An increasing number of securities firms are marketing and offering securities-backed lines of credit, or SBLOCs, to investors. SBLOCs can be a key revenue source for securities firms, especially in times of solid market returns and growing investment portfolios, when investors may feel more comfortable leveraging their assets. Firms market SBLOCs as a type of financing and liquidity strategy that can unlock the value of your investment portfolio. Between 2012 and 2014, one large brokerage firm that offers these programs reported a 70 percent increase in its securities-based lending business, while another firm reported an over 50 percent increase.
The Financial Industry Regulatory Authority (FINRA) and the SEC’s Office of Investor Education and Advocacy (OIEA) are issuing this investor alert to provide information about the basics of SBLOCs, how they may be marketed to you, and what risks you should consider before posting your investment portfolio as collateral. SBLOCs may seem like an attractive way to access extra capital when markets are producing positive returns, but market volatility can magnify your potential losses, placing your financial future at greater risk.
What Are SBLOCs?
SBLOCs are loans that are often marketed to investors as an easy and inexpensive way to access extra cash by borrowing against the assets in your investment portfolio without having to liquidate these securities. They do, however, carry a number of risks, among them potential unintended tax consequences and the possibility that you may, in fact, have to sell your holdings, which could have a significant impact on your long-term investment goals.
Set up as a revolving line of credit, an SBLOC allows you to borrow money using securities held in your investment accounts as collateral. You can continue to trade and buy and sell securities in your pledged accounts. An SBLOC requires you to make monthly interest-only payments, and the loan remains outstanding until you repay it. You can repay some (or all) of the outstanding principal at any time, then borrow again later. Some investors like the flexibility of an SBLOC as compared to a term loan, which has a stated maturity date and a fixed repayment schedule. In some ways, SBLOCs are reminiscent of home equity lines of credit, except of course that, among other things, they involve the use of your securities rather than your home as collateral.
How Do SBLOCs Work?
Many firms might offer you the opportunity to pursue an SBLOC, including your brokerage or advisory firm, a clearing firm (a firm that maintains custody of your securities and other assets, such as cash in your account), or a third-party lender like a bank. To set one up, you and the lender execute an SBLOC contract. The contract specifies the maximum amount you may borrow, and you agree to use your investment account assets as collateral. If the value of your securities declines to an amount where it is no longer sufficient to support your line of credit, you will receive a “maintenance call” notifying you that you must post additional collateral or repay the loan within a specified period (typically two or three days). If you are unable to add additional collateral to your account or repay the loan with readily available cash, the firm can liquidate your securities and keep the cash to satisfy the maintenance call.
SBLOCs are non-purpose loans, which means you may not use the proceeds to purchase or trade securities. However, an SBLOC still provides a fair amount of flexibility when you consider the restrictions on other types of loans, such as a mortgage or auto loan, or borrowing on margin. Those types of loans all require that loan proceeds be used for a specific purpose. Money from an SBLOC can be used to finance virtually anything you might want, from home renovations and real estate purchases, to personal travel or a new business venture. They also can be used, for example, to fund education expenses or to pay an unexpected tax bill.
But remember: The fact that you might be eligible for an SBLOC doesn’t mean the loan is necessarily a good idea. And be aware that SBLOCs are just one type of securities-based lending offered to investors. Other types include margin and stock-based loan programs.
What About Credit Limits?
A typical SBLOC agreement permits you to borrow from 50 to 95 percent of the value of the assets in your investment account, depending on the value of your overall holdings and the types of assets in the account. To qualify for an SBLOC, firms often require that both the market value of your portfolio assets and your initial withdrawal on an SBLOC meet certain minimum requirements. It’s not uncommon for a firm to require that your assets have a market value of $100,000 or more to qualify for an SBLOC.
In general, securities that are eligible to serve as collateral for an SBLOC include stocks, bonds and mutual funds held in fully paid-for, cash accounts. The maximum credit limit for an SBLOC typically is based on the quantity and type of underlying collateral in your account, and is determined by assigning an advance rate to your eligible securities. Advance rates vary by institution, depending on the firm’s underwriting criteria. Typical advance rates range from 50-65 percent for equities, 65-80 percent for corporate bonds and 95 percent for U.S. Treasuries. For example, if your account contains a mix of equity securities and mutual fund shares with a total market value of $500,000, you could be eligible to borrow from $250,000 to $325,000 for an SBLOC.
SBLOCs generally allow you to borrow as little as $100,000 and up to $5 million, depending on the value of your investments. Once approved, you can access your SBLOC funds using checks provided by the firm, a federal funds wire, electronic funds transfer, or ACH payments. SBLOC funds may be available to you within a week from the date you sign your SBLOC contract.
Interest Rates and Repayment
The interest rates for SBLOCs often are lower than those you would be able to qualify for with a personal loan or line of credit from your bank or by using a credit card to fund purchases. In fact, some SBLOC lenders might not run a credit check or conduct an analysis of your liabilities before setting and extending the credit line, and may determine your maximum limit solely based on the value of your portfolio. SBLOC interest rates typically follow broker-call, prime or LIBOR rates plus some stated percentage or “spread”—and you will be responsible for interest payments on an on-going basis. Although interest is calculated daily, and the interest rate on your loan can change every day, it is usually charged monthly and will appear on your monthly account statement. Some firms offer the option of a fixed rate SBLOC.
Weigh Potential Advantages and Risks
An SBLOC may allow you to avoid potential capital gains taxes because you don’t have to liquidate securities for access to funds. You might also be able to continue to receive the benefits of your holdings, like dividends, interest and appreciation. Marketing materials for SBLOCs also promote the flexibility of spending that comes with an SBLOC as a key feature. And, some firms market SBLOCs as part of a retirement income strategy to fund short-term expenses.
However, as with virtually every financial product, SBLOCs have risks and downsides. Be aware that marketing materials touting the advantages of SBLOCs may suggest benefits that you may not achieve given the risks. For instance, if the value of the securities you pledge as collateral decreases, you may need to come up with extra money fast, or your positions could be liquidated. So even if an SBLOC may be an appropriate solution for you, it always pays to ask questions.
10 Questions to Ask Before Taking Out an SBLOC
Before you use your assets as collateral for an SBLOC, take time to understand the risks, and get answers to important questions about how this type of lending arrangement could impact your long-term investment goals.
(1) When I take out an SBLOC, what am I agreeing to? Make sure you fully understand the details of any SBLOC offered to you, including the terms of your agreement with the lender and how the lending arrangement will impact your holdings, including potential tax consequences, maintenance call requirements, and other costs. You need to know what aspects of the arrangement are out of your control. For example, the interest that you pay on your loan may change every day. In addition, your firm may decide that a security that was previously eligible as collateral for an SBLOC is no longer eligible. If this happens, your credit limit will be adjusted to reflect the change, leaving you with less money to borrow than you planned for. You also may be required to post additional assets to shore up the account if the remaining eligible securities cannot cover the balance. In addition, some SBLOC agreements permit the lender to increase the percentage of equity you must keep in your pledged accounts, which would require you to deposit additional securities or cash into the account, or pay down the loan.
(2) Who is the lender? Before you sign up for an SBLOC, understand who you are doing business with (your brokerage or advisory firm, one of its affiliates, a clearing firm or a third-party lending institution). Many brokerage firms offering SBLOCs do so through a bank affiliate, so your broker may not be the point of contact for your loan and may not know much about how the program works. Make sure you know who to contact with questions about the SBLOC and ongoing account services. If your securities firm is offering the SBLOC for a third-party lending institution, ask your firm how they will continue monitoring your account and how, and when, you will be notified if a collateral shortfall or other issue may impact your assets.
(3) Should I use my investments as collateral? While SBLOCs’ low rates and quick access to cash may be appealing, remember that your investment portfolio may not be the best option for loan collateral. The prices of securities in your portfolio are constantly shifting, which means that the collateral backing your line of credit may be volatile. If the market is up and the value of your assets increases, then great. But nothing guarantees that the market, or the value of your assets, won’t go down.
(4) What if the value of my portfolio decreases? The firm might sell your securities if you receive a maintenance call and are unable to meet it. SBLOCs seem like a great option for extra capital when markets are producing positive returns and interest rates are low, but a market downswing or change in interest rates could make it much less enticing, and this can happen at any time. The value of your holdings is always changing, so you can’t assume that the price today will be the price tomorrow. And keep in mind that SBLOCs are classified as demand loans, which means lenders may call the loan at any time. If you are unable to repay some, or all, of the loan on demand, the firm can liquidate securities and reduce your credit limit.
(5) Does my investment mix matter? Consider the extent to which your portfolio is diversified. If your portfolio is concentrated in a particular stock or sector, a single market event could cause your portfolio value to drop precipitously and trigger a maintenance call. Then you might be forced to liquidate your assets at the bottom of the market. Other assets may be more appropriate to serve as collateral for a loan, and without terms that allow the lender to liquidate your investments at a moment’s notice. With that in mind, if you do decide to pursue an SBLOC, consider taking out less than the maximum amount of credit offered to you.
