Legal Developments in Securities Law

Too Good to be True?: Investment Schemes to Watch Out For
Recently, the North American Securities Administrators Association (“NASAA”) released a list of the “Top 10 Financial Products and Practices” that investors should watch out for. See the NASAA’s article here.

The article lists the following products and practices:

  • PRODUCTS: distressed real estate schemes, energy investments, gold and precious metal investments, promissory notes, and securitized life settlement contracts.
  • PRACTICES: affinity fraud, bogus or exaggerated credentials, mirror trading, private placements, and securities and investment advice offered by unlicensed agents.

Although the lists above provide the most likely culprits, investors should be diligent and watch out for warning signs with any investment they seek to make. Some of these warning signs may include:

  • If the promised return of an investment seems too good to be true, it probably is. Above normal rates of return could signal a Ponzi scheme, now often associated with Bernie Madoff and Bernard L. Madoff Investment Securities. Investors may be promised large rates of return, then those returns are paid with the funds investors’ contributed, and more investors may continue to contribute as word spreads that the investment is paying off. Ultimately, however, the funds will diminish and investors will no longer receive their payments or a return of their initial investments.
  • Watch out for investments offered by individuals whose credentials cannot be verified. In a world where a multitude of information is accessible through the Internet, it is easy to research someone’s background online. Investors should particularly look out for previous securities violations, which can be investigated through the Securities and Exchange Commission’s website or the Financial Industry Regulatory Authority’s website. Some individuals may try to emphasize prior successful enterprises or ties with influential individuals – investors can investigate these issues, as well. Note the NASAA’s example of how individuals can try to use credentials to mislead investors:
    • Securities regulators in Utah came across a broker who listed “C.H.S.G.” after his name on his business card. When asked, the broker told regulators the initials stood for “Certified High School Graduate.”
  • If you are not a sophisticated investor, investments that are not offered to you by a securities professional you trust should be treated with extreme caution. Even a prospectus or financial statements that are provided to you should be carefully investigated if you are interested in the potential investment, as those documents can be fabricated. Of course, as the NASAA points out, investors are often unaware that their securities brokers or investment advisers are unregistered or unlicensed. Even when enlisting the advice of a securities professional, be sure to check the SEC’s Investment Adviser Search or FINRA’s BrokerCheck to ensure the professional is licensed to give you advice.

What to Do if You Believe Your Investment was Part of a Scheme

If you believe you may have fallen victim to a potential investment scheme because it falls into one of the NASAA’s categories or because it fits some or all of the criteria mentioned above, you should immediately preserve all documents pertaining to the investment and contact an attorney with experience in the field. You may also wish to report the conduct to the SEC (see the blog post below on the SEC’s Whistleblower Incentives). Be aware that a statute of limitations may apply.

Legal Developments in Securities Law

Update: SEC Appeals Judge Rakoff’s Ruling Denying Proposed Settlement
One of our earlier blog posts referenced Judge Rakoff’s criticism of the SEC’s proposed settlement with Citigroup – found here. Unsurprisingly, Judge Rakoff rejected the parties’ proposed settlement. The SEC has now filed an appeal, citing legal error and claiming that, “We believe the district court committed legal error by announcing a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits,” as set forth in a statement by Robert Khuzami, the S.E.C.’s director of enforcement (see the New York Times article on this issue here).

The SEC’s appeal is certainly not unprecedented, as the New York Times notes that the agency has indeed appealed such rulings in the past, and in fact won such an appeal in S.E.C. v. Randolph. The SEC’s decision to appeal Judge Rakoff’s decision, which reasoned that the proposed settlement simply was not in the public interest and that more facts were necessary to approve such a settlement, suggests a reluctance to fight Wall Street. One could reason that the SEC may treat larger institutions that are repeat offenders, like Citigroup, less harshly than the “little guys,” or individuals and small companies involved in SEC enforcement actions.

Certainly, the resources involved in litigating against a large institution like Citigroup in federal court are not minimal, but given that investors experienced over $700 million in losses, a settlement amount of $285 million concerning charges of securities law violations pales in comparison to the harm caused. By comparison, the “little guys” cannot afford lengthy litigation against the SEC, and perhaps the SEC can use that as leverage to obtain a settlement that fully disgorges the defendant’s ill-begotten gains. Settlements, however, do involve a case of give and take – the SEC may not get the full amount requested and the defendant agrees to a sum that may be lower than the potential outcome in litigation. With an institution like Citigroup, the SEC may be additionally motivated to settle the matter more expeditiously to avoid a lengthy trial and potential failure in court. With the “little guys,” the SEC holds the upper hand, and it’s hard to imagine a scenario where the SEC would appeal a Judge’s ruling rejecting a settlement with such an individual.

