Securities Industry Commentator by Bill Singer Esq

Federal Court Can't Find Any Basis For FINRA Arbitration Decision In HSBC Managing Director Case (BrokeAndBroker.com Blog)

Disbarred Attorney Pleads Guilty To $5 Million Cryptocurrency Fraud (DOJ Release)

Suffolk Man Sentenced for Real Estate Investment Scheme (DOJ Release)

South Florida Man Sentenced to 7 Years in Federal Prison for Multi-Million Dollar Investment Scam Targeting the Elderly, and Spending Investor Money on Gambling, Jewelry, and Luxury Vehicles (DOJ Release)

Chief Compliance Officers Revisit Personal Liability (FinOps Report by Chris Kentouris)

SEC Charges Shari'ah-Focused Online Investment Service with Misleading Clients (SEC Release)

SEC Proposed Changes to Two Whistleblower Program Rules (SEC Release)

Statement on Proposal to Revisit Recently Adopted Whistleblower Rule Amendments by SEC Commissioner Hester Peirce

SEC Proposes Rule Amendments to Modernize Beneficial Ownership Reporting (SEC Release)

Dissenting Statement on Proposed Modernization of Beneficial Ownership Reporting by SEC Commissioner Hester M. Peirce

SEC Obtains Partial Summary Judgment Against Portfolio Manager for Misrepresenting Risk Management in Mutual Fund (SEC Release)

Investment Club Treasurer Going To Prison For Two Years For Embezzling Hundreds Of Thousands Of Dollars (DOJ Release)

2022 Report on FINRA's Examination and Risk Monitoring Program

FINRA Expels Funding Portal Member and Bars Its President

In the Matter of Buy the Block and Linda Pierre Smith, Respondents (FINRA AWC)

FINRA Censures and Fines Firm Over Private Placement Due Diligence and Escrow 

In the Nobles & Richards, Inc, Respondent (FINRA AWC)

FINRA Fines and Suspends Rep for Discretionary Trading

In the Matter of Christopher Edward Bond, Respondent (FINRA AWC)

FINRA Suspends Rep for Economic Injury Disaster Loan

In the Matter of Raphael Mack, Respondent (FINRA AWC)

FINRA Customer Claimant Says Arbitrators Left Out Zeros In Award (BrokeAndBroker.com Blog)

Court Finds FINRA Arbitration Process Not Fundamentally Fair (BrokeAndBroker.com Blog)

The charges against Levine and REICHENTHAL involve two fraudulent schemes.  In the first fraudulent scheme, in approximately June and July 2018, Levine induced another individual, the principal of a purported cryptocurrency escrow firm ("Individual-1"), to wire to REICHENTHAL over $3 million of funds from an over-the-counter cryptocurrency broker ("Company-1") to fund the purchase of Bitcoin after falsely telling Individual-1 that Levine would sell thousands of Bitcoin, when in truth and in fact, Levine never intended to sell Bitcoin.  After receiving the $3 million, REICHENTHAL, in turn, wired over $2 million to bank accounts in Guatemala held in the name of one of Levine's aliases.  Levine then lied to Individual-1 for days about why the deal had not worked out, the status of the purported Bitcoin, and the location of Company-1's money, which was never returned.

In the second fraudulent scheme, from approximately February 2019 to May 2019, Levine induced a Florida resident involved in brokering Bitcoin transactions ("Individual-2") to cause investors to send to REICHENTHAL over $2 million of the investors' money to fund the purchase of Bitcoin.  Again, Levine told Individual-2 that Levine would sell Bitcoin, when in truth and in fact, Levine never had any intention of selling Bitcoin to the investors. After receiving the funds from the investors, REICHENTHAL, in turn, sent over $1.9 million to bank accounts in Mexico controlled by Levine; the money was then wired to a bank account in Russia held in the name of one of Levine's aliases.  Levine then lied to Individual-2 and an investor about the status of the investors' funds, which were never returned. 

