The Wall Street Legal & Regulatory Feed

Securities Industry Commentator by Bill Singer Esq

March 29, 2022









http://www.brokeandbroker.com/6372/finra-arbitration-counsel/
Is there a right to have legal counsel appointed in a civil court case? Interesting question and one that often elicits the wrong answer. In today's blog we come across the plight of a public customer Claimant who filed an arbitration claim against a FINRA member firm. Except the firm says she's not a customer and can't compel them to arbitrate. Where did the firm make that argument? In federal court. Which means that the Claimant now has to deal with both her FINRA arbitration and a federal court case. But she's representing herself pro se in the pending court matter, and, she asks the Court for help. Will she get it?

Former Comptroller And Compliance Specialist At Investment Adviser Firm Pleads Guilty To Conspiring To Defraud Clients (DOJ Release)
https://www.justice.gov/usao-sdny/pr/former-comptroller-and-compliance-specialist-investment-adviser-firm-pleads-guilty
Vania May Bell (the former comptroller and chief compliance officer of registered investment advisor/financial planning firm Executive Compensation Planners, Inc.) ("ECP")) pled guilty in the United States District Court for he Southern District of New York to one count of conspiracy to commit wire fraud. Bell's father,, Hector May (the former President of ECP) pled guilty in a separate case in December 2018, to charges of conspiracy to commit wire fraud and investment advisor fraud; and he was sentenced on July 31, 2019, to thirteen years in prison plus three years of supervised release, and ordered to pay $8,041,233 in restitution and forfeit $11,452,185.  As alleged in part in the DOJ Release:

Beginning in 1982, May was the president of ECP and provided financial advisory services to numerous clients. In 1993, BELL joined ECP, where she held various titles including comptroller and chief compliance officer.  ECP worked with a broker dealer ("Broker Dealer-1"), of which May became a registered representative in 1994.  In its role as a broker dealer, Broker Dealer-1 facilitated the buying and selling of securities for clients of Broker Dealer-1's registered representatives, including clients of May.  Broker Dealer-1 and associated clearing firms maintained securities accounts for ECP's clients and, through those accounts, held ECP's clients' money, executed their securities trades, produced account statements reflecting activity in the clients' accounts, and forwarded these account statements to ECP's clients. 

In order to obtain money from the Victims' securities accounts with Broker Dealer-1, May advised the Victims, among other things, that they should use money from those accounts to have ECP, rather than Broker Dealer-1, purchase bonds on their behalf.  He further represented that by purchasing bonds through ECP directly, the Victims could avoid transaction fees.  Because May lacked the authority to withdraw money directly from the Victims' accounts with Broker Dealer-1, he persuaded the Victims to withdraw the money themselves and to forward that money to an ECP "custodial" account (the "ECP Custodial Account"), so that he could use the money to purchase bonds on their behalf. 

With BELL's assistance, May guided the Victims, first, to withdraw their money from their Broker Dealer-1 accounts, and second, to send that money to the ECP Custodial Account by wire transfer or check.  At times, May falsely represented that the funds being withdrawn from Victims' Broker Dealer-1 accounts were the proceeds of prior bond purchases May had made.  After the Victims sent their money to the ECP Custodial Account, May and BELL did not use the money to purchase bonds.  Instead, BELL and May transferred the money to ECP's "operating" account and spent it on business expenses, personal expenses, and to make payments to certain Victims in order to perpetuate the scheme and conceal the fraud. 

Specifically, in some cases, BELL and May used Victims' funds to make purported bond interest payments to other Victims.  In other cases, May used Victims' funds to make payments to other Victims who wished to withdraw funds from their accounts.  BELL and May also created phony "consolidated" account statements that they issued through ECP and sent to the Victims.  These "consolidated" account statements purported to reflect the Victims' total portfolio balances and included the names of bonds May falsely represented that he purchased for the Victims and the amounts of interest the Victims were supposedly earning on the bonds.  In order to create the phony consolidated account statements, May provided BELL with bond names and false interest earnings, and BELL created ECP computerized account statements and had them distributed to the Victims.

