), available at https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q1.pdf.  See also Annual Staff Report Relating to the Use of Form PF Data, U.S. Securities and Exchange Commission: Division of Investment Management (Dec. 3, 2021), at n.1, available at https://www.sec.gov/files/2021-pf-report-to-congress.pdf (noting that "[r]eported net assets of private funds have more than doubled since this data collection began, growing from about $5 trillion as of the end of the first quarter of 2013") [hereinafter "Annual Report"]; Amendments to Form PF to Require Current Reporting and Amend Reporting Requirements for Large Private Equity Advisers and Large Liquidity Fund Advisers, Investment Advisers Act Release No. IA-5950 (Jan. 26, 2022) [hereinafter "Proposing Release"].

[2] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010), at section 111 (establishing the Financial Stability Oversight Council ("FSOC")). See also Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Investment Advisers Act Release No. 3308 (Oct. 31, 2011), [76 FR 71128 (Nov. 16, 2011)], available at https://www.sec.gov/rules/final/2011/ia-3308.pdf. 

[3] See, e.g., Annual Report, supra footnote 1, at Section III (noting how Form PF data "promotes the ability of the Commission staff to . . . evaluate existing regulatory policies and programs directed to private fund advisers [and] evaluate the impact of policy choices on private funds' activities"); Private Fund Statistics, U.S. Securities and Exchange Commission: Division of Investment Management, available at https://www.sec.gov/divisions/investment/private-funds-statistics.shtml.

[4] See Proposing Release, supra footnote 1.

[5] Readout of Financial Stability Oversight Council Meeting on March 31, 2021, U.S. Department of the Treasury (Mar. 31, 2021), available at https://home.treasury.gov/news/press-releases/jy0093 (stating that "[a]t the request of Chairperson Yellen, the Council will reconvene its Hedge Fund Working Group, which last reported to the Council in 2016, to enhance interagency data sharing and improve the Council's ability to identify, assess, and address potential risks to financial stability related to hedge funds").

[6] See, e.g., Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Investment Advisers Act Release No. 3145 (Jan. 26, 2011) [76 FR 8068 (Feb. 11, 2011)], at text accompanying n.56 (noting that "high levels of leverage, can increase the likelihood that the [hedge] fund will experience stress or fail, and amplify the effects on financial markets"); Hedge Funds, Leverage, and the Lessons of Long-Term Capital Management, Report of the President's Working Group on Financial Markets (April 1999), available at https://www.treasury.gov/resource-center/fin-mkts/Documents/hedgfund.pdf, at 23 (noting that "highly leveraged investors have the potential to exacerbate instability in the market as a whole").

[7] Pub. L. No. 111-203, 124 Stat. 1376 (2010), at section 112 (stating that the purposes of the FSOC include "to identify risks to the financial stability of the United States that could arise from the material financial distress or failure, or ongoing activities, of large, interconnected bank holding companies or nonbank financial companies, or that could arise outside the financial services marketplace" and "to respond to emerging threats to the stability of the United States financial system").

[8] Year in Review: Treasury's Top Accomplishments During Year One of the Biden-Harris Administration, U.S. Department of the Treasury Press Release (Jan. 20, 2022), available at https://home.treasury.gov/news/press-releases/jy0563 (noting Secretary Yellen's reinvigoration of the FSOC). See also Remarks by Secretary Janet L. Yellen at the Open Session of the meeting of the Financial Stability Oversight Council (Mar. 31, 2021), available at https://home.treasury.gov/news/press-releases/jy0092 (stating that the FSOC's "task is to guard the nation's financial system").

[9] See, e.g., Report on Climate-Related Financial Risk, Financial Stability Oversight Council (Oct. 21, 2021), available at https://home.treasury.gov/system/files/261/FSOC-Climate-Report.pdf.