In connection with the above transactions, Levine used, among other things, various false aliases to communicate with the individuals sending funds to REICHENTHAL and foreign bank accounts held in his false names.  REICHENTHAL used bank accounts held in the name of his law firm and an attorney trust account to receive the funds and the pass them to Levine, before he or investors received the Bitcoin, contrary to REICHENTHAL's and Levine's promises.  

[K]ordrick Gibbons, 52, had a reputation with his co-workers and friends as being a savvy investor who was financially successful. From approximately 2015 through in or about 2018, Gibbons utilized this reputation to convince his co-workers to "invest" in his real estate holdings and, in exchange, Gibbons promised them lavish returns on their investments. Gibbons claimed to invest in properties, including businesses and condominiums, and that investors could realize 50% to 100% returns on their investments in as little as four to six months. Gibbons falsified documents to convince his investors that he had ownership interests in these properties. On multiple occasions, Gibbons emailed the victims documents that were inaccurate or false to deceive them into thinking he was wealthy and had multiple income-generating properties, when, in fact, he did not. The victims stated that Gibbons would make excuses as to why they had not yet received their money, all while promising that they would be paid. For instance, Gibbons often falsely suggested a bank had frozen his account in error or falsely asserted he was battling cancer.

In total, Gibbons defrauded at least 13 known victims and caused his investors to lose approximately $378,000. 

From September 2014 through April 2018, Grossman raised approximately $2.4 million in investor funds for his company, Dragon-Click Corp., by soliciting investments from elderly retirees nationwide.  Grossman told potential investors that Dragon-Click was developing an internet application that would revolutionize internet shopping by allowing a user to upload a photograph of any item the user wanted to purchase, identify all retailers offering that item for sale, provide price comparisons for that item across retailers, and provide a link to retailers' websites where the user could purchase the item.  Grossman solicited funds by falsely telling potential investors they would double, triple, or quadruple their investments, and that Dragon-Click was on the verge of being sold to a large technology company, such as Google, Apple, or Amazon, for over $1 billion.  He concealed from investors that, prior to raising funds for Dragon-Click, he had been permanently barred by the Financial Industry Regulatory Authority ("FINRA") from acting as a broker-dealer or associating with any broker-dealer firm, and that he had been permanently banned from commodities trading by the U.S. Commodity Futures Trading Commission ("CFTC"). 

Grossman falsely told investors that their investment money would be used to complete the technological development of the Dragon-Click internet application, to pay legal fees related to the patent application process, and to close the sale of the application to a large technology company.  But rather than using investors' money for any legitimate business purpose, Grossman misappropriated investors' funds for his own personal use.  Specifically, Grossman spent $1.3 million of investors' money on gambling, diamond jewelry, luxury cars, home mortgage payments, tuition payments for his children's private school education, and other personal expenditures.  For example, Grossman's unlawful expenditures included a McLaren MP4-12C, a Chevrolet Corvette, and a 4.81 carat diamond ring.

[F]rom September 2018 through July 2019, Wahed Invest advertised the existence of its own proprietary funds when no such funds existed, and also promised investors that it would periodically rebalance their advisory accounts, but did not do so.

The SEC's order further finds that when Wahed Invest ultimately launched a proprietary ETF in July 2019, it used its clients' advisory assets to seed the ETF without prior disclosure to clients of any conflicts of interest.

The order also finds that Wahed Invest marketed itself as providing advisory services compliant with Islamic, or Shari'ah law, including marketing the importance of its income purification process on its website. Despite these representations, the order finds that Wahed Invest did not adopt and implement written policies and procedures addressing how it would assure Shari'ah compliance on an ongoing basis.

Specifically, the proposed amendment to Rule 21F-3 would allow the Commission to pay whistleblower awards for certain actions brought by other entities, including designated federal agencies, in cases where those awards might otherwise be paid under the other entity's whistleblower program. The proposed amendments also would affirm the Commission's authority under Rule 21F-6 to consider the dollar amount of a potential award for the limited purpose of increasing the award amount, and it would eliminate the Commission's authority to consider the dollar amount of a potential award for the purpose of decreasing an award.