To keep track of the money that the co-conspirators were taking from the Victims, BELL processed the Victims' payments for the purported bonds, entered them in a computerized accounting program, and, through that program, kept track of how BELL and May received and spent the Victims' stolen money.  In this way, from the late 1990's through March 9, 2018, BELL and May induced Victims to forward them more than $11,400,000.

https://www.sec.gov/news/press-release/2022-55
In a Complaint, filed in the United States District Court for Northern District of California
https://www.sec.gov/litigation/complaints/2022/comp-pr2022-55.pdf, the SEC  charge Hari Prasad Sure, Lokesh Lagudu, Chotu Prabhu Tej Pulagam, Dileep Kumar Reddy Kamujula, Sai Mounika Nekkalapudi, Abhishek Dharmapurikar, and Chetan Prabhu Sree Karteek Pulagam with violating the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934 nd Rule 10b-5 thereunder. Parallel criminal charges were filed against Dileep Kamujula. As alleged in part in the SEC Release:

The Securities and Exchange Commission today announced insider trading charges against three software engineers employed at Twilio, Inc., a San Francisco-based cloud computing communications company, and four family members and friends for allegedly generating more than $1 million in collective profits by insider trading ahead of the company's positive first quarter 2020 earnings announcement on May 6, 2020.

According to the SEC's complaint, friends Hari Sure, Lokesh Lagudu and Chotu Pulagam were software engineers at Twilio and had access to various databases relevant to the company's reporting of revenue. As alleged, around March 2020, they learned through the databases that Twilio's customers had increased their usage of the company's products and services in response to health measures taken in light of the Covid-19 pandemic, and concluded in a joint chat that Twilio's stock price would "rise for sure."

The SEC's complaint alleges that despite receiving a company policy that prohibited them from insider trading, Sure, Lagudu and Chotu Pulagam knowingly tipped off, or used the brokerage accounts of, their family and close friends - Dileep Kamujula, Sai Nekkalapudi, Abhishek Dharmapurikar and Chetan Pulagam - to trade Twilio options and stock in advance of its May 6, 2020 earnings announcement while in possession of the confidential information concerning customer usage. According to the complaint, the scheme generated more than $1 million in illegal trading profits.

CFTC Awards Approximately $625,000 to Four Whistleblowers (CFTC Release)
https://www.cftc.gov/PressRoom/PressReleases/8506-22
CFTC awarded about $625,000 to four whistleblowers
https://www.whistleblower.gov/sites/whistleblower/files/2022-03/No.%2022-WB-04.pdf. As asserted in part in the CFTC Release:

This award recognizes the contributions of each of them, three of whom provided support to the CFTC jointly. One of the whistleblowers received a higher award percentage to recognize that he or she provided the highest level of ongoing assistance and cooperation to the Division of Enforcement.

If adopted, the proposed rules, Exchange Act Rules 3a5-4 and 3a44-2, would further define the phrase "as a part of a regular business" in Sections 3(a)(5) and 3(a)(44) of the Act to identify certain activities that would cause persons engaging in such activities to be "dealers" or "government securities dealers" and subject to the registration requirements of Sections 15 and 15C of the Act, respectively.

Under the proposed rules, any market participant that engages in activities as described in the rules would be a "dealer" or "government securities dealer" and, absent an exception or exemption, required to: register with the Commission under Section 15(a) or Section 15C, as applicable; become a member of an SRO; and comply with federal securities laws and regulatory obligations, including as applicable, SEC, SRO, and Treasury rules and requirements.

