The Wall Street Legal & Regulatory Feed

Securities Industry Commentator by Bill Singer Esq

March 18, 2022












http://www.brokeandbroker.com/6351/zipper-dakota-finra-sec/
Today's blog is less a legal analysis of a case than it is a somewhat pathetic rendering of all that is wrong with Wall Street regulation. Unfolded before us is what appears to be a record of misconduct by the respondents as developed by FINRA; regardless, you're left wondering whether FINRA would have opted for the same hammer and tongs approach against a large member firm and one of its C-suiters. Making matters worse, FINRA and the SEC seem engaged in a ping-pong game of sending a case up to the federal regulator on appeal and back down to the self-regulator on remand and then back up and then back down and, well, sigh . . .

https://www.finra.org/sites/default/files/2022-03/Regulatory-Notice-22-10.pdf
As set forth in part under the "Summary" portion of the FINRA NTM [Ed: footnotes omitted]:

Chief Compliance Officers (CCOs) at member firms play a vital role. For example, CCOs and their compliance teams help design and implement compliance programs, help educate and train firm personnel, and work in tandem with senior business management and legal departments to foster compliance with regulatory requirements. In this way, CCOs help promote strong compliance practices that protect investors and market integrity, as well as the member firm itself.

Rule 3110 (Supervision) imposes specific supervisory obligations on member firms. The responsibility to meet these obligations rests with a firm's business management, not its compliance officials. The CCO's role, in and of itself, is advisory, not supervisory. Accordingly, FINRA will look first to a member firm's senior business management and supervisors to determine responsibility for a failure to reasonably supervise. FINRA will not bring an action against a CCO under Rule 3110 for failure to supervise except when the firm conferred upon the CCO supervisory responsibilities and the CCO then failed to discharge those responsibilities in a reasonable manner. As a result, charges against CCOs for supervisory failures represent a small fraction of the enforcement actions involving supervision that FINRA brings each year.

Bill Singer's Comment: Lemme see if got this -- FINRA thinks it's a good idea to remind the industry that Chief Compliance Officers play a vital compliance role. Like, who knew, right? Further, FINRA wants CCOs to know that FINRA will not bring a regulatory action against them for failure to supervise except when the firm conferred upon the CCO supervisory responsibilities and the CCO then failed to discharge those responsibilities in a reasonable manner. As I recall FINRA Rule 3110: Supervision starts off as follows: 

(a) Supervisory System
Each member shall establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules. . . .

How thoughtful for FINRA to issue a Regulatory Notice that confirms that if a CCO discharges his/her supervisory duties in a reasonable manner that they will not be charged with violating a rule that requires them to supervise in a reasonable manner. What a nice about-face from FINRA! Let me write that down so I don't forget that wonderful, illuminating clarification. Of course, one could imagine a situation where CCOs might thing that their supervision was reasonable and FINRA might think it was unreasonable. Not that there would ever be such a disagreement over such a core issue, right? Thankfully, on Page 4 of the eight-page FINRA NTM 22-10 we have this brilliant clarification:

When assessing potential liability under Rule 3110, FINRA will evaluate whether the CCO's conduct in performing designated supervisory responsibilities was reasonable in terms of achieving compliance with the federal securities laws, regulations, or FINRA rules.

In case you didn't grasp the helpful guidance in the above quote, FINRA will evaluate a supervising CCO's conduct do determine if the supervision was reasonable; and, FINRA will only find liability for unreasonable supervision. Moreover, FINRA will utilize a so-called "Reasonableness Standard" in order to ferret out unreasonable conduct. Who'd a thunk it? In response to a rule imposing a reasonable standard upon supervision, FINRA will only find a supervising CCO liable if the scrutinized supervision is deemed by FINRA to be unreasonable. And for that nugget of idiotic, circular nonsense, FINRA thought it necessary to issue a Notice to Members. If only someone on FINRA's lackluster Board of Governors could staunch the flow of the useless NTMs that issue forth from the self-regulatory-organization.

https://www.justice.gov/usao-sdca/pr/ceo-local-financial-firm-sentenced-multi-million-dollar-securities-and-tax-fraud-scheme
David John Nava pled guilty in the United States District Court for the Southern District of California to one count of conspiracy to commit securities fraud, one count of operating an unlicensed money transmitting business, and one count of tax fraud; and he was sentenced to 12 months in prison, ordered to forfeit $3.1 million and to pay $3,716,888,27 in restitution. As alleged in part in the DOJ Release:

[N]ava managed Surf Financial Group, LLC despite federal securities regulators permanently banning and censuring him in 1994 from participating in the industry. Nava admitted that he and other co-conspirators, including a licensed attorney, converted the debt of various publicly traded companies under materially false and fraudulent pretenses into unrestricted stock and then sold the stock for profit. Nava further admitted that he and his co-conspirators carried out their fraudulent scheme by entering into agreements where Nava sold shares of various entities' stock on public exchanges after fraudulently claiming an exemption from the U.S. Securities and Exchange Commission's (SEC) registration requirements for selling securities in the public marketplace.