In September 2020, after a lengthy notice-and-comment period and two years of careful consideration, the Commission amended its whistleblower rules for the first time since they were adopted in 2011.[1] I supported the amendments because they drew from a decade of experience with the whistleblower program and were calibrated to balance efficient administration of our effective whistleblower program with the program's overarching goal of providing incentives for individuals to report, sometimes at great risk to their careers, violations of the federal securities.[2] Yet in June 2021, a spare seven months after the 2020 Amendments became effective, the whistleblower rules returned to the Chair's regulatory agenda, notwithstanding the fact that there appeared to be no new information that merited revisiting the recently amended rules.[3] Two months later, over my objection, the Commission published a "policy statement" that, in response to a legal challenge to certain of the 2020 rule amendments, effectively nullified the challenged provisions.[4]

I cannot support today's proposed amendments. Absent some pressing need to remedy inadvertent oversights, address unanticipated consequences, or deal with significant new factual developments, revisiting recently adopted rules subverts the regulatory consistency and certainty essential to well-functioning markets. As was observed nearly 250 years ago, often "it is of more consequence that a rule should be certain, than whether the rule is established one way or the other."[5] The markets we regulate are best served when, consistent with the principles of the Administrative Procedure Act, we engage in thoughtful, measured rule-making, and then adhere to the results of that process. Abandoning recently adopted rules simply because they have been challenged in court both thwarts our rule-making process and risks the perception that our duly adopted rules are provisional, subject to further revision if one really, really objects.

When one reads the proposal, it becomes apparent that, as then-Commissioner Roisman and I observed in June 2021, there is no new information that compels reopening the recently adopted rules. In fact, as the proposal acknowledges, the whistleblower program in the past fiscal year received the most tips it has ever received in a given year, awarded more money to whistleblowers than it has ever awarded in a given year (including some of the largest single awards in the program's history), and made more awards than in all its previous years combined.[6] These facts indicate that the program's rules, as amended in 2020, are functioning well, not that they are in need of further revision.

Nonetheless, the proposal contends that Rule 21F-3(b) needs amendment because the Commission has learned of "a number" of applications for related action awards that may (or may not) "implicate" other award programs that offer less generous payouts, either because the other programs have statutory award caps lower than the cap applicable to the Commission's program or because the award is entirely discretionary.[7] But the Commission plainly was aware of other potentially relevant award programs-and of FIRREA and its award cap in particular-when it adopted the 2020 Amendments, so the possibility that a claimant might be left to make a claim under a less generous award program was known and considered at that time.[8]

The 2020 amendments to Rule 21F-3(b) were explicitly "based on the Commission's experience and past practice" and "codifie[d] the approach the Commission has previously taken where another award program is available in connection with an action for which a related-action award is sought."[9] It seems highly improbable that the Commission, in the ten-year period of the whistleblower program that preceded the 2020 Amendments, had no experience dealing with related award applications that implicated other whistleblower programs with less generous award provisions. Additionally, the failure to identify the number of pending related action award applications that may "implicate" other award programs renders it difficult to assess the scope of the issue and to conduct a reasonable analysis of the costs and benefits of applying the existing rule versus the proposed amendments to such pending applications. The economic analysis admits as much, acknowledging that "the benefits and costs" of the proposals "are difficult to quantify."[10]

The proposal also asserts that Rule 21F-6 should be amended to provide that the Commission will use its statutory discretion to consider the dollar amount of an award only to increase an award, and that it "shall not" consider dollar amounts when determining whether to decrease an award.[11] The proposal offers three reasons for this amendment: (1) the Commission has not considered dollar amounts to lower an award since the 2020 Amendments were adopted; (2) large awards generate publicity, which in turn might increase reporting by whistleblowers; and (3) "the Commission perceives a risk that merely maintaining the authority to lower awards based on dollar amounts of the award may create the misimpression that the Commission is exercising such authority frequently-and this could in turn potentially deter individuals from reporting misconduct."[12] These reasons are not compelling.