It is no surprise that the reaction among members of the public toward the SEC has been one of outrage concerning the SEC’s decision to appeal Judge Rakoff’s decision. Dennis M. Kelleher, of Better Markets, Inc., wrote in the Huffington Post:

No one should be surprised that the risk-adverse, Wall Street friendly SEC chose not to litigate against Citigroup for pocketing more than $600 million from its $1 billion fraudulent subprime mortgage scheme that cost its customers more than $700 million. Instead, the SEC decided to litigate against the one federal judge who had the audacity to scrutinize their proposed settlements. As the Wall Street Journal headline correctly captured it, “SEC Cops Want to Fight U.S. Judge.”

Ironically, in the eyes of the SEC, Judge Rakoff is a repeat offender (first, Bank of American and now Citigroup!), but Citigroup is literally a repeat offender, having been toothlessly sanctioned by the SEC 5 times in the last 8 years for violations of the securities laws. Judge Rakoff had the nerve to ask the SEC what was the point of slapping their wrist one more time given that the prior five slaps appeared not to make much of an impression. (Such repeated toothless “sanctions” is common for the SEC.)

View Mr. Kelleher’s article here. The Wall Street Journal’s Law Blog featured a piece by Neal Lipschutz that stated:

Here’s a quote from Judge Rakoff’s decision, which I have cited before, that gets to the crux of the matter. “An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous … If its deployment does not rest on facts – cold, hard, solid facts, established either by admissions or by trials — it serves no lawful or moral purpose and is simply an engine of oppression.”

Khuzami said in part Thursday: “In fact, courts have routinely approved settlements in which a defendant does not admit or even expressly denies liability, exactly because of the benefits that settlements provide.”

But just because something happens a lot doesn’t mean it’s correct. Here’s hoping the power of Rakoff’s apparently singular argument sets a new precedent.

The Wall Street Journal Law Blog post can be found here.

Although it is certainly true that settlements routinely include language in which the defendant neither admits nor denies liability, it appears that perhaps Judge Rakoff took issue with that language in the Citigroup proposed settlement because the institution has been sanctioned multiple times in the last eight years. If the “little guys” commit multiple securities law violations, they would face injunctions and bars from practicing their profession which hit them much harder than a nominal monetary settlement for a large institution. If a large institution can pay only a nominal settlement without admitting or denying liability, what would prevent that institution from carrying on illegal activity that results in a profit? In this situation, Citigroup allegedly made around $600 million from its fraudulent scheme, but tried to settle the matter for $285 million – a $315 million profit. Even if the SEC’s recent actions are not out of the ordinary, appealing Judge Rakoff’s decision has not improved the agency’s image.

Legal Developments in Securities Law

Investors and Investment Advisers Beware: The Use of Social Media in Financial Services
Recently, the SEC charged an investment adviser for violations of the securities laws based on offerings on LinkedIn. Social media has obviously taken on a greater role in everyday life in recent years, with many businesses utilizing outlets like Facebook, Twitter, LinkedIn, YouTube and even blogs (check out our social media guide below for a breakdown of the types of social media, in case you are unfamiliar). The SEC’s enforcement proceeding and the guidelines it released simultaneously are instructive particularly for individuals in the financial services industry and for individuals interested in investing their money in something of which they learned through social media. Here are the salient points to take away from the SEC’s recent guidance.

Investment Advisers: The Securities Laws Apply to the Use of Social Media
It should be obvious that the securities laws do apply to all representations that registered investment advisers (“RIAs” or “firms”) publish to the various social media outlets. Firms should pay careful attention to the antifraud provisions, compliance provisions, and recordkeeping provisions, as specified by the SEC in its January 4, 2012 National Examination Risk Alert. In its Risk Alert, the SEC Staff addressed three areas of review for firms to consider: (A) Compliance Programs Related to the Use of Social Media, (B) Third Party Content, and (C) Recordkeeping Responsibilities.