To conceal his involvement in the securities fraud scheme, Nava admitted using various nominees to ensure that, as Nava described it, he was a "ghost" in the transactions.  Brokerage firms relied on the purported truth and accuracy of the attorney opinion letters in evaluating whether to clear the sale of shares of the restricted stocks on public markets. After the stocks were cleared for sale as a result of the false attorney opinion letters, Nava and his co-conspirators sold millions of shares of these stocks to the investing public. 

Nava further admitted that, from approximately 2017 to 2018, he operated an unlicensed money transmitting business as a means to transmit financial proceeds from foreign locations, including Hong Kong and the Bahamas, as a way to disguise the source, origin and control of the proceeds.

As stated in his plea agreement, in 2017 Nava entered into a business partnership with at least one person who resided in Mexico and delivered dairy products for a living. To conceal Nava's control over the money transmitting business, Nava directed the Mexican resident to open a bank account at a financial institution in San Diego, and to transmit millions of dollars in funds as directed by Nava. Nava failed to register his money transmitting business with the U.S. Treasury Department's Financial Crimes Enforcement Network, or FinCEN, as required under federal law. 

https://www.justice.gov/usao-sdny/pr/founder-cyberfraud-prevention-company-pleads-guilty-defrauding-investors-over-100
Adam Rogas pled guilty in the United States District Court for the Southern District of New York to one count of securities fraud. As alleged in part in the DOJ Release:

ADAM ROGAS was a co-founder of NS8, and served as its CEO, CFO, and a member of its board of directors.  ROGAS was also primarily responsible for the company's fundraising activities.  NS8, which was based in Las Vegas, Nevada, was a cyberfraud prevention company that developed and sold electronic tools to help online vendors assess the fraud risks of customer transactions.  In the fall of 2019 and the spring of 2020, NS8 engaged in fundraising rounds through which it issued Series A Preferred Shares and obtained approximately $123 million in investor funds.

ROGAS maintained control over a bank account into which NS8 received revenue from its customers, and periodically provided monthly statements from that account to NS8's finance department so that NS8's financial statements could be created.  ROGAS also maintained control over spreadsheets that purportedly tracked customer revenue, which were also used to generate NS8's financial statements.

ROGAS altered the bank statements before providing them to NS8's finance department to show tens of millions of dollars in both customer revenue and bank balances that did not exist.  In the period from January 2019 through February 2020, between at least approximately 40% and 95% of the purported total assets on NS8's balance sheet were fictitious.  In that same period, the bank statements that ROGAS altered reflected over $40 million in fictitious revenue.

[Ed: Images shown in original]

ROGAS used these materially misleading financial statements to raise approximately $123 million from investors in the fall of 2019 and the spring of 2020.  During the fundraising process, ROGAS also provided the falsified bank records he had created to auditors who were conducting due diligence on behalf of potential investors.  After these fundraising rounds concluded, NS8 conducted a tender offer with the funds raised from investors, and ROGAS received $17.5 million in proceeds from that tender offer, personally and through a company he controlled.

https://www.justice.gov/usao-cdca/pr/former-ceo-santa-clarita-valley-financial-services-company-sentenced-nearly-3-years
Scott Allensworth, 68, pled guilty in the United States District Court for the Central District of California to one count of wire fraud; and he was sentenced to 33 months in prison and ordered to pay $2,321,429 in restitution. As alleged in part in the DOJ Release:

Allensworth was the owner and CEO of Capital Growth Group Associates (CGGA), a company that provided financial services to clients, including tax advice and return preparation services, accounting services, retirement planning and investment advisory services.

From November 2015 to March 2017, Allensworth schemed to defraud investors along with David Hunt Weddle, 66, who managed a private investment fund through JustInfo LLC, a company Weddle controlled and operated out of his Somerset, Kentucky home.

