Federal Court Denies Kim TRO and Injunction Against FINRA Enforcement Action (BrokeAndBroker.com Blog)
https://www.brokeandbroker.com/7177/kim-finra-tro/
Regardless of whether you agree or not with the Court's Opinion in Kim, it is an impressive bit of jurisprudence. Clearly, this Opinion remains somewhat at odds with Alpine, and that tension suggests that we have not heard the last of the challenges to FINRA's constitutionality. 

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5Cir Affirms Criminal Convictions in United Development Funding Convictions Via Substituted Opinion
United States of America, Plaintiff/Appellee, v. Hollis Morrison Greenlaw; Benjamin Lee Wissink; Cara Delin Obert; Jeffrey Brandon Jester, Defendants/Appellants. (Opinion,United States Court of Appeals for the Fifth Circuit, No. 22-10511 / October 11, 2023)
https://www.ca5.uscourts.gov/opinions/pub/22/22-10511-CR0.pdf
As set forth in the preamble to the Court's Opinion:

Treating the petition for rehearing en banc as a petition for panel rehearing (5th Cir. R. 35 I.O.P.), the petition is DENIED. Our prior panel opinion, United States v. Greenlaw, 2023 WL 4856259 (5th Cir. 2023), is WITHDRAWN, and the following opinion is SUBSTITUTED therefor.

In January 2022, a jury convicted United Development Funding executives Hollis Greenlaw, Benjamin Wissink, Cara Obert, and Jeffrey Jester (collectively “Appellants”) of conspiracy to commit wire fraud affecting a financial institution, conspiracy to commit securities fraud, and eight counts of aiding and abetting securities fraud. 18 U.S.C. §§ 1343, 1348,1349 & 2. Jurors heard evidence that Appellants were involved in what the Government deemed “a classic Ponzi-like scheme,” in which Appellants transferred money out of one fund to pay distributions to another fund’s investors, without disclosing this information to their investors or the Securities Exchange Commission (“SEC”). Appellants did not refute that they conducted these transactions. They instead pointed to evidence that their conduct did not constitute fraud because it amounted to routine business transactions that benefited all involved without causing harm to their investors. On appeal, they urge this court to view this evidence as proof that they did not intend to deprive their investors of money or property as a conviction under the fraud statutes requires.

Appellants each filed separate appeals, challenging their convictions on several grounds. Considered together, they argue that (1) the jury verdict should be vacated because the evidence at trial was insufficient to support their convictions or alternatively, (2) they are entitled to a new trial because the jury instructions were improper. As explained below, Appellants have demonstrated at least one error in the jury instructions—the intent to defraud instruction. Because this error was harmless, and thus, does not warrant a new trial, we also address Appellants’ remaining challenges on the merits.

Appellants also argue that the district court erred in (3) limiting cross-examination regarding a non-testifying government informant; (4) allowing the Government to constructively amend the indictment and include certain improper statements in its closing argument; (5) imposing a time limit during trial; and (6) failing to apply the cumulative-error doctrine. Because these arguments also do not warrant a new trial, we AFFIRM the jury verdict in its entirety.

Between 2013 and 2016, Martinez served as a real-estate attorney for Avtar Singh Dhillon, who was then chairman of the Massachusetts-based biotechnology company, Arch Therapeutics, Inc. Dhillon and Martinez placed 2.75 million Arch Therapeutics shares that Dhillon beneficially owned into a limited liability company that Martinez created and for which Martinez was the sole manager. At Dhillon’s direction, Martinez then sold the shares in the open market without a valid exemption under the relevant securities laws and distributed the approximately $1.34 million in proceeds. Martinez distributed the proceeds primarily to third parties for Dhillon’s benefit, taking a small portion directly for himself. 

In December 2022, Dhillon pleaded guilty to one count of willful failure to disclose stock sales, one count of aiding and abetting the sale of unregistered securities and one count of touting compensation nondisclosure conspiracy. He is scheduled to be sentenced on May 23, 2024.  

[B]eginning in at least February 2014, Steven Vernon Cross, 52, along with co-defendant Pranit Patil, 34, an Indian national, engaged in a years-long scheme to defraud victims who lent funds to or invested in Cross’s company, Commonwealth Applied Silica Technologies, LLC (CAST). Cross falsely represented to victims that CAST had valuable contracts with the National Aeronautics and Space Administration (NASA) for silica processing. As part of the scheme, Cross provided victims with fake NASA contracts, assisted by Patel, who falsely presented himself as a NASA employee in charge of contracting. Cross led victims to believe that their funds were being invested in profit-making endeavors, when in fact many of the funds were being used to pay Cross’s personal expenses and also being paid out to Patil.

Chatham Man Pleads Guilty to Insider Trading Scheme / Defendant purchased 3,000 shares of stock based on material non-public information (DOJ Release)
https://www.justice.gov/usao-ma/pr/chatham-man-pleads-guilty-insider-trading-scheme
In the United States District Court for the District of Massachusetts, Gregory Manning pled guilty to one count of conspiracy to commit securities fraud and one count of securities fraud. As alleged in part in the DOJ Release:

In or around June 2016, Forte ¬obtained material non-public information from his brother who was a senior executive at Analog Devices, Inc. (Analog), a Norwood-based semiconductor company, about Analog’s planned acquisition of Linear Technology Corp. (Linear), a semiconductor company based in Milpitas, Calif. Forte passed the information to Manning, who purchased 3,000 shares of Linear stock in the week leading up to the public announcement of the acquisition on July 26, 2016. After the deal was announced, Manning sold all of the Linear shares he had purchased in the days leading up to the announcement for a profit and later paid Forte a kickback in appreciation for Forte’s stock tip.

In June 2022, Younis was sentenced to one month of home detention and two years of probation after pleading guilty to trading in Linear securities based on the material non-public information Forte provided to him. On July 20, 2023, Forte was convicted by a federal jury of one count of conspiracy to commit securities fraud and one count of securities fraud. He is scheduled to be sentenced on Oct. 24, 2023.

Former CEO Of Iconix Brand Group Sentenced To 18 Months In Prison For Accounting Fraud (DOJ Release)
https://www.justice.gov/usao-sdny/pr/former-ceo-iconix-brand-group-sentenced-18-months-prison-accounting-fraud
After a four-week jury re-trial in the United States District Court for the Southern District of New York, former Iconix Brand Group, Inc. Chief Executive Officer Neil Cole, 66, was found guilty of participating in a scheme to fraudulently inflate Iconix’s revenue and earnings per share, making false filings with the Securities and Exchange Commission , and misleading the conduct of audits. Cole was sentenced to 18 months in prison plus three years of supervised release and ordered to pay forfeiture in the amount of $790,200. As alleged in part in the DOJ Release:

Iconix, whose shares traded on the NASDAQ, was in the business of acquiring various brands, including clothing and fashion brands, and then licensing those brands to retailers, wholesalers, and suppliers who, in turn, produced and sold clothing and other products bearing the brand names.

Iconix utilized joint ventures (“JVs”) to profit from its brands in foreign markets.  With respect to these JVs, Iconix transferred ownership of a trademark or brand to the JV while maintaining a 50% ownership interest in the JV itself.  The other party involved in the JV purchased a 50% interest in the JV from Iconix.  As part of the JV agreements, each JV partner was generally entitled to 50% of the JV’s licensing revenue.  When it entered into a JV, Iconix recognized as revenue the buy-in purchase price paid by the JV partner, less Iconix’s cost basis in the trademarks.