(6) What if my securities are liquidated to meet collateral requirements? There might be tax consequences. For example, if your lending firm notifies you that securities will be liquidated to maintain collateral at a sufficient level to support your SBLOC, you could be faced with paying capital gains taxes on the proceeds from these sales, depending on your cost basis in the stock and other factors affecting your tax status. Lenders often are permitted to make these decisions without giving you any notice. One way to protect yourself and your assets is to limit the amount you borrow. If you are offered an SBLOC based on a high percentage of the value of your assets, consider taking a lesser amount than what you are offered, so that you are not putting such a substantial portion of your portfolio on the line.
(7) What impact will an SBLOC have on my pledged investments? If you pledge securities that typically receive dividend payments, you should determine whether those payments will be credited to your loan balance and what, if any, circumstances will cause ownership of your holdings to change. In addition, certain account features may change with securities pledged for an SBLOC, such as check-writing privileges and recurring distributions. Some firms cancel check-writing privileges for your account when you take out an SBLOC because you will be issued a new set of checks directly tied to the SBLOC.
(8) What about interest rates? If interest rates rise, it could cause a spike in the broker-call, prime or LIBOR rates that apply to your SBLOC. If this happens, the cost of your SBLOC may increase significantly. Also, for accounts that have money market funds or bank sweeps, depending on your firm’s SBLOC policy, the debit in your account from the interest charge may be paid from redemptions, effectively reducing your cash or money fund balances. Interest payments may be rolled into the balance, which, over time, can erode the value of your account (particularly if the SBLOC is sizeable), or increase your indebtedness. In addition, depending on the interest rate environment, if you have a money market fund or cash in your account, you may be paying more in interest for your SBLOC than you are earning.
(9) How is my broker compensated with SBLOCs? Your broker or adviser may receive additional compensation or a portion of the fees generated by SBLOCs sold to customers. Some firms pay salespersons on a quarterly basis depending on how much money you have borrowed on the line of credit. Your broker or adviser also will benefit from your SBLOC because you don’t have to liquidate assets in your account to pay for things with cash, which would diminish the assets held in the account and the potential fees and commissions that could be earned by your broker or adviser from holding or engaging in future transactions with those assets. For example, with a fee-based account, by encouraging investors to take out an SBLOC to fund some purchase or financial need rather than liquidate securities, the firm continues to earn fees on the full account value, and may also earn revenue from the new loans.
(10) Can I move to a new firm if I have an SBLOC? It is not as easy to pick up and move your assets to a new firm if they are pledged as collateral for an SBLOC. This makes an SBLOC a “sticky” product because it makes it more difficult to leave your current brokerage or advisory firm. To move, you will likely have to pay off the loan.
Today, financing opportunities come in all shapes and sizes. Remember to exercise caution and consider the risks before pledging your securities as collateral. You worked hard to build your investment portfolio.
Tuesday, December 29, 2015
Friday, December 18, 2015
Convicted Fraudster Using Aliases Charged Again for Defrauding Investors
An SEC examination revealed that Edward Durante, who served a 10-year prison term following his securities fraud conviction in 2001, has again been soliciting investors under such aliases as Ted Wise, Efran Eisenberg, and Anthony Walsh. The SEC alleges that Durante defrauded investors by selling shares of a shell company he secretly controlled and falsely telling them stock sale proceeds would be used to fund the company’s operations when they were actually tapped for other purposes including Durante’s personal use.In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Durante.
“As alleged in our complaint, Durante shamelessly peddled worthless stock under phony names to steal millions of dollars from unsuspecting investors,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office.
According to the SEC’s complaint filed in federal district court in Manhattan:
- Durante began laying the groundwork for his next stock fraud while still in prison, using the name Anthony Walsh to negotiate his acquisition of the shell company VGTel Inc.
- From 2012 to 2014, Durante defrauded at least 50 relatively inexperienced investors through at least $11 million in sales of VGTel stock.
- Durante held sales meetings with investors under his Ted Wise alias in such locations as San Diego and Tewksbury, Mass.
- Durante separately bribed investment advisers to steer clients toward VGTel stock purchases without disclosing they had received money from Durante to do so.
- Durante also engaged in matched trading of VGTel stock with a stockbroker to artificially control the stock’s market price.
http://1.usa.gov/1IZgHoQ
Thursday, December 17, 2015
SEC Charges Martin Shkreli With Fraud
The SEC alleges that Martin Shkreli misappropriated money from two hedge funds he founded and made material misrepresentations to investors among other widespread misconduct. The SEC also charged Retrophin’s former outside counsel and corporate secretIn a parallel action, the U.S. Attorney’s Office for the Eastern District of New York today announced criminal charges against Shkreli and Greebel.
“Over a five-year period, Shkreli is alleged to have perpetrated a series of frauds on investors in his hedge funds and Retrophin’s shareholders in order to cover up his poor trading decisions,” said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.
Andrew M. Calamari, Director of the SEC’s New York Regional Office, added, “Greebel’s alleged role in facilitating Shkreli’s fraud on Retrophin’s shareholders not only crossed legal boundaries but also grossly violated both his professional and ethical obligations.”
According to the SEC’s complaint filed in federal district court in Brooklyn:
- Shkreli was portfolio manager for the hedge fund MSMB Capital Management LP from October 2009 to March 2014, and also served as portfolio manager of another hedge fund he founded and controlled named MSMB Healthcare LP.
- Shkreli misappropriated about $120,000 from MSMB Capital Management from October 2009 to July 2011 to unlawfully pay for food, clothing, medical expenses, clothing, office rent, and cash withdrawals.
- Shkreli misled investors and prospective investors in MSMB Capital Management about the fund’s size and performance, claiming for example in July 2010 to have “returned +35.77% since inception on 11/1/2009.” In fact, the fund generated losses of about 18 percent.
- In another example, Shkreli falsely stated in December 2010 that the fund had $35 million in assets under management. In fact, the fund had less than $1,000 in assets in its bank and brokerage accounts.
- Shkreli lied to one of MSMB Capital Management’s executing brokers in February 2011 about the fund’s ability to settle a sizeable short sale in a pharmaceutical stock in MSMB Capital Management’s account. This transaction resulted in losses of more than $7 million to the executing broker who had to cover the short position in the open market.
- Shkreli misappropriated $900,000 from MSMB Healthcare in 2013 to settle claims asserted by MSMB Capital Management’s executing broker arising out of the losses suffered in the short selling transaction.
- From September 2013 to March 2014, Shkreli, with assistance from Greebel, fraudulently induced Retrophin to issue stock and make cash payments to certain disgruntled investors in Shkreli’s hedge funds who were threatening legal action. Shkreli and Greebel had investors enter into agreements with Retrophin misleadingly stating the payments were for consulting services when in fact the purpose was the release of potential claims against Shkreli.
http://1.usa.gov/1NVo6pn
Wednesday, December 16, 2015
SEC Files Charges in Multi-Million Dollar Market Manipulation
SEC Files Charges in Multi-Million Dollar Market Manipulation
The SEC alleges that Samuel DelPresto teamed up with others to secretly obtain control of substantially all available stock in four microcap companies and to facilitate coordinated trading that created the appearance of liquidity and market demand for the stocks. After unwitting investors were enticed through promotional campaigns to buy the stock at inflated prices, DelPresto dumped his shares on the market.
According to the SEC's complaint, the microcap companies manipulated by DelPresto were: BioNeutral Group (BONU), NXT Nutritionals Holdings (NXTH), Mesa Energy Holdings (MSEH), and Clear-Lite Holdings (CLRH).
The SEC's complaint charges DelPresto with violations of the antifraud provisions of the federal securities laws. The complaint seeks a permanent injunction, disgorgement of ill-gotten gains along with prejudgment interest, financial penalties, and a penny stock bar.
"The series of fraudulent schemes alleged in our complaint enticed unwitting investors to pay inflated prices for four companies secretly controlled by DelPresto and others and then left the investors holding the bag when the manipulative activity ceased and the stock price dropped," said Andrew M. Calamari, Regional Director of the SEC's New York office.In a parallel action, the U.S. Attorney's Office for the District of New Jersey today announced criminal charges against DelPresto.
According to the SEC's complaint, the microcap companies manipulated by DelPresto were: BioNeutral Group (BONU), NXT Nutritionals Holdings (NXTH), Mesa Energy Holdings (MSEH), and Clear-Lite Holdings (CLRH).
The SEC's complaint charges DelPresto with violations of the antifraud provisions of the federal securities laws. The complaint seeks a permanent injunction, disgorgement of ill-gotten gains along with prejudgment interest, financial penalties, and a penny stock bar.
SEC Announces Fraud Charges Against Investment Adviser
SEC Announces Fraud Charges Against Investment Adviser
The Securities and Exchange Commission today announced fraud charges against a Stamford, Conn.-based investment advisory firm accused of investing clients in certain bonds with a hidden financial benefit to a broker-dealer connected to the firm.
The SEC alleges that Atlantic Asset Management LLC (AAM) invested more than $43 million of client funds in illiquid bonds issued by a Native American tribal corporation without disclosing the conflict of interest that the bond sales generated a private placement fee for the broker-dealer, whose parent company partially owns AAM.
"As alleged, Atlantic violated a fundamental duty to its clients by placing its own financial interests ahead of client interests," said Andrew M. Calamari, Director of the SEC's New York Regional Office. "AAM's clients should have been informed that the investments in illiquid bonds would financially benefit people with ownership control over AAM."
According to the SEC's complaint filed in federal court in Manhattan:
The SEC alleges that Atlantic Asset Management LLC (AAM) invested more than $43 million of client funds in illiquid bonds issued by a Native American tribal corporation without disclosing the conflict of interest that the bond sales generated a private placement fee for the broker-dealer, whose parent company partially owns AAM.
"As alleged, Atlantic violated a fundamental duty to its clients by placing its own financial interests ahead of client interests," said Andrew M. Calamari, Director of the SEC's New York Regional Office. "AAM's clients should have been informed that the investments in illiquid bonds would financially benefit people with ownership control over AAM."
According to the SEC's complaint filed in federal court in Manhattan:
- AAM is partially owned by an entity called BFG Socially Responsible Investing Ltd., although BFG's ownership is not disclosed in AAM's public SEC filings.
- At the suggestion of a BFG representative, AAM purchased the dubious, illiquid bonds on behalf of clients while aware that the sales would generate a private placement fee for a broker-dealer affiliated with BFG. AAM also was aware that proceeds from the bond sales were to be used to purchase an annuity provided by BFG's parent company.
- An AAM officer evaluating whether or not to make the investments discussed balancing the "fiduciary duty" owed to the placement agent with the duty owed to AAM's clients.
- AAM ultimately decided to put its owner's financial interests first, approving the bond purchases without telling clients about the conflict of interest.
- Upon learning about the investments in the bonds, several AAM clients expressed concern over the bonds' valuation and suitability. They demanded, unsuccessfully, that the investments be unwound.
Tuesday, December 15, 2015
SEC Announces Fraud Charges Against Investment Adviser
The Securities and Exchange Commission today announced fraud charges against a Stamford, Conn.-based investment advisory firm accused of investing clients in certain bonds with a hidden financial benefit to a broker-dealer connected to the firm.
The SEC alleges that Atlantic Asset Management LLC (AAM) invested more than $43 million of client funds in illiquid bonds issued by a Native American tribal corporation without disclosing the conflict of interest that the bond sales generated a private placement fee for the broker-dealer, whose parent company partially owns AAM.
“As alleged, Atlantic violated a fundamental duty to its clients by placing its own financial interests ahead of client interests,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office. “AAM’s clients should have been informed that the investments in illiquid bonds would financially benefit people with ownership control over AAM.”
According to the SEC’s complaint filed in federal court in Manhattan:
- AAM is partially owned by an entity called BFG Socially Responsible Investing Ltd., although BFG’s ownership is not disclosed in AAM’s public SEC filings.
- At the suggestion of a BFG representative, AAM purchased the dubious, illiquid bonds on behalf of clients while aware that the sales would generate a private placement fee for a broker-dealer affiliated with BFG. AAM also was aware that proceeds from the bond sales were to be used to purchase an annuity provided by BFG’s parent company.
- An AAM officer evaluating whether or not to make the investments discussed balancing the “fiduciary duty” owed to the placement agent with the duty owed to AAM’s clients.
- AAM ultimately decided to put its owner’s financial interests first, approving the bond purchases without telling clients about the conflict of interest.
- Upon learning about the investments in the bonds, several AAM clients expressed concern over the bonds’ valuation and suitability. They demanded, unsuccessfully, that the investments be unwound.
The SEC complaint charges AAM with violations of the antifraud provisions of the Investment Advisers Act of 1940 and related rules as well as violations of Section 207 of the Advisers Act by failing to disclose BFG’s ownership interest in the Form ADV filed with the SEC.
The SEC’s continuing investigation is being conducted by Tejal D. Shah, Christopher Ferrante, and Adam Grace. The litigation will be handled by Ms. Shah and Nancy A. Brown. The case is being supervised by Sanjay Wadhwa.
http://1.usa.gov/1UvNkMf
SEC Files Charges in Multi-Million Dollar Market Manipulation
The Securities and Exchange Commission today charged a New Jersey man and his company with illicitly pocketing $13 million from an elaborate pump-and-dump scheme.
The SEC alleges that Samuel DelPresto teamed up with others to secretly obtain control of substantially all available stock in four microcap companies and to facilitate coordinated trading that created the appearance of liquidity and market demand for the stocks. After unwitting investors were enticed through promotional campaigns to buy the stock at inflated prices, DelPresto dumped his shares on the market.
“The series of fraudulent schemes alleged in our complaint enticed unwitting investors to pay inflated prices for four companies secretly controlled by DelPresto and others and then left the investors holding the bag when the manipulative activity ceased and the stock price dropped,” said Andrew M. Calamari, Regional Director of the SEC’s New York office.
In a parallel action, the U.S. Attorney’s Office for the District of New Jersey today announced criminal charges against DelPresto.
According to the SEC’s complaint, the microcap companies manipulated by DelPresto were: BioNeutral Group (BONU), NXT Nutritionals Holdings (NXTH), Mesa Energy Holdings (MSEH), and Clear-Lite Holdings (CLRH).
The SEC’s complaint charges DelPresto with violations of the antifraud provisions of the federal securities laws. The complaint seeks a permanent injunction, disgorgement of ill-gotten gains along with prejudgment interest, financial penalties, and a penny stock bar.
The SEC’s continuing investigation is being conducted by Rhonda L. Jung, Teresa A. Rodriguez, Melissa Coppola, Nancy A. Brown, Adam S. Grace, and Wendy B. Tepperman of the New York office. The SEC’s litigation will be led by Ms. Brown and the case is being supervised by Lara Shalov Mehraban. The SEC appreciates the assistance of the U.S. Attorney’s Office for the District of New Jersey, the Federal Bureau of Investigation, and the Financial Industry Regulatory Authority.
http://1.usa.gov/1O3x1kj
Saturday, December 12, 2015
SEC Proposes New Derivatives Rules for Registered Funds and Business Development Companies
SEC Proposes New Derivatives Rules for Registered Funds and Business Development Companies
The Securities and Exchange Commission today voted to propose a new rule designed to enhance the regulation of the use of derivatives by registered investment companies, including mutual funds, exchange-traded funds (ETFs) and closed-end funds, as well as business development companies. The proposed rule would limit funds' use of derivatives and require them to put risk management measures in place which would result in better investor protections.
"Today's proposal is designed to modernize the regulation of funds' use of derivatives and safeguard both investors and our financial system," said SEC Chair Mary Jo White. "Derivatives can raise risks for a fund, including risks related to leverage, so it is important to require funds to monitor and manage derivatives-related risks and to provide limits on their use."
The Investment Company Act limits the ability of funds to engage in transactions that involve potential future payment obligations, including derivatives such as forwards, futures, swaps and written options. The proposed rule would permit funds to enter into these derivatives transactions, provided that they comply with certain conditions.
Under the proposed rule, a fund would be required to comply with one of two alternative portfolio limitations designed to limit the amount of leverage the fund may obtain through derivatives and certain other transactions.
A fund would also have to manage the risks associated with their derivatives transactions by segregating certain assets in an amount designed to enable the fund to meet its obligations, including under stressed conditions.
A fund that engages in more than a limited amount of derivatives transactions or that uses complex derivatives would be required to establish a formalized derivatives risk management program.
The proposed reforms would also address funds' use of certain financial commitment transactions, such as reverse repurchase agreements and short sales, by requiring funds to segregate certain assets to cover their obligations under such transactions.
The proposal will be published on the Commission's website and in the Federal Register. The comment period for the proposal will be 90 days after publication in the Federal Register.
Action
The Commission will consider whether to propose a new rule designed to provide a modernized, more comprehensive approach to the regulation of funds' use of derivatives. The proposed rule would place restrictions on funds, such as mutual funds and exchange-traded funds (ETFs) that would limit their use of derivatives and require funds to put in place risk management measures resulting in better protection for investors.
Highlights of the Proposal
Requirements for Derivatives
Portfolio Limitations for Derivatives Transactions
Under the proposed rule, a fund would be required to comply with one of two alternative portfolio limitations designed to limit the amount of leverage the fund may obtain through derivatives and certain other transactions.
A fund would be required to manage the risks associated with derivatives by segregating certain assets (generally cash and cash equivalents) equal to the sum of two amounts.
Funds that engage in more than limited derivatives transactions or use complex derivatives would be required to establish a formalized derivatives risk management program consisting of certain components administered by a designated derivatives risk manager. The fund's board of directors would be required to approve and review the derivatives risk management program and approve the derivatives risk manager.
These formalized risk management program requirements would be in addition to certain requirements related to derivatives risk management that would apply to every fund that enters into derivatives transactions in reliance on the rule.