The first reason, simply stated, is that we do not need it because we have not used it; however, that we have not used our discretion to consider dollar amounts when lowering an award also is reasonably understood as evidence that we have not abused our discretion by misapplying it to lower awards. Discretion exists so officials can exercise it when appropriate facts arise; that those facts have not yet arisen is no guarantee that they never will arise. The second reason is an unremarkable truism: large awards generate publicity for the program, which in turn leads to potential increased reporting from whistleblowers. Nothing in that reasoning chain explains why the Commission should disavow part of its statutory discretion to set award amounts appropriate to the facts and circumstances of the case. Moreover, as already noted, the Commission issued some of the largest awards in the program's history in the past fiscal year, and there is no evidence that the mere possibility that we might have considered dollar amounts in determining those awards diminished the programmatic value of the publicity they generated.

The third reason appears to be the operative one, but it is no more persuasive than the first two. The Commission has other options to ameliorate the purported "misimpression" that it frequently exercises its discretion to consider dollar amounts as a reason to lower an award. We could issue guidance explaining when and how we typically will use discretion to consider dollar amounts when determining award amounts. We also could state in the final award determination that we considered, or did not consider, the dollar amount in setting the award amount. Indeed, one presumes that the Commission could and should explain itself if and when it exercises its discretion to consider dollar amounts in its determination to increase an award. That the Commission historically has not done so does not mean that it is precluded from doing so when necessary. The proposal offers no compelling reasons why the Commission could not both protect the identity of the claimant and offer a concise explanation of how and why it considered dollar amounts when determining a particular award amount.

In sum, this proposal is a solution in search of a problem. Given the demanding rulemaking agenda on which the Commission and its staff have embarked in recent months, this unnecessary and unpersuasive proposal to revisit the recently adopted amendments to the whistleblower rules is an imprudent use of our resources. I thank the staff for their work on this proposal amidst the many others on their plates and thank the commenters in advance for their thoughts on the proposal. I respectfully dissent.[13]

[1] The 2020 Amendments, which were proposed in July 2018, became effective on December 7, 2020. Whistleblower Program Rules, No. 34-89963, 85 Fed. Reg. 70898 (Nov. 5, 2020) (adopting release); Whistleblower Program Rules, No. 34-83557, 83 Fed. Reg. 34702 (July 20, 2018) (proposing release). The rules were first adopted in 2011. Securities Whistleblower Incentives and Protections, No. 34-64545, 76 Fed. Reg. 34300 (June 13, 2011).

[2] Statement on Amendments to the Commission's Whistleblower Program Rules, https://www.sec.gov/news/public-statement/peirce-whistleblower-2020-09-23 (last visited Feb. 8, 2022).

[3] Moving Forward or Falling Back? Statement on Chair Gensler's Regulatory Agenda, https://www.sec.gov/news/public-statement/moving-forward-or-falling-back-statement-chair-genslers-regulatory-agenda (last visited Feb. 8, 2022).

[4] Procedures for the Commission's Use of Certain Authorities Under Rule 21F-3(b)(3) and Rule 21F-6 of the Securities and Exchange Act of 1934, No. 34-92565, 86 Fed. Reg. 44604 (August 13, 2021); Statement on the Commission's Action to Disregard Recently-Amended Whistleblower Rules, https://www.sec.gov/news/public-statement/peirce-roisman-whistleblower-procedures-2021-08-05 (last visited Feb. 8, 2022).

[5] Vallejo v. Wheeler, 1 Cowp. 143, 153 (1774) (Lord Mansfield, C.J.).

[6] The Commission's Whistleblower Program Rules ("Proposed Amendments"), n.59 and n.64; see also Whistleblower Program: 2021 Annual Report to Congress, 1-2, 10-12 (2021), https://www.sec.gov/files/2021_OW_AR_508.pdf (last visited Feb. 8, 2022). The fiscal year runs from October 1, 2020 to September 30, 2021, so the 2020 Amendments were in effect for 10 months of the fiscal year.