Last year, I gave a speech about assessing the unknown.[1] My thesis was that we should proactively try to anticipate the risks that may arise and proliferate in our financial markets. If we continuously evaluate the threats that our markets and investors may face, it should help us promote market resilience and appropriate investor protections, even when destabilizing events inevitably occur.

That process is critical, but must begin with reviewing and analyzing accurate and sufficient data.   With regard to the private funds market, the Commission historically has had little data about the economic activities of private funds and any risks they may present to both investors and to the larger financial   system.[2]  Consequently, as part of the Dodd-Frank Act reforms, the Commission adopted Form PF.  It was a good step forward, providing both the Commission and the Financial Stability Oversight Council (FSOC) with data about private funds to help assess risks.

And while Form PF information has been helpful to our understanding of private funds, the past ten years also have highlighted shortcomings and gaps in the data.[3]  These gaps in visibility are compounded by the simultaneous growth in the size of the private funds market and these funds' increasingly complex structures, strategies, and exposures.[4]

The Commission must keep pace with the market evolution, and Form PF updates are fundamental to providing the Commission with high-quality and meaningful disclosures. This includes requiring more granular and timely disclosures and updates[5] that will improve our understanding of the private fund industry and the potential risks within it.  Accordingly, today's rule proposes to amend Form PF in a variety of ways.  I'll briefly address three of those important changes.   

First, the proposal would require advisers to certain large funds to notify the Commission when there are signs of stress at those funds that could result in acute risks to investors and markets.[6]   The more timely updates should advance the Commission's oversight role. It is much harder to effectively plan for or mitigate risks when the information we're getting is already stale.  

Second, the proposal requires more detailed information from some of the biggest advisers to liquidity funds.[7]  These new data are essential to understanding these funds' characteristics, including their susceptibility to runs.[8]

Finally, the proposal would require more specific disclosures from all advisers to private equity funds. The private equity fund market in particular has grown dramatically in the last decade and private equity advisers have expanded the scope of their investment strategies and the types of their offerings, including a significant increase in credit strategies. In other words, they could be investing more heavily in risky debt, such as collateralized loan obligations ("CLOs")[9].  

This proposal is an important step that seeks to put the Commission and FSOC in a better position to understand, assess, and take action regarding significant developments at private funds, potential stresses to the broader financial markets, and practices that raise potentially significant investor protection concerns.

Thank you to the Chair's office, the staff in the Division of Investment Management, the Office of the General Counsel, and the Division of Economic and Risk Analysis for their thoughtful work on today's proposal. I look forward to reviewing the comment letters and working with the staff as we move toward a final rule.

 
[1] Caroline A. Crenshaw, Commissioner, Sec. & Exch. Comm'n, Assessing the Unknown (Sept. 24, 2021).

[2] See Proposed Amendments to Form PF to Require Current Reporting and Amend Reporting Requirements for Large Private Equity Advisers and Large Liquidity Fund Advisers, Release No. IA-5950 [hereinafter Proposing Release] at 82.

[3] See id. at 83-91.

[4] There were 6,910 funds with $1.60 trillion in gross assets in first quarter of 2013 and 15,584 funds with $4.71 trillion in gross assets in the fourth quarter of 2020. Div. of Investment Mgmt., Sec. & Exch. Comm'n, Private Fund Statistics (Aug. 21, 2021).

[5] Instruction 9 to Form PF directs large hedge fund advisers file within 60 calendar days of their first, second and third fiscal quarters.  Large liquidity fund advisers file within 15 calendar days of their first, second and third fiscal quarters.  All other advisers file their annual updates within 120 calendar days after their fiscal year ends. These filing deadlines result in the delay of timely information being provided to the Commission.

[6] Reporting events for large hedge funds include: extraordinary investment losses; certain margin events; counterparty defaults; material changes in prime broker relationships; changes in unencumbered cash; operations events; and certain events associated with redemptions. Reporting events for all private equity funds include: execution of an adviser-led secondary transaction; implementation of a general partner or limited partner clawback; and removal of a fund's general partner, termination of a fund's investment period, or termination of a fund. 