Requirements for Financial Commitment Transactions
A fund that enters into financial commitment transactions would be required to segregate assets with a value equal to the full amount of cash or other assets that the fund is conditionally or unconditionally obligated to pay or deliver under those transactions.
Disclosure and Reporting
The Commission will also consider whether to propose amendments to two reporting forms the Commission proposed in May 2015, Form N-PORT and Form N-CEN.
Proposed Form N-PORT
Form N-PORT would require registered funds other than money market funds to provide portfolio-wide and position-level holdings data to the Commission on a monthly basis. The proposal would amend the form to require a fund that is required to have a derivatives risk management program to disclose additional risk metrics related to a fund's use of certain derivatives.
Proposed Form N-CEN
Form N-CEN would require registered funds to annually report certain census-type information to the Commission. The proposal would amend the form to require that a fund disclose whether it relied on the proposed rule during the reporting period and the particular portfolio limitation applicable to the fund.
Derivatives White Paper
The proposal refers to a white paper prepared by the SEC's Division of Economic and Risk Analysis (DERA) staff entitled, "Use of Derivatives by Registered Investment Companies." Granular information on the extent to which funds currently use derivatives is not generally available. The paper analyzes the use of derivatives by a random sample generated by DERA of 10 percent of all registered funds. The paper presents data on their derivatives positions, financial commitment transactions, and certain other transactions.
The paper reports that some funds use derivatives extensively, with notional exposures ranging up to approximately 950% of net assets, while most funds either do not use derivatives or do not use a substantial amount. The paper also presents figures showing that since 2010 some fund investment categories that make greater use of derivatives have received a disproportionately large share of inflows.
The white paper will be available on www.sec.gov.
Background
The ability of funds to borrow money or otherwise issue "senior securities" is limited under Section 18 of the Investment Company Act. A core purpose of the Investment Company Act is the protection of investors against potential adverse effects of a fund's leveraging its assets by issuing senior securities.
Certain derivatives transactions (e.g., forwards, futures, swaps and written options), as well as financial commitment transactions (e.g., reverse repurchase agreements, short sale borrowings, or firm or standby commitment agreements or similar agreements) impose on a fund an obligation to pay money or deliver assets to the fund's counterparty, which implicates section 18. The Commission's proposed derivatives framework would be an exemptive rule under section 18.
What's Next
If approved for publication by the Commission, the proposal will be published on the Commission's website and in the Federal Register. The comment period for the proposal will be 90 days after publication in the Federal Register.
"Today's proposal is designed to modernize the regulation of funds' use of derivatives and safeguard both investors and our financial system," said SEC Chair Mary Jo White. "Derivatives can raise risks for a fund, including risks related to leverage, so it is important to require funds to monitor and manage derivatives-related risks and to provide limits on their use."
The Investment Company Act limits the ability of funds to engage in transactions that involve potential future payment obligations, including derivatives such as forwards, futures, swaps and written options. The proposed rule would permit funds to enter into these derivatives transactions, provided that they comply with certain conditions.
Under the proposed rule, a fund would be required to comply with one of two alternative portfolio limitations designed to limit the amount of leverage the fund may obtain through derivatives and certain other transactions.
A fund would also have to manage the risks associated with their derivatives transactions by segregating certain assets in an amount designed to enable the fund to meet its obligations, including under stressed conditions.
A fund that engages in more than a limited amount of derivatives transactions or that uses complex derivatives would be required to establish a formalized derivatives risk management program.
The proposed reforms would also address funds' use of certain financial commitment transactions, such as reverse repurchase agreements and short sales, by requiring funds to segregate certain assets to cover their obligations under such transactions.
The proposal will be published on the Commission's website and in the Federal Register. The comment period for the proposal will be 90 days after publication in the Federal Register.
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FACT SHEET
Use of Derivatives by Registered Investment Companies and Business Development Companies
SEC Open Meeting
December 11, 2015
The Commission will consider whether to propose a new rule designed to provide a modernized, more comprehensive approach to the regulation of funds' use of derivatives. The proposed rule would place restrictions on funds, such as mutual funds and exchange-traded funds (ETFs) that would limit their use of derivatives and require funds to put in place risk management measures resulting in better protection for investors.
Highlights of the Proposal
Requirements for Derivatives
Portfolio Limitations for Derivatives Transactions
Under the proposed rule, a fund would be required to comply with one of two alternative portfolio limitations designed to limit the amount of leverage the fund may obtain through derivatives and certain other transactions.
- Exposure-Based Portfolio Limit: Under the exposure-based portfolio limit, a fund would be required to limit its aggregate exposure to 150 percent of the fund's net assets. A fund's "exposure" generally would be calculated as the aggregate notional amount of its derivatives transactions, together with its obligations under financial commitment transactions and certain other transactions.
- Risk-Based Portfolio Limit: Under the risk-based portfolio limit, a fund would be permitted to obtain exposure up to 300 percent of the fund's net assets, provided that the fund satisfies a risk-based test (based on value-at-risk). This test is designed to determine whether the fund's derivatives transactions, in aggregate, result in a fund portfolio that is subject to less market risk than if the fund did not use derivatives.
A fund would be required to manage the risks associated with derivatives by segregating certain assets (generally cash and cash equivalents) equal to the sum of two amounts.
- Mark-to-Market Coverage Amount: A fund would be required to segregate assets equal to the amount that the fund would pay if the fund exited the derivatives transaction at the time of the determination.
- Risk-Based Coverage Amount: A fund also would be required to segregate an additional risk-based coverage amount representing a reasonable estimate of the potential amount the fund would pay if the fund exited the derivatives transaction under stressed conditions.
Funds that engage in more than limited derivatives transactions or use complex derivatives would be required to establish a formalized derivatives risk management program consisting of certain components administered by a designated derivatives risk manager. The fund's board of directors would be required to approve and review the derivatives risk management program and approve the derivatives risk manager.
These formalized risk management program requirements would be in addition to certain requirements related to derivatives risk management that would apply to every fund that enters into derivatives transactions in reliance on the rule.
Requirements for Financial Commitment Transactions
A fund that enters into financial commitment transactions would be required to segregate assets with a value equal to the full amount of cash or other assets that the fund is conditionally or unconditionally obligated to pay or deliver under those transactions.
Disclosure and Reporting
The Commission will also consider whether to propose amendments to two reporting forms the Commission proposed in May 2015, Form N-PORT and Form N-CEN.
Proposed Form N-PORT
Form N-PORT would require registered funds other than money market funds to provide portfolio-wide and position-level holdings data to the Commission on a monthly basis. The proposal would amend the form to require a fund that is required to have a derivatives risk management program to disclose additional risk metrics related to a fund's use of certain derivatives.
Proposed Form N-CEN
Derivatives White Paper
The proposal refers to a white paper prepared by the SEC's Division of Economic and Risk Analysis (DERA) staff entitled, "Use of Derivatives by Registered Investment Companies." Granular information on the extent to which funds currently use derivatives is not generally available. The paper analyzes the use of derivatives by a random sample generated by DERA of 10 percent of all registered funds. The paper presents data on their derivatives positions, financial commitment transactions, and certain other transactions.
The paper reports that some funds use derivatives extensively, with notional exposures ranging up to approximately 950% of net assets, while most funds either do not use derivatives or do not use a substantial amount. The paper also presents figures showing that since 2010 some fund investment categories that make greater use of derivatives have received a disproportionately large share of inflows.
The white paper will be available on www.sec.gov.
Background
The ability of funds to borrow money or otherwise issue "senior securities" is limited under Section 18 of the Investment Company Act. A core purpose of the Investment Company Act is the protection of investors against potential adverse effects of a fund's leveraging its assets by issuing senior securities.
Certain derivatives transactions (e.g., forwards, futures, swaps and written options), as well as financial commitment transactions (e.g., reverse repurchase agreements, short sale borrowings, or firm or standby commitment agreements or similar agreements) impose on a fund an obligation to pay money or deliver assets to the fund's counterparty, which implicates section 18. The Commission's proposed derivatives framework would be an exemptive rule under section 18.
What's Next
If approved for publication by the Commission, the proposal will be published on the Commission's website and in the Federal Register. The comment period for the proposal will be 90 days after publication in the Federal Register.
Friday, December 11, 2015
SEC: Sports Team Offering Is A Penny Stock Fraud
The Securities and Exchange Commission today announced fraud charges and a court-ordered asset freeze obtained against a Florida-based penny stock company falsely touting itself as “the largest publicly traded diversified portfolio of professional sports teams in the world.”
The SEC alleges that Thomas Anthony Guerriero as CEO of Oxford City Football Club Inc. used pressure tactics and a boiler room of salespeople to raise more than $6.5 million from primarily inexperienced investors who were misled to believe that the company was a thriving conglomerate of sports teams, academic institutions, and real estate holdings. But in reality the company was losing millions of dollars each year and turning zero profit from its two lower-division soccer teams in the U.K.