[7] Proposed Amendments, 13-14.

[8] 85 Fed. Reg. 70937 and n.358 (identifying the Commodity Futures Trading Commission, Internal Revenue Service, and False Claims Act award programs as potentially related and specifically addressing FIRREA's award cap).

[9] 85 Fed. Reg. 70906, 70908.

[10] Proposed Amendments, 45.

[11] Id., 37. The Commission has always had statutory authority to consider dollar amounts when determining awards. See 85 Fed. Reg. 70909-10. The proposal necessarily affirms this authority because it maintains that the Commission may consider dollar amounts in its determination to increase awards.

[12] Proposed Amendments, 38-40.

[13] Rectifying scrivener's errors does not reopen closed rulemakings, so I do not object to the technical amendments being made to Rules 21F-4(c) and 21F-8(e).

The proposed amendments to Regulation 13D-G would accelerate the filing deadlines for Schedules 13D beneficial ownership reports from 10 days to five days and require that amendments be filed within one business day; generally accelerate the filing deadlines for Schedule 13G beneficial ownership reports (which differ based on the type of filer); expand the application of Regulation 13D-G to certain derivative securities; clarify the circumstances under which two or more persons have formed a "group" that would be subject to beneficial ownership reporting obligations; provide new exemptions to permit certain persons to communicate and consult with one another, jointly engage issuers, and execute certain transactions without being subject to regulation as a "group;" and require that Schedules 13D and 13G be filed using a structured, machine-readable data language.

This proposal is characterized as modernization, but it fails to contend fully with the realities of today's markets or the balance embodied in Section 13(d) of the Exchange Act.  The proposed amendments acknowledge some of the challenges, but do not fully grapple with or resolve them in a consistent manner.  Accordingly, I do not believe the proposed amendments are prudent and respectfully dissent. 

Congress passed the Williams Act and enacted Section 13(d) in response to hostile takeovers in the form of cash tender offers in the 1960s.[1]  The Williams Act balanced shareholders' interest in learning of potential changes in corporate control with the benefit of allowing the party seeking to engage in a change in control of the company to keep that information private.  The balance-requiring a person who has acquired five percent of a class of shares to file within ten days of that acquisition-recognizes both the need for other shareholders to know of the impending change in control and the need to allow the person seeking control to reap some of the benefit of the work it did in determining that a change in control would be beneficial. 

Ten days is not a magic number.  As Congress recognized when it authorized us to shorten the number of days, it might not be the right number.  But to move from ten to five requires a justification, and the one included in the proposal is not compelling.  The release suggests that shortening the ten-day reporting window to five days is appropriate given the significant technological advances that have occurred since 1968, when Section 13(d) was enacted.  Given that the ten-day window does not seem to be based on the limitations of 1960s technology,[2] why should we consider technological advancements as a deciding factor in our consideration of the reporting window?

The Commission more generally sees an inconsistency between the ten-day filing period and how quickly today's markets move.[3]  Market participants receive and process information quickly and can build up large positions rapidly.  In recognition of these changes, the Commission has shortened reporting timelines imposed for Section 16 reports and Form 8-Ks, and foreign jurisdictions also have shorter timelines for reports comparable to Schedule 13D.  Of course, reports by insiders and issuers are distinguishable from reports by investors, and foreign markets' regulatory choices might not be appropriate for our markets. 

The crux of the Commission's justification, however, seems to be that shareholders need to have confidence that their trades are not being made based on stale information.[4]  Presuming that stock prices generally rise when a Schedule 13D is filed, this theory of investor harm posits that a shareholder who sells during the ten-day window would be harmed by not knowing that someone else had acquired a large stake in the company; if the Schedule 13D had been filed, she might have sold at a higher price or re-evaluated whether to sell at all.  The Commission invents investor harm and unduly paints the selling shareholder as a victim; she chose to transact at the prevailing market price on the date she sought liquidity.  Are there other pieces of information that other market participants have that might have informed her decision?  Sure, but information disparities make markets function.  Issuers and insiders have reporting obligations to resolve the problem of information asymmetry between these groups, who have privileged access to information, and investors.  Apart from the Williams Act requirements, investors, on the other hand, generally do not have disclosure obligations with respect to information they have, including their own ownership positions and plans.  We want to encourage investors to ferret out information and find undervalued companies.  Indeed, information asymmetries in this sense-where investors have equal access to disclosure from the issuer and insiders, but come to different conclusions about the long term prospects of a company based on their respective due diligence-are a feature, not a bug, of our capital markets. 