(A) Compliance Programs Related to the Use of Social Media
Overall, the SEC highlighted that firms’ compliance policies and procedures may not be designed to address social media concerns specifically, causing some confusion about what is permitted and which policies apply to social media use. The SEC provided a number of factors to firms to help evaluate the effectiveness of their compliance programs’ effectiveness vis-à-vis social media, which includes usage guidelines, content standards, monitoring, frequency of monitoring, approval of content, firm resources, criteria for approving participation, training, certification, functionality, personal/professional sites, information security and enterprise wide sites. Particularly, firms may need to consider adopting policies to address investment advisory representatives’ (“IARs”) or solicitors’ business that is conducted on personal or third-party social media sites. As an example, an IAR may have a personal Facebook, but may use his or her network of “friends” as a business opportunity. Although the SEC notes that including business card information may be acceptable, individuals who exceed that very narrow scope may run afoul of the securities laws, and will also implicate their RIAs by doing so. Firms may also have to adopt policies or install firewalls to prevent individuals within the firm’s computer system from uploading sensitive customer information or the firm’s own proprietary information to social media sites. Firms may choose simply to block access to social media sites from within their computer network to avoid such security concerns. To the extent that firms do allow content on social media sites, it should be carefully scrutinized and submitted to such sites only after the compliance department has reviewed the content and approved it. Obviously, consulting an experienced attorney is important for firms to ensure they have built an effective compliance program, but the SEC’s guidance is an important first step for firms or even IARs or solicitors to take to evaluate their use of social media.

(B) Third Party Content
If a firm or IAR operates a Facebook page or similar social media site, third party content is often permitted and indeed encouraged. Individuals can choose to “post” comments, videos, articles, photos, etc. to the firm’s or IAR’s social media site. The SEC noted that clicking “like” on a social media site, such as Facebook, could constitute a “testimonial” under the Advisers Act, and could be the type prohibited under Rule 206(4)-1(a)(1). Per the SEC’s example, clicking “like” concerning an IAR’s biography on a social media site would be considered a prohibited testimonial. Firms or IARs could limit the risks inherent in third party content by:

  1. Not allowing for any third-party postings on their social media sites;
  2. Deleting third-party postings or “likes” if the social media site does not have the option to limit such postings;
  3. Limit third-party postings to approved users;
  4. Posting disclaimers directly on their site stating that they do not approve or endorse any third-party communications posted on their site in an attempt to avoid having a third-party posting attributed to the firm; and/or
  5. Putting in place policies and procedures to address third-party postings.

(C) Recordkeeping Responsibilities
The recordkeeping obligations under the Advisers Act do not distinguish between the various types of social media or other electronic communications (discussion boards, chat rooms, instant messages, texts, e-mails). If a firm or its IARs communicate through social media, the firm must ensure that it can maintain all required records to have them easily available for inspection, for the applicable retention period. The firm must also evaluate all of the social media communications to determine whether they are indeed required records under the Advisers Act. The firm’s compliance department should also ensure that records are being properly maintained. Consulting with an experienced attorney is important to ensure that the required records are being kept for the required amount of time.

Investors: Be Careful What You Believe Via Social Media
In light of the SEC’s recent proceeding against an Illinois-based investment adviser who was allegedly offering to sell fictitious securities on LinkedIn, the SEC likewise issued an alert to investors, entitled Investor Alert: Social Media and Investing – Avoiding Fraud. Individuals often maintain their own Facebook, LinkedIn, and Twitter accounts, and will also use resources such as blogs or YouTube videos to obtain information on potential investments. Even searching one of the popular search engines for more information on a potential investment could lead potential investors to any one of these sites, among many others, such as discussion boards or business review sites. It’s not unusual for an investor to do some investigative research on a company or investment by Googling them – but some of the search results may include fraudulent information on an otherwise legitimate website. The SEC has a number of tips to help investors navigate the stormy waters of social media.

1.“Be Wary of Unsolicited Offers to Invest”
This shouldn’t come as a surprise – people are usually wary of any kind of unsolicited offer, but sometimes these “investment opportunities” can appear particularly enticing in a difficult economic market. If someone whom you don’t know sends you an e-mail inviting you to purchase an haute couture purse for $25, your first reaction will likely be to click the delete button because it’s likely a counterfeit purse (among other reasons). An unsolicited e-mail to invest in a one-of-a-kind opportunity should likewise be treated with suspicion. This kind of message may come up via e-mail, a chat room, a Facebook message, a tweet sent to the investor, or a message directed at the investor on a discussion board. The same message holds true – be incredibly cautious about such offers to invest.