“As alleged in our complaint, Guerriero portrayed himself as one of the most powerful and influential CEOs in the history of Wall Street when he’s really a penny stock fraudster mixing lies and verbal threats to line his own pocket with money from unsuspecting investors,” said Scott Friestad, Associate Director of the SEC Enforcement Division.
According to the SEC’s complaint filed in U.S. District Court for the Southern District of Florida:
http://1.usa.gov/1Y30qWU
The SEC alleges that Thomas Anthony Guerriero as CEO of Oxford City Football Club Inc. used pressure tactics and a boiler room of salespeople to raise more than $6.5 million from primarily inexperienced investors who were misled to believe that the company was a thriving conglomerate of sports teams, academic institutions, and real estate holdings. But in reality the company was losing millions of dollars each year and turning zero profit from its two lower-division soccer teams in the U.K.
“As alleged in our complaint, Guerriero portrayed himself as one of the most powerful and influential CEOs in the history of Wall Street when he’s really a penny stock fraudster mixing lies and verbal threats to line his own pocket with money from unsuspecting investors,” said Scott Friestad, Associate Director of the SEC Enforcement Division.
According to the SEC’s complaint filed in U.S. District Court for the Southern District of Florida:
- Since at least August 2013, Guerriero has operated a classic boiler room scheme under the guise of nominal legitimate businesses through which millions of unregistered shares of stock were sold to investors who were deceived about the stock value and potential profits.
- Guerriero’s salespeople sold Oxford City stock to the public based on leads lists he purchased from third parties. Guerriero crafted scripts for the salespeople, who used aliases to mask their true identities.
- Prospective investors were told they were being offered a limited-time deal to purchase Oxford City shares at a deep discount from the publicly quoted price. Unbeknownst to the victims, the stock price was controlled by Guerriero.
- Guerriero claimed to record phone conversations with potential investors using a “verbal verification system” that supposedly tied the stock “transaction” to their social security number and birthday. In reality, Guerriero and his associates simply pressed any button on their phone to make a sound signaling the fake start of a recording. If investors later refused to pay, Guerriero would threaten them with lawsuits based on their “recorded” verbal commitment.
- Investors were falsely told that Oxford City would pay a 50-cents-per-share dividend within a year. In reality, the company was losing millions of dollars a year and was legally prohibited from paying a dividend.
- Oxford City purportedly had real estate holdings worth approximately $100 million and owned a radio broadcast network that projected profits of almost $20 million. Oxford City actually had assets of approximately $1 million and never owned a radio station – it simply purchased one hour of air time per week.
- Oxford City claimed to own an online university with students already enrolled and projected profits of $495 million for the upcoming five-year period. In reality, there was no such university that ever enrolled a student or had revenue.
- Oxford City purported it would earn more than $238 million over five years from existing and new sports-related facilities. The truth was that Oxford City owned a minority interest in a lower division English soccer club, which generated a small amount of revenue but never turned a profit.
http://1.usa.gov/1Y30qWU
Thursday, December 10, 2015
Investor Bulletin: Exchange Traded Notes (ETNs)
The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to educate investors about exchange-traded notes (“ETNs”). ETNs are unsecured debt obligations of financial institutions that trade on a securities exchange. ETN payment terms are linked to the performance of a reference index or benchmark, representing the ETN’s investment objective.
You should understand that ETNs are complex and involve many risks for interested investors, and can result in the loss of your entire investment.
What is an ETN?
ETNs are unsecured debt obligations of financial institutions. They are very different from traditional corporate bonds because, unlike traditional corporate bonds – which pay a stated rate of interest – the return on an ETN is based on the performance of a reference index or benchmark (minus any investor fees you may pay). ETNs generally do not pay interest to their holders. Payments on ETNs may be linked to well-known broad based securities indexes or based on indexes tied to emerging markets, commodities, volatility, a specific industry sector (e.g. oil and gas pipelines), foreign currencies, or other assets. ETNs that offer leveraged exposure pay a multiple of the performance of the reference index or benchmark. Other ETNs (called inverse ETNs) are calculated based on the opposite of the performance of the reference index or benchmark. Many ETNs are issued with maturities of 20 or 30 years, and are not intended to be held to maturity. Accordingly, returns to an investor generally arise from trading the ETN rather than from holding the ETN to maturity.
What is the Difference Between an ETN and an ETF?
ETNs are often confused with exchange-traded funds (ETFs). ETNs and ETFs are both traded on a securities exchange and can be bought and sold throughout the day, but there are important differences. ETFs are registered investment companies. An investor in an ETF owns shares of a fund, which represents an ownership interest in an underlying portfolio of assets. An ETF discloses to investors the value of its portfolio of assets by publishing an end-of-day net asset value and by disseminating an estimate of its value generally every 15 seconds during the trading day, which is sometimes called an intraday indicative value. An ETF issues and redeems its shares in creation units, at their net asset value.
ETNs share some characteristics with ETFs. For example, ETNs also issue and redeem notes in creation unit sizes (generally, 25,000 to 50,000 notes); like with ETFs, the creation and redemption process affects the number of notes trading at any point in time. For both ETNs and ETFs, the purchasers of the creation units split them up to sell the individual notes or shares, as applicable, to investors in transactions on an exchange. But there is a fundamental difference between ETFs and ETNs. Unlike ETFs, ETNs do not own an underlying portfolio of assets and this makes holders of ETNs subject to the creditworthiness of the issuer. As ETNs do not own assets, when issuing new ETNs, ETN issuers calculate the value of the ETN using a described formula, rather than using net asset value.
Market Trading and Valuing ETNs
ETNs are listed on an exchange and may be bought and sold at market prices. An ETN’s prospectus will describe both how the value of the note is determined on any particular trading day, as well as how the value of the reference index or benchmark is calculated. Issuers publish a value at the conclusion of each trading day representing the amount an issuer would be obligated to pay the investor. Market prices may vary from these published values.
Potential Risks to Consider Before Investing in ETNs
Potential risks of investing in ETNs include the following:
Complexity – You and your broker should take time to understand the manner in which the reference index or benchmark is calculated, including the fees that are included in either the reference index or the calculation of the value of the ETN. Compare and contrast the ETN to other investment products offering a similar investment strategy.
Credit Risk (Issuer Default) – You should be aware that when you purchase an ETN you are subject to the creditworthiness of the issuing financial institution and would be a creditor if the issuer defaults on payments due.
Market Risk – In addition to the credit risk of the issuer, ETNs also expose investors to the performance risk of the reference index or benchmark.
Leverage – Leveraged, inverse, or inverse-leveraged ETNs reset on a daily basis their exposure to the leveraged, inverse, or inverse-leveraged exposure stated in the prospectus, meaning that all investors receive an equal amount of leveraged, inverse, or inverse-leveraged exposure. As a result, investors holding such ETNs for more than one day should not expect to receive returns proportional to the exposure stated in the prospectus. The difference can be significant. Consequently, leveraged, inverse, or inverse-leveraged ETNs are not typically used as buy-and-hold instruments.
Price Volatility (Market Price versus Indicative Value) – ETNs can trade at premiums or discounts to their indicative value, especially in instances in which the issuer has suspended further note issuances. If you are considering purchasing ETNs, you should compare market prices against indicative values.
Liquidity Risk – There is a risk that if you need to cash out your investment, you may not be able to sell the ETN immediately and at a price that you would consider reasonable (for example, you may have to sell the ETN at a lower price than if you were able to wait to liquidate your investment). This is the case for most illiquid securities and the liquidity of ETNs varies significantly. For example, some ETNs have daily volume in excess of a million notes, while others may have little trading activity over several days. You should consider your overall timeframe for the investment, including how quickly you may need to sell the ETN.
Additional Considerations:
Do not invest in something that you do not understand. Before purchasing an ETN, you should consider:
Additional Resources:
Submit a question to the SEC or call the SEC’s toll-free investor assistance line at (800) 732-0330 (dial 1-202-551-6551 if calling from outside of the United States).
Report a problem concerning your investments or report possible securities fraud to the SEC.
Stay Informed:
You should understand that ETNs are complex and involve many risks for interested investors, and can result in the loss of your entire investment.
What is an ETN?
ETNs are unsecured debt obligations of financial institutions. They are very different from traditional corporate bonds because, unlike traditional corporate bonds – which pay a stated rate of interest – the return on an ETN is based on the performance of a reference index or benchmark (minus any investor fees you may pay). ETNs generally do not pay interest to their holders. Payments on ETNs may be linked to well-known broad based securities indexes or based on indexes tied to emerging markets, commodities, volatility, a specific industry sector (e.g. oil and gas pipelines), foreign currencies, or other assets. ETNs that offer leveraged exposure pay a multiple of the performance of the reference index or benchmark. Other ETNs (called inverse ETNs) are calculated based on the opposite of the performance of the reference index or benchmark. Many ETNs are issued with maturities of 20 or 30 years, and are not intended to be held to maturity. Accordingly, returns to an investor generally arise from trading the ETN rather than from holding the ETN to maturity.