[7] Form PF defines "liquidity fund" broadly to include any private fund that seeks to generate income by investing in a portfolio of short term obligations in order to maintain a stable net asset value or minimize principal volatility for investors. See Form PF Glossary. Liquidity funds follow similar investment strategies as money market funds, but are unregistered.

[8] See Proposing Release at 67-68, 105-106.

[9] See Crenshaw, supra note 1. Collateralized Loan Obligations (CLOs) are structured investment vehicles that hold pools of leveraged loans. Leveraged loans refer to loans made to highly levered or non-investment grade debt. See S.P. Kothari et al., Sec. & Exch. Comm'n., U.S. Credit Markets Interconnectedness and the Effects of the COVID-19 Economic Shock (Oct. 2020). CLOs share some key characteristics with Collateralized Debt Obligations (CDOs). Namely, both are highly complex products that involve high-risk debt that have been structured into a set of securities with AAA-rated tranches, which are marketed to investors as higher-yielding safe debt. See, e.g., Profs. Elizabeth DeFontenay & Erik Gerding, Meeting of the Securities and Exchange Commission Investor Advisory Committee (Sept. 19, 2019); Frank Portnoy, The Looming Bank Collapse: The U.S. Financial System Could be on the Cusp of Calamity. This Time, We Might Not Be Able to Save It, Atlantic (July/Aug. 2020). I am continuing to think about the risks such structured products can pose, including how deteriorating loan documentation, "covenant-lite" loans that result in fewer protections for lenders, and lower expectations of recoveries in default increase the risks attendant to CLOs.

I want to begin by offering my thanks to the staff of the Divisions of Investment Management and Economic and Risk Analysis, and the Offices of the Chief Accountant and General Counsel.  Although I am unable to support today's proposal, I appreciate all of the work and effort staff put into the proposal, including fielding numerous comments and questions from me.

My objections to the proposed changes to Form PF, however, are fundamental.  As we described at the time of its adoption in 2011, Form PF "is primarily intended to assist [the Financial Stability Oversight Counsel (also known as FSOC)] in its monitoring obligations under the Dodd-Frank Act."[1]  As the Commission made clear in the release accompanying Form PF's finalization, the Commission's use of Form PF information in conducting its regulatory program is ancillary to the underlying purpose of facilitating FSOC's monitoring for systemic risk.[2]  Congress did not conceive of Form PF to facilitate the Commission's desire to inoculate well-heeled investors against downturns, losses, or fund failures.  Today's proposal disregards these facts and represents a fundamental shift in Form PF's scope and purpose.

Although the release cites monitoring and, where possible, mitigating or forestalling, market-wide disruptions as rationales for the proposed changes in reporting, the release provides scant evidence that the amendments to Form PF would enhance FSOC's ability to monitor for systemic risk.  Rather, the enhanced reporting seems intended primarily to provide the Commission with additional information to support its regulatory and enforcement programs.  A regulator's desire for data is insatiable, but more data is not always better.  Before we seek additional information through Form PF, we must show what we have done with the information we already require and show that it is insufficient to allow FSOC to monitor for systemic risk.  I do not think we have done that.  Merely citing gaps in data is not enough.  There will always be gaps-or at least I hope there will always be gaps-in just what information the government can access on private activities.  But we must ask: is our desire to fill these gaps born of necessity or curiosity?  I judge it to be the latter.

If finalized, large hedge fund advisers and all advisers to private equity funds would have one business day to report to the Commission the particulars surrounding certain "key events."  These reportable events include: extraordinary investment losses; significant margin and default events; and large withdrawals and redemptions for large hedge fund advisers; and, in the case of private fund advisers, the execution of an adviser-led secondary transaction, implementation of general or limited partner clawbacks, and the removal of a fund's general partner.