2. “Look Out for Common ‘Red Flags’”
We’ve blogged in the past about how if it sounds good to be true, it probably is. The SEC repeats this warning to potential investors, and notes that investors should beware of phrases like “INCREDIBLE GAINS,” “BREAKOUT STOCK PICK,” and “HUGE UPSIDE AND ALMOST NO RISK!” The SEC notes that investors should take a look at the returns on well known stock indexes – if the promised amount is substantially more, it could be incredibly risky or simply fraudulent. The SEC also mentions that “guaranteed” investments will carry lower returns, and every investment involves some degree of risk. “Risk free” investments are a huge red flag. Finally, the SEC notes that investors should think about each “opportunity,” and not be rushed into an investment.

3. “Look out for Affinity Fraud”
This type of investment scheme is particularly dangerous, as it has a more personal connection than random unsolicited offers. If an individual is a member of an organization or a group, especially online, he or she may be particularly susceptible to investing in an opportunity recommended by a fellow group member. Even if the individual personally knows the person suggesting the investment opportunity, he or she may be the victim of fraud and mistakenly may believe the investment is legitimate. Exercise extreme caution with any offers made through your connection to an organization, religion or group – recently, the SEC has brought enforcement proceedings against individuals who allegedly targeted fellow members of the Church of Jesus Christ of Latter Day Saints through church functions.

4. “Be Thoughtful About Privacy and Security Settings”
Keeping your personal information safe is especially important on the Internet. Do not give away any of your sensitive financial information on social media sites – even if prompted by a supposedly “official” looking account. Hackers can send e-mails or messages from accounts that appear to be from your financial institution, but which are really ploys to obtain your financial information for their own illicit motives. Overall, if you maintain a social media site, consider changing your privacy settings to “friends only” or “private,” to cut back on potential unsolicited investment “opportunities.”

5. “Ask Questions and Check Out Everything”
Many investors who are victims to investment fraud could have avoided the loss of their money by doing some simple research. Check the SEC’s website and its EDGAR system for company filings or your state’s securities regulator’s site (for New York’s Investor Protection Bureau website, click here). You can also check FINRA’s BrokerCheck for more information on registered brokers and the SEC’s Investment Adviser Public Disclosure website for RIAs. Check to see if the company you are investing with has a legitimate address – it could just be a P.O. Box or mailbox. Check the SEC’s website for disciplinary proceedings that may have involved the company or the individual(s) with whom you’ve communicated. Sometimes the Better Business Bureau may have information on complaints lodged against the company. Finally, trust your instincts, and if the research you’ve done doesn’t add up, don’t fall for the hype.

The SEC also posted information on the common types of schemes investors may face and listed a number of resources for victims of investment fraud. Of course, investors who feel they have been defrauded should consider finding an experienced attorney who will be able to assist them with their claims.

Firms and Individuals Should “Like” the SEC’s Recent Alerts
In sum, the SEC’s new guidance on the use of social media is helpful to firms and investors alike, and likely indicates that the SEC will carefully monitor all forms of social media for potential securities fraud violations. If you suspect you have encountered securities fraud through your use of social media, consult with an attorney who may assist you with filing a Whistleblower complaint with the SEC, as we specified in our blog post here. If you are an individual or firm in the financial services industry, pay heed to the warnings from the SEC and ensure that you have an effective compliance system in place, which can be set up with the assistance of a competent attorney.

Social Media Guide

Facebook: Initially started as a social networking site for a select few colleges, Facebook has expanded to over 800 million active users. Used by individuals and businesses alike, Facebook offers the opportunity to create a “Profile,” which can include information on your contact information, interests, photos, and other personal information. Users can also post “status updates” on any topic they may choose. The site also includes a “Wall,” which enables individuals to post comments, photos, videos, articles, etc. to the individual or business’s page. Facebook also includes an instant messaging system, a message system similar to e-mail and a “Like” button under posts by other users which you can click if you “Like” the post. Facebook offers users the opportunity to customize privacy settings, so that only certain parts of a user’s profile can be visible to everyone, while others can be made private, or even available only to certain users.

LinkedIn: LinkedIn is a social networking site used primarily for professional networking, and it has over 135 million registered users. The site helps individuals build a network of connections, which can then be used to find business opportunities, jobs and other people. LinkedIn also features groups, ranging from alumni associations to professional bar associations, which encourage users to post comments or questions. The user’s profile will typically include his or her work experience, similar to a resume, and can include a photograph.