What is the Difference Between an ETN and an ETF?
ETNs are often confused with exchange-traded funds (ETFs). ETNs and ETFs are both traded on a securities exchange and can be bought and sold throughout the day, but there are important differences. ETFs are registered investment companies. An investor in an ETF owns shares of a fund, which represents an ownership interest in an underlying portfolio of assets. An ETF discloses to investors the value of its portfolio of assets by publishing an end-of-day net asset value and by disseminating an estimate of its value generally every 15 seconds during the trading day, which is sometimes called an intraday indicative value. An ETF issues and redeems its shares in creation units, at their net asset value.
ETNs share some characteristics with ETFs. For example, ETNs also issue and redeem notes in creation unit sizes (generally, 25,000 to 50,000 notes); like with ETFs, the creation and redemption process affects the number of notes trading at any point in time. For both ETNs and ETFs, the purchasers of the creation units split them up to sell the individual notes or shares, as applicable, to investors in transactions on an exchange. But there is a fundamental difference between ETFs and ETNs. Unlike ETFs, ETNs do not own an underlying portfolio of assets and this makes holders of ETNs subject to the creditworthiness of the issuer. As ETNs do not own assets, when issuing new ETNs, ETN issuers calculate the value of the ETN using a described formula, rather than using net asset value.
Market Trading and Valuing ETNs
ETNs are listed on an exchange and may be bought and sold at market prices. An ETN’s prospectus will describe both how the value of the note is determined on any particular trading day, as well as how the value of the reference index or benchmark is calculated. Issuers publish a value at the conclusion of each trading day representing the amount an issuer would be obligated to pay the investor. Market prices may vary from these published values.
Potential Risks to Consider Before Investing in ETNs
Potential risks of investing in ETNs include the following:
Complexity – You and your broker should take time to understand the manner in which the reference index or benchmark is calculated, including the fees that are included in either the reference index or the calculation of the value of the ETN. Compare and contrast the ETN to other investment products offering a similar investment strategy.
Credit Risk (Issuer Default) – You should be aware that when you purchase an ETN you are subject to the creditworthiness of the issuing financial institution and would be a creditor if the issuer defaults on payments due.
Market Risk – In addition to the credit risk of the issuer, ETNs also expose investors to the performance risk of the reference index or benchmark.
Leverage – Leveraged, inverse, or inverse-leveraged ETNs reset on a daily basis their exposure to the leveraged, inverse, or inverse-leveraged exposure stated in the prospectus, meaning that all investors receive an equal amount of leveraged, inverse, or inverse-leveraged exposure. As a result, investors holding such ETNs for more than one day should not expect to receive returns proportional to the exposure stated in the prospectus. The difference can be significant. Consequently, leveraged, inverse, or inverse-leveraged ETNs are not typically used as buy-and-hold instruments.
Price Volatility (Market Price versus Indicative Value) – ETNs can trade at premiums or discounts to their indicative value, especially in instances in which the issuer has suspended further note issuances. If you are considering purchasing ETNs, you should compare market prices against indicative values.
Liquidity Risk – There is a risk that if you need to cash out your investment, you may not be able to sell the ETN immediately and at a price that you would consider reasonable (for example, you may have to sell the ETN at a lower price than if you were able to wait to liquidate your investment). This is the case for most illiquid securities and the liquidity of ETNs varies significantly. For example, some ETNs have daily volume in excess of a million notes, while others may have little trading activity over several days. You should consider your overall timeframe for the investment, including how quickly you may need to sell the ETN.
Additional Considerations:
Do not invest in something that you do not understand. Before purchasing an ETN, you should consider:
- Whether ETNs are a suitable investment for you. You should review your investment objectives and tolerance for risk with your broker or financial adviser before you consider investing in an ETN. They can help you determine whether or not the risks associated with a particular ETN are within your tolerance for risk, or whether your investment needs are better served by investing in another product. Your broker should only recommend transactions and investment strategies that are suitable for you based on your investment profile.
- What fees are associated with an ETN, such as fees included in the reference index or benchmark, daily investor fees that reduce the closing indicative value of the ETN, and the amount of brokerage commissions you may pay when buying and selling an ETN.
- Whether you understand how the reference index or benchmark is calculated.
- Whether you understand how the indicative values and redemption values are calculated and what they measure.
- Whether you understand the tax implications, if any, because the tax treatment can vary depending upon the nature of the ETN. It may be appropriate to consult a tax professional.
Additional Resources:
- FINRA – Investor Alert – “Exchange-Traded Notes – Avoid Unpleasant Surprises” at: http://www.finra.org/investors/protectyourself/investoralerts/tradingsecurities/p131262
- SEC Investor Bulletin: "Top Tips for Selecting a Financial Professional" at: www.sec.gov/investor/alerts/ib_top_tips.pdf
- SEC Investor Bulletin: “How Fees and Expenses Affect Your Investment Portfolio” at http://investor.gov/news-alerts/investor-bulletins/investor-bulletin-how-fees-expenses-affect-your-investment-portfolio
- SEC Investor Bulletin: “The ABCs of Credit Ratings” at http://investor.gov/news-alerts/investor-bulletins/investor-bulletin-abcs-credit-ratings
- SEC Publication: “Protect Your Money: Check out Brokers and Investment Advisers”
Submit a question to the SEC or call the SEC’s toll-free investor assistance line at (800) 732-0330 (dial 1-202-551-6551 if calling from outside of the United States).
Report a problem concerning your investments or report possible securities fraud to the SEC.
Stay Informed:
- Visit Investor.gov, the SEC’s website for individual investors
- Receive SEC Investor Alerts and Bulletins by email or RSS feed
- Follow the Office of Investor Education and Advocacy on Twitter @SEC_Investor_Ed
- Like the Office of Investor Education and Advocacy on Facebook at www.facebook.com/secinvestoreducation
SEC, FINRA, MSRB to Hold Compliance Outreach Program for Municipal Advisors
SEC, FINRA, MSRB to Hold Compliance Outreach Program for Municipal Advisors
The Securities and Exchange Commission, Financial Industry Regulatory Authority (FINRA), and the Municipal Securities Rulemaking Board (MSRB) today announced the opening of registration for the Compliance Outreach Program for Municipal Advisors that will take place in Philadelphia on Feb. 3, 2016, and be webcast live on the SEC website.
The SEC's Office of Compliance Inspections and Examinations, in coordination with the SEC's Office of Municipal Securities, is partnering with FINRA and the MSRB to sponsor the program. Similar to the compliance outreach programs for broker-dealers and investment advisers, the municipal advisor program will provide municipal advisor professionals a forum for discussions with regulators about recent exam findings, regulatory issues, and compliance practices.
Jessica Kane, Director of the SEC's Office of Municipal Securities, said, "This year's outreach program is designed to promote compliance with municipal advisor rules by providing municipal advisor professionals the opportunity to interact with all three regulators and to discuss regulatory and compliance issues with their industry peers."
"The municipal advisor outreach will be extremely informative and educational for new municipal advisors as they build their compliance programs," said Kevin Goodman, National Associate Director of the SEC's broker-dealer and municipal advisor examination programs. "This outreach, following the first ever in 2014, illustrates our continued commitment to foster an open dialogue among municipal advisors and regulators regarding regulatory obligations and expectations."
Mike Rufino, FINRA's Head of Member Regulation-Sales Practice, said, "The discussions covering exam trends, general findings and the application of exemptions and exclusions from the municipal advisor registration rules will be valuable to municipal advisors. Any firm that is uncertain as to the full application of municipal advisor rules and regulations to its business may benefit from attending the conference."
"This program is consistent with the MSRB's goal of providing resources to municipal advisors to help them understand their regulatory obligations," said MSRB Executive Director Lynnette Kelly. "Municipal advisors will benefit from hearing first-hand from our staff."
There is no cost to attend the program. Registration is open to all municipal advisor professionals with limited in-person seating available (preference given to employees of registered municipal advisors on a first-come, first-served basis) and unlimited webcast viewing. If you plan to attend in-person or view via webcast, please register for the program here.
Information on accessing the webcast will be posted on the SEC website on the day of the outreach. For additional information visit the SEC, FINRA, or the MSRB websites.
The SEC's Office of Compliance Inspections and Examinations, in coordination with the SEC's Office of Municipal Securities, is partnering with FINRA and the MSRB to sponsor the program. Similar to the compliance outreach programs for broker-dealers and investment advisers, the municipal advisor program will provide municipal advisor professionals a forum for discussions with regulators about recent exam findings, regulatory issues, and compliance practices.
Jessica Kane, Director of the SEC's Office of Municipal Securities, said, "This year's outreach program is designed to promote compliance with municipal advisor rules by providing municipal advisor professionals the opportunity to interact with all three regulators and to discuss regulatory and compliance issues with their industry peers."
"The municipal advisor outreach will be extremely informative and educational for new municipal advisors as they build their compliance programs," said Kevin Goodman, National Associate Director of the SEC's broker-dealer and municipal advisor examination programs. "This outreach, following the first ever in 2014, illustrates our continued commitment to foster an open dialogue among municipal advisors and regulators regarding regulatory obligations and expectations."