Among the most critical financial metrics disclosed in Iconix’s public filings with the SEC were Iconix’s quarterly and annual revenue and non-GAAP diluted earnings per share (“EPS”).  Iconix executives, including COLE, publicly identified revenue and EPS as the principal metrics demonstrating Iconix’s growth.  They also touted Iconix’s consistent record of revenue and earnings growth and of meeting or exceeding Wall Street analyst consensus with respect to these metrics.

The Accounting Fraud Scheme

COLE engaged in a scheme to falsely inflate Iconix’s reported revenue and EPS by orchestrating a series of “round trip” transactions in which COLE and a senior Iconix executive induced a JV partner, a Hong Kong-based international apparel licensing company (“Company-1”), to pay artificially inflated buy-in purchase prices for JV interests, with the understanding that Iconix would then reimburse Company-1 for the overpayments.  COLE executed the scheme for the purpose of enabling Iconix to report fraudulently inflated revenue and EPS figures based on the inflated buy-in purchase prices it obtained from Company-1.

COLE arranged for Iconix to enter into at least two JVs with Company-1 that included inflated buy-in purchase prices from Company-1: (i) an amendment to a preexisting Southeast Asia joint venture, which closed on or about June 30, 2014 (“SEA-2”), and (ii) a second amendment to the Southeast Asia joint venture, which closed on or about September 17, 2014 (“SEA-3”).  SEA-2 and SEA-3 involved a fraudulent “round trip” transaction, lacking in economic substance, in which Company-1 paid an artificially inflated buy-in purchase price for its interest in the JV, in exchange for COLE’s agreement that Iconix would give back the inflated portion of the purchase price to Company-1.  COLE and a senior Iconix executive hid from Iconix’s lawyers and outside auditors that COLE had reached an understanding with Company-1 to artificially increase the consideration Company-1 paid Iconix in exchange for COLE’s agreement to round-trip the overpayment back to Company-1.

Through the scheme, COLE caused Iconix to report fraudulently inflated revenue and EPS figures to the investing public.  COLE did so, in part, to ensure that the reported figures met analyst consensus and to fraudulently convey the impression to the investing public that Iconix was growing quarter after quarter, as COLE had touted to the investing public. 

Two New Jersey Men Plead Guilty To Defrauding Investors In Hemp Company / Vitaly Fargesen and Igor Palatnik Misappropriated Approximately $4 Million of Investor Funds (DOJ Release)
https://www.justice.gov/usao-sdny/pr/two-new-jersey-men-plead-guilty-defrauding-investors-hemp-company
In the United States District Court for the Southern District of New York, Vitaly Fargesen and Igor Palatnik each pled guilty to one count of conspiracy to commit securities fraud and one count of conspiracy to commit wire fraud. As alleged in part in the DOJ Release:

From in or about March 2019 to in or about March 2020, CanaFarma was a privately held Delaware corporation with offices in New York, New York.  Beginning on or about March 19, 2020, CanaFarma was listed on the Canadian Stock Exchange, and beginning on or about March 23, 2020, CanaFarma was listed on the Frankfurt Stock Exchange.  CanaFarma marketed itself to the investors as a “fully integrated cannabis company addressing the entire cannabis spectrum from seed to delivery of consumer products.”  To the public, FARGESEN was held out as Senior Vice President of Strategic Planning at CanaFarma and PALATNIK was held out as Senior Vice President of Product Acquisition at CanaFarma.  In truth, the two men exercised full control of CanaFarma but hid their control from the investing public by, among things, convincing an experienced businessman to falsely present himself to the market as the CEO of the company.

Using their control of CanaFarma, FARGESEN and PALATNIK devised and carried out a scheme to defraud CanaFarma’s investors by soliciting approximately $14 million in funds, including investments in private shares of CanaFarma, with false and misleading representations concerning the company’s management, products, and financials; failing to invest investors’ funds as promised; and secretly misappropriating at least $4 million of CanaFarma funds for their own benefit.  FARGESEN and PALATNIK effectuated the scheme by, among other things, controlling CanaFarma through a nominal Chief Executive Officer who reported to FARGESEN and PALATNIK, lying to investors regarding CanaFarma’s actual and anticipated operations, attempting to artificially inflate CanaFarma’s reported revenue, making false statements to CanaFarma’s auditors, and misappropriating millions of dollars of investor funds.

SEC Files Settled Charges Against Investment Advisers for Statements About Their Qualifications and Securities Industry Registrations (SEC Release)
https://www.sec.gov/enforce/ia-6457-s
Without admitting or denying the findings in an SEC Order https://www.sec.gov/files/litigation/admin/2023/ia-6457.pdf that they violated Section 206(2) of the Investment Advisers Act of 1940, Jason Todd Reynolds and Collaborative Financial Consulting LLC agreed to a cease-and-desist order; a censure for Collaborative; securities industry bars and prohibitions for Reynolds with the right to apply for reentry after three years; and a civil money penalty in the amount of $20,000 with payment deemed satisfied by the issuance of the parallel California Department of Financial Protection and Innovation Order, which imposes a penalty in the same amount. As alleged in part in the SEC Release:

[C]ollaborative and Reynolds held themselves out publicly as investment advisers and marketed the services Reynolds provided through a website, publications, and a podcast. The Order states that from 2019 to 2021, Reynolds provided Client Agreements to prospective and existing clients that characterized Reynolds as "an Investment Adviser Representative ('Investment Advisory Representative') holding Series 7, 66, 63 licenses in CA, NV, ID, PA, NY, WV, GA, TN." While Reynolds previously had been a registered representative and investment adviser representative, associated with broker-dealers and investment advisers registered with the Commission, those registrations had terminated on June 26, 2019.

According to the Order, at the time Reynolds drafted the representations included in the Client Agreements, he knew or should have known that he was not registered as an investment adviser or broker-dealer with the Commission or any state, or associated with a registered broker-dealer, or registered with one or more states as an investment adviser representative. As a result, the SEC finds that Collaborative's Client Agreements gave misleading impressions about Reynolds' qualifications and that Reynolds held active securities industry registrations related to the investment advice he was providing to clients through Collaborative.

The California Department of Financial Protection and Innovation ("DFPI") also issued a parallel Desist and Refrain Order against Reynolds and Collaborative.

SEC Adopts Rule to Increase Transparency Into Short Selling and Amendment to CAT NMS Plan for Purposes of Short Sale Data Collection (SEC Release)
https://www.sec.gov/news/press-release/2023-221

Specifically, Rule 13f-2 will require institutional investment managers that meet or exceed certain thresholds to report on Form SHO specified short position data and short activity data for equity securities. The Commission will aggregate the resulting data by security, thereby maintaining the confidentiality of the reporting managers, and publicly disseminate the aggregated data via EDGAR on a delayed basis. This new data will supplement the short sale data that is currently publicly available.

Relatedly, the Commission today also adopted an amendment to the National Market System Plan (NMS Plan) governing the consolidated audit trail (CAT). The amendment to the NMS Plan governing the CAT (CAT NMS Plan) will require each CAT reporting firm that is reporting short sales to indicate when it is asserting use of the bona fide market making exception in Rule 203(b)(2)(iii) of Regulation SHO

SEC Adopts Rule to Increase Transparency in the Securities Lending Market (SEC Release)
https://www.sec.gov/news/press-release/2023-220

Rule 10c-1a will require certain confidential information to be reported to an RNSA to enhance the RNSA’s oversight and enforcement functions. Further, the new rule requires that an RNSA make certain information it receives, along with daily information pertaining to the aggregate transaction activity and distribution of loan rates for each reportable security, available to the public. The Financial Industry Regulatory Authority (FINRA) is currently the only RNSA.