While the release acknowledges that there must be a balancing of interests between timely dissemination of the five percent ownership threshold and preserving an incentive structure for investors to seek change of control at under-performing companies, it summarily concludes that the proposed amendments will achieve the proper balance.  While "many Schedule 13D filers currently do not avail themselves of the full 10-day filing period,"[5] over 55 percent of Schedule 13Ds filed in 2020 were made on Day 10 or later.[6]  My former colleague Rob Jackson, along with Professor Lucian Bebchuk, advised the Commission in 2012 that shortening the reporting window "cannot be justified by an appeal to general intuitions about market transparency or by the claim that tightening is required to achieve the objectives of the Williams Act."[7]  Regrettably, I think we attempt to do just that with this release. 

The release also makes a number of other policy choices that I hope commenters will address.  The proposed expansion of the definition of beneficial ownership to cover certain cash-settled derivative securities lacks sufficient justification given that these securities do not convey ownership or voting rights.  The proposed amendments to Rule 13d-3 appear to be based on concerns raised in academic literature that focus on transactions in foreign jurisdictions and security-based swaps, both of which are excluded from the scope of these rules.  Perhaps commenters will provide evidence establishing a clearer link between ownership of cash-settled derivatives and the potential to change control of the issuer.  On the other hand, the release takes a very narrow view of the pressure placed on companies by institutional activists.  Proposed Rule 13d-6(c) contains a broad exemption for groups engaged in concerted actions related to an issuer or its equity securities, and the release cites as an example the following behavior that presumably would fit within the proposed exemption:

[I]nstitutional investors or shareholder proponents may wish to communicate and consult with one another regarding an issuer's performance or certain corporate policy matters involving one or more issuers. Subsequently, those investors and proponents may take similar action with respect to the issuer or its securities, such as engaging directly with the issuer's management or coordinating their voting of shares at the issuer's annual meeting with respect to one or more company or shareholder proposals.[8] 

Given the kind of activism that occurs today, will that exemption swallow the rule?  As others have pointed out, our markets are different than when the Williams Act was adopted.[9]  Hostile takeovers are less frequent, institutional shareholders are more dominant, and activist investors rely on methods other than taking control to force change at companies.

I look forward to reviewing the public's comments on the proposal.  Thank you to the staff of the Division of Corporation Finance, Division of Trading and Markets, Division of Investment Management, Division of Economic and Risk Analysis, and the Office of the General Counsel for your work on this release.  I will be very interested to hear what commenters have to say about the proposal.  Is ten days right?  Is five days right?  Or is some number in between better? 

 

[1] See Section II.A.1 of Proposing Release, Modernization of Beneficial Ownership Reporting, Rel. No. 33-11030; 34-94211 (Feb. 10, 2022) (hereinafter "Proposing Release"), available at https://www.sec.gov/rules/proposed/2022/33-11030.pdf.

[2] See Proposing Release at footnote 17.

[3] See id. at 18-20. 

[4] See id. at 125-30.

[5] Id. at 20. 

[6] See id. at 124. 

[7] Lucian A. Bebchuk & Robert J. Jackson, Jr., The Law and Economics of Blockholder Disclosure, 2 Harv. Bus. L. Rev. 39, 59 (2012).

[8] Proposing Release at 95. 

[9] See generally id. at 113-14. 