Mike Rufino, FINRA's Head of Member Regulation-Sales Practice, said, "The discussions covering exam trends, general findings and the application of exemptions and exclusions from the municipal advisor registration rules will be valuable to municipal advisors. Any firm that is uncertain as to the full application of municipal advisor rules and regulations to its business may benefit from attending the conference."
"This program is consistent with the MSRB's goal of providing resources to municipal advisors to help them understand their regulatory obligations," said MSRB Executive Director Lynnette Kelly. "Municipal advisors will benefit from hearing first-hand from our staff."
There is no cost to attend the program. Registration is open to all municipal advisor professionals with limited in-person seating available (preference given to employees of registered municipal advisors on a first-come, first-served basis) and unlimited webcast viewing. If you plan to attend in-person or view via webcast, please register for the program here.
Information on accessing the webcast will be posted on the SEC website on the day of the outreach. For additional information visit the SEC, FINRA, or the MSRB websites.
SEC Charges Bitcoin Mining Companies
The Securities and Exchange Commission today charged two Bitcoin mining companies and their founder with conducting a Ponzi scheme that used the lure of quick riches from virtual currency to defraud investors.
According to the SEC's complaint filed in federal court in Connecticut, "mining" for Bitcoin or other virtual currencies means applying computer power to try to solve complex equations that verify a group of transactions in that virtual currency. The first computer or collection of computers to solve an equation is awarded new units of that virtual currency.
The SEC alleges that Homero Joshua Garza perpetrated the fraud through his Connecticut-based companies GAW Miners and ZenMiner by purporting to offer shares of a digital Bitcoin mining operation. In reality, GAW Miners and ZenMiner did not own enough computing power for the mining it promised to conduct, so most investors paid for a share of computing power that never existed. Returns paid to some investors came from proceeds generated from sales to other investors.
"As alleged in our complaint, Garza and his companies cloaked their scheme in technological sophistication and jargon, but the fraud was simple at its core: they sold what they did not own, misrepresented what they were selling, and robbed one investor to pay another," said Paul G. Levenson, Director of the SEC's Boston Regional Office.
According to the SEC's complaint:
According to the SEC's complaint filed in federal court in Connecticut, "mining" for Bitcoin or other virtual currencies means applying computer power to try to solve complex equations that verify a group of transactions in that virtual currency. The first computer or collection of computers to solve an equation is awarded new units of that virtual currency.
The SEC alleges that Homero Joshua Garza perpetrated the fraud through his Connecticut-based companies GAW Miners and ZenMiner by purporting to offer shares of a digital Bitcoin mining operation. In reality, GAW Miners and ZenMiner did not own enough computing power for the mining it promised to conduct, so most investors paid for a share of computing power that never existed. Returns paid to some investors came from proceeds generated from sales to other investors.
"As alleged in our complaint, Garza and his companies cloaked their scheme in technological sophistication and jargon, but the fraud was simple at its core: they sold what they did not own, misrepresented what they were selling, and robbed one investor to pay another," said Paul G. Levenson, Director of the SEC's Boston Regional Office.
According to the SEC's complaint:
- From August 2014 to December 2014, Garza and his companies sold $20 million worth of purported shares in a digital mining contract they called a Hashlet.
- More than 10,000 investors purchased Hashlets, which were touted as always profitable and never obsolete.
- Although Hashlets were depicted in GAW Miners' marketing materials as a physical product or piece of mining hardware, the promised contract purportedly entitled the investor to control a share of computing power that GAW Miners claimed to own and operate.
- Investors were misled to believe they would share in returns earned by the Bitcoin mining activities when in reality GAW Miners directed little or no computing power toward any mining activity.
- Because Garza and his companies sold far more computing power than they owned, they owed investors a daily return that was larger than any actual return they were making on their limited mining operations.
- Therefore, investors were simply paid back gradually over time under the mantra of "returns" out of funds that Garza and his companies collected from other investors.
- Most Hashlet investors never recovered the full amount of their investments, and few made a profit.
SEC: Grant Thornton Ignored Red Flags in Audits
SEC: Grant Thornton Ignored Red Flags in Audits
The Securities and Exchange Commission today announced that national audit firm Grant Thornton LLP and two of its partners agreed to settle charges that they ignored red flags and fraud risks while conducting deficient audits of two publicly traded companies that wound up facing SEC enforcement actions for improper accounting and other violations.
Grant Thornton admitted wrongdoing and agreed to forfeit approximately $1.5 million in audit fees and interest plus pay a $3 million penalty.
Melissa Koeppel was an engagement partner on the deficient audits of both companies, and Jeffrey Robinson was an engagement partner on one of the deficient audits, which spanned from 2009 to 2011 and involved senior housing provider Assisted Living Concepts (ALC) and alternative energy company Broadwind Energy. An SEC investigation found that Grant Thornton and the engagement partners repeatedly violated professional standards, and their inaction allowed the companies to make numerous false and misleading public filings.
"Audit firms must be held responsible when systemic failures such as inadequate engagement procedures, staffing, or supervision cause the firms' work to fall significantly short of expected standards, particularly when multiple audits and engagements are involved," said Andrew J. Ceresney, Director of the SEC's Division of Enforcement. "Grant Thornton was aware of red flags suggesting audit quality issues in the audits conducted by one of its engagement partners and its audit quality more generally, but failed to remedy the situation."
Last December, the SEC announced fraud charges against two former ALC executives accused of making false disclosures and manipulating internal books and records by listing fake occupants at some senior residences in order to meet lease covenant requirements. Earlier this year, the SEC charged Broadwind and senior officers with accounting and disclosure violations that prevented investors from knowing that reduced business was damaging the company's long-term financial prospects.
Without admitting or denying the SEC's findings, Koeppel agreed to pay a $10,000 penalty and be suspended from practicing before the SEC as an accountant for at least five years, and Robinson agreed to pay a $2,500 penalty and be suspended from practicing before the SEC as an accountant for at least two years.
Grant Thornton admitted wrongdoing and agreed to forfeit approximately $1.5 million in audit fees and interest plus pay a $3 million penalty.
Melissa Koeppel was an engagement partner on the deficient audits of both companies, and Jeffrey Robinson was an engagement partner on one of the deficient audits, which spanned from 2009 to 2011 and involved senior housing provider Assisted Living Concepts (ALC) and alternative energy company Broadwind Energy. An SEC investigation found that Grant Thornton and the engagement partners repeatedly violated professional standards, and their inaction allowed the companies to make numerous false and misleading public filings.
"Audit firms must be held responsible when systemic failures such as inadequate engagement procedures, staffing, or supervision cause the firms' work to fall significantly short of expected standards, particularly when multiple audits and engagements are involved," said Andrew J. Ceresney, Director of the SEC's Division of Enforcement. "Grant Thornton was aware of red flags suggesting audit quality issues in the audits conducted by one of its engagement partners and its audit quality more generally, but failed to remedy the situation."
Last December, the SEC announced fraud charges against two former ALC executives accused of making false disclosures and manipulating internal books and records by listing fake occupants at some senior residences in order to meet lease covenant requirements. Earlier this year, the SEC charged Broadwind and senior officers with accounting and disclosure violations that prevented investors from knowing that reduced business was damaging the company's long-term financial prospects.
"Grant Thornton auditors recognized that representations by ALC and Broadwind management were questionable. Yet in the end, Grant Thornton accepted faulty explanations as the truth and failed to demonstrate adequate professional skepticism or obtain corroborating evidence," said David Glockner, Director of the SEC's Chicago Regional Office.According to the SEC's orders instituting settled administrative proceedings:
- In the ALC audit, Grant Thornton, Koeppel, and Robinson knew or should have known that heightened scrutiny was warranted with respect to the effects of ALC's calculations of occupancy and coverage ratio covenants in a lease pursuant to which ALC operated eight assisted living facilities.
- The firm and both partners were aware of repeated red flags surrounding ALC's claim that it had an agreement with the lessor to meet lease covenants by treating ALC employees and other non-residents as occupants of the facilities.
- They violated professional auditing standards by failing to take reasonable steps to determine that an agreement with the lessor existed or that ALC employees whom ALC claimed to be occupants of the facilities were actually staying there.
- During the Broadwind engagement, Grant Thornton and Koeppel relied almost exclusively on unsupported management representations that a $58 million impairment charge had not occurred ahead of a significant public offering by Broadwind, even after learning of management's own expectation of impairment and other facts establishing impairment.
- Grant Thornton and Koeppel failed to obtain adequate audit evidence to support management's conclusion that the impairment had occurred after the offering.
- They also failed to exercise due professional care and skepticism or obtain adequate audit evidence related to a significant bill-and-hold transaction. The revenue from this transaction allowed Broadwind to meet its debt covenants.