Allensworth and Weddle solicited money - to be invested with CGGA and Weddle - from victim-investors, who included Allensworth's clients. These clients trusted him based on their prior relationship with him, and recommended Allensworth to their friends and family members, who also became victims of the scheme.

To lure victim-investors, Allensworth and Weddle promised them that their money would go into a brokerage account, and they would soon realize profits because Weddle employed a special trading strategy that would limit their losses and generate investment monthly returns of between 5% and 20%.

Instead of investing the money as promised, Allensworth and Weddle used part of the funds to pay for their personal expenses, including - for Allensworth - credit card bills. In Ponzi style, they also used victim-investor money to repay and fund withdrawals requested by other victim-investors, falsely representing that the money comprising these withdrawals arose from their investment gains.

Allensworth and Weddle failed to inform victim-investors that neither of them was registered or licensed as a commodity trading advisor and that the United States Securities and Exchange Commission had subpoenaed both of them in December 2016.

Weddle also fabricated multiple false account statements which they sent to victim-investors that purported to show the investments were steadily increasing in value based on Weddle's trading activity, when Allensworth and Weddle had misappropriated the funds.

As a result of the fraudulent scheme, Allensworth and Weddle caused more than 50 victims to suffer total losses of approximately $2,320,000.

Weddle pleaded guilty in March 2021 to one count of wire fraud. He is serving a 41-month prison sentence for that crime.

The SEC brought civil charges against Allensworth, Weddle and JustInfo LLC in October 2017. That case settled the following year with the defendants agreeing to pay more than $300,000 in civil penalties.

https://www.sec.gov/litigation/litreleases/2022/lr25347.htm
The United States District Court for the Southern District of Ohio entered a Final Default Judgment against Scott Allen Fries enjoining him from violating the antifraud provisions of Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. Fries was ordered to a $428,334.53 disgorgement plus prejudgment interest of $110,548.02 and a $208,500  civil penalty. As alleged in part in the SEC Release:

[B]etween March 2014 and March 2019, Fries raised at least $458,000 from at least ten investors, including some of his brokerage customers, and spent that money on personal expenses. The amended complaint further alleged that, in order to hide his fraudulent activities, Fries lied to investors about the status of their investments, created and distributed false account statements purporting to show profitable investments, paid off an investor couple who had discovered that their account statement was fake, and subsequently lied to his employer about receiving investment funds from his brokerage customers.

Order Determining Whistleblower Award Claims ('34 Act Release No. 34-94442; Whistleblower Award Proc. File No. 2022-40)
https://www.sec.gov/rules/other/2022/34-94442.pdf
The SEC's Claims Review Staff ("CRS") issued a Preliminary Determination recommending a Whistleblower Award to a Claimant in the amount of about $1.5 million involving a Covered Action and a Related Action. The Commission ordered that CRS' recommendations be approved. The Order asserts that the SEC considered the [Ed: footnote omitted]:

[C]laimant's information in part caused the Enforcement staff to open the investigation that resulted in the Covered Action. Claimant provided information based on Claimant's independent knowledge and independent analysis that alerted Enforcement staff to potential violations of the securities laws, and Claimant provided ongoing assistance during the litigation phase of the Covered Action. 

Finally, we find that the contributions made by Claimant to the Related Action were similar to Claimant's contributions to the success of the Covered Action, and, therefore, it is appropriate that the Claimant receive the same award percentage for the Related Action.

https://www.finra.org/sites/default/files/fda_documents/2020066817601
%20Steven%20Martin%20Barnett%20CRD%201143510%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, Steven Martin Barnett submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that Steven Martin Barnett was first registered in 1983, and from February 2018 to June 2, 2020, he was registered with FINRA member firm LPL Financial, LLC. In accordance with the terms of the AWC, FINRA found that Barnett violated FINRA Rules 4511 and 2010; and the regulator imposed upon him a $5,000 fine and a 30-calendar-day suspension from associating with any FINRA member in all capacities. As alleged in part in the AWC:

Between March 22, 2018 and May 19, 2020, Barnett mismarked at least 74 mutual fund order tickets as unsolicited when he had solicited the trades. Barnett marked the order tickets as unsolicited when he made investment recommendations in connection with customers reallocations of their mutual fund portfolios. Barnett's mismarking of these orders caused LPL to make and maintain inaccurate books and records. 

