SEC, FINRA ISSUE ALERT TO INVESTORS REGARDING SHELL COMPANIES BEING SOLD AS PENNY STOCKS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission’s Office of Investor Education and Advocacy and the Financial Industry Regulatory Authority (FINRA) today issued an alert warning investors that some penny stocks being aggressively promoted as great investment opportunities may in fact be stocks of dormant shell companies with little to no business operations.

The investor alert provides tips to avoid pump-and-dump schemes in which fraudsters deliberately buy shares of very low-priced, thinly traded stocks and then spread false or misleading information to pump up the price.  The fraudsters then dump their shares, causing the prices to drop and leaving investors with worthless or nearly worthless shares of stock.

“Fraudsters continue to try to use dormant shell company scams to manipulate stock prices to the detriment of everyday investors,” said Lori J. Schock, Director of the SEC’s Office of Investor Education and Advocacy.  “Before investing in any company, investors should always remember to check out the company thoroughly.”

Gerri Walsh, FINRA’s Senior Vice President for Investor Education, said, “Investors should be on the lookout for press releases, tweets or posts aggressively promoting companies poised for explosive growth because of their ‘hot’ new product.  In reality, the company may be a shell, and the people behind the touts may be pump-and-dump scammers looking to lighten your wallet.”

The investor alert highlights five tips to help investors avoid scams involving dormant shell companies:

Research whether the company has been dormant – and brought back to life.  You can search the company name or trading symbol in the SEC’s EDGAR database to see when the company may have last filed periodic reports.

Know where the stock trades.  Most stock pump-and-dump schemes involve stocks that do not trade on The NASDAQ Stock Market, the New York Stock Exchange or other registered national securities exchanges.

Be wary of frequent changes to a company's name or business focus.  Name changes and the potential for manipulation often go hand in hand.

Check for mammoth reverse splits. A dormant shell company might carry out a 1-for-20,000 or even 1-for-50,000 reverse split.

Know that "Q" is for caution.  A stock symbol with a fifth letter "Q" at the end denotes that the company has filed for bankruptcy.

SEC ANNOUNCES WHISTLEBLOWER AWARD OF $300,000

 FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION

The Securities and Exchange Commission announced a whistleblower award of more than $300,000 to a company employee who performed audit and compliance functions and reported wrongdoing to the SEC after the company failed to take action when the employee reported it internally.

It’s the first award for a whistleblower with an audit or compliance function at a company.

“Individuals who perform internal audit, compliance, and legal functions for companies are on the front lines in the battle against fraud and corruption.  They often are privy to the very kinds of specific, timely, and credible information that can prevent an imminent fraud or stop an ongoing one,” said Sean McKessy, Chief of the SEC’s Office of the Whistleblower.  “These individuals may be eligible for an SEC whistleblower award if their companies fail to take appropriate, timely action on information they first reported internally.”

This particular whistleblower award recipient reported concerns of wrongdoing to appropriate personnel within the company, including a supervisor.  But when the company took no action on the information within 120 days, the whistleblower reported the same information to the SEC.  The information provided by the whistleblower led directly to an SEC enforcement action.

The SEC’s whistleblower program rewards high-quality, original information that results in an SEC enforcement action with sanctions exceeding $1 million.  Whistleblower awards can range from 10 percent to 30 percent of the money collected in a case.  By law, the SEC must protect the confidentiality of whistleblowers and cannot disclose any information that might directly or indirectly reveal a whistleblower’s identity.

SEC CHARGES 4 PROMOTERS WITH MANIPULATING THE SECURITIES OF MICROCAP MARIJUANA-RELATED STOCKS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today charged four promoters with ties to the Pacific Northwest for manipulating the securities of several microcap companies, including marijuana-related stocks that the agency has warned investors about in recent weeks.

The SEC alleges that the four promoters bought inexpensive shares of thinly traded penny stock companies on the open market and conducted pre-arranged, manipulative matched orders and wash trades to create the illusion of an active market in these stocks.  They then sold their shares in coordination with aggressive promotional campaigns that urged investors to buy the stocks because the prices were on the verge of rising substantially.  However, these companies had little to no business operations at the time. The promoters reaped more than $2.5 million in illegal profits through their schemes.

Two of the companies manipulated in this case – GrowLife Inc. and Hemp Inc. – claim to be related to the medical marijuana industry.  The SEC has issued an investor alert warning about possible scams involving marijuana-related investments, noting that fraudsters often exploit the latest growth industries to lure investors into stock manipulation schemes.  Other schemes by these four promoters involved an oil-and-gas company – Riverdale Oil and Gas Corporation – and three other microcap stocks, ISM International, Allied Products Corp, and Aden Solutions.

The SEC was able to unearth the schemes through the work of its recently created Microcap Fraud Task Force.

“Our Microcap Fraud Task Force is taking direct aim at abusive practices and serial violators within the microcap markets like these four promoters seeking to exploit retail investors for personal gain,” said Michael Paley, co-chair of the SEC’s Microcap Fraud Task Force.  “In this case, we meticulously reviewed trading records and developed the evidence necessary to connect these four promoters and their coordinated trading efforts.”

The SEC’s complaint filed in federal court in Tacoma, Wash., charges the following individuals:

Mikhail Galas, a stock promoter who lives in Vancouver, Wash.
Alexander Hawatmeh, a member of Worthmore Investments LLC, which owns a stock promotion website called stockhaven.com.  He formerly lived in Vancouver and currently resides in Lincoln City, Oregon.
Christopher Mrowca, a stock promoter who operates Money Runners Group LLC, which has an affiliated stock promotion website called MoneyRunnersGroup.com.  He lives in Bradenton, Fla.
Tovy Pustovit, who owns a stock promotion website called Explosive Alerts.  He also lives in Vancouver.
In a parallel action, the U.S. Attorney’s Office for the Western District of Washington announced criminal charges against Galas, Hawatmeh, and Mrowca.

According to the SEC’s complaint, GrowLife Inc. was part of a broader online promotion of several marijuana-related stocks in early 2014.  Mrowca specifically promoted GrowLife through his Money Runners Group website and predicted that the stock price would nearly double.  Mrowca, Galas, and Hawatmeh meanwhile engaged in manipulative trading designed to increase the price and volume of GrowLife stock, and they later sold their shares for illicit profits.

Similarly, the SEC alleges that Hawatmeh, Galas, and Mrowca bought and sold approximately 41.7 million shares of Hemp Inc. in January and February 2014 while the stock was actively promoted on the Internet.  For example, one Internet tout on February 6 claimed that Hemp could reach “a REAL Possible Gain of OVER 2900%.”  During the promotion, Hawatmeh, Mrowca, and Galas engaged in manipulative wash trades and matched orders to manipulate Hemp’s common stock before selling their shares for illegal gains.

“This was a carefully planned operation by Galas, Hawatmeh, Mrowca, and Pustovit to distort the performance of specific penny stocks as they were simultaneously promoted through social media and the Internet.  As the companies’ stock prices increased, these four promoters opportunistically dumped their shares for illicit gains,” said Amelia A. Cottrell, associate director in the SEC’s New York Regional Office.

The SEC’s complaint charges Galas, Hawatmeh, Mrowca and Pustovit with violating antifraud provisions of the federal securities laws.  The SEC seeks temporary, preliminary, and permanent injunctions along with an emergency asset freeze, disgorgement, prejudgment interest, financial penalties, and orders barring the promoters from participating in a penny stock offering.

The SEC’s complaint names Nadia Hawatmeh as a relief defendant for the purposes of recovering ill-gotten gains in her brokerage account, which was used by the promoters to conduct some of their manipulative trades.

The SEC’s investigation has been conducted by Michael Paley, Eric M. Schmidt, Mona Akhtar, Joseph Darragh, and Tejal Shah.  The case was supervised by Ms. Cottrell, and the litigation will be led by David Stoelting.  The SEC appreciates the assistance of the U.S. Attorney’s Office for the Western District of Washington, the Federal Bureau of Investigation, and the Financial Industry Regulatory Authority

TRADER PLEADS GUILTY FOR PARTICIPATION IN HIGH YIELD INVESTMENT FRAUD

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION  

Monday, July 21, 2014

Unlicensed Trader Pleads Guilty in Los Angeles for Role in Fraudulent High Yield Investment Program Scheme

An unlicensed trader who solicited $500,000 from undercover FBI agents to invest in a fraudulent high yield investment program pleaded guilty today in federal court in Los Angeles.

Assistant Attorney General Leslie R. Caldwell of the Justice Department’s Criminal Division, U.S. Attorney André Birotte Jr. of the Central District of California and Assistant Director in Charge Bill Lewis of the FBI’s Los Angeles Field Office made the announcement.

Jessie Tolbert, 38, of Bastrop, Louisiana, pleaded guilty today to one count of conspiracy to commit wire fraud and one count of wire fraud.   He is scheduled to be sentenced on Oct. 20, 2014.

According to court documents, in December 2011, Tolbert and his co-conspirators, including Eriq Brye and Greg Preston, placed an advertisement online for an investment opportunity.   Undercover federal agents responded to this advertisement.    During several weeks of email and telephone communications, Tolbert and his co-conspirators informed the agents that a spot recently had opened up on a high yield investment program they purportedly were running and that a $500,000 investment in their program would generate $30 million in 30 days.   Tolbert did not actually run an investment program.

In an effort to induce the undercover agents to invest in the program, Tolbert and his co-conspirators made numerous material misrepresentations.   Specifically, Tolbert falsely and repeatedly guaranteed the success of the proposed trade based on his purported past success in generating similar returns in comparable trades, as well as his success in other investments in the financial industry.   Tolbert had never applied for, nor received, a license with any federal agency related to the financial industry.

Brye is a fugitive.   Preston pleaded guilty in May 2013 for conduct including his role in this investment scheme.   He is scheduled to be sentenced on December 19, 2014.

An indictment is merely an allegation, and a defendant is presumed innocent unless and until proven guilty beyond a reasonable doubt.

This case was investigated by the FBI and prosecuted by Assistant Chief Benton Curtis and Trial Attorneys Kyle Maurer and Alex Porter of the Criminal Division’s Fraud Section.

SEC CHARGES SCHOOL DISTRICT WITH MISLEADING BOND INVESTORS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission charged a school district in California with misleading bond investors about its failure to provide contractually required financial information and notices.  The case is the first to be resolved under a new SEC initiative to address materially inaccurate statements in municipal bond offering documents. 

The SEC found that in the course of a 2010 bond offering, Kings Canyon Joint Unified School District affirmed to investors that it had complied with its prior continuing disclosure obligations.  The statement was inaccurate because between at least 2008 and 2010, the school district had failed to submit some required disclosures.  The California school district agreed to settle the charges without admitting to or denying the findings.

Under the Municipalities Continuing Disclosure Cooperation (MCDC) initiative, the SEC’s Enforcement Division agreed to recommend standardized settlement terms for issuers and underwriters who self-report or were already under investigation for violations involving continuing disclosure obligations.  The 2014 initiative, launched on March 10, expires on September 10.

“The integrity of the municipal securities market requires that issuers carefully comply with all of their disclosure obligations,” said Andrew J. Ceresney, director of the SEC’s Division of Enforcement.  “Our MCDC initiative is one piece of our efforts to ensure that issuers meet their obligations going forward.”

LeeAnn Ghazil Gaunt, chief of the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit added, “An important component of the MCDC program is that it provides issuers who were already under investigation the opportunity to accept the standard terms and resolve their enforcement matters in a fair and efficient manner.  We are pleased that King’s Canyon has taken advantage of the program and we continue to encourage all eligible issuers and underwriters to do so while the MCDC terms are still available.”

The SEC’s order instituting settled administrative proceedings finds that in three bond offerings between 2006 and 2007, Kings Canyon contractually agreed to disclose annual financial information and notices of certain events pertaining to those bonds.  When it conducted a $6.8 million bond offering in November 2010, Kings Canyon was required to describe any instances where it had failed to materially comply with its prior disclosure obligations.  In the 2010 offering document, Kings Canyon inaccurately affirmed that there was “no instance in the previous five years in which it failed to comply in all material respects with any previous continuing disclosure obligation.”  Because Kings Canyon failed to submit some of the contractually required disclosures relating to the 2006 and 2007 offerings, the November 2010 bond offering document contained an untrue statement of a material fact.

Without admitting or denying the SEC’s findings, Kings Canyon consented to an order to cease and desist from committing or causing any future violations of Section 17(a) of the Securities Act.  It also agreed to adopt written policies for its continuing disclosure obligations, comply with its existing continuing disclosure obligations, cooperate with any subsequent investigation by the Enforcement Division, and disclose the terms of its settlement with the SEC in future bond offering materials.   

The SEC’s investigation was conducted by Monique C. Winkler and was supervised by Cary Robnett.  Both are in the SEC’s San Francisco Regional Office and are members of the Enforcement Division’s Municipal Securities and Public Pensions Unit.

SEC ISSUES INVESTOR ALERT REGARDING FINANCIAL PROFESSIONALS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION

The SEC’s Office of Investor Education and Advocacy is issuing this Investor Alert to help investors identify and be aware of financial professionals that may have a history of misconduct.

Potential Red Flags for Financial Professionals

The SEC oversees key participants in the securities industry, including broker-dealers and investment advisers.  The SEC and other regulators may bring enforcement actions against financial professionals for misconduct in connection with their securities related activities.  Some financial professionals may also have a history of customer complaints or other indications of possible bad behavior.

Investors should be cautious of financial professionals with a history of misconduct.  Red flags may include:

Disciplinary actions by a government regulator, such as the SEC or a state securities regulator, or by a self-regulatory organization, such as FINRA;
A history of customer complaints;
Lawsuits or arbitration claims brought by customers;
Employment with one or more firms that have been expelled from the securities industry.

Check the Financial Professional’s Background

Even if a close friend or family member recommends a financial professional, you should still check out that person for signs of potential problems.  Before becoming a customer, take the time to look at the registration status and background of any firm or financial professional you are considering.

Anyone registered to sell securities or provide investment advice generally must disclose certain customer complaints, lawsuits and arbitrations, regulatory actions, employment terminations, bankruptcy filings, and certain other criminal or civil legal proceedings.  You should also be able to find out whether the individual is currently registered or licensed, or has been suspended, as well as the individual’s qualifications and employment history.  These records are available through the SEC, FINRA, and/or state securities regulators.

           FINRA’s BrokerCheck Program

For an individual broker or a brokerage firm, background information is available through FINRA’s BrokerCheck report.  BrokerCheck reports are free and investment professionals or firms are not made aware of any search conducted.

A FINRA BrokerCheck report for an individual includes a listing of the broker’s registrations or licenses, industry exams that the broker has passed, and information on a broker’s previous employment, customer disputes, and regulatory or disciplinary events.  A FINRA BrokerCheck report for a firm includes, among other things, the firm’s history (including any mergers, acquisitions or name changes), a listing of the firm’s active licenses and registrations, arbitration awards against the firm, and regulatory or disciplinary events.

As noted above, a potential red flag for financial professional misconduct is previous employment at one or more firms that have been expelled from the securities industry.  To determine whether this red flag applies to an individual broker, review the BrokerCheck report for the individual broker and review the firms listed under the “Registration History” section.  Then, run a separate BrokerCheck report for each of those firms listed.

A BrokerCheck report may be obtained from FINRA in any of the following ways:
Submitting a request to FINRA via U.S. mail or fax.  The BrokerCheck mailing address and fax number are:
      FINRA BrokerCheck
      P.O. Box 9495
      Gaithersburg, MD 20898-9495
      Fax: (240) 386-4750

            Investment Adviser Public Disclosure (IAPD) Website

Certain firms or financial professionals, such as money managers, investment consultants, and financial planners may be required to register with the SEC or your state’s securities regulator as investment advisers.

For state-registered investment advisers or their representatives, background information such as a description of the adviser’s business practices, fees, conflicts of interest, and disciplinary history, is generally available from your state securities regulator. You may find information on how to contact your state securities regulator in the “State Securities Regulators” section of this investor alert.

            State Securities Regulators

State securities regulators also have background information on brokers and state-registered investment advisers. Notably, state securities regulators may, in certain instances, provide information in addition to what may be found in a FINRA BrokerCheck report or on the SEC’s IAPD website.

            Professional Titles

Some financial professionals also may have professional titles, such as Certified Financial Planner (CFP®) or Chartered Financial Analyst (CFA®).  The requirements for obtaining and using professional titles vary widely.  To use certain titles, a financial professional may need to pass exams, meet ethical standards, have relevant work experience, and undertake continuing education.  Other titles, however, may be obtained with little time, effort, and experience.  Keep in mind that a professional title is not the same as a license or registration granted by federal or state regulatory authorities.


The SEC does not endorse any financial professional titles, and you are strongly encouraged to look beyond a financial professional’s title when determining whether he or she can provide the type of financial services or products you need.

SEC FILES ACTION TO HALT ALLEGED ONGOING FRAUD

FROM:  SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission filed an emergency
 enforcement action to halt an ongoing fraud by an investment adviser based in Albany, N.Y., who is charged with lying to clients about the success of their investments while stealing their money for his personal use.

The SEC alleges that Scott Valente and his firm The ELIV Group LLC have fraudulently raised more than $8.8 million from approximately 80 clients by falsely claiming they achieve consistent and outsized positive returns among other misrepresentations about the safety of the investments.  ELIV Group has in fact earned no positive results at all, instead sustaining consistent investment losses for the past three years. Meanwhile, Valente has been making substantial cash withdrawals of client funds and spending their money on his home improvements and mortgage payments as well as jewelry and a vacation condominium.  Valente’s unsuccessful trading strategies and misappropriations have severely diluted the amount of client funds on hand at ELIV Group, and the SEC is seeking an asset freeze to halt the fraud as Valente continues to solicit new clients with his false claims.  ELIV Group has offices in Albany and Warwick, N.Y.

“Valente used his one-man advisory firm to fraudulently lure unsuspecting investors in the Albany and Warwick communities to invest millions of dollars with him as advisory clients,” said Andrew M. Calamari, director of the SEC’s New York Regional Office.  “He said all the right things to make investors believe he was making the right investments and taking the right precautions with their money, but he was merely telling blatant false tales about the safety and success of the investments.”

Sanjay Wadhwa, senior associate director for enforcement in the SEC’s New York office, added, “Beyond the lies to his clients regarding his investment performance, Valente’s abuse of his fiduciary obligations included the theft of at least $2.66 million in client funds for personal spending, including hefty credit card bills, a vacation home, and jewelry.”

According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, Valente misleadingly told his clients that he has a 30-year record of investing experience “dedicated to the highest standards of service” and that he founded ELIV Group after leaving the “corporate financial industry” upon concluding there “had to be a better way for clients to achieve financial independence.”  What he failed to disclose was that he twice filed for bankruptcy and started ELIV Group only after the Financial Industry Regulatory Authority (FINRA) permanently expelled him from the broker-dealer industry in 2009 for engaging in serial misconduct against numerous customers.

The SEC alleges that Valente and ELIV Group attracted clients by falsely assuring them that the principal amount of their investments was fully liquid and “guaranteed” because it was backed by a large money market fund.  Client funds were in fact never guaranteed or backed by any money market funds, and the majority of ELIV Group’s investments were in highly illiquid investments in privately-held companies.  Valente and ELIV Group also assured clients that the firm’s books and records were audited independently.  However, ELIV Group never had an auditor, and the firm sent clients monthly investment reports in which they actually inflated the monthly returns, assets under management, and client account values.

The SEC’s complaint charges Valente and ELIV with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(b) as well as Sections 206(1) and 206(2) of the Investment Advisers Act of 1940.  The SEC is seeking a temporary restraining order to freeze their assets and prohibit Valente and ELIV from committing further violations of the federal securities laws.  The SEC seeks a final judgment ordering them to disgorge their ill-gotten gains plus prejudgment interest and pay financial penalties.

The SEC’s investigation, which is continuing, has been conducted by Gerald Gross, Richard Primoff, and Barry O’Connell of the New York Regional Office.  The inquiry that led to the investigation was conducted by Richard Heaphy, Yvette Panetta, Dee-Ann DiSalvo, and Edward Cody of the New York Regional Office.  The SEC appreciates the assistance of the Federal Bureau of Investigation.

SEC CHARGES BROKERAGE FIRM WITH IMPROPER USE OF TRADER CONFIDENTIAL INFORMATION

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission charged a New York-based brokerage firm that operates a dark pool alternative trading system with improperly using subscribers’ confidential trading information in marketing its services.

Regulations require an alternative trading system (ATS) to establish and enforce safeguards and procedures to protect the confidential trading information of its subscribers.  Among them is limiting access to subscribers’ data to employees who operate the ATS or have a direct compliance role.

An SEC investigation found that Liquidnet Inc. violated its regulatory obligations and its own promises to its ATS subscribers during a nearly three-year period when it improperly allowed a business unit outside the dark pool operation to access the confidential trading data.  Employees in that unit used the confidential information about Liquidnet’s dark pool subscribers during marketing presentations and various communications to other customers.  Liquidnet also used subscribers’ confidential trading information in two ATS sales tools that it devised.

SEC examiners spotted potential data access problems during an examination of Liquidnet and referred the matter to the Enforcement Division for further investigation.  Liquidnet has agreed to settle the SEC’s charges and pay a $2 million penalty.

“Dark pool operators violate the law when they fail to protect the confidential trading information that their subscribers entrust to them, as Liquidnet did here when it used this confidential information to try to expand its business,” said Andrew J. Ceresney, director of the SEC Enforcement Division.  “We will continue to aggressively police broker-dealers who operate an ATS and fail to rigorously ensure the protection of confidential trading information.”

According to the SEC’s order instituting a settled administrative proceeding, Liquidnet’s core business is operating a block-trading dark pool for large institutional investors.  Liquidnet has represented to its dark pool subscribers that it would keep their trading information confidential and allow them to trade with maximum anonymity and minimum information leakage.  In an effort to find additional sources of liquidity for its dark pool, Liquidnet launched an Equity Capital Markets (ECM) desk in 2009 to offer block execution services to corporate issuers and control persons of corporate issuers as well as private equity and venture capital firms looking to execute large equity capital markets transactions with minimal market impact.

The SEC’s order finds that Liquidnet provided ECM employees with access to the confidential trading information of dark pool subscribers from 2009 to late 2011, and they used it to market ECM’s services.  For example, ECM employees would provide issuers with descriptions of ATS subscribers who had recently indicated interest in buying or selling shares of issuers’ stock.  These descriptions included the geographic locations, approximate assets under management, and investment styles of those dark pool subscribers.  ECM employees used dark pool subscribers’ trading data to advise issuers about which institutional investors they should meet during investor conferences or non-deal roadshows.  They also used dark pool subscriber data to advise ECM customers when they should execute transactions in the ATS given the liquidity the ECM employees could see in the dark pool.

“Liquidnet’s subscribers trusted and believed that the firm was safeguarding their confidential information,” said Daniel M. Hawke, chief of the SEC Enforcement Division’s Market Abuse Unit.  “Instead, the firm breached its assurances of confidentiality and anonymity to them by allowing its ECM employees to improperly access subscriber trading data.”

According to the SEC’s order, Liquidnet also improperly used the confidential trading data of dark pool subscribers in two ATS sales tools.  Liquidnet created “ships passing” alerts that alerted ATS sales employees to missed execution opportunities between subscriber algorithmic orders and subscriber indications.  The firm also developed an application called Aqualytics, which identified subscribers to be contacted about Liquidnet’s recent dominance in certain stocks.

The SEC’s order charges Liquidnet with violating Section 17(a)(2) of the Securities Act of 1933, which prohibits obtaining money or property by means of materially false or misleading statements in the offer or sale of securities.  Liquidnet also violated Rule 301(b)(2) of Regulation ATS, which requires that an ATS file certain amendments on Form ATS with the SEC, as well as Rule 301(b)(10) of Regulation ATS, which requires an ATS to establish adequate safeguards and procedures for protecting confidential trading information of its subscribers.  Without admitting or denying the findings, Liquidnet consented to the SEC’s order, which censures the firm and requires it to pay the $2 million penalty and cease and desist from committing the violations.

The SEC’s investigation was conducted by Simona Suh, Stephen A. Larson, and Mandy B. Sturmfelz of the Market Abuse Unit and Thomas P. Smith Jr. and Jordan Baker of the New York Regional Office.  The case was supervised by Amelia A. Cottrell of the New York office.  The SEC examiners who conducted the examination of Liquidnet that led to the investigation were June Reinertsen, Maggie Simmermon, Ronald Sukhu, Ilan S. Felix, and Richard A. Heaphy of the New York office.  The SEC appreciates the cooperation of the Financial Industry Regulatory Authority.

BITCOM-RELATED WEBSITE OWNER CHARGED BY SEC WITH OFFERING UNREGISTERED SECURITIES

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today charged the co-owner of two Bitcoin-related websites for publicly offering shares in the two ventures without registering them.

An SEC investigation found that Erik T. Voorhees published prospectuses on the Internet and actively solicited investors to buy shares in SatoshiDICE and FeedZeBirds.  But he failed to register the offerings with the SEC as required under the federal securities laws.  Investors paid for their shares using Bitcoin, a virtual currency that can be used to purchase real-world goods and services and exchanged for fiat currencies on certain online exchanges.  The profits ultimately earned by Voorhees through the unregistered offerings totaled more than $15,000.

Voorhees agreed to settle the SEC’s charges by paying full disgorgement of the $15,843.98 in profits plus a $35,000 penalty for a total of more than $50,000.

“All issuers selling securities to the public must comply with the registration provisions of the securities laws, including issuers who seek to raise funds using Bitcoin,” said Andrew J. Ceresney, director of the SEC’s Division of Enforcement.  “We will continue to focus on enforcing our rules and regulations as they apply to digital currencies.”

According to the SEC’s order instituting a settled administrative proceeding, the first unregistered offering occurred in May 2012 as 2,600 bitcoins were raised through the sale of 30,000 shares in FeedZeBirds, which promises to pay bitcoins to Twitter users who forward its sponsored text messages.  Then in two separate offerings from August 2012 to February 2013, SatoshiDICE sold 13 million shares and raised 50,600 bitcoins that were worth approximately $722,659 at the time.  SatoshiDICE, which calls itself the biggest Bitcoin-betting game in the world and pays out casino-like winnings in bitcoins, ultimately returned these offering proceeds to investors in a buy-back transaction in July 2013.  A significant rise in the exchange rate of U.S. dollars to bitcoins actually increased the amount paid back to investors to approximately $3.8 million for 45,500 bitcoins.

The SEC’s order finds that Voorhees actively solicited investors to buy FeedZeBirds and SatoshiDICE shares on a website dedicated to Bitcoin known as the Bitcoin Forum.  Voorhees also publicly promoted the unregistered offerings on other Bitcoin-related websites as well as Facebook.  The first unregistered offering was explicitly referred to as the “FeedZeBirds IPO.”  Despite these general solicitations, no registration statement was filed for the FeedZeBirds or SatoshiDICE offerings, and no exemption from registration was applicable to these transactions.

The SEC’s order finds that Voorhees violated Sections 5(a) and 5(c) of the Securities Act of 1933.  Voorhees consented to cease and desist from committing or causing any future violations of the registration provisions without admitting or denying the SEC’s findings.  In addition to the monetary sanctions, Voorhees agreed that he will not participate in any issuance of any security in an unregistered transaction in exchange for any virtual currency including Bitcoin for a period of five years.  The entry of the SEC’s order disqualifies Voorhees from relying on Rule 506(b) and 506(c) of Regulation D under the Securities Act, as defined in the bad actor disqualification provisions of Rule 506.

The SEC’s investigation was conducted by Daphna A. Waxman, Daphne P. Downes, and Philip R. Moustakis of the New York Regional Office.  The case was supervised by Valerie A. Szczepanik and Amelia A. Cottrell.

SEC CHARGES CHARTER SCHOOL OPERATOR WITH DEFRAUDING INVESTORS IN $37.5 MILLION BOND OFFERING

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission charged a charter school operator in Chicago with defrauding investors in a $37.5 million bond offering for school construction by making materially misleading statements about transactions that presented a conflict of interest.

The SEC alleges that UNO Charter School Network Inc. and United Neighborhood Organization of Chicago not only failed to disclose a multi-million-dollar contract with a windows company owned by the brother of one of its senior officers, but investors also weren’t informed about the potential financial impact the conflicted transaction had on its ability to repay the bonds.

UNO is settling the SEC’s charges by agreeing to undertakings to improve its internal procedures and training, including the appointment of an independent monitor.

“UNO misled its bond investors by assuring them it had reported conflicts of interest in connection with state grants when in fact it had not,” said Andrew J. Ceresney, director of the SEC’s Division of Enforcement.  “Investors had a right to know that UNO’s transactions with related persons jeopardized its ability to pay its bonds because they placed the grant money that was primarily funding the projects at risk.”

According to the SEC’s complaint filed in federal court in Chicago, UNO entered into two grant agreements with the Illinois Department of Commerce and Economic Opportunity (IDCEO) in 2010 and 2011 to build three schools.  Each grant agreement contained a provision requiring UNO to certify that no conflict of interest existed when it signed the agreements.  UNO was required to immediately notify IDCEO in writing if any actual or potential conflicts subsequently arose.  If UNO breached this conflict of interest provision, IDCEO could suspend the payment of grants and recover grant funds already paid to UNO.

According to the SEC’s complaint, UNO breached the conflict of interest provision as it entered the construction phases of the project in 2011 and 2012.  UNO contracted two companies owned by brothers of its chief operating officer.  UNO agreed to pay one company approximately $11 million to supply and install windows and the other company approximately $1.9 million to serve as an owner’s representative during construction.  UNO did not advise IDCEO in writing about either of those conflicted transactions.

The SEC alleges that when UNO conducted its $37.5 million bond offering in October 2011, it issued an official statement to investors in bond offering documents that devoted an entire subsection to the subject of conflicts of interest.  UNO affirmatively assured investors that its conflicts policy was more robust than required for non-profit organizations.  UNO did disclose the contract with the company serving as owner’s representative, which was owned by the chief operating officer’s brother – who was a former UNO board member himself.

The SEC alleges that UNO nonetheless failed to disclose its much larger transactions with the windows company owned by another brother of the chief operating officer.  Moreover, nothing in the official statement disclosed that UNO already was in breach of the conflict of interest provision in its June 2010 grant agreement with the IDCEO because it already had transacted with both companies without advising the agency in writing about those engagements.  UNO also failed to disclose in the official statement that IDCEO could recoup all of the grant money as a result of this breach of the conflicts of interest provision.  Had IDCEO exercised its rights under the grant agreements and recouped the entire amount of the grants, UNO would not have had the cash to repay the grants and therefore would have had to liquidate its charter schools – the very revenue-producing assets essential for repayment of the bonds.

“Conflicted transactions and self-dealing by issuer officials can be material information for municipal bond investors and should be given appropriate focus by issuers and underwriters in disclosure documents,” said LeeAnn Gaunt, chief of the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit.  “Failing to disclose material information undermines investor confidence in the municipal securities market and places at risk an important source of funding for local government projects.”

The SEC complaint charges UNO with violations of Section 17(a)(2) of the Securities Act of 1933.  UNO neither admitted nor denied the charges in the settlement.

The SEC’s investigation is continuing.  It has been conducted jointly by staff in the Chicago Regional Office and the Municipal Securities and Public Pensions Unit, including Michael Mueller, Eric Celauro, and Michael Foster.  The case is being supervised by Peter K.M. Chan.

SEC ANNOUNCES ANOTHER CASE INVOLVING ALLEGED SECURITIES PRICE MANIPULATION IN A MICROCAP COMPANY

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

Litigation Release No. 23000 / May 22, 2014

The Securities and Exchange Commission announced the latest in a series of cases against microcap companies, officers, and promoters arising out of a joint law enforcement investigation to unearth penny stock schemes with roots in South Florida.

In complaints filed in federal court in Miami, the SEC charged five penny stock promoters with conducting various manipulation schemes involving undisclosed payments to induce purchases of a microcap stock to generate the false appearance of market interest. The SEC also charged a Massachusetts-based microcap company and the CEO with orchestrating a pair of illicit kickback schemes and an insider trading scheme involving the company's stock. A stock promoter in Texas was charged for his role in the insider trading scheme.

The SEC has now charged 48 individuals and 25 companies in this series of penny stock investigations out of the agency's Miami Regional Office, which has worked closely with the U.S. Attorney's Office for the Southern District of Florida and the Federal Bureau of Investigation. The first of the joint enforcement actions was announced in October 2010.

The U.S. Attorney's Office for the Southern District of Florida today announced criminal charges against many of the same individuals charged today by the SEC.

According to the SEC's complaint against Boca Raton, Fla.-based stock promoters Kevin McKnight and Stephen C. Bauer, they engaged in market manipulation fraud involving the penny stock of Environmental Infrastructure Holdings Corp. (EIHC). They generated the appearance of market interest in EIHC to induce investors to purchase the stock and artificially increase the trading price and volume. In a separate complaint against Jeffrey M. Berkowitz of Jupiter, Fla., the SEC alleges that he participated in a market manipulation scheme involving the stock of Face Up Entertainment Group (FUEG) and similarly worked to falsely generate the appearance of market interest in that stock. The SEC's complaint against Eric S. Brown of Brooklyn, N.Y., alleges that he engaged in a pair of market manipulation schemes involving the stock of International Development & Environmental Holdings Corp. (IDEH) and DAM Holdings Inc. (DAMH), the latter of which is now known as Premier Beverage Group Corp. (PBGC). And according to an SEC complaint against Boca Raton, Fla.-based stock promoter Richard A. Altomare, he engaged in a market manipulation scheme involving the stock of Sunset Brands Inc. (SSBN).

The SEC alleges in a separate complaint that North Andover, Mass.-based Urban AG Corp. (AQUM) and its president and CEO Billy V. Ray Jr. of Cumming, Ga., schemed to make an undisclosed kickback payment to a hedge fund manager in exchange for the fund's purchase of restricted shares of stock in the company. In a separate kickback scheme, Ray made an inducement payment to a stock promoter who would purchase shares of Urban on the open market ahead of planned press releases to help him manipulate the stock. Meanwhile, stock promoter Wade Clark participated in Ray's insider trading scheme involving Urban stock by providing the hedge fund fiduciary with an advance copy of a press release containing material nonpublic information about the company so the hedge fund manager would purchase stock prior to the news being issued.

The SEC's complaints allege that Altomare, Bauer, Berkowitz, Brown, Clark, McKnight, Ray, and Urban AG Corp. violated Section 17(a)(1) of the Securities Act of 1933 and/or Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5(a) and 10b-5(c). The SEC is seeking financial penalties, disgorgement of ill-gotten gains plus prejudgment interest, and permanent injunctions. The SEC also seeks penny stock bars against all of the individuals charged in these cases as well as an officer-and-director bar against Ray.

The SEC appreciates the assistance of the U.S. Attorney's Office for the Southern District of Florida and the Miami division of the Federal Bureau of Investigation.

CHIEF RISK OFFICER OF AUDIT COMPANY CHARGED WITH VIOLATING AUDITOR INDEPENDENCE RULES

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today charged the former chief risk officer at Deloitte LLP for causing violations of the auditor independence rules that ensure audit firms maintain their objectivity and impartiality with respect to their clients.

An SEC order finds that certified public accountant James T. Adams repeatedly accepted tens of thousands of dollars in casino markers while he was the advisory partner on subsidiary Deloitte & Touche’s audit of a casino gaming corporation.  A marker is an instrument utilized by a casino customer to receive gaming chips drawn against the customer’s line of credit at the casino.  Adams opened a line of credit with a casino run by the gaming corporation client and used the casino markers to draw on that line of credit.  Adams concealed his casino markers from Deloitte & Touche and lied to another partner when asked if he had casino markers from audit clients of the firm.

Adams, who lives in California, agreed to settle the SEC’s charges by being suspended for at least two years from practicing as an accountant on behalf of any publicly traded company or other entity regulated by the SEC.

“The transactions by which Adams accepted the casino markers were loans from an audit client that are prohibited by the auditor independence rules,” said Scott W. Friestad, associate director in the SEC’s Division of Enforcement.  “Auditor independence is critical to the integrity of the financial reporting process.  Through his extensive use of casino markers, Adams clearly violated the rules and put his own desires ahead of his client’s interests.”

According to the SEC’s order instituting a settled administrative proceeding, Adams drew $85,000 worth of markers in July 2009 that remained outstanding for 43 days.  In September, he drew $3,000 in markers that were outstanding for 13 days and $70,000 in markers that were outstanding for 27 days.  In October, he drew $110,000 in markers that were outstanding for 38 days.  In December, he drew $100,000 in markers that were outstanding for seven days, and later drew $110,000 in markers that remained outstanding when he retired from the firm in May 2010.

The SEC’s order requires Adams to cease-and-desist from causing violations of Rule 2-02(b)(1) of Regulation S-X, Section 13(a) of the Securities Exchange Act of 1934, and Exchange Act Rule 13a-1.  Adams consented to the order without admitting or denying the SEC’s findings.

The SEC’s investigation was conducted by Steve Varholik, Kam Lee, Robert Peak, and Jeffrey Infelise.  The case was supervised by David Frohlich.

SEC WARNS INVESTORS TO TAKE CARE WHEN INVESTING IN MICRO CAP MARIJUANA INDUSTRY COMPANIES

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today cautioned investors about the potential for fraud in microcap companies that claim their operations relate to the marijuana industry after the agency suspended trading in the fifth such company within the past two months.

The SEC issued an investor alert warning about possible scams involving marijuana-related investments, noting that fraudsters often exploit the latest growth industry to lure investors with the promise of high returns.  “For marijuana-related companies that are not required to report with the SEC, investors may have limited information about the company’s management, products, services, and finances,” the SEC’s alert says.  “When publicly available information is scarce, fraudsters can more easily spread false information about a company, making profits for themselves while creating losses for unsuspecting investors.”

Spearheaded by its Microcap Fraud Task Force, the SEC Enforcement Division scours the microcap market and proactively identifies companies with publicly disseminated information that appears inadequate or potentially inaccurate.  The SEC has the authority to issue trading suspensions against such companies while the questionable activity is further investigated.

As the markets opened today, the SEC suspended trading in Denver-based FusionPharm Inc., which claims to make a professional cultivation system for use by cannabis cultivators among others.  According to the SEC’s order, the trading suspension was issued “because of questions that have been raised about the accuracy of assertions by FusionPharm” concerning the company’s assets, revenues, financial statements, business transactions, and financial condition.

“Recent changes in state laws concerning medical and recreational marijuana have created new opportunities for penny stock fraud,” said Elisha Frank, co-chair of the SEC Enforcement Division’s Microcap Fraud Task Force.  “Wherever we see incomplete or misleading disclosures, we act quickly to protect investors.”

Other marijuana-related companies in which the SEC recently suspended trading are Irvine, Calif.-based Cannabusiness Group Inc., Woodland Hills, Calif.-based GrowLife Inc., Colorado Springs-based Advanced Cannabis Solutions Inc., and Bedford, Texas-based Petrotech Oil and Gas Inc.

Under the federal securities laws, the SEC can suspend trading in a stock for 10 days and generally prohibit a broker-dealer from soliciting investors to buy or sell the stock again until certain reporting requirements are met.  More information about the trading suspension process is available in an SEC investor bulletin on the topic.

“We know from experience that fraudsters follow the headlines,” said Lori J. Schock, director of the SEC’s Office of Investor Education and Advocacy, which prepared the investor alert.  “Given the attention that marijuana-related companies have attracted recently, we urge investors to exercise caution when looking at investments in this space.  Always thoroughly research the company – and the person selling the investment – before making a decision.”

ONE ARRESTED, ANOTHER SOUGHT AS A FUGITIVE FOR ROLES IN PYRAMID SCHEME

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

Criminal Charges Filed Against Two Principals of Massachusetts-Based Telexfree

On Friday, May 9, 2014, the U.S. Attorney for the District of Massachusetts charged James M. Merrill, of Ashland, Massachusetts, and Carlos N. Wanzeler, of Northborough, Massachusetts, with conspiracy to commit wire fraud in connection with the alleged TelexFree pyramid scheme previously charged by the Securities and Exchange Commission. Federal authorities arrested Merrill on Friday, and an arrest warrant was issued for Wanzeler, who the Department of Justice announced is a fugitive. The Department of Justice also announced it has executed 37 seizure warrants seizing assets relating to the fraudulent pyramid scheme.

The criminal charges against Merrill and Wanzeler related to the same conduct charged in a civil enforcement action filed by the SEC on Tuesday, April 15, 2014, against Merrill, Wanzeler, and others. Those charges were filed under seal, in connection with the Commission's request for an immediate asset freeze. That asset freeze, which the U.S. District Court in Boston ordered on Wednesday, April 16, secured millions of dollars of funds and prevented the potential dissipation of investor assets. After the SEC staff implemented the asset freeze, at the SEC's request the Court lifted the seal on April 17. On April 30, 2014, the Court entered preliminary injunctions extending the asset freeze as to defendants Santiago De La Rosa, of Lynn, Massachusetts, and Randy N. Crosby, of Alpharetta, Georgia. On May 8 and 9, the Court entered preliminary injunctions extending the asset freeze as to all the remaining defendants (Merrill, Wanzeler, TelexFree, Inc., TelexFree, LLC, Joseph H. Craft, of Boonville, Indiana, Steve Labriola, of Northbridge, Massachusetts, Faith R. Sloan, of Chicago, Illinois, and relief defendants (TelexFree Financial, Inc., TelexElectric, LLLP, and Telex Mobile Holdings, Inc.).

 The SEC alleges that TelexFree, Inc. and TelexFree, LLC claim to run a multilevel marketing company that sells telephone service based on “voice over Internet” (VoIP) technology but actually are operating an elaborate pyramid scheme. In addition to charging the company, the SEC charged several TelexFree officers and promoters, and named several entities related to TelexFree as relief defendants based on their receipt of investor funds. According to the SEC's complaint filed in federal court in Massachusetts, the defendants sold securities in the form of TelexFree “memberships” that promised annual returns of 200 percent or more for those who promoted TelexFree by recruiting new members and placing TelexFree advertisements on free Internet ad sites. The SEC complaint alleges that TelexFree's VoIP sales revenues of approximately $1.3 million from August 2012 through March 2014 are barely one percent of the more than $1.1 billion needed to cover its promised payments to its promoters. As a result, in classic pyramid scheme fashion, TelexFree was paying earlier investors, not with revenue from selling its VoIP product but with money received from newer investors.

In related proceedings, on May 6, 2014, the U.S. Bankruptcy Court in the District of Nevada granted the SEC's motion to transfer venue of those proceedings from Nevada to Massachusetts. The SEC had contended that the TelexFree entities hastily filed for bankruptcy in Nevada on Sunday night, April 13, 2014, in a transparent attempt to avoid Massachusetts. The SEC had noted that TelexFree does virtually no business in Nevada but rather was headquartered in Marlborough, Massachusetts. The SEC also argued that TelexFree did not have a legitimate business capable of reorganization under the bankruptcy code. The bankruptcy case will be transferred to Massachusetts for all further proceedings.

THREE SOFTWARE COMPANY FOUNDERS CHARGED BY SEC WITH INSIDER TRADING

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today filed insider trading charges against three software company founders for taking unfair advantage of incorrect media speculation and analyst reports about the company’s acquisition.

They agreed to pay nearly $5.8 million to settle the SEC’s charges.

The SEC alleges that Lawson Software’s co-chairman Herbert Richard Lawson tipped his brother William Lawson and family friend John Cerullo with nonpublic information about the status of the company’s 2011 merger discussions with Infor Global Solutions, a privately-held software provider.  Lawson Software’s stock price had begun to climb following media and analyst reports that the company was considering a sale and multiple bidders were possible.  However, Richard Lawson knew reports about possible multiple bidders were incorrect, and the merger share price offered by the lone bidder was significantly lower than what journalists and analysts were speculating.  While in possession of the accurate, inside information from his brother, William Lawson sold more than one million shares of his family’s Lawson Software stock holdings.  He also suggested that another trader sell shares.  Cerullo sold approximately 175,000 of his company shares on the basis of the nonpublic information.  When Lawson Software later announced the merger agreement at the lower-than-anticipated share price, the company’s stock value dropped 8.7 percent.  By selling their shares at the inflated stock prices prior to the merger announcement, the traders collectively profited by more than $2 million.

“Richard Lawson conveyed material information that was contrary to what was being publicly reported, and his brother and friend made a windfall when they subsequently sold their company shares at inflated prices,” said Stephen L. Cohen, an associate director in the SEC’s Division of Enforcement. "When news surfaces about the possibility of a merger and details of the media reports are incorrect, it is illegal for insiders who know the true facts to trade and profit.”

According to the SEC’s complaint filed in federal court in San Francisco, Lawson Software was founded by the Lawsons and Cerullo in 1975 and based in St. Paul, Minn.  William Lawson and Cerullo each retired in 2001, but Richard Lawson was still serving as co-chairman of the board of directors when the company began considering a possible sale.  After Lawson Software and Infor Global Solutions entered into a non-disclosure agreement and met about a possible merger, Richard Lawson and other members of the board were regularly informed about the ongoing merger discussions.  While Infor conducted its due diligence in late February 2011, Lawson Software began a “market check” in which its financial adviser reached out to five competitors to gauge their interest in acquiring the company.  The market check elicited little-to-no interest, and Richard Lawson and the board were kept informed throughout the process.

Meanwhile, according to the SEC’s complaint, a March 8 article reported that Lawson Software had retained a financial adviser to explore a possible sale.  The article identified other companies as potential acquirers of Lawson Software and led to a 13-percent jump in Lawson Software’s stock price that day.  The article also fueled widespread – and incorrect – media speculation about potential acquirers of Lawson Software and possible merger prices.  Soon thereafter, Lawson Software publicly confirmed an acquisition offer from Infor for $11.25 per share.  Nevertheless, ensuing media and analyst reports still incorrectly suggested that other potential purchasers would likely enter the bidding and submit competing higher offers for Lawson Software.  Some reports suggested a merger price of up to $15-16 per share.  In reality, the same companies being speculated as potential purchasers already had informed Lawson Software that they weren’t interested in an acquisition.  But fueled in part by the reports, Lawson Software’s stock price closed at $12.24 per share on March 14 – nearly $1 higher than Infor’s offer of $11.25.  The stock price had increased approximately 23 percent since the March 8 article.

The SEC alleges that Richard Lawson knew that these media and analyst reports were inaccurate and the very entities mentioned as possible acquirers had in fact told the company they were not interested.  He knew that Infor was the lone bidder and would not increase its offer.  Richard Lawson also knew that Lawson Software’s financial adviser and board of directors viewed Infor’s bid as reasonable.  After Richard Lawson tipped his brother and Cerullo with nonpublic information about the planned deal, they proceeded to sell their shares at approximately $1 per share higher than the eventual merger price of $11.25.  Following the merger announcement on April 26, Lawson Software’s stock price dipped to $11.06 per share at market close.  The merger became effective in July 2011.

Richard Lawson agreed to settle the SEC’s charges by paying a penalty of $1,557,384.57 for tipping his brother and Cerullo. The penalty amount is equivalent to the ill-gotten gains received by William Lawson and Cerullo.  Richard Lawson also agreed to be barred from serving as an officer or director of a public company.  William Lawson agreed to pay disgorgement of $1,853,671.28, prejudgment interest of $162,442.60, and a penalty of $1,853,671.28 for a total of $3,869,785.16.  William Lawson’s disgorgement amount includes the ill-gotten gains of the other trader who he suggested sell shares.  Cerullo agreed to pay disgorgement of $178,481.29, prejudgment interest of $15,640.81, and a penalty of $178,481.29 for a total of $372,603.39.  Without admitting or denying the SEC’s allegations, the Lawsons and Cerullo agreed to the entry of final judgments enjoining them from future violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  The settlement is subject to court approval.

The SEC’s investigation was conducted by Michael Fuchs and Wendy Kong, and supervised by Josh Felker.  The SEC appreciates the assistance of the Options Regulatory Surveillance Authority and the Financial Industry Regulatory Authority.

SEC COMMISSIONER GALLAGHER'S REMARKS AT ROCKY MOUNTAIN SECURITIES CONFERENCE

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

Remarks at the 46th Annual Rocky Mountain Securities Conference

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Commissioner Daniel M. Gallagher

Denver, CO

May 9, 2014

Thank you, Julie [Lutz], for that kind introduction. I’m very pleased to be here today, and I’m proud to say that this will be my fourth time addressing this conference, the last three as a Commissioner. I am always happy to visit Denver, in large part given the presence of a key SEC regional office here. I am a big supporter of our regional offices, and I am very pleased to report that yesterday I made good on my oath to visit all of our offices when I made it to Fort Worth. Now I will try to pull off second visits before the end of my term.

* * *

Despite the onslaught of regulation over the past ten years and the consistency with which extremely costly and often frivolous plaintiff actions are brought, our capital markets continue to be the strongest and most vibrant in the world. As the primary U.S. capital markets regulator, the SEC administers a regulatory framework built upon our threefold mandate to protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.

Consistent with that framework, industry professionals such as registered representatives of broker-dealers and investment advisors are required by law to be licensed or registered and to subject themselves to the regulatory oversight, examination, and reporting requirements of the federal securities laws. In other words, we require market professionals, particularly those who interact with retail investors, to apply for, and prove themselves worthy of, the privilege of working in the industry.

Unfortunately, this privilege is all too often abused by scoundrels, including some that repeatedly engage in egregