Legal Developments in Securities Law

Federal Judge Critiques SEC’s Proposed Settlement with Citigroup
Could Force SEC to be More Aggressive in the Future
This blog post references Peter Latman’s NY Times article, “Judge in Citigroup Mortgage Settlement Criticizes S.E.C.’s Enforcement,” found here.

Yesterday, the Securities and Exchange Commission (“SEC”) was asked by Judge Rakoff to defend its proposed settlement with Citigroup Global Markets, Inc. (“Citigroup”) based on its structuring and marketing of a largely synthetic collateralized debt obligation. Specifically, the SEC alleged that Citigroup negligently misrepresented key deal terms, such as its own financial interest in the transaction and that Citigroup had exercised significant influence over the selection of assets.

Judge Rakoff questioned the SEC’s decision to accept a settlement of $285 million, while indicating that the SEC estimated that investors lost close to a total of $700 million in the investments. Judge Rakoff was equally inquisitive about the SEC’s injunction, to bar Citigroup from violating securities laws in the future. Notably, the Judge asked, “Why do you ask for an injunction when you never use it?” The SEC can file civil contempt proceedings if an organization or individual under an injunction not to violate securities laws in fact violates securities laws again in the future. Notably, no such charges have been brought in the last ten years. Such injunctive relief has been the subject of ridicule in the past – it is axiomatic that an organization or an individual is prohibited by law from violating securities laws. As is standard with settlements with the SEC, the entity or individual involved does not admit or deny any wrongdoing with regard to the allegations. Judge Rakoff likewise questioned Citigroup’s unwillingness to admit liability in this matter.

Some may remember that Judge Rakoff likewise questioned the SEC’s proposed settlement with Bank of America concerning whether Bank of America misled investors about its acquisition of Merrill Lynch. There, Judge Rakoff initially rejected a $33 million settlement proposal, and later reluctantly accepted a revised settlement for $150 million.

Judge Rakoff’s refusal to “rubber stamp” the SEC’s proposed settlements with large financial institutions could have potential ramifications on the settlements the SEC negotiates in the future. Judge Rakoff’s comment, “I won’t be cute and ask what percentage of Citigroup’s net worth is $95 million because I do not have a microscope with me,” indicates that this type of scrutiny is perhaps reserved for larger financial institutions, rather than their smaller counterparts or even individuals. Seemingly, given the alleged violations involved and the impact on the shareholders involved, the settlement amount was not proportionate to the harm based on Judge Rakoff’s observation. Although the SEC may adjust its disgorgement figures or civil penalties based upon a respondent’s showing of its/his/her financial inability to pay, an entity like Citigroup clearly does not face such a burden. As a result of Judge Rakoff’s refusal to acquiesce to whatever settlement proposal the SEC sets forth, the SEC may play hardball with large financial institutions to avoid future judicial scrutiny. Further, it is conceivable that the SEC may file a civil contempt proceeding the next time that an institution that has been barred from violating securities laws, violates securities laws. Although the SEC has not done so in at least ten years, pressure from the public may mount if an entity like Citigroup or Bank of America is accused of violating securities laws again. It seems unlikely, however, that respondents would be forced to admit liability as a condition of settlements – the practice of neither admitting nor denying liability is not only standard among settlements with the SEC, but in the general practice of law.

So-called smaller actors, such as smaller entities or individuals, may nonetheless find the SEC requesting large settlement amounts, especially given the impact, severity or frequency of their alleged securities law violations. The SEC takes into account a number of factors when determining an appropriate civil penalty, such as the egregiousness of the defendant’s actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant’s assurances against future violations, the defendant’s recognition of the wrongful nature of his conduct, and the likelihood that his occupation will present opportunities for future violations. Think of an individual like Raj Rajaratnam, who was recently ordered to pay a total of $156.6 million in fines and disgorgement, an amount that Judge Rakoff again questioned given Rajaratnam’s net worth and the fact that the civil penalty was designed, in Judge Rakoff’s words, “to make such unlawful trading a money-losing proposition not just for this defendant, but for all who would consider it.”

Further, although the SEC may request injunctive relief that an individual be barred from violating securities laws in the future, that individual may also be barred from serving as a director of a public company, from working in the securities industry, or from participating in the issuance of certain kinds of securities offerings, to name but a few examples. Judge Rakoff’s remarks should serve as a wake-up call for large financial institutions, but others are by no means less vulnerable to the range of consequences the SEC could request.

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 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.

SEC Reaches Settlement With Evercore Insider Trader

The U.S. Securities and Exchange Commission reached a $682,000 settlement with a former Evercore Partners Inc. investment banker who was sentenced to 30 months in prison for insider trading. Under the terms of the deal, Frank Perkins Hixon Jr., formerly a senior managing director in Evercore’s mining and metals group, would pay the sum and be restrained from future securities violations, according to court documents. The settlement has been in the works since September, court filings said. Hixon pled guilty in April to related criminal charges in New York, admitting that he traded the stocks of Evercore clients based on inside information about upcoming deals in a scam that netted more than $700,000.