- As a result of these and other deficiencies, Grant Thornton issued audit reports containing unqualified opinions on ALC's 2009, 2010, and 2011 financial statements and Broadwind's 2009 financial statements that inaccurately stated the audits had been conducted in accordance with PCAOB standards.
Without admitting or denying the SEC's findings, Koeppel agreed to pay a $10,000 penalty and be suspended from practicing before the SEC as an accountant for at least five years, and Robinson agreed to pay a $2,500 penalty and be suspended from practicing before the SEC as an accountant for at least two years.
SEC Announces Charges for Spoofing and Order Mismarking
SEC Announces Charges for Spoofing and Order Mismarking
The Securities and Exchange Commission today announced fraud charges against three Chicago-based traders accused of circumventing market structure rules in a pair of options trading schemes.
The SEC Enforcement Division alleges that twin brothers Behruz Afshar and Shahryar Afshar and their friend and former broker Richard Kenny mismarked option orders to obtain execution priority and lower fees, and engaged in manipulative trading known as "spoofing" to generate liquidity rebates from an options exchange.
"We allege that the Afshar brothers and Kenny fraudulently mismarked their orders to obtain benefits that they were not entitled to receive, and engaged in spoofing to collect liquidity rebates. This alleged scheme deceived the options exchanges, disadvantaged other market participants, and undermined the fair operation of the U.S. securities markets," said Andrew Ceresney, Director of the SEC Enforcement Division.
Robert A. Cohen, Co-Chief of the SEC Enforcement Division's Market Abuse Unit, added, "We allege that these individuals tricked the exchanges into giving them benefits not meant for professional traders, and fooled other market participants by spoofing the market with non-bona fide orders."
In an order instituting an administrative proceeding, the SEC Enforcement Division alleges:
Mismarking of Options Orders
Spoofing
The SEC Enforcement Division alleges that twin brothers Behruz Afshar and Shahryar Afshar and their friend and former broker Richard Kenny mismarked option orders to obtain execution priority and lower fees, and engaged in manipulative trading known as "spoofing" to generate liquidity rebates from an options exchange.
"We allege that the Afshar brothers and Kenny fraudulently mismarked their orders to obtain benefits that they were not entitled to receive, and engaged in spoofing to collect liquidity rebates. This alleged scheme deceived the options exchanges, disadvantaged other market participants, and undermined the fair operation of the U.S. securities markets," said Andrew Ceresney, Director of the SEC Enforcement Division.
Robert A. Cohen, Co-Chief of the SEC Enforcement Division's Market Abuse Unit, added, "We allege that these individuals tricked the exchanges into giving them benefits not meant for professional traders, and fooled other market participants by spoofing the market with non-bona fide orders."
In an order instituting an administrative proceeding, the SEC Enforcement Division alleges:
Mismarking of Options Orders
- Options exchange rules provide that a non-broker-dealer that places more than 390 orders in options per day (on average) – whether executed or not – during any calendar month in a quarter will be designated as a "professional" for the next quarter.
- Conversely, a "customer" is a non-broker-dealer that does not exceed the 390-order threshold for each calendar month in a quarter.
- Despite far exceeding the 390-order threshold for every quarter from October 2010 to December 2012, the Afshars' accounts (in the names of Fineline Trading Group LLC and Makino Capital LLC) were able to continually place "customer" orders throughout this time period by alternating their trading on a quarterly basis between accounts.
- When one account was "professional" for an upcoming quarter, they switched their trading to the other account, which was designated as "customer." They then switched back the following quarter.
- The "customer" and "professional" designations are supposed to apply to all accounts beneficially owned by the trader. However, the Afshars and Kenny accomplished this back-and-forth scheme through false representations that Behruz solely owned Fineline and that Shahryar solely owned Makino, despite the fact that Behruz had an ownership interest in both companies.
- From May 2011 to December 2012, the spoofing scheme was designed to take advantage of the "maker-taker" program offered by an options exchange.
- Under the maker-taker program, an order that is sent to an exchange and executes against a subsequently received order generates a "maker" rebate from the exchange. In contrast, an order that immediately executes against a pre-existing order is charged a "take" fee.
- The Afshars and Kenny carried out the scheme by using All-Or-None (AON) options orders – hidden orders that must be executed in their entirety or not at all – and placing smaller, non-bona fide displayed orders in the same option series and price as the AON orders, but on the opposite side of the market.
- The smaller orders were not intended to be executed but instead were placed to alter the option's best bid or offer in order to induce, or spoof, other market participants into placing orders at the same price.
- Those orders from other market participants executed against the Afshars' hidden AON orders, and any open displayed orders were then canceled.
- Because the executed AON orders existed before the orders sent by the spoofed counterparties, they were deemed to have added liquidity and generated rebates for the accounts of Fineline and Makino.
SEC: Lawyers Offered EB-5 Investments as Unregistered Brokers
The Securities and Exchange Commission today announced a series of enforcement actions against lawyers across the country charged with offering EB-5 investments while not registered to act as brokers.
In one case, the lawyer and his firm are charged with defrauding foreign investors in the government's EB-5 Immigrant Investor Program, through which they seek a path to U.S. residency by investing in a specific project that creates or preserves at least 10 jobs for U.S. workers.
In a complaint filed in federal district court in Los Angeles, the SEC alleges that New York-based immigration attorney Hui Feng and the Law Offices of Feng & Associates not only acted as unregistered brokers by selling EB-5 investments to more than 100 investors, but they also defrauded clients by failing to disclose they received commissions on the investments in breach of their fiduciary and legal duties. They also allegedly defrauded some entities offering the EB-5 investments.
"We allege that Feng abused his role as an immigration attorney to illicitly operate as a broker and engage in a scheme to secretly receive commissions for selling EB-5 securities," said Michele Wein Layne, Director of the SEC's Los Angeles Regional Office.
According to the SEC's orders instituting settled administrative proceedings against several other lawyers and firms for broker registration violations:
"These settled enforcement actions reflect the cooperation by these individuals in entering into early discussions with the staff and conserving precious investigative resources," said Stephen L. Cohen, Associate Director in the SEC Enforcement Division.
In one case, the lawyer and his firm are charged with defrauding foreign investors in the government's EB-5 Immigrant Investor Program, through which they seek a path to U.S. residency by investing in a specific project that creates or preserves at least 10 jobs for U.S. workers.
"Individuals and entities performing certain services and receiving commissions must be registered to legally operate as securities brokers if they're raising money for EB-5 projects," said Andrew J. Ceresney, Director of the SEC Enforcement Division. "The lawyers in these cases allegedly received commissions for selling, recommending, and facilitating EB-5 investments, and they are being held accountable for disregarding the relevant securities laws and regulations."
In a complaint filed in federal district court in Los Angeles, the SEC alleges that New York-based immigration attorney Hui Feng and the Law Offices of Feng & Associates not only acted as unregistered brokers by selling EB-5 investments to more than 100 investors, but they also defrauded clients by failing to disclose they received commissions on the investments in breach of their fiduciary and legal duties. They also allegedly defrauded some entities offering the EB-5 investments.
"We allege that Feng abused his role as an immigration attorney to illicitly operate as a broker and engage in a scheme to secretly receive commissions for selling EB-5 securities," said Michele Wein Layne, Director of the SEC's Los Angeles Regional Office.
According to the SEC's orders instituting settled administrative proceedings against several other lawyers and firms for broker registration violations:
- Various EB-5 regional centers or their managers paid commissions to the attorney or law firm for each new investor they successfully sold limited partnership interests.
- These payments were separate from legal fees received to provide legal services to the same clients.
- The lawyers and firms engaged in activities necessary to effectuate the transactions, such as recommending one or more EB-5 investments, acting as a liaison between the regional center and the investor, or facilitating the transfer or documentation of investment funds to the regional center.
- The lawyers thereby acted as unregistered brokers in violation of Section 15(a)(1) of the Securities Exchange Act of 1934.
- Austin, Texas-based Mehron P. Azarmehr and Azarmehr Law Group, who agreed to pay disgorgement of $30,000, prejudgment interest of $2,965, and a penalty of $25,000.
- Miami-based Michael A. Bander and Bander Law Firm, who agreed to pay disgorgement of $228,750, prejudgment interest of $19,434, and a penalty of $25,000.
- Miami-based attorney Roger A. Bernstein, who agreed to pay disgorgement of $132,500, and prejudgment interest of $8,243.
- Hoboken, N.J.-based attorney Allen E. Kaye.
- Los Angeles-based attorney Taraneh Khorrami, who agreed to pay disgorgement of $60,000, prejudgment interest of $7,843, and a penalty of $25,000.
- Los Angeles-based Mike S. Manesh and Manesh & Mizrahi, who agreed to pay disgorgement of $85,000 and prejudgment interest of $11,159.
- China-based resident Kefei Wang, who agreed to pay disgorgement of $40,000, prejudgment interest of $1,590, and a penalty of $25,000.
"These settled enforcement actions reflect the cooperation by these individuals in entering into early discussions with the staff and conserving precious investigative resources," said Stephen L. Cohen, Associate Director in the SEC Enforcement Division.
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