SEC Statements on CAT NMS and Transparency Rules

SEC Adopts Amendments to Rules Governing Beneficial Ownership Reporting / Final rules intended to improve transparency and provide more timely information for shareholders and the market (SEC Release)
https://www.sec.gov/news/press-release/2023-219
The SEC adopted rule amendments https://www.sec.gov/files/rules/final/2023/33-11253.pdf that update Regulation 13D-G to provide for more timely information. In part the SEC Release asserts that:

Exchange Act Sections 13(d) and 13(g), along with Regulation 13D-G, require an investor who beneficially owns more than 5 percent of a covered class of equity securities to publicly file either a Schedule 13D or a Schedule 13G, as applicable. An investor with control intent files Schedule 13D, while Exempt Investors and investors without a control intent, such as Qualified Institutional Investors and Passive Investors, file Schedule 13G.

Among other things, today’s amendments: shorten the deadline for initial Schedule 13D filings from 10 days to five business days and require that Schedule 13D amendments be filed within two business days; generally accelerate the filing deadlines for Schedule 13G beneficial ownership reports (the filing deadlines differ based on the type of filer); clarify the Schedule 13D disclosure requirements with respect to derivative securities; and require that Schedule 13D and 13G filings be made using a structured, machine-readable data language.

Further, the adopting release provides guidance regarding the current legal standard governing when two or more persons may be considered a group for the purposes of determining whether the beneficial ownership threshold has been met, as well as how, under the current beneficial ownership reporting rules, an investor’s use of certain cash-settled derivative securities may result in the person being treated as a beneficial owner of the class of the reference equity securities.

SEC Statements on Beneficial Ownership Rule

In-securities: What Happens When Investors in an Important Market are not Protected? (Remarks to the Center for American Progress by SEC Commissioner Caroline A. Crenshaw)
https://www.sec.gov/news/speech/crenshaw-remarks-center-american-progress-101123

Thank you, Emily, for your kind introduction. I’m grateful to you and the Center for American Progress for organizing the event, as well as for the invitation to speak to you today. The topic of the event is timely. Private markets are an increasingly large portion of the overall markets. That means solutions to any of the most important issues in the markets today will naturally require consideration of the private markets and the assets that trade in them.

Before I begin, I need to give my standard disclaimer: I speak today in my official capacity as a Commissioner of the SEC, but this speech does not necessarily reflect the views of the Commission, the other Commissioners, or members of the staff.

I remember my first few days in private practice. Before joining my firm, I had intended to practice criminal law, not securities law. The learning curve was steep at first. Though I had learned about materiality and the basics of the public offering process, there is a lot you do not learn in law school. The acronyms alone could take years to master. After meetings, I sometimes found myself searching through rule text, academic articles and the Internet to glean context and background on questions or ideas we had discussed.

Things obviously get more familiar with every new experience. And the more I practiced, the more my research delved into complex and nuanced questions. But I’ve found that even as my knowledge base has grown, there will always be questions I don’t know the answer to, areas I don’t know as well as others, and issues I find confusing. Sometimes, this is because the words themselves seem to bear little resemblance to what they are describing.

For example, I spent much of my time in private practice litigating issues that had arisen in securities offerings, with plaintiffs alleging misconduct by one of the participants in the offering. Even when these were termed “private” offerings, I found that they were often sold to hundreds of different investors, often with little financial experience, and none of whom had any relationship with the company in which they were investing. I confess that this still does not make a lot of sense to me, and I have recently spoken on the topic.[1]

Likewise, I knew what a bank was — or, I thought I did — but in the aftermath of the global financial crisis we also began to hear more and more about “shadow banks.” These non-bank entities engaged in many activities associated with the traditional banking system and thus posed similar spillover risks as depository banks.

Shadow banks function by intermediating between borrowers and investors in capital markets, but they had structured themselves in ways that allowed them to evade many of the regulations designed to prevent banks from posing undue risks to the financial system.[2] The resultant lack of oversight was a principal cause of the crisis.[3] As with private offerings, I have also spoken about this topic recently. I believe that as industries become larger, it is important to reevaluate the regulatory framework to ensure it remains fit for its purpose, and allowing parts of the financial system to operate in the shadows creates risks to investors and the financial system.[4]

And this brings me to today — I am growing increasingly concerned with “loans” that look less and less like loans. The syndicated loan market has grown vastly larger in recent years and the loans themselves are far different from traditional loans. Many are sold to hundreds of “passive” investors. They trade frequently and on standardized documentation. And they are used to conduct activities far beyond traditional borrowing to buy a piece of machinery or a new building.

Despite this significant growth, much of this market is not subject to meaningful regulation and investors are being put at risk. In addition, I am concerned that systemic financial issues are lurking in the market, and that if these instruments are not monitored more closely, the risk to the financial system itself will continue to grow.

The Beginnings

Exactly where this story begins is hard to pin down. We are all familiar with the idea of lending memorialized in “It’s a Wonderful Life.” That film is certainly an easy place to think of as a starting point — customers obtained loans from a particular bank, and those loans were made using the deposits at that bank. But as the economy grew and capital needs increased, the business of lending began to shift. Banks kept lending, but more often shared the risk of large transactions with other banks as part of a syndicate. This allowed banks to maintain relationships with their customer rather than losing that customer to the bond market, but not to take on the entire credit risk on their own.

Over time, the link back to “It’s a Wonderful Life” has grown more attenuated. Banks or groups of banks originate loans but quickly syndicate nearly all of the risk to others, either as a participation (meaning the other party’s relationship is only with the bank, not to the underlying borrower) or an assignment (meaning the assignee has direct contractual privity with the borrower).

Syndications, loan participations, and assignments are not new. But whereas in previous decades they were small scale and bespoke — with banks selling interests to a small circle of highly sophisticated institutional investors, often other banks — these practices are now supersized and systematized. We are now a far cry from banks negotiating participations or assignments of one large loan directly, and only with a handful of peers.

Instead, investment banks and other financial institutions have become dominant players. These global institutions source loans from other banks and, increasingly, shadow banks and market them to a range of investors.[5]

Frequently, those investors are institutions like registered investment funds, pension funds, insurance companies, collateralized loan obligations (“CLOs”), or other financial institutions that have large sums of money to deploy but do not have the customer relationships to make loans directly. Helpfully for these counterparties, they are not subject to bank capital regulations. One commentator called this a “symbiotic arbitrage,” with banks arranging loans they are not able to hold on their own books, but instead sell to institutional purchasers.[6]

Some of these changes were due to regulatory developments. For instance, discussions of this trend frequently note that the Basel framework’s risk-based capital rules pushed banks to diversify their portfolios to make them safer, and that this in turn led to banks holding less of any particular loan on their own books.[7] The impacts of the Basel framework and its successors have undoubtedly been positive overall, and have contributed to a safer, more resilient banking system. But the downsides of the originate-to-distribute model— the same model that came to grief with respect to mortgages and triggered the global financial crisis in 2007 and 2008 — have become more apparent over time.

Cracks Begin to Develop

As the industry approach to loan syndication continued to develop, so too did misconduct in these largely unregulated corners of the market. As I mentioned a moment ago, the market and practices of loan syndication began to change dramatically. Driven in part by pressures to compete against investment banks that were able to place short term commercial paper, banks began to market loan participations to their institutional clients.[8] These new structures did not create any relationship with the borrower through which an investor could enforce its claim. They also did not provide a mechanism for investors to conduct their own diligence or information gathering.

Instead, investors were entirely dependent on the efforts of the intermediary bank, which frequently retained little or no risk. The practical result of this structure was to leave investors with no recourse against any party to the transaction, even in the case of intentional misconduct.[9] The results were sadly all too predictable. Certain companies were not able to make good on their debts and defaulted, leaving investors holding the bag with little to no recourse.

For example, in a case in the late 1980s, a California bank marketed participations in loans it had made to a large company called Integrated Resources. The bank’s marketing efforts involved conduct reminiscent of boiler room scams. This included daily cold calls to market the notes to investors who had neither the means nor the ability to conduct diligence on the company. These participations were marketed as investments and looked like securities. Investors, relying on publicly available information, purchased them as yield-enhancing alternatives to money-market investments.[10] There was no other risk-reducing regulatory framework as the investors were not in privity with the underlying borrower and thus had no ability to sue it directly.[11]

But in Banco Espanol de Credito v. Security Pacific National Bank, the Second Circuit ruled that the investments in loan participations were not, in fact securities, and dismissed the investors’ claims.[12] The Banco Espanol opinion applied the four-part test in Reves v. Ernst & Young, which starts with the presumption that an instrument described as a note is a security, but then applies four factors to determine whether the note bears “family resemblance” to another instrument which is not a security and, if so, treats the instrument similarly.[13]

Even in 1992, when the Banco Espanol opinion came down, it was clear that the opinion—which has been variously described by some critics as “puzzling,” “relatively cursory,” and “incorrect”— was meant to be narrow. The Second Circuit retreated from it almost immediately (at least in part).[14] For example, when it denied a petition for rehearing, the court narrowed the scope of its original decision to emphasize that it only ruled with respect to the particular loan participations before it, and it also emphasized that “even if an underlying instrument is not a security, the manner in which participations in that instrument are used, pooled, or marketed might establish that such participations are securities.”[15]

Then, only two years later, a different panel of the same circuit court held that participations in mortgage loans were securities, which required the panel to consider a very similar factual situation and come out the opposite way.[16] But despite the fact that the Banco Espanol opinion was controversial and narrow from the start, and was undermined by a different ruling nearly immediately, it continues to reverberate. A vibrant market for broadly syndicated loans (or “BSLs”) now exists.

After Banco

In some ways, a BSL looks like a loan to a company. Like a loan, companies can use the proceeds for any purpose, including purchasing equipment or issuing a dividend to their equity owners.

In other ways, BSLs look more like bonds. Evidence of the obligation is generally in the form of a “note” purchased by institutional investors (not banks), such as investment funds, insurance companies, pension funds, CLOs, and various other non-bank financial institutions.[17] In addition, like a bond, a company generally will only make interest payments, with a single principal payment due all at once upon maturity.[18] BSLs are frequently structured to accommodate the market into which they are sold, and are designed to be relatively freely tradable among the institutions that invest in them.[19]

In the years since the Banco Espanol decision, the market for BSLs has continued to grow and evolve, including in ways that further undermine investor protections. Indeed, one cause of this undermining of investor protections may be the perception that federal securities laws do not apply. Recently, the SEC was asked to weigh in on whether a particular BSL met the definition of a security. The SEC did not weigh in, and the court ruled without such input.[20] While that case has now been decided, it brought new attention to an issue that had been steadily growing. But will this be the end?

The default assumption under Reves is that a particular instrument marketed as note is a security, and I am concerned that the lack of clear guidance on which factors are sufficient for a BSL to rebut that presumption is resulting in market confusion.[21] This could result in a court, or the SEC, being asked to weigh in again. This matters for both investors and the markets more broadly.[22] Here’s why.

Investor Protection

First, investor protection. I am aware that some commentators have argued that BSL investors do not need the protections of the securities laws because they are sophisticated institutions. Of course, institutional investors also need and deserve the protections of the federal securities laws. Consider the experience of institutional investors who purchased investments based on residential real estate before and during the global financial crisis of 2007 and 2008.[23]

And, to be clear, it is not just institutional investors. Retail investors have enormous exposure to this market. For example, many of the vehicles that purchase BSLs are registered investment companies that focus on these types of assets, and these funds represent an important component of the market for BSLs.[24] These funds, in turn, are owned by retail investors. Even if it is the case that the parties making investment decisions understand the important protections they are giving up, do the underlying investors? Funds investing in BSLs have been heavily marketed to retail investors in recent years as a hedge against rising interest rates.[25] Less prominent, however, have been discussions of the differences in legal status between BSLs and other credit instruments like bonds. I believe it is unlikely that most retail investors in these funds would understand these nuances, and that they would reasonably expect their funds to have more legal protections than in fact exist.

At a minimum, investors benefit from the protections of the crucial antifraud rules of the federal securities laws, such as Rule 10b-5. This rule polices any materially false or misleading statements made to investors. Rule 10b-5 and other rules do more. Consider: do investors in BSLs have sufficient protection from the risks of insider trading? Investors in traditional securities benefit from the knowledge that the SEC has the power to police when insiders trade on the basis of material nonpublic information. The enhanced investor protection results in increased market efficiency because investors do not need to worry that the other side is trading on the basis of inside information.[26]

When a BSL issuer encounters difficulty, it is common for some of the notes it has issued to be purchased by investors specializing in “distressed” assets — that is, assets where the issuer may go bankrupt, and where a savvy investor can make a profit by understanding which parts of the issuer’s capital structure are most likely to have a recovery. These investors also seek to profit by influencing the process by which the issuer seeks new capital to avoid bankruptcy.

In many cases, these distressed investors negotiate for access to nonpublic information about the issuer, which is not available to all holders of its notes. To the degree the underlying assets are not securities, investors may decide to trade on the basis of this inside information without disclosing it to the market. The future of a market rife with insider trading is concerning at best, especially for investors in funds that have not received the inside information (which generally includes the passive vehicles favored by retail investors). Investors will get hurt.

In addition, investors in securities rely on the vigilance of other participants in the process to ensure that an issuer discloses material information about its condition. In registered offerings, these are known as “gatekeepers,” and they exert a heavy influence in favor of investors. Of course, gatekeepers themselves can make mistakes (and we have seen lapses in the gatekeeping role lead to catastrophic results that affect the entire market).[27] As a whole, though, their influence helps promote confidence in the market by providing a second set of eyes on an issuer’s disclosures before they reach investors.

Even in unregistered offerings, where there is less of a role for a formal gatekeeper, the banks, accountants, and other service providers who participate in these offerings are motivated by the securities laws to ensure that the documents they produce are accurate and not misleading. But when the assets themselves are not registered, and are not even securities, do these participants exercise sufficient vigilance? In certain cases, we have seen that the answer is no, and that, when the participants are not subject to the securities laws, they are more willing not to disclose — and in some cases, to affirmatively hide — negative information about a company. They seem to rely on the caveat emptor doctrine that the securities laws were specifically designed to root out.[28]

Instead of a strong gatekeeper, documents marketing BSLs to investors frequently contain what is known in the industry as a “big boy” representation. That acknowledgment is designed to protect the bank intermediating the transaction from liability by requiring investors to represent that they have done their own diligence on the issuer of the notes. But frequently, investors have neither the means nor the time to conduct meaningful diligence. The loan is generally marketed to investors very late in the process after nearly all the terms are settled, and generally an investor’s only real choice is whether to participate. While some might argue that this is evidence of investors exhibiting rational ignorance, meaning the market is working, I think it could also be evidence of a market failure— the vehicles purchasing BSLs are doing so with other people’s money, and the bonuses of the people investing on behalf of those vehicles will be paid long before it is clear whether the BSLs at issue will perform in line with expectations.[29] This is a clear conflict. Shouldn’t the expectations of the party who will actually be harmed be given precedence?