The Exchange Act defines "dealer" broadly to encompass any person that is "engaged in the business of buying and selling securities . . . for [its] own account," unless it is not doing so as "part of a regular business."[1] Drawing the line between dealers and other active participants in our markets has long been challenging, and those challenges have only increased as our markets have evolved over the decades. Today's proposal seeks to bring some clarity to how this definition applies in markets where some of the key providers of liquidity are not registered as dealers and may not be subject to any Commission registration framework. It would do this by establishing a qualitative test and, solely for the government securities market, a quantitative trading threshold to determine whether such firms should be required to register as dealers.

While I have deep reservations about the breadth of today's proposal, it addresses some important issues on which public comment will be valuable. I particularly appreciate the use of the rulemaking process to clarify the scope of the term "dealer." Using the notice-and-comment rulemaking process to solicit public input to inform the Commission's response to market and technological evolution, in lieu of extending ambiguous provisions of the law through enforcement actions against unsuspecting market participants, demonstrates a commitment to transparency and good government that should be the hallmark of all our work at the Commission. In addition, I appreciate the concerns expressed in the proposal about the largest firms making markets in U.S. Treasury securities sitting outside of the dealer framework.

To be clear, however, I am not convinced that the proposal gets the scope of its clarification of the dealer definition right, and I look forward to hearing what commenters have to say in response. In particular, I look forward to commenters' views on the following questions.

  1. What will the proposal's effect be on liquidity in different markets? The market generally benefits when there are more, rather than fewer, liquidity providers. A more varied set of liquidity providers also benefits market resilience; when one type of liquidity provider is unwilling to step in, another may be able to fill the gap. A market in which all of the liquidity provision is concentrated in a handful of large dealers regulated on the traditional model-which the proposal seems to favor-may impair market liquidity without increasing market resilience.

  2. Does the proposal articulate a sufficiently clear rationale-other than leveling the regulatory playing field-for requiring active traders who do not have any customers to register? What benefit would come from requiring active liquidity providers to register as dealers? The proposing release seems to take the position that some non-dealer liquidity providers are too highly leveraged and too risky for their own good and that of the markets,[2] and that dealer rules would be a handy tool to tamp down this leverage. One of the reasons our capital markets are so dynamic, however, is that we allow market participants to fail. Externalities matter, but the market is quite good at absorbing bad decisions by individual firms, albeit usually not at a price that the failed firm likes. Taking steps that seem designed to save market participants from themselves sends a terribly destructive message-the government is watching out for your risk-taking, so you do not have to. Markets are actually more resilient as a whole when individual firms know they can fail and that, if they do, nobody will be there to rescue them.

  3. Is there something unique about the Treasury markets that makes dealer registration of large liquidity providers in that market appropriate? As the proposing release notes, not only have Treasury markets grown dramatically, but "technological advances have increasingly enabled certain market participants that are not registered as dealers to perform critical market functions, including liquidity provision, that once were primarily performed by regulated dealers."[3] Would regulating these market participants as dealers help to address the types of market events we have seen over the past several years?

  4. Should we create explicit exemptions from dealer registration for any categories of liquidity provider? Although the Securities Exchange Act defines "dealer" broadly, we also have broad authority to craft appropriate exemptions. For example, does it make sense to subject to the dealer regulatory framework proprietary market participants that do not have any customers and that add to market liquidity through their own regular trading activities? If so, what conditions, if any, should be placed on those exemptions?

  5. Is the proposal's approach to private funds, and the investment advisers that advise them, reasonable? Although the proposal appropriately excludes registered investment companies entirely from application of the rule, private funds and investment advisers that meet either the qualitative or quantitative test set forth in the proposed rule would be required to register as dealers. How many private funds and advisers would be captured by the proposed rule? Is the proposed rule more complicated than it needs to be to pull in funds and advisers that should be registered as dealers? Would it even be feasible for funds and advisers to register as dealers?

  6. What lies down the road? While the obligations on dealers that would have to register under the proposal would be relatively limited initially-self-regulatory organization membership, net capital, transaction reporting, and recordkeeping and certain other requirements-experience suggests that, once registered with us, firms are likely to see their regulatory obligations grow over time. Once registered with us, firms become attractive candidates for additional regulation. Look no further than our recent proposal to vastly expand the requirements on private fund advisers for an example of this phenomenon at work.[4] What are the ancillary and future regulatory burdens that firms required to register as dealers under this rule should expect to incur?