https://www.finra.org/sites/default/files/fda_documents/2020067520001
%20Donovan%20Thomas%20Kelly%20CRD%202622366%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, Donovan Thomas Kelly submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that Donovan Thomas Kelly was first registered in 1994, and by 2012, he was registered with FINRA member firm Independent Financial Group ("IFG"). In accordance with the terms of the AWC, FINRA found that Kelly violated FINRA Rules 4511 and 2010; and the regulator imposed upon him a $10,000 fine and a seven-month-suspension from associating with any FINRA member in all capacities. As alleged in part in the AWC:

Between April 2016 and July 2018, Kelly participated in private securities transactions outside the regular course or scope of Kelly's employment with IFG by recommending 19 investors to purchase promissory notes in an oil and gas drilling company, summarizing the investment for the investors, and arranging for some of the investors to fund the purchases through sales and money transfers from their IFG accounts. The promissory notes were securities. Collectively, these 19 individuals invested $688,000 in the company. These investors consisted of 16 of his IFG customers, including himself, and 3 other individuals who were not IFG customers. Kelly did not receive compensation for the investments. 

Kelly failed to provide any written or other form of notice to IFG prior to his participation in these transactions. Further, when asked on multiple annual firm attestation forms whether he had participated in private securities transactions, Kelly answered "no."

In a FINRA Arbitration Statement of Claim filed in February 2021, FINRA member firm Claimant Charles Schwab sought $69,039.21 in an unsecured debit balance plus interest, costs, and fees. Public customer Respondent Louis did not appear. The sole FINRA Arbitrator found Respondent Louis liable to and ordered him to pay to Claimant Charles Schwab $69, 031.29 plus interest and $1,681 in costs. As explained in the "Case Summary" portion of the Award:

In the Statement of Claim, Claimant asserted the cause of action of check-kiting. The cause of action relates to Respondent's alleged use of non-existing funds transferred from an external bank account to trade on margin in his Charles Schwab & Co., Inc. brokerage account. 

Bill Singer's Comment: Tough to read above summary and not laugh. Gotta love the euphemism" "non-existing funds." In Plain English, it seems that Schwab opened an account based upon a deposit of a check that was drawn against $0 at another bank, and, prior to ensuring that the deposit had cleared, Schwab seems to have allowed Claimant to trade on margin. One can only wonder as to the likely success that Schwab will now face trying to collect on its Award. 

http://www.brokeandbroker.com/6338/breuer-doj-russia-2022/
  In March 2011, United States Assistant Attorney General Lanny Breuer traveled to Russia to attend, of all things, the American Conference Institute's "Moscow Anti-Corruption Summit," replete with high-profile private-sector sponsors and a pricey $3,925 registration fee. I voiced my opposition to the AAG's participation in the conference in "One Day In the Life Of Lanny Breuer (the Moscow Anti-Corruption Summit)" (BrokeAndBroker.com Blog / March 17, 2011). Just going by events in 2022, that 2011 ACI anti-corruption seminar didn't accomplish jack. Perhaps the 2023 Anti-Corruption Summit will be held in Kiev or Kiyv or however the hell they will spell what's left of the city after the Russians have reduced it to rubble. 
  In my March 17, 2011 blog about the Moscow anti-corruption summit, I referenced an article that I had written for Forbes.com: "The Great Kentucky Caviar Criminal Caper Comes To An End In Ohio." Inexplicably, Senator Rand Paul plagiarized my Forbes' Kentucky caviar article for use in a book that he purportedly authored; see: "Section Of Rand Paul's Book Plagiarized Forbes Article / More copying and pasting from the senator. The author was unaware, but flattered, Paul used his wording" (BuzzFeed.News by Andrew Kaczynski / November 5, 2013). Adding insult to injury, the reporter who uncovered Senator Paul's plagiarism of my article, misconstrued my sarcasm about plagiarism being a sincere form of flattery as implying that I was, indeed, flattered by Senator Paul. I was not. I'm still not. Talk about being victimized twice! 

http://www.brokeandbroker.com/6340/sec-crs-denial/
After a whistleblower files a Form WB-APP with the SEC in order to secure a Whistleblower Award, far too much time elapses until the issuance of a Preliminary Determination by the Claims Review Staff. SEC Chair Gensler needs to reform the manner in which the CRS handles its docket, which seems to have mushroomed into somewhat unmanageable dimensions given the growing chorus of complaints from Claimants and their lawyers. Before you buy into the recent spate of self-serving press about the SEC Whistleblower Program, consider a recent case in which one deserving whistleblower was jerked around by the process.

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