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.

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FACT SHEET

Use of Derivatives by Registered Investment Companies and Business Development Companies

SEC Open Meeting

December 11, 2015

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.

• 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.      

Asset Segregation for Derivatives 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.

• 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.

Derivatives Risk Management Program
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. 

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:

• 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.

The SEC’s complaint charges Guerriero and Oxford City with violations of Sections 10(b) and 20(b) of Securities Exchange Act of 1934 and Rule 10b-5 as well as Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933.

http://1.usa.gov/1Y30qWU

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:

• 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.

Finally, you may wish to consider seeking the advice of an investment professional.  If you do, be sure to work with someone who understands your investment objectives and tolerance for risk.  Your investment professional should understand complex products, such as ETNs, and be able to explain to your satisfaction whether or how they fit with your objectives.

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”

Contact the SEC:
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.

SEC Charges Bitcoin Mining Companies

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:

• 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. 

The SEC's complaint seeks permanent injunctive relief as well as the disgorgement of ill-gotten gains plus prejudgment interest and penalties.

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.

"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. 

The SEC's orders find that Grant Thornton, Koeppel and Robinson engaged in improper professional conduct pursuant to Section 4C(b) of the Securities Exchange Act of 1934 and Rule 102(e)(1)(iv) of the SEC's Rules of Practice.  They also were found to have caused violations of Section 13(a) of the Exchange Act and Rules 13a-1, and Grant Thornton and Koeppel were found to have caused violations of Rule 13a-13.

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

• 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. 

Spoofing

• 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.

The SEC Enforcement Division alleges that Behruz, Shahryar, Kenny, Fineline, and Makino violated Section 17(a) of the Securities Act as well as Sections 9(a)(2) and 10(b) of the Exchange Act and Rule 10b-5.  The matter will be scheduled for a public hearing before an administrative law judge for proceedings to adjudicate the Enforcement Division's allegations and determine what, if any, remedial actions are appropriate.   

Related articles

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• SEC News - Unregistered Stock, Insider Trading Charges, Accounting Violations 
• UBS Puerto Rico Investment Problems Expand
• SEC Continues to Permit Reps to Sell their Company's Stock to Clients 
• SEC Charges Tacoma, Wash.-Area Firm for Undisclosed Principal Transactions and Misleading Performance Advertisements (seclaw.blogspot.com)

SEC: Lawyers Offered EB-5 Investments as Unregistered Brokers

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.

"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.

Without admitting or denying the SEC's findings, the following individuals and firms agreed to cease and desist from acting as unregistered brokers:

• 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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SEC Charges Three RMBS Traders With Defrauding Investors

SEC Charges Three RMBS Traders With Defrauding Investors

09/08/2015 11:00 AM EDT

The Securities and Exchange Commission today announced fraud charges against three traders accused of repeatedly lying to customers relying on them for honest and accurate pricing information about residential mortgage-backed securities (RMBS).
The SEC alleges that Ross Shapiro, Michael Gramins, and Tyler Peters defrauded customers to illicitly generate millions of dollars in additional revenue for Nomura Securities International, the New York-based brokerage firm where they worked.  They misrepresented the bids and offers being provided to Nomura for RMBS as well as the prices at which Nomura bought and sold RMBS and the spreads the firm earned intermediating RMBS trades.  They also trained, coached, and directed junior traders at the firm to engage in the same misconduct.
In a parallel action, the U.S. Attorney's Office for the District of Connecticut announced criminal charges against Shapiro, Gramins, and Peters, who no longer work at Nomura.
"The alleged misconduct reflects a callous disregard for the integrity and obligations expected of registered securities professionals," said Andrew Ceresney, Director of the SEC's Enforcement Division. "Not only did these traders lie to their customers, but they created a corrupt culture on Nomura's trading desk by coaching more junior traders to employ the same deceptive and dishonest trading practices we allege in our complaint."
According to the SEC's complaint filed in federal court in Manhattan:

• The lies and omissions to customers by Shapiro, Gramins, and Peters generated at least $5 million in additional revenue for Nomura, and lies and omissions by the subordinates they trained and coached generated at least $2 million in additional profits for the firm. 
• Nomura determined bonuses for Shapiro, Gramins, and Peters based on several factors including revenue generation.  Nomura paid total compensation of $13.3 million to Shapiro, $5.8 million to Gramins, and $2.9 million to Peters during the years this misconduct was occurring.
• Customers sought and relied on market price information from these traders because the market for this type of RMBS is opaque and accurate price information is difficult for a customer to determine.  Therefore it was particularly important for the traders to provide honest and accurate information.
• Shapiro, Gramins, and Peters went so far as to invent phantom third-party sellers and fictional offers when Nomura already owned the bonds the traders were pretending to obtain for potential buyers.

The SEC's complaint charges Shapiro, Gramins, and Peters with violating Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 as well as Section 17(a) of the Securities Act of 1933.
The SEC separately entered into deferred prosecution agreements (DPAs) with three other individuals who have extensively cooperated with the SEC's investigation and provided enforcement staff with access to critical evidence that otherwise would not have been available.
"The SEC is open to deferring charges based on certain factors, including when cooperators come forward with timely and credible information while candidly acknowledging their own misconduct," said Michael Osnato, Chief of the SEC's Complex Financial Instruments Unit.  "The decision to defer charges in this matter reflects the early and sustained assistance provided by these individuals."
The SEC's continuing investigation is being conducted by James R. Drabick, Susan Curtin, Rua Kelly, and Celia Moore.  The SEC's litigation will be led by Ms. Kelly.

SEC Files Subpoena Enforcement Action Against Michael J. Forster for Failure to Produce Documents in Investigation of SLO 3 Holdings LLC

SEC Files Subpoena Enforcement Action Against Michael J. Forster for Failure to Produce Documents in Investigation of SLO 3 Holdings LLC

SEC Files Subpoena Enforcement Action Against Michael J. Forster for Failure to Produce Documents in Investigation of SLO 3 Holdings LLC

SEC Charges Investment Adviser With Defrauding Retired Teachers

The Securities and Exchange Commission today charged an investment adviser in Miami with siphoning money from his investment fund and defrauding investors, including several local teachers and law enforcement officers.

The SEC alleges that Phil Donnahue Williamson conducted a Ponzi scheme with money he raised for the Sterling Investment Fund, which purportedly invested in mortgages and properties in Florida and Georgia.  Many of Williamson’s investors were public sector retirees such as teachers and law enforcement officers who sought safe investments for their retirement savings.  Williamson assured investors there was no risk involved and they would receive annual returns of 8 to 12 percent.  But rather than invest their money as promised, he used the majority of fund assets to pay his personal expenses and make supposed returns to investors.  Williamson created fictitious valuations that were sent to investors.

“We allege that Williamson lured retired teachers, law enforcement officers, and others into believing that the Sterling Investment Fund was a safe investment generating significant returns,” said Eric I. Bustillo, Director of the SEC’s Miami Regional Office.  “Investors entrusted him with their retirement savings, and he spent it as his own money.”

According to the SEC’s complaint filed in U.S. District Court for the Southern District of Florida, one retired Miami-Dade County school teacher and church pastor invested $125,000 in the fund.  That same day, Williamson transferred himself $10,000 to pay his credit card bill and make a car payment to BMW among other personal expenditures.  Williamson later paid $24,400 to other investors in the fund as purported distributions, and transferred himself another $24,000 to pay additional personal expenses.

In a parallel action, the U.S. Attorney’s Office for the Southern District of Florida today announced criminal charges against Williamson.

Williamson has agreed to settle the SEC’s charges and is liable for $748,050.01 in disgorgement.  He also agreed to be permanently prevented from violating the antifraud provisions of the Investment Advisers Act of 1940, including misleading clients or prospective clients about investment strategies, the use of client funds, or his qualifications to advise clients.  The settlement is subject to court approval.