In many contexts, parties are not allowed to waive rights that are central to a particular regulatory scheme. In fact, recognizing the fundamental unfairness and power imbalances that can exist when powerful parties are able to manipulate the circumstances of a transaction, provisions in each of the major securities laws state that attempts to waive the protections of those laws are void.[30] In light of the remedial nature of the securities laws and the identity of many underlying investors, should we take a fresh look at assets that seem structured to avoid these important protections?

Systemic Risk

I am also concerned that risk has accumulated in the BSL market and that it may be reaching a scale that could affect the financial system more broadly.[31] These assets trade privately, preventing regulators like the SEC from fully assessing whether particular institutions have too much exposure, or whether other risks are brewing. Ultimately, the lack of these data could result in us being unable to detect risks that could affect the efficiency, fairness, or orderliness of our capital markets. And, if a negative outcome does ultimately occur, the same lack of data could also hamper our ability to effectively respond.

Worse, the types of BSLs that look most similar to securities also seem to have characteristics that make them especially likely to have procyclical systemic effects on the market. Though BSLs trade regularly, many passive investors will only buy assets that trade on “par docs.” This essentially means that they are not trading at a discount due to distress or potential distress at the borrower. In fact, many investors have strict guidelines that require them to sell BSLs even when they are downgraded below a certain level — well before the issuer is truly in distress. I am concerned that this can result in a procyclical cycle of sales which in turn could cause forced sales of other BSLs market-wide and affect the ability of companies to receive financing even though they are not otherwise distressed. The echoes of the 2008 financial crisis are hard to ignore.

In addition, as BSLs grow larger, they naturally need to be syndicated to more participants. But this also renders them especially vulnerable if problems develop. If investors sour on the market, (for example due to forced sales by market participants depressing prices throughout the market), the largest loans that depend on being especially widely syndicated are the ones that are most likely to get “hung” on bank balance sheets and potentially affect financing to other companies.

As we continue to move into a new era of higher interest rates, these effects may become more apparent. For example, many companies took advantage of the near-zero interest rates of the pandemic and its immediate aftermath to borrow new money using BSLs. The amount of BSLs maturing in the next several years is more than any other comparable period in history.[32]

Though it is still early innings, we are already seeing indications of what could happen when companies crash into this maturity wall. In the aftermath of the financial crisis, many companies engaged in “extend and pretend” transactions. These involved extending the maturity of the company’s debt on the hope that financial conditions would improve but without any meaningful changes to the company’s business. As of earlier this year, extend and pretend transactions were at their highest on record.[33] Though it appears this has not yet resulted in immediate negative effects, will our luck run out in future years?

Many of the traditional passive investors in BSLs are not well-equipped to handle decisions requiring analysis of the issuer’s business prospects. This has led to the rise of the “snooze drag,” where CLOs strategically do not take action on extension requests (allowing them to take effect by default).[34] This has resulted in investor complaints because the CLOs would otherwise be required to return their investors’ money.

To me, a situation where many borrowers are seeking to refinance by extending their existing loans without any real changes, and can only do so by convincing their lenders to “snooze” is a flashing warning sign – what happens when borrowers’ ability to engage in this tactic runs out? Will procyclical forced sales occur? And will regulators and the public be caught by surprise when this begins to affect the real economy?

I should note that the two dynamics I have mentioned — investor protection and systemic risk – are interconnected. Markets in which securities protections are not present mean investors have less information, less confidence in the integrity of the information they do have, and fewer assurances that market participants will not abuse the trust investors place in them.[35] Without these rules, the market runs a higher risk of unraveling, with potentially systemic consequences for the real economy.[36] Greater disclosure and the greater integrity of disclosure that comes with antifraud rules, protections against insider trading, and gatekeepers would guard against the BSL market becoming a proverbial “market for lemons.”[37]

* * * * *

I would also like briefly to touch on several other areas that commentators have raised when discussing whether particular instruments described as notes, such as BSLs, should be regulated as securities. Though I believe consideration of these policy issues would not alter the application of the binding Supreme Court precedent in Reves, I believe they could merit some consideration so that regulators and the industry can work together to develop guidance on areas that may be unclear. In the face of uncertainty about the future development of the BSL market, it could be that regulators have work to do to prepare for a future ruling that certain BSLs are securities for purposes of the Securities Act.

First, BSLs are frequently originated by large, national banks. I am aware that these banks are generally prohibited from underwriting securities, and that some have argued that if a court were to deem these widely syndicated notes securities, it could reduce capital formation. I believe further work is necessary to determine whether this is a realistic concern. Are there other arrangements a bank could make, such as conducting the activity through an affiliate? Would doing so require any additional regulatory actions from the SEC or banking regulators?

Second, these assets are already defined as securities for some purposes and not for others. For example, they are already treated as securities under the Investment Company Act.[38] What would prevent a banking regulator from issuing guidance stating that it would not deem widely syndicated loans to be securities for the purposes of the Volcker rule, even though the assets would be securities for other purposes?

* * * * *

Throughout my remarks today, I have referred to the global financial crisis of 2008. In the years leading up to that crisis, financial institutions had successfully convinced regulators that the laws and regulations enacted in the wake of the Great Depression could be loosened. They were able to point to decades without a crisis to argue that strict regulations were unnecessary and that the business of banking had become safer. Just over 25 years ago, the hedge fund Long Term Capital Management failed. Until its failure, many believed that hedge funds did not to pose a risk to the financial system.[39] This was because investments in these vehicles were privately placed to sophisticated investors who were capable of sustaining large losses. LTCM was run by Wall Street legends (including several Nobel laureates) who were viewed as some of the brightest minds in finance. But despite the apparent safety, the firm melted down over the course of a few weeks and ultimately required a multi-billion dollar bailout from its counterparties (at the strong urging of the Federal Reserve Bank of New York).[40] Its failure is one reminder that the non-occurrence of a crisis does not mean that one could never occur in the future. Regulators must be vigilant about the risks that are around the corner, not just the ones in the past.

I am aware that some may argue that BSLs have only exhibited isolated problems, and that these problems alone are not necessarily evidence of systemic risk. It could be the case that this means BSLs will never cause systemic issues in the financial system. But, as in the years leading up to 2008, a metamorphosis in the system may be occurring before our eyes. I worry that this market is becoming riskier in ways that regulators have not yet fully considered. While some loan syndication may make sense to reduce the risk taken by individual banks, I am concerned that we are now in a world where banks lend, but nearly all the risk is transferred to investors who have no relationship with the borrower, and that investors — including retail investors — frequently have a great deal of exposure to these assets.[41] If that is to be the case, regulators across the board must assess whether investors have sufficient protection, and whether there are other risks to consider. For example, is the risk of BSLs compounded due to the lack of transparency, price discovery, and regulation of the private offerings through which BSLs are distributed to investors?

Consideration of these issues now, before further problems develop, is necessary. Doing so allows us to ensure that a crisis does not threaten the fair, orderly, and efficient markets that we strive to maintain. I look forward to working with the public — including the people in this room today — to ensure that these outcomes do not occur. Thank you.