The court ruled that the SEC was entitled to summary judgment on certain of its negligence-based fraud claims against Walczak. The court found that Walczak repeatedly told investors that he used modeling software to stress test the Fund's portfolio on a daily basis, when, in fact, Walczak did not use the software on a daily basis. The court further held that Walczak's misstatements that he stressed the portfolio daily were material given that risk management was of considerable concern to potential investors and investment advisers and that the Fund's strategy subjected it to possible dramatic swings in value. The court reserved judgment for the jury whether Walczak acted with scienter with respect to these misstatements and whether Walczak should be liable for other alleged misstatements concerning his management to an 8% drawdown limit on the Fund's value.

[T]he Transport Investment Club (TIC), which had approximately 25 investing members, was formed in 1958, in the small community of Wellsboro, PA. Mann, a well-known high school math teacher and long-time friend of most of the TIC members, was elected treasurer of TIC in 1994. Mann's duties included collecting and disbursing funds, buying, and selling stocks as directed by TIC and its members, maintaining a set of books covering operations and assets, and preparing a monthly statement documenting the club's liquidating value, which was the total value of the club's stock holdings. Mann had sole control over the TIC bank account at Citizens and Northern Bank (C&N Bank) and the TIC investment accounts at brokerage firms. Funds collected at TIC monthly meetings were supposed to be used to purchase stocks in the TIC investment accounts as directed by the club members. Over the years, Mann regularly embezzled TIC's funds for his personal use rather than investing the funds. By February 2020, TIC's investments should have been worth approximately $290,614.05.  In actuality, Mann had embezzled all but $707.74 of TIC's stock holdings. For more than a decade, Mann routinely provided TIC members with fraudulent liquidation statements, which misrepresented the actual values of TIC's purported investments.  As one of the victims stated: "Mann's soulless duplicity and clear cunning fooled us all."

The 2022 Report on FINRA's Examination and Risk Monitoring Program (the Report) provides firms with information that may help inform their compliance programs. For each topical area covered, the Report identifies the relevant rule(s), highlights key considerations for member firms' compliance programs1, summarizes noteworthy findings from recent examinations, outlines effective practices that FINRA observed during its oversight, and provides additional resources that may be helpful to member firms in reviewing their supervisory procedures and controls and fulfilling their compliance obligations. 

FINRA's intent is that the Report be an up-to-date, evolving resource or library of information for firms. To that end, the Report builds on the structure and content in the 2021 Report by adding new topics (e.g., Disclosure of Order Routing Information, Funding Portals) denoted NEW FOR 2022 and new material (e.g., new exam findings, effective practices) to existing sections where appropriate. (New material in existing sections is in bold type.) In addition, those general findings that are also particularly relevant for firms in their first year of operation are denoted with a star.

This matter originated from Member Supervision's investigation of Respondents' potential misuse of investor funds and failure to use a qualified third party to hold investor funds as required by Regulation Crowdfunding Rule 303(e). 

FINRA Funding Portal Rule 800(a) provides, with exceptions not relevant here, that funding portal members are subject to the FINRA Rule 8000 series. FINRA Funding Portal Rule 100(a) states that associated persons of funding portals have the same duties and obligations as funding portal members under the Funding Portal Rules. FINRA Rule 8210(a)(1) states, in relevant part, that FINRA may require any "member, person associated with a member, or any other person subject to FINRA's jurisdiction to provide information orally, in writing, or electronically . . . and to testify at a location specified by FINRA staff . . .with respect to any matter involved in the investigation." A violation of FINRA Funding Portal Rule 800(a) and FINRA Rule 8210 is also a violation of FINRA Funding Portal Rule 200(a), which requires a funding portal member, in the conduct of its business, to "observe high standards of commercial honor and just and equitable principles of trade." 

On October 4, 2021, FINRA sent a request for documents and information to Buy the Block pursuant to FINRA Funding Portal Rule 800(a) and FINRA Rule 8210. On November 3, 2021, FINRA requested that Smith appear for on-the-record testimony pursuant to FINRA Funding Portal Rule 800(a) and FINRA Rule 8210. As stated during their counsels' phone call with FINRA on November 30, 2021, and by this agreement, Respondents acknowledge that they received FINRA's requests and will not produce all documents and information requested and will not appear for on-the-record testimony at any time. 