  7. How does this rule interact with other recent Commission proposals? The Commission has issued a large number of extremely complicated rules over the past several months. Do commenters have sufficient time and understanding of existing proposals to comment on how this proposal might be affected by-or might affect-other rules that have been proposed. To take one example, the proposal notes that the rule is designed to capture dealing activity wherever it occurs, including on Communication Protocol Systems, which were the subject of a proposal the Commission approved in January of this year.[5] What issues might this raise?
Thank you to the Division of Trading and Markets, the Division of Economic and Risk Analysis, the Division of Investment Management, and the Office of General Counsel for your work on the release and our many discussions about its contents.
= = = = =
[1] See Section 3(a)(5) of the Securities Exchange Act (defining the term "dealer" to mean "any person engaged in the business of buying and selling securities . . . for such person's own account through a broker or otherwise" and to exclude any "person that buys or sells securities. . .for such person's own account, either individually or in a fiduciary capacity, but not as a part of a regular business").

[2] See, e.g., Proposing Release at 123 ("Since . . . losses on the part of one market participant can harm others, dealer regulations are designed to mitigate the magnitude of these externalities and to reduce the probability that they occur at all. However, these regulations do not currently apply to market participants that are not registered as dealers.").

[3] Id. at 5-6.

[4] For a discussion of this proposal, see Commissioner Hester M. Peirce, Statement on Proposed Private Fund Advisers; Documentation of Investment Adviser Compliance Reviews Rulemaking (Feb. 9, 2022), available at https://www.sec.gov/news/statement/peirce-statement-proposed-private-fund-advisers-020922.

[5] Amendments Regarding the Definition of "Exchange" and Alternative Trading Systems (ATSs) That Trade U.S. Treasury and Agency Securities, National Market System (NMS) Stocks, and Other Securities, Exchange Act Rel. No. 94062 (Jan. 26, 2022), 87 Fed. Reg. 15496 (Mar. 18, 2022).
FINRA's Department of Enforcement filed a Complaint against Respondent Jason Lynn
DiPaola on May 3, 2021. The Complaint has three causes of action. The first two causes of action relate to DiPaola's trading in his mother's securities account at an outside firm without disclosing the account to his employer firm and the executing firm. The third and most serious allegation charges him with failing to appear and provide on-the-record ("OTR") testimony.

On its face, this is a simple case. Many underlying facts are undisputed, including that
DiPaola actively traded in his mother's outside account, did not disclose it to his employer firm, and did not provide the requested testimony. Still, DiPaola denies the charges. He maintains that: (1) he did not engage in discretionary trading and therefore was not required to disclose his mother's account to his employer firm; (2) he did not control his mother's account, so he did not give misleading answers on the compliance questionnaires; and (3) FINRA lacked authority to require him to testify.

However narrow their factual disagreements, the parties could not differ more about the merits of the case or its proper outcome. Enforcement considers DiPaola's conduct egregious and wants him barred for failing to appear for an OTR interview, suspended for a lengthy period, and heavily fined for failing to disclose his mother's securities account. DiPaola insists the Complaint is meritless and should be dismissed. 

The Hearing Panel finds that Enforcement proved the Complaint's allegations by a preponderance of the evidence. Considering the totality of the circumstances, however, we conclude that the appropriate remedial sanctions are far less severe than Enforcement seeks. Accordingly, the Hearing Panel imposes a $5,000 fine and a 30-day suspension for DiPaola's violations.

Bill Singer's Comment: Recently, the quality of FINRA's OHO Decisions have shown a marked improvement; and the DiPaola OHO Decision is another excellent example. My comment is not intended to address the merits of Enforcement's allegations or the OHO Panel's findings, which may well be subject to appeals. By way of proscription, I note that I am solely voicing my approval of the excellent draftsmanship and clarity of expression in the OHO Decision. To the credit of OHO Hearing Officer Matthew Campbell, the 36-page document is replete with sufficient content and contest and deftly handles a particularly thorny issue pertaining to the esoterica of so-called FINRA "Wells Notices," Rule 8210 demands, and what exactly constitutes a failure to cooperate versus an untimely failure to cooperate versus a dispute as to the semantics of cooperation. In particular, I applaud HO Campbell's lucid rationale as presented here [Ed: footnotes omitted]:

We agree with Enforcement that DiPaola failed to offer a valid reason for his failure to provide testimony in April. DiPaola's assumption that FINRA lacked authority to require a postWells Notice interview absent a Wells Submission, and his assertion that Enforcement had nothing new to ask him, did not excuse him from complying with the Rule 8210 interview request. As we have discussed above, our understanding of the controlling precedents and the language of the Rule lead us to conclude that a Rule 8210 request is permissible at any stage of an investigation or proceeding, and was permissible here. 

But we disagree with Enforcement's insistence that a bar is appropriate. Enforcement emphasizes DiPaola's "complete failure to appear and testify on either April 5, 2021, or April 15, 2021." True, and regrettably, he refused to testify. But it was a refusal at the end of a long investigation, during which he had provided testimony on three days and after he had complied with other Rule 8210 information requests. We do not consider DiPaola's refusal to testify a fourth time to be a "complete failure." 

Furthermore, we find here, as the SEC found in Plunkett, that there was extensive overlap between Enforcement's interrogations of DiPaola in 2019 and what it intended to question him about in 2021. Enforcement wanted to question DiPaola further about possible market manipulation, insider trading, conflicts of interest, patterns of trading, and the timing and volume of trading in ADMD in his mother's E*Trade account. These were not new topics. In 2019 Enforcement questioned DiPaola about his trading in his and his mother's E*Trade accounts; about conflicts of interest in his trading; and probed whether DiPaola had access to nonpublic information when he traded and whether he had engaged in market manipulation.

We also cannot ignore the fact that the Wells Notice told DiPaola that Enforcement had reached a preliminary determination to recommend formal discipline against him for manipulative trading and trading while possessing material nonpublic information. This was, at least, an implicit concession by Enforcement that during its 2019 OTR interviews and information requests, it had gathered sufficient information to satisfy itself that it had obtained evidence supporting those charges. Enforcement changed its mind and did not include them in the Complaint, as was its prerogative. But to us, Enforcement's preliminary decision to recommend the charges suggests that Enforcement considered DiPaola's testimony and information responses before April 2021 significantly, if not substantially, compliant with Enforcement's Rule 8210 requests. They were significant enough to support a preliminary decision to recommend charges. We disagree, therefore, with Enforcement's conclusion that there are no mitigating circumstances present. 

For these reasons, we find that a bar is inappropriate for DiPaola's failure to comply with the Rule 8210 request to testify in April 2021. Considering all the circumstances, we conclude that we may best serve the remedial purposes of FINRA's Sanction Guidelines by imposing a suspension for 30 business days in all capacities upon DiPaola for violating FINRA Rules 8210 and 2010 by refusing to appear for a fourth OTR interview in April 2021 in the investigation Enforcement started in January 2018.

at Pages 33 - 35 of the OHO Decision

http://www.brokeandbroker.com/6362/nicolassy-finra-wizard/
They would like you to believe that there is some super-duper, state-of-the-art regulatory oversight keeping an eye on Wall Street. In case you were wondering, there ain't no such vigilance. The industry sure as hell doesn't want it. The regulators sure seem more interested in self-serving publicity and the appearance of regulation rather than the substance. In the end, the regulation of Wall Street is more about what the public investor is willing to believe. Frankly, don't believe too much. If you pull the curtain back, there's no mighty wizard. 

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