[1] See Commissioner Caroline A. Crenshaw, Big “Issues” in the Small Business Safe Harbor (Jan. 30, 2023), available at https://www.sec.gov/news/speech/crenshaw-remarks-securities-regulation-institute-013023.

[2] I note that private offerings and shadow banks are often deeply interconnected; securities offerings by shadow banks are often conducted through offerings exempt from registration under the federal securities laws. And resales and trading of these securities likewise rely on registration exemptions. See id.

[3] See, e.g., Ass’t Sec. for Fin. Inst. Michael Barr, Remarks on Reforming the Global Financial System (Dec. 2, 2010), available at https://home.treasury.gov/news/press-releases/tg986 (noting “the development of new products and markets for which [existing] protections had not been designed” and discussing that regulatory treatment seemed based on what an entity was called, rather than its underlying characteristics).

[4] See Commissioner Caroline A. Crenshaw, Statement Regarding Private Fund Advisers Rulemaking (Aug. 23, 2023), available at https://www.sec.gov/news/statement/crenshaw-statement-private-fund-advisers-082323.

[5] They also actively encourage the growth of the market by creating options for the clearing, settlement, and trading of these assets.

[6] Frederick Tung, Do Lenders Still Monitor? Leveraged Lending and the Search for Covenants, 47 J. Corp. L. 154, 179 (2021).

[7] See Bank for Int’l Settlements, International Convergence of Capital Measurement and Capital Standards (1998), available at https://www.bis.org/publ/bcbsc111.pdf; see also generally, Tung, supra note 6. To be clear, the capital rules themselves are not a problem. But rather than reducing risk, when regulators fail to police arbitrage of bank capital rules, this can result in risk reappearing in places that regulators may not expect. See generally David Jones, Emerging Problems with the Basel Capital Accord: Regulatory Capital Arbitrage and Related Issues, 24 J. Banking & Fin. 35 (2000).

[8] See Richard Y. Roberts & Randall W. Quinn, Leveling The Playing Field: The Need For Investor Protection For Bank Sales Of Loan Participations, 63 Fordham L. Rev. 2115, 2119 (1995).

[9] This is because participations do not create contractual privity with the underlying issuer of the notes, meaning investors are unable to recover directly against the issuer. As discussed further, infra, the intermediary bank is likewise insulated from liability because some courts have historically found that the federal securities laws would not apply to the historical version of these assignment and participation transactions.

[10] See Roberts & Quinn, supra note 8, at 2123.

[11] Elisabeth de Fontenay, Do the Securities Laws Matter? The Rise of the Leveraged Loan Market, 39J. of Corp. L.725, 749 (2014). Thus, the practical result of a decision that the notes were not securities was to prevent the investors from recovering against anyone.

[12] Banco Espanol de Credito v. Security Pac. Nat’l Bank, 973 F.2d 51 (2d Cir. 1992).

[13] See Reves v. Ernst & Young, 494 U.S. 56 (1990). These factors are (1) the motivations of the parties, (2) the plan of distribution, (3) the reasonable expectations of the investing public, and (4) the existence of an alternative regulatory scheme making the application of the securities laws unnecessary.

[14] de Fontenay, supra note 11 at 750; Roberts & Quinn, supra note 8 at 2132.

[15] See Roberts & Quinn, supra note 8, at 2123 (quoting Banco Espanol, supra note 12).

[16] Pollack v. Laidlaw Holdings, Inc., 27 F.3d 808 (2d Cir. 1994).

[17] See The LSTA, The U.S. Syndicated Loan Market: Trends in Credit Cycles and Systemic Risks, available at https://www.lsta.org/content/comparison-of-loans-to-corporate-borrowers/

[18] Unlike bonds, however, BSLs are generally floating rate and are more likely to be secured against a company’s assets. This dividing line is not absolute, and examples exist of bonds that have floating rates or that are secured against a company’s assets.

[19] For example, a trade group for the BSL industry has expended substantial effort to shorten the settlement cycle for these assets in an effort to make the market more liquid. See Letter from LSTA to SEC Secretary Vanessa Countryman, File No. S7-26-22 (Oct. 3, 2023), available at https://www.sec.gov/comments/s7-26-22/s72622.htm.

[20] See Letter from Securities and Exchange Commission General Counsel Megan Barbero, Kirschner v. JP Morgan Chase Bank, N.A., No. 21-2726 (2d Cir. Jul. 18, 2023), ECF No. 207. As noted above, this speech does not necessarily reflect the views of the Commission, the other Commissioners, or members of the staff, including on the legal analysis or merits of any particular case.

[21] See Reves, supra note 13, at 65 (“The test begins with the language of the statute; because the Securities Acts define ‘security’ to include ‘any note,’ we begin with a presumption that every note is a security.”).

[22] Some aspects of the BSL market may be within the purview of banking regulators, however any such regulation would not apply to the numerous non-bank investors such as registered funds, insurance companies, pension plans, and CLOs. Even when regulators have issued statements on similar topics, such as the 2013 Interagency Guidance on Leveraged Loans, they have emphasized that following that guidance is optional. See Sally Bakewell, Risk Is Just Fine, U.S. Government Tells Wall Street Lenders, Bloomberg (Mar. 1, 2018), available at https://www.bloomberg.com/news/articles/2018-03-01/risk-is-just-fine-u-s-government-tells-wall-street-lenders (noting statements to this effect from Federal Reserve Chair Powell and then-Comptroller Otting, as well as a quote from a market participant that the statements “will likely drive further excesses.”); see also Bd. of Governors of the Fed. Rsrv. Sys. et al., Interagency Guidance on Leveraged Lending (Mar. 21, 2013), available at https://www.federalreserve.gov/supervisionreg/srletters/sr1303a1.pdf (“2013 IGLL”).

[23] Even markets entirely made up of institutional investors can be, and frequently are, protected by the securities laws. These markets do not always require registration (for example, many fixed income securities rely on the Rule 144A exemption), but institutional investors nonetheless receive the crucial protection offered by core antifraud rules of Federal securities laws.

[24] Almost 10% of BSLs are held directly by registered investment companies. In addition to the amount they hold directly, they “provide substantial secondary market liquidity” due to their flexibility and lack of strict restrictions compared to CLOs. See Letter from LSTA to Vanessa Countryman, File No. S7-26-22 (Feb. 14, 2023), available at https://www.sec.gov/comments/s7-26-22/s72622-20157336-325683.pdf. Together with their holdings of CLOs (which in turn hold BSLs), this means registered investment companies hold hundreds of billions in exposure to this market. In addition, many pension plans and insurance are also active purchasers in this market.

[25] This is because BSLs are typically floating-rate instruments which should mean that they are less likely to lose value in the face of rising rates. Unfortunately, as many investors are discovering, even when the BSLs do not lose value due to rising interest rates alone, they may decline in value if the issuer of the BSL becomes a default risk in the face of rising rates.

[26] In the wake of the financial crisis, a court did raise concerns with apparent insider trading in loans issued by a bankrupt bank. These claims were never fully litigated because a settlement was approved. See In re Wash. Mut., Inc., 461 B.R. 200, 236 (Bankr. D. Del. 2011).

[27] Congress and the courts have recognized that the enormous losses borne by investors due to the failures of Enron and WorldCom were both caused, in part, by failures of the gatekeepers to exercise sufficient diligence regarding the frauds being perpetrated by those companies. See, e.g., Lawson v. FMR LLC, 571 U.S. 429 (2014) (describing Congressional recognition of the role of “outside professionals as ‘gatekeepers who detect and deter fraud’”).