By virtue of the foregoing, Respondents violated FINRA Funding Portal Rules 800(a) and 200(a) and FINRA Rule 8210. 

Between May 2016 and June 2018, the firm served as the managing broker dealer for two offerings involving Manager A, who was in the case of each issuer a director, general partner, or managing member of the issuer. One of the offerings involved a Massachusetts issuer. 

On or before May 2016, the firm was aware that Manager A had entered into a settlement agreement with the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts. Manager A's settlement with the Commonwealth of Massachusetts served as the basis for an October 13, 2013, consent order. In the consent order, Manager A was ordered to cease and desist committing violations of the securities registration provisions of the Massachusetts Securities Act. The consent order also contained an undertaking that prohibited Manager A from offering or selling securities from or within Massachusetts or to Massachusetts residents and also prohibited him from acting as a manager, director, officer, partner, or control person of any Massachusetts entity offering or selling securities in the Commonwealth of Massachusetts for a period of five years. The relevant prohibitions contained within the consent order did not terminate until October 2018. 

Prior to approving and selling the 2016 and 2018 offerings, the firm failed to obtain and review a copy of the consent order and undertaking during its due diligence process. As a result, the firm failed to determine the impact of the consent order and whether the consent order and undertaking had any impact on whether the SEC Regulation D Rule 506 securities offering registration exemption was available for the two offerings.

As a result, the firm failed to conduct reasonable due diligence on the 2016 and 2018 private placement offerings in violation of FINRA Rules 3110(a) and 2010. 

. . .

In June 2016, the firm served as the managing broker-dealer for a private placement offering of Issuer A. The offering was sold on a best-efforts basis with a minimum contingency. The firm failed to deposit investor funds from this minimum contingency offering into an escrow account. In addition, the firm deposited investor funds directly into bank accounts of Issuer A four days prior to the minimum contingency being satisfied. 

As a result, the firm violated Exchange Act § 15(c)(2), Rule 15c2-4 thereunder, and FINRA Rule 2010. 

During the period July 2019 through August 2020, Bond exercised discretion on 288 occasions in four customers' brokerage accounts. Although the customers gave Bond oral or implicit discretion to purchase or sell securities, none of the customers provided prior written authorization for Bond to exercise discretion in their accounts. Additionally, National Securities Corporation did not accept any of the customer accounts as discretionary accounts, and in fact did not permit discretionary trading in non-advisory accounts during the relevant period. On September 2, 2020, Bond stated on a firm compliance questionnaire that he had not engaged in discretionary trading during the period January 2019 through June 2020. 

Therefore, Bond violated FINRA Rules 3260(b) and 2010.

In 2020, as a result of the COVID-19 pandemic, the federal government initiated several programs to assist small businesses, including the COVID-19 Economic Injury Disaster Loan Program, which was administered by the SBA. In May 2020, Mack submitted an application to the SBA for an Economic Injury Disaster Loan. 

In the loan application, Mack recklessly misrepresented that he was the owner of a childcare business and that the business earned $24,500 in revenue and incurred $16,000 in costs between January 31, 2019, and January 31, 2020. Mack, then a registered representative of Wells Fargo with no disclosed outside business activities, did not have a business eligible for an Economic Injury Disaster Loan from the SBA. In late 2019, Mack did some work for a childcare business; but he did not own that business, and he earned only a few hundred dollars from that work. 

Based on Mack's misrepresentations, the SBA approved the loan application. In June 2020, Mack signed a loan agreement with the SBA, affirming that the representations in his application were correct. Mack did not review the information he had provided in the loan application prior to certifying its accuracy when he signed the loan agreement. On June 23, 2020, the SBA provided Mack with a $3,300 loan. 

Based on the foregoing, Mack violated FINRA Rule 2010. 

• Securities Industry Commentator
• Bill Singer