Requiring almost immediate reporting of localized events would distend Form PF into a tool for government to micromanage private fund risk management.  A hedge fund suffering losses equal to or greater than 20 percent of its net asset value over the course of ten days is unquestionably a significant turn of events for that hedge fund and its investors, but why is it appropriate or even wise for the Commission to insist on being notified of this within one business day?  Surely the fund adviser will have its hands full in such a fraught period and will have little time to spare to fill out government forms.  What makes this information so critical to us at the Commission, let alone FSOC?  If the losses are localized to a single fund, or even a handful of funds, why involve either government entity on a real-time basis? 

Form PF's purpose is to facilitate FSOC's monitoring of system-wide stability, not to inform the Commission about isolated trigger events affecting individual private funds.  Sure, isolated events can be indicative of systemic or potentially broader downstream disruptions, but what is the limiting principle here?  Merely asserting that isolated particular events could potentially indicate system-wide vulnerabilities, without any hard data-driven analysis, seems inadequate to justify the enhanced reporting.  Will FSOC and the Commission really be blind to system-wide threats absent these real-time reports of one-off events? 

Whether it is twenty percent losses or general or limited partner clawbacks, what does the record tell us concerning the correlative links between certain noteworthy events at one or a handful of funds and the wider market?  We owe the public a clearer understanding of the objective or subjective calculus or metric we have in mind when we say that contemporaneous reports from advisers concerning one or a handful of key events are significant enough to justify this added reporting burden for hundreds of advisers.  Saying that an otherwise isolated problem in a hedge fund could be indicative of a more global concern just is not good enough.  What will FSOC and the SEC do with this information?  Jump in to protect private fund investors from losses?

We are also proposing to change the reporting threshold for large private equity advisers.  But rather than raise a threshold that is now more than a decade old, we are proposing to reduce it from the current $2 billion to $1.5 billion private equity assets under management.  The reasoning behind this proposed reduction is unsatisfying and potentially harmful.  

When the current threshold was established, approximately 75% of the private equity market based on committed capital was covered.  In the intervening years, the private equity market has grown, such that with the increased number of smaller private equity funds operating below the $2 billion threshold, only 67% of that market is represented.  By this logic, if the industry continues to grow, we have set the precedent that we will continue to reduce the threshold again and again as the addition of smaller advisers means a smaller percentage of advisers meet the reporting threshold.  What is so magical about 75% of the industry falling within the ambit of Form PF?  Was the current $2 billion threshold chosen to reach 75%, or was 75% nothing more than the result of a $2 billion dollar threshold? 

Moreover, reducing the threshold seems to fly in the face of the Commission's thinking in 2011, when we said that "[t]hese thresholds are designed so that the group of Large Private Fund Advisers filing Form PF will be relatively small in number, but represent a substantial portion of the assets of their respective industries."[3]  By anyone's definition, a form that continues to gather data on the activities of 67% of the private equity market based on committed capital is substantial, so what has changed?  Why are we no longer concerned about costs to smaller private fund advisers and, relatedly, are we in danger of putting the brakes on an otherwise dynamic and competitive industry?  Changing the threshold is a good idea: but I urge my fellow Commissioners to put their support behind increasing it, not reducing it.

I look forward to hearing from commenters as they evaluate the merits of this proposal.  Thank you in advance, commenters, for your insights and wisdom, which will inform my determination about how to vote on any adopting release.  Again, my thanks go to the agency's staff who worked so hard on this proposal. 

 
[1] See Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Advisers Act Release No. 3308 (Oct. 31, 2011), [76 FR 71128 (Nov. 16, 2011)] ("2011 Form PF Adopting Release") at p.17.    https://www.sec.gov/rules/final/2011/ia-3308.pdf.  See also, Advisers to Hedge Funds and Other Private Funds, https://www.sec.gov/spotlight/dodd-frank/hedgefundadvisers.shtml.