Twitter: Twitter is a social networking site that is essentially microblogging, and it has over 300 million users. Users “tweet” messages of up to 140 characters, and can “tweet” at specific users by using @, or can use a hashtag # to signify a topic or phrase, which could become a “trending topic,” or one of the most popular topics at the moment. Twitter is used by a vast variety of users – the government, individuals, businesses, etc. Twitter is becoming the first source for breaking news for many individuals, with its instantaneous ability to convey information publicly. Even unregistered users can view tweets from its users, unless the user has restricted his or her account.

YouTube: YouTube is a video-sharing website, which enables users to upload, share and comment on videos. Although often thought of as a means to listen to new singers or specific songs, to find clips from television shows or to view funny videos, YouTube is being used more and more by companies to post advertisements or information about themselves.

Blogs: Blogs are similar to journals and often concern a particular subject, and there are over 156 million public blogs currently in existence. Many businesses have started using blogs to provide commentary on subjects pertinent to the fields in which they operate. A blog can be an interesting source of information for different viewpoints or insight into certain topics. Some blogs are more personal, akin to a diary. Some blogs have even developed into important news sources, such as those that have exposed political scandals. Blogs will often allow comments and can spur interesting debates on various subjects.

Bulletin Boards: Much like a community bulletin board, online bulletin boards encourage users to post public messages about any topic imaginable. Sometimes called internet forums, each new discussion starts a thread, and users can comment on the thread until the forum moderator decides to close commenting (if he or she does so at all). Users can post with usernames that will keep their true identities anonymous. Threads may start with questions like “How do I fix a flat tire?” or “What do you think about investing in gold?” Although there are moderators for such forums, that does not guarantee the truth or accuracy of the statements on these forums.

Google+: Google’s answer to Facebook, Google+ is a social networking site that has around 62 million users. Google+ has features like Facebook, such as a profile, a messenger and the ability to post updates, but also includes things like a user’s “Circles” or a collection of contacts, “Hangouts” or places to facilitate group video chat, or sharing links that the user found interesting or useful. Although Google+ has not caught on to the same degree as Facebook, it’s expected that its number of users will grow greatly in 2012.

SEC Steps Up Its Policing of Accounting Fraud

The Wall Street Journal recently reported that the Securities and Exchange Commission has stepped up its policing of accounting fraud. “The SEC’s first year-over-year increase in such enforcement actions since 2007, comes as the agency returns its focus to alleged financial-reporting and disclosure problems that might have gone unpunished as crisis-era misconduct, such as selling of flawed mortgage securities, dominated its attention in recent years. These new cases are on a smaller scale and typically involve conduct that is far less egregious than the accounting scandals of the early 2000,such as the implosion of energy giant Enron Corp.,” said the newspaper.

SEC Announces Charges Against Standard & Poor’s for Fraudulent Ratings Misconduct

On January 21, 2015, the Securities and Exchange Commission announced a series of federal securities law violations by Standard & Poor’s Ratings Services involving fraudulent misconduct in its ratings of certain commercial mortgage-backed securities (CMBS). S&P agreed to pay more than $58 million to settle the SEC’s charges, plus an additional $19 million to settle parallel cases announced today by the New York Attorney General’s office ($12 million) and the Massachusetts Attorney General’s office ($7 million). The SEC issued three orders instituting settled administrative proceedings against S&P. One order, in which S&P made certain admissions, addressed S&P’s practices in its conduit fusion CMBS ratings methodology. The SEC alleged that S&P’s public disclosures affirmatively misrepresented that it was using one approach when it actually used a different methodology in 2011 to rate six conduit fusion CMBS transactions and issue preliminary ratings on two more transactions. As part of this settlement, S&P agreed to take a one-year timeout from rating conduit fusion CMBS.

SEC Charges Texas-Based Brokerage Firm With Violating Supervisory and Customer Protection Rules

The Securities and Exchange Commission recently charged an Irving, Texas-based brokerage firm with violating key customer protection rules after failing to adequately supervise registered representatives who misappropriated customer funds. H.D. Vest Investment Securities agreed to settle the charges by paying a financial penalty and retaining an independent compliance consultant to improve its supervisory controls. According to the SEC’s order instituting a settled administrative proceeding, H.D. Vest has more than 4,500 registered representatives typically working as independent contractors who also operate tax businesses outside of their securities businesses. H.D. Vest failed to have proper policies and procedures in place to monitor its representatives’ outside business activities, and as a result some representatives used their outside businesses to defraud brokerage customers in such ways as transferring or depositing customer brokerage funds into their outside business accounts.