SEC Charges Two Stock Promoters With Conducting Market Manipulation Schemes

The Securities and Exchange Commission today charged a pair of penny stock promoters in Canada with manipulating two microcap stocks to create the false appearance of market interest.

The SEC alleges that Mike Taxon and Itamar Cohen distributed promotional mailings of glossy "newsletters" with fake publication names like "Stock Trend Report" and "Global Investor Watch" in order to tout the stocks of purported gold and silver exploration company Raven Gold Corporation (RVNG) and natural gas production company Kentucky USA Energy (KYUS).  The newsletters misled investors with purportedly positive – but fake – price and volume trends for these stocks and other false information about the promoters' identity, compensation, and control of the stock. In reality, most of the touted market activity was generated by Taxon, Cohen, and their associates who controlled large blocks of the companies' stocks.  Earlier this week, the SEC charged attorney Adam Gottbetter for his role in the scheme involving Kentucky USA Energy stock.

In a parallel action, the U.S. Attorney's Office for the District of New Jersey today announced criminal charges against Taxon and Cohen.

"Taxon and Cohen lured investors to these stocks by depicting the illusion of an active market and positive market trends," said Andrew M. Calamari, Director of the SEC's New York Regional Office.
The SEC's complaint filed in federal court in New Jersey alleges that Taxon and Cohen violated Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933, and violated and aided and abetted violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.

Taxon and Cohen agreed to partial settlements of the SEC's charges, with monetary sanctions to be determined by the court at a later date.  They consented to the entry of a judgment enjoining them from future violations and barring them from participating in penny stock offerings.  The partial settlements are subject to court approval.

Investor Bulletin and Consumer Advisory: Planning for Diminished Capacity and Illness

The SEC’s Office of Investor Education and Advocacy and the CFPB’s Office for Older Americans are issuing this bulletin to help investors and consumers understand the potential impact of diminished capacity on their ability to make financial decisions and to encourage investors and consumers to plan for possible diminished financial capacity well before it happens.
What is diminished financial capacity?
“Diminished financial capacity” is a term used to describe a decline in a person’s ability to manage money and financial assets to serve his or her best interests, including the inability to understand the consequences of investment decisions.  While the inability to manage one’s money is clearly a problem in itself, when people of any age lose the capability to manage their finances, they may also become more vulnerable to investment fraud and other forms of financial abuse.
Preparing for Your Own Financial Future: Hope for the Best, But Plan for the Worst.
Losing the ability to manage your finances may be something you’d rather not think about.  We often think about our financial capabilities, like our ability to drive, as an important measure of our independence.  But planning ahead may help you stay in control of your finances, even if diminished financial capacity becomes a serious problem.  Taking the steps listed below now may help avoid or minimize problems for you and your family.

• Organize your important documents.  Organize and store important documents in a safe, easily accessible location.  That way, they are readily available in an emergency.  Give copies to trusted loved ones or let them know where to find the documents.  Typically, the following documents will be most relevant to your finances:

• Bank and brokerage statements and account information.  Make a list of your accounts with account numbers.  Keep a separate list of online bank and brokerage passwords and PINs and keep the lists in a safe place.  In addition, make a list of the locations of your safe-deposit boxes, including where the keys to the safe-deposit boxes are located.  Also, keep your recent bank and brokerage statements available, as well as information about how to get those statements online if you access them electronically.
• Mortgage and credit information.  Make a list of your debts and regular payments, with account numbers and names of the financial institutions that issued the loans or credit cards.
• Insurance policies
• Pension and other retirement benefit summaries
• Social Security payment information
• Contact information for financial and medical professionals, such as doctors, lawyers, accountants, and securities professionals.

• Provide your financial professionals with trusted emergency contacts.  If you have a financial professional, such as a broker or investment adviser, provide that person with emergency or alternate contact information in case he or she cannot contact you or suspects something is wrong.  You may wish to discuss with your financial professional what you would consider to be an “emergency,” and specify when he or she may contact someone on your behalf.  Discuss what information can be shared with your emergency contact.  For example, you might provide your financial professional with a simple written instruction, such as:  “Please call my son Mark at (222) 555-5555 if: (i) you are unable to reach me and there appears to be unusual activity regarding my account; (ii) you are unable to reach me for two weeks irrespective of any unusual account activity; or (iii) if you think I am confused or acting strangely.”  Providing an emergency contact generally will not enable the person to make investment decisions on your behalf – so be sure to take other steps if you want someone else to manage your accounts if you cannot.