[2] See 2011 Form PF Adopting Release at p.17. ("Form PF is primarily intended to assist FSOC in its monitoring obligations under the Dodd-Frank Act, but the Commissions may use information collected on Form PF in their regulatory programs, including examinations, investigations and investor protection efforts relating to private fund advisers.").

[3] Id at p.31.

https://www.sec.gov/litigation/litreleases/2022/lr25315.htm
Without admitting or denying the allegations in an Complaint filed by the SEC in the United States District Court for the Eastern District of New York, Heidi Mao consented to the entry of a Judgment, which permanently enjoins her from violating the securities registration provisions of Sections 5(a) and 5(c) of the Securities Act, the anti-fraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, and the broker-dealer registration provisions of Section 15(a) of the Exchange Act.  Also, Mao agreed to conduct-based injunctions that prohibit her from participating in an illegal pyramid scheme disguised as a multi-level marketing program. Further, the Judgment orders Mao to pay disgorgement of $449,729 and a civil penalty of $335,000. In related SEC administrative proceedings, Mao was permanently barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and from participating in any offering of a penny stock. As alleged in part in the SEC Release:

The SEC's complaint, filed on October 9, 2013, charged 16 defendants, including Mao, with perpetrating a worldwide pyramid scheme. According to the SEC's complaint, through the efforts of three CKB executives who live overseas and top promoters living in the U.S., including Mao, the scheme ensnared investors in New York, California, and other areas with large Asian-American communities. The executives and promoters collectively raised tens of millions of dollars from investors in the United States, Canada, Taiwan, Hong Kong, and other countries in Asia.

. . .

The SEC has now obtained judgments of liability against all the individual defendants. The five corporate defendants have defaulted. The SEC continues to litigate to obtain final judgments against the remaining non-settling defendants and the corporate defendants.

https://www.finra.org/sites/default/files/fda_documents/2021071109501
%20Riley%20Smith%20CRD%207270268%20AWC%20sl.pdf
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Riley Smith submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that Riley Smith entered the industry in June 2020 as a non-registered fingerprint person.  In accordance with the terms of the AWC, FINRA imposed upon Smith a $5,000 fine and an 18-month suspension from associating with any FINRA member in all capacities. As alleged in part in the AWC:


https://www.finra.org/sites/default/files/fda_documents/2019060991102
%20BLV%20Securities%20CRD%2035205%20AWC%20sl.pdf
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, BLV Securities submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that BLV Securities has been a FINRA member firm since 1994 with two registered representatives at one office.  As alleged in part in the AWC's "Overview":

From May 2018 through December 2019, BLV Securities failed to establish and implement anti-money laundering (AML) policies and procedures reasonably expected to detect and cause the reporting of suspicious activity, in violation of FINRA Rules 3310(a) and 2010. The firm also failed to conduct an independent AML test in 2019, in violation of FINRA Rules 3310(c) and 2010. 

Additionally, from May 2018 to December 2018, BLV Securities opened customer accounts without obtaining the signature of a firm principal approving the accounts' opening. As a result, BLV Securities violated FINRA Rules 4512(a)(1)(D) and 2010. 

In accordance with the terms of the AWC, FINRA imposed upon BLV Securities a Censure, $20,000 fine, and an undertaking to certify its compliance with the AML and Bank Secrecy Act issues cited.

(BrokeAndBroker.com Blog)
http://www.brokeandbroker.com/6252/finra-bequest-widow/
It is always disconcerting when elderly customers change their wills in order to leave eye-opening bequests to their stockbrokers or financial advisors. There are many decent men and women on Wall Street, and they often service their elderly customers with affection and unimpeachable rectitude. On the other hand, there are many predators on the Street. In a recent FINRA regulatory settlement, we seem to have a swirl of considerations involving a stockbroker and an elderly widow. Frankly, it's next to impossible to reconcile FINRA's allegations with FINRA's sanctions, which raises many questions. 

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