[28] See, e.g., President Franklin D. Roosevelt, “White House Statement on Securities Legislation,” (Mar. 29, 1933), available at https://www.presidency.ucsb.edu/documents/white-house-statement-securities-legislation. President Roosevelt’s statement on signing the Securities Act was one of many contemporaneous statements describing his and Congress’ intent to “change[] the ancient doctrine of caveat emptor” in order to “bring back public confidence in the sale of securities.” Public confidence in the sale of securities promotes capital formation and is a necessary component of fair, orderly, and efficient markets.

[29] Cf. Fin. Crisis Inquiry Comm’n, Fin. Crisis Inquiry Report at 8 (Jan. 2011), available at https://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf (“You had no incentive whatsoever to be concerned about the quality of the loan, whether it was suitable for the borrower or whether the loan performed...a new term was coined: IBGYBG, ‘I’ll be gone, you’ll be gone.’”).

[30] See, e.g., 15 U.S.C. 77n (Securities Act); 15 U.S.C. 78ccc (Exchange Act); 15 U.S.C. 77aaaa (Trust Indenture Act); 15 U.S.C. 80a-46 (Investment Company Act); 15 U.S.C. 80b-15 (Investment Advisers Act).

[31] I am far from alone in being concerned about this risk. See, e.g., Moody’s, Syndicated and private lenders will spar as LBOs revive, upping systemic risk (Sep. 28, 2023), available at https://www.moodys.com/research/Private-Credit-Global-Syndicated-and-private-lenders-will-spar-as-Sector-In-Depth--PBC_1376890?cid=7380D0F05C817753 (”Increased concentrations, conflicts of interest and lack of regulation underscore risks . . . Lack of visibility will make it difficult to see where risk bubbles may be building.”)

[32] See Rachelle Kakouris, Leveraged loan maturity wall pits riskier credits against rising funding costs, Pitchbook (Apr. 4, 2023), available at https://pitchbook.com/news/articles/near-term-leveraged-loan-maturity-wall-riskier-credits-rising-costs.

[33] See Tracy Alloway & Joe Weisenthal, It’s the Return of Extend and Pretend, Bloomberg (June 16, 2023), available at https://www.bloomberg.com/news/newsletters/2023-06-16/it-s-the-return-of-extend-and-pretend.

[34] See Eleanor Duncan, CLO Investors Push Back on Use of ‘Snooze Drag’ Tactic, Bloomberg Law (Sept. 20, 2023), available at https://www.bloomberglaw.com/bloomberglawnews/banking-law/XAKIHKI8000000?bna_news_filter=banking-law.

[35] I have spoken before about the potential problems with the growth of private markets. Private securities markets can suffer from these problems, too, but at least private securities markets enjoy core antifraud protections of federal securities laws. Markets in which the assets are functionally similar to securities but are not treated as such do not have even this foundational level of investor protection. See Big “Issues,” supra note 1.

[36] Cf. Hal S. Scott, The Global Financial Crisis: A Plan for Regulatory Reform (Compressed Version) (May 2009), available at https://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2009-1020-Scott-article-3.pdf (“More information enables the market to more accurately price assets, risk, and other relevant inputs. Much of the [2008 global financial] crisis can be attributed to a lack of critical information.”).

[37] See George A. Akerlof, The Market for Lemons, 84 Q.J. of Econ. 488 (1970).

[38] See Marine Bank v. Weaver, 455 U.S. 551 (1982). Without this treatment, registered bank loan funds would not be able to exist since a company needs to hold “securities” to register as an investment company.

[39] See generally Roger Lowenstein, When Genius Failed (2000).

[40] I also delivered remarks on this subject last month on the fifteenth anniversary of the failure of Washington Mutual, the largest bank failure in American history. Like LTCM, the WaMu bankruptcy involved an institution that was viewed as safe until the very last moment.

[41] Federal banking regulators raised similar concerns soon after the Banco Espanol decision. A 1997 joint statement noted that programs like that engaged in by Banco Espanol could present unwarranted risks to the originating institution, including legal, reputation and compliance risks. I would be interested to learn if these concerns are no longer applicable and, if so, which intervening developments have led to this lack of applicability. See Off. of the Comptroller of the Currency et al., Interagency Statement on Sales of 100% Loan Participations (Apr. 10, 1997), available at https://www.occ.gov/news-issuances/bulletins/1997/bulletin-1997-21a.pdf; see also 2013 IGLL, supra note 21, at 14-15.

CFTC Charges Former Chief Executive Officer of Digital Asset Platform with Fraud in Massive Commodity Pool Scheme (CFTC Release)
https://www.cftc.gov/PressRoom/PressReleases/8805-23
In the United States District Court for the Southern District of New York, the CFTC filed a Complaint https://www.cftc.gov/media/9446/enfstephenehrlichcomplaint101223/download charging former Voyager Digital Ltd./Voyager Digital Holdings,Inc./Voyager Digital, LLC Chief Executive Officer Stephen Ehrlich with fraud and registration failures. In a parallel action, the Federal Trade Commission filled a Complaint https://www.ftc.gov/system/files/ftc_gov/pdf/voyager_complaint_filed.pdf that charged Ehrlich and Voyager with violating the FTC Act and the Gramm-Leach-Bliley Act. As alleged in part in the CFTC Release:

[F]rom at least February 2022 through July 2022, Ehrlich and Voyager engaged in a scheme to defraud customers by misrepresenting the safety and financial health of the Voyager digital asset platform. Ehrlich and Voyager, via publicly available postings on social media and their website, touted Voyager as a “safe haven” for customers’ digital assets in an otherwise volatile market environment and that Voyager would operate with the “same level of rigor and trust” as a traditional financial institution. Ehrlich and Voyager also promised customers high-yield returns—as much as 12%—on certain digital asset commodities stored on the Voyager platform.

To generate income to pay its customers the promised returns, Ehrlich and Voyager pooled customer assets stored on the Voyager platform and transferred billions of dollars’ worth of customers’ digital asset commodities as “loans” to high-risk third parties. In early 2022, following grossly inadequate due diligence, Ehrlich and Voyager transferred over $650 million in customer digital asset commodities to Firm A (a digital assets hedge fund) on an unsecured basis, with the understanding that Firm A would generate returns for Voyager by pooling Voyager’s investment and trading commodity interests. In so doing, Voyager operated the Voyager Pool and acted as a commodity pool operator (CPO) without the required CFTC registration.

Additionally, Ehrlich did not register as an associated person of a CPO, despite soliciting members of the public to contribute to the Voyager Pool. Based on the false promises related to the safety of Voyager’s operations and receipt of high-yield returns, customers often collectively stored more than $2 billion worth of digital asset commodities on the Voyager platform. However, instead of providing a “safe haven,” Ehrlich and Voyager transferred customer digital assets to risky counterparties, such as Firm A, to fuel the high-yield returns used to attract and retain customers. In June 2022, Voyager recalled its customer digital assets commodities from Firm A. Firm A defaulted and, as a result, Voyager experienced dire operational liquidity issues. However, Ehrlich continued to falsely assert publicly that customer assets were safe with Voyager. On July 5, 2022, Voyager filed for bankruptcy, owing its customers in the United States more than $1.7 billion.

CFTC Awards Whistleblower Over $18 Million (CFTC Release)
https://www.cftc.gov/PressRoom/PressReleases/8806-23
The CFTC awarded over $18 million to a whistleblower https://www.whistleblower.gov/sites/whistleblower/files/2023-10/No.%2024-WB-01_1.pdf who provided detailed information and assistance in a CFTC enforcement action and in a related action by another agency. 

FINRA

FINRA Suspends Former Branch Manager for Unreasonable Supervision
In the Matter of Frank L. Martin, Respondent (FINRA AWC 2018056483904)
https://www.finra.org/sites/default/files/fda_documents/2018056483904
%20Frank%20L.%20Martin%20CRD%202859847%20AWC%20gg.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, Frank L. Martin submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that Frank L. Martin was first registered in 1997, and by 2015, he was registered with Arive Capital Markets. In accordance with the terms of the AWC, FINRA imposed upon Frank L. Martin a three-month suspension from associating with any FINRA member in all Principal-only capacities. No fine was imposed based upon Respondent's financial status. As alleged in part in the "Overview" of the AWC [Ed: footnote omitted]:

From August 2016 to July 2019, Martin failed to reasonably supervise six Arive Capital Markets registered representatives, who each excessively traded one or more customers accounts. As a result, Martin violated FINRA Rules 3110 and 2010.  

FINRA Fines and Suspends Rep For Discretionary Trading
In the Matter of Arun K. Aggarwal, Respondent (FINRA AWC 2022076586001)
https://www.finra.org/sites/default/files/fda_documents/2022076586001
%20Arun%20Aggarwal%20CRD%201658436%20AWC%20lp.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, Arun K. Aggarwal submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that Arun K. Aggarwal was first registered in 1987, and by 2009, he was registered with Morgan Stanley. In accordance with the terms of the AWC, FINRA imposed upon Arun K. Aggarwal a $7,500 fine and a two-month suspension from associating with any FINRA member in all capacities. As alleged in part in the "Overview" of the AWC:

Between June 2021 and September 2022, Aggarwal exercised discretionary authority to effect 163 trades in a customer’s account without obtaining written authorization from the customer to exercise discretion and without his firm having accepted the account as discretionary, in violation of FINRA Rules 3260(b) and 2010. 

FINRA Suspends Rep For Business Transaction with Customer and Willful Failure to Timely Disclose Felonies Charges
In the Matter of James R. Dickie, Respondent (FINRA AWC 2022076282801)
https://www.finra.org/sites/default/files/fda_documents/2022076282801
%20James%20R.%20Dickie%2C%20CRD%204465359%20AWC%20gg.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, James R. Dickie submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that James R. Dickie was first registered in 2002, and by 2018, he was registered with Southeast Investments, N.C., Inc. In accordance with the terms of the AWC, FINRA imposed upon James R. Dickie an eight-month suspension from associating with any FINRA member in all capacities. No fine was imposed based upon Respondent's financial status. The AWC includes this admonition:

Respondent understands that this settlement includes a finding that he willfully omitted to state a material fact on a Form U4, and that under Section 3(a)(39)(F) of the Securities Exchange Act of 1934 and Article III, Section 4 of FINRA’s By-Laws, this omission makes him subject to a statutory disqualification with respect to association with a member.

As alleged in part in the "Overview" of the AWC:

In March 2019, while associated with Southeast Investments, Dickie received $9,000 from a customer of the firm as part of a business transaction and failed to notify his firm. By doing so, Dickie violated FINRA Rules 3270 and 2010. Dickie also willfully failed to timely amend his Uniform Application for Securities Industry Registration or Transfer (Form U4) to disclose that he had been charged with several felonies. As a result, he violated Article V, Section 2(c) of FINRA’s By-Laws and FINRA Rules 1122 and 2010. 

FINRA Censures and Fines HSBC Securities (USA) for Inaccurate Research Disclosures
In the Matter of HSBC Securities (USA) Inc., Respondent (FINRA AWC 2021073545201)
https://www.finra.org/sites/default/files/fda_documents/2021073545201
%20HSBC%20Securities%20%28USA%29%20Inc.
%20CRD%2019585%20AWC%20lp.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, HSBC Securities (USA) Inc. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that HSBC Securities (USA) Inc. was first registered in 1987 and employs 1,371 registered representatives at 62 branches. In accordance with the terms of the AWC, FINRA imposed upon HSBC Securities (USA) Inc. a Censure, $2,000,000 fine and an undertaking to certify remediation of the cited issues. As alleged in the "Overview" of the AWC:

Between January 2013 and December 2021, each research report HSBC published contained inaccurate disclosures about the firm’s conflicts of interest. Specifically, HSBC published 67,482 equity research reports with approximately 275,000 disclosure inaccuracies in violation of FINRA Rules 2241(c) and 2010 and NASD Rule 2711(h). Similarly, between July 2016 and December 2021, each debt research report HSBC published contained inaccurate disclosures about the firm’s conflicts of interests. Specifically, HSBC published 2,470 debt research reports with approximately 39,000 inaccurate disclosures in violation of FINRA Rules 2242(c) and 2010. HSBC also did not establish and maintain a supervisory system, including written supervisory procedures, reasonably designed to achieve compliance with FINRA Rule 2241(c), FINRA Rule 2242(c), and NASD Rule 2711(h). As a result, HSBC violated FINRA Rules 3110 and 2010 and NASD Rule 3010. 

FINRA Fines and Suspends Rep For Unsuitable Recommendations
In the Matter of Arni J. Diamond, Respondent (FINRA AWC 201806089730)
https://www.finra.org/sites/default/files/fda_documents/2018060897303
%20Arni%20J.%20Diamond%20CRD%202667392%20AWC%20lp.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, Arni J. Diamond submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that Arni J. Diamond was first registered in 1995 and from 2013 - September 2018, he was registered with Kalos Capital, Inc. In accordance with the terms of the AWC, FINRA imposed upon Arni J. Diamond a $5,000 fine and a four-month suspension from associating with any FINRA member in all capacities. As alleged in part in the AWC:

From November 2014 to March 2018, Diamond recommended and sold GPB Capital limited partnership interests to two Kalos customers that were unsuitable in light of the customers' investment profiles. The customers include:

• Customer A who made a $50,000 investment in Automotive Portfolio in June 2015. At the time of the investment, Customer A was 67 years old with an annual income and net worth that did not qualify him as an accredited investor, as required to invest in Automotive Portfolio. Moreover, Customer A had a moderate risk tolerance and no prior experience investing in limited partnerships. ³

• Customer B who made six investments totaling $200,000 in GPB Capital limited partnership interests between November 2014 and March 2018, including one investment in Holdings totaling $50,000, three investments in Automotive Portfolio totaling $90,000, and two investments in Waste Management totaling $60,000. At the time of the investments, Customer B was in his early sixties and had a moderate risk tolerance. Customer B's investments in GPB Capital limited partnership interests resulted in Customer B's combined holdings of alternative investments to constitute between 28.7% and 32.5% of his total net worth. ⁴

Diamond's seven recommendations to purchase GPB Capital limited partnership interests to Customers A and B were unsuitable for the customers based on their age, income, net worth, risk tolerance, and because Customer A was not an accredited investor as was required to invest in Automotive Portfolio, and because Diamond's recommendations to Customer B resulted in the over-concentration of Customer B's net worth in alternative investments.

Therefore, Diamond violated FINRA Rules 2111 and 2010

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3 Customer A settled an arbitration filed against Kalos, alleging, among other things, that the Automotive Portfolio investment Diamond recommended and sold was unsuitable.

4 Customer B settled an arbitration filed against Kalos, alleging, among other things, that the Holdings, Automotive Portfolio, and Waste Management investments Diamond recommended and sold were unsuitable.