FINRA Sanctions Three Firms for Inadequate Supervision of Consolidated Reports

The Financial Industry Regulatory Authority (FINRA) announced today that it has sanctioned three firms – H. Beck, Inc., LaSalle St. Securities, LLC, and J.P. Turner & Company, LLC – with fines of $425,000, $175,000 and $100,000, respectively, for inadequate supervision of consolidated reports provided to customers and other violations. A consolidated report is a single document that combines information regarding most or all of a customer’s financial holdings, regardless of where those assets are held.

Blackstone Group To Pay $39 million to Settle SEC Charges

The SEC last week ordered the $330 billion mega-firm Blackstone Group to pay $39 million to settle charges related to inadequate disclosure of fees charged to portfolio companies. The Blackstone enforcement action represents the SEC’s fourth PE fees and expenses case, with the others involving KKR, Lincolnshire Management and Clean Energy Capital. The Commission’s enforcement division said it will continue to investigate abuses of fees and expenses by private equity firms. It also cautioned firms that it is better to voluntarily come forward when problems are discovered internally rather than wait for the SEC to find out about them later.

SEC Charges Six Firms for Short Selling Violations in Advance of Stock Offerings

The Securities and Exchange Commission (“SEC”) announced enforcement actions against six firms, including more than $2.5 million in monetary sanctions and, in the case of one previously sanctioned firm, an order barring the firm from participating in stock offerings for a period of one year as part of its ongoing enforcement initiative focused on violations of Rule 105 of Regulation M. Intended to preserve the independent pricing mechanisms of the securities markets and prevent stock price manipulation, Rule 105 prohibits firms from participating in public stock offerings after selling short those same stocks.Through its Rule 105 Initiative, which was first announced in 2013 as an effort to address violations of the rule in an expedited and streamlined way, the Division of Enforcement has taken action on every Rule 105 violation over a de minimis amount that has come to its attention—promoting a message of zero tolerance for these offenses. As a result, based on available information, the SEC has seen a dramatic decrease in Rule 105 violations since the Initiative began. In the first fiscal year after the Initiative was announced, Rule 105 violations, detected through various means available to the SEC, decreased by approximately 90 percent over the previous six years. Rule 105 violations in fiscal year 2015 were similarly lower than before the Initiative.

SEC Charges Colorado Investment Firm and Its Manager with Fraud

The Securities and Exchange Commission today filed fraud and other charges in the United States District Court for the District of Colorado against Donald J. Lester and his self-described private equity firm Rubicon Alliance, LLC (“Rubicon”). According to the SEC’s complaint, from approximately January 2010 through December 2014, Lester and Rubicon raised over $10 million through the sale of unregistered securities for two investment funds managed by them, CFI Fund, LLC (“CFI”) and NuPower, LLC (“NuPower”). Previously, as alleged in the complaint, Lester was involved in the sale of unregistered securities for a group of investment funds known as Equity Edge, which was struggling to repay investors. Among other things, the SEC’s complaint alleges that Rubicon had guaranteed Equity Edge’s performance, and that Lester devised a fraudulent and undisclosed scheme to use $2.8 million of CFI investor funds to satisfy Rubicon’s repayment obligations to the Equity Edge investors.

Final Judgment Entered Against California-Based Unregistered Broker Alleged to Have Fraudulently Offered and Sold Pre-IPO Facebook and Twitter Shares; Defendants Ordered to Pay Over $3 Million in Monetary Relief

The Securities and Exchange Commission announced that on September 29, 2015, a final judgment was entered against Efstratios “Elias” Argyropoulos of Santa Barbara, California, and his solely owned company, Prima Capital Group, Inc., by a United States District Judge in Los Angeles. In addition to the permanent injunction to which the defendants had previously consented, the Court granted the Commission’s motion for monetary relief, finding the defendants jointly and severally liable for disgorgement of $1,495,657, together with prejudgment interest of $84,239.59 totaling $1,579,896.59, and additionally ordering Argyropoulos to pay a civil penalty of $1,495,697.

On December 23, 2014, the Commission filed the action, alleging that the defendants fraudulently raised nearly $3.5 million from investors purportedly to purchase Facebook and Twitter shares prior to the companies’ initial public offerings (IPOs). Instead of purchasing the shares in the secondary market as promised, the defendants misappropriated investor funds. They used the money primarily for day trading of stocks and options as well as to pay off certain investors who complained when they didn’t receive the promised Facebook or Twitter shares.

Argyropoulos and Prima Capital agreed to settle the SEC’s charges and to be barred from working for an investment adviser or broker-dealer when the action was filed, and further agreed that monetary relief would be determined at a later date.

Without admitting or denying the allegations in the SEC’s complaint, Argyropoulos and Prima consented to a judgment permanently enjoining them from violations of the antifraud provisions of Section 17(a) of the Securities Act of 1933 and the antifraud and broker-dealer registration provisions of Sections 10(b) and 15(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.