• Consider creating a durable financial power of attorney.  A financial power of attorney gives someone the legal authority to make financial decisions for you if you cannot.  That person is called your agent.  The document is called “durable” because it remains in effect even if you become incapacitated.  You retain the ability to change it or cancel it as long as you are still able to make decisions.  A financial power of attorney differs from a health care power of attorney, which only covers health care decisions.  You may want to consult with a lawyer to determine whether a durable financial power of attorney is right for you.  After signing a durable financial power of attorney, you can still manage your money and property as long as you have the ability to make decisions. Also, it is important to remember that you always have the option to change who you choose to act as your appointed representative and the individuals you allow to access your financial information.  As you are essentially giving financial decision-making authority to your agent, it is critical that he or she be someone you can trust.   

• Think about involving a trusted relative, friend, or professional.  Besides listing them as emergency contacts, you may wish to give a trusted relative, friend, or professional an overview of your finances (even if you don’t want to share all the details).  For example, you might ask your broker or bank to send duplicate statements to your daughter or accountant.  You might also consider asking a trusted friend or relative to join you on periodic visits to your financial professional.  This would give someone you trust a sense of your financial situation and with whom you’ve been doing business.  If you choose to involve a relative or friend, it is very important it is someone you are sure you can trust.  Consider discussing the selection of the person with a number of other trusted friends or relatives.

• Keep things up to date.  Be sure that if something changes (for example, you open a new account) you keep your information as current as possible.  Also, your trusted contact may change over time.  Keep your financial professionals informed of changes regarding who has authority to review your account or whom they should contact in case of an emergency.

• Speak up if something goes wrong.  If you ever think someone is taking advantage of you, or that you’ve been the victim of a fraud, speak up.  Sadly, sometimes even financial professionals and people we know commit financial crimes.  There’s no shame in being a victim, and the sooner you let someone know about it, the better chance there is of putting an end to it.  Contact information for reporting abuse appears at the end of this document.

Helping Others Who May Have Diminished Financial Capacity
You may have a parent or other loved one with diminished financial capacity, or who you worry may face that issue in the future.  If so, consider the following steps to help. 

• Have an open conversation about investments and other financial matters sooner rather than later.  Even if it feels awkward, it is important to have an honest conversation about finances.  Ask your loved one to consider taking the steps outlined above.  Even if he or she does not want to take these steps, ask your relative or friend to consider how he or she wants to maintain control of his or her finances in the future.  Explain that advance planning is a way to make sure that a trusted person makes decisions if he or she no longer can.

• Help your relative or friend with managing finances.  You may also offer to take a more active role in helping your loved one manage his or her financial accounts.  Be alert both to mistakes that your loved one may make in managing finances and to any signs of elder financial abuse.  It can be hard to tell whether actions are the result of confusion or of financial exploitation.  For example, if you find that a loved one has paid the same bill twice by mistake, you should help him or her fix the error.  But beware that multiple or unusual payments could also be a sign of financial exploitation, so don’t rule out that possibility without looking into it.  Be on guard for any sudden changes in investments that seem out of keeping with the loved one’s longstanding goals, values and investment style.  These changes may have come about because of confusion or may be a sign of financial exploitation.

• If your family member or friend has named you to manage money or property, understand your responsibilities and how you can protect your loved one from financial exploitation.  For example, your loved one may have named you as an agent under a power of attorney or a trustee under a revocable living trust.  Read the Consumer Financial Protection Bureau’s Managing Someone Else’s Money guides.  They walk you through your duties, tell you how to watch out for financial exploitation and scams, and tell you where you can go for help. 

If you’ve been asked by a loved one or friend to help out with his or her finances, here are some things you can do to help. 

• Help with ongoing financial responsibilities.  You may need to take on immediate tasks, such as helping to pay bills, arranging for benefit claims, preparing tax returns, or helping with investment decisions.
   
• Review their investment portfolio.  This might be a good time to help reevaluate the person’s portfolio in light of his or her financial and medical situation.  Does the person expect a big increase in health care, personal care or other costs as a result of his or her illness or disability?  If so, will he or she have enough cash or liquid assets on hand to cover those costs?  (Liquid investments are assets that the owner can sell readily and without paying a hefty fee to get money when it is needed.)  These can be complex questions and you may wish to discuss them with a financial professional.  Keep in mind that buying and selling investments on behalf of a loved one requires legal authority, through a power of attorney, a trust or similar arrangement.

• Assess the riskiness of their investment portfolio.  All investments involve some level of risk.  But do the investments present the right level of risk at this stage of the person’s life?  If not, you may wish to consider contacting a registered investment adviser representative or registered broker-dealer representative for help.

• Contact their investment professional.  If your loved one has a financial professional and has authorized that person to speak with you, make the professional aware of your loved one’s condition.  This is critical so that the financial professional can make recommendations appropriate to the client’s financial needs and can watch for signs of declining financial skills or potential abuse.

Your financial professional, or that of your loved one, may raise topics discussed in this bulletin.  Financial services firms are paying increasing attention to improving communications on this subject.  If a financial professional does not raise these topics, however, you should feel free to raise them yourself. 
Additional Resources

• Financial Protection for Older Americans webpage of the Consumer Financial Protection Bureau (CFPB), available at www.consumerfinance.gov/older-americans

• The U.S. Department of Justice’s Elder Justice Initiative website at http://justice.gov/elderjustice (including the page on victim and family support)

• The SEC Investor.gov web page for Seniors, available at http://investor.gov/seniors

To Report Suspected Elder Abuse

• To report suspected elder abuse in general, locate the appropriate adult protective services agency by calling the Eldercare Locator at (800) 677-1116, or
  www.eldercare.gov.

• Elder financial abuse often violates one or more criminal laws.  To report it, contact your local police or sheriff.

• To report suspected elder financial abuse involving brokers or investment advisers, contact:

• The SEC at (800) 732-0330 or www.sec.gov/complaint/select.shtml
• The Financial Industry Regulatory Authority (FINRA) at (240) 386-HELP (4357) or http://www.finra.org/investors/investor-complaint-center , or
• Your state securities regulator.  For a contact list of state securities regulators, visit www.nasaa.org/about-us/contact-us/contact-your-regulator.

To Submit a Complaint with the CFPB

• If you have an issue with a consumer financial product (such as a mortgage or credit card), you can submit a complaint to CFPB.  CFPB will forward your complaint to the company and work to get a response from them. Visit consumerfinance.gov/complaint or call (855) 411-2372.

The SEC’s Office of Investor Education and Advocacy and the CFPB’s Office of Older Americans have provided this information as a service to investors and consumers.  It is neither a legal interpretation nor a statement of SEC or CFPB policy.  If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities or consumer finance law.

Merrill Lynch Admits Using Inaccurate Data for Short Sale Orders, Agrees to $11 Million Settlement

Merrill Lynch Admits Using Inaccurate Data for Short Sale Orders, Agrees to $11 Million Settlement

06/01/2015 02:30 PM EDT

The Securities and Exchange Commission today charged two Merrill Lynch entities with using inaccurate data in the course of executing short sale orders.  Merrill Lynch agreed to admit wrongdoing, pay nearly $11 million, and retain an independent compliance consultant in order to settle the charges.
According to the SEC's order instituting a settled administrative proceeding, Merrill Lynch and other broker-dealers are routinely asked by customers to "locate" stock for short selling, and firms prepare easy-to-borrow (ETB) lists comprised of stocks they have deemed readily accessible for the purpose of granting locates.  At times during the course of a trading day, some securities that Merrill Lynch placed on its ETB list that morning became no longer easily available to borrow as determined by lending desk professionals tracking market events and other daily developments.
The SEC's order finds that Merrill Lynch personnel appropriately ceased using the ETB list to source locates when availability of certain shares became restricted, but the firm's execution platforms were programmed to continue processing short sale orders based on the ETB list.  For example, while personnel received responses from lenders that a supply of a particular security was no longer available, Merrill Lynch's systems continued to rely on the ETB list and execute short sales totaling thousands of shares of that security.  It wasn't until the platforms received the next day's ETB list that they returned to utilizing accurate and present data.  After the SEC started investigating, Merrill Lynch began implementing systems enhancements to correct the problem.
"Firms must comply with their short-selling obligations by making sure they do not rely on inaccurate ETB lists," said Andrew M. Calamari, Director of the SEC's New York Regional Office.  "When firm personnel determine that a security should no longer be considered easy to borrow, the firm's systems need to incorporate that knowledge immediately."
The SEC's order further finds that for a period until 2012, a flaw in Merrill Lynch's systems occasionally triggered the inadvertent use of day-old data when constructing ETB lists.  The stale data caused some securities to be included on an ETB list when they should not have been.
Merrill Lynch admits violating Rule 203(b) of Regulation SHO of the Securities Exchange Act of 1934, and the SEC's order requires the firm to cease and desist from committing or causing any future violations.  Merrill Lynch agreed to pay a $9 million penalty, $1,566,245.67 in disgorgement, and $334,564.65 in prejudgment interest.  The independent compliance consultant must conduct a comprehensive review of the firm's policies, procedures, and practices for accepting short sale orders for execution, effecting short sales in reliance on the ETB list, and monitoring compliance.

SEC Charges Deutsche Bank With Misstating Financial Reports During Financial Crisis

SEC Charges Deutsche Bank With Misstating Financial Reports During Financial Crisis

05/26/2015 11:25 AM EDT

The Securities and Exchange Commission today charged Deutsche Bank AG with filing misstated financial reports during the height of the financial crisis that failed to take into account a material risk for potential losses estimated to be in the billions of dollars.

Deutsche Bank agreed to pay a $55 million penalty to settle the charges.

An SEC investigation found that Deutsche Bank overvalued a portfolio of derivatives consisting of "Leveraged Super Senior" (LSS) trades through which the bank purchased protection against credit default losses.  Because the trades were leveraged, the collateral posted for these positions by the sellers was only a fraction (approximately 9 percent) of the $98 billion total in purchased protection.  This leverage created a "gap risk" that the market value of Deutsche Bank's protection could at some point exceed the available collateral, and the sellers could decide to unwind the trade rather than post additional collateral in that scenario.  Therefore, Deutsche Bank was protected only up to the collateral level and not for the full market value of its credit protection.  Deutsche Bank initially took the gap risk into account in its financial statements by adjusting down the value of the LSS positions.
According to the SEC's order instituting a settled administrative proceeding, when the credit markets started to deteriorate in 2008, Deutsche Bank steadily altered its methodologies for measuring the gap risk. Each change in methodology reduced the value assigned to the gap risk until Deutsche Bank eventually stopped adjusting for gap risk altogether.  For financial reporting purposes, Deutsche Bank essentially measured its gap risk at $0 and improperly valued its LSS positions as though the market value of its protection was fully collateralized.  According to internal calculations not for the purpose of financial reporting, Deutsche Bank estimated that it was exposed to a gap risk ranging from $1.5 billion to $3.3 billion during that time period.

"At the height of the financial crisis, Deutsche Bank's financial statements did not reflect the significant risk in these large, complex illiquid positions," said Andrew J. Ceresney, Director of the SEC's Division of Enforcement.  "Deutsche Bank failed to make reasonable judgments when valuing its positions and lacked robust internal controls over financial reporting."

In addition to the $55 million penalty, the SEC's order requires Deutsche Bank to cease and desist from committing or causing any violations or future violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 12b-20, 13a-1, and 13a-16.  Deutsche Bank neither admits nor denies the SEC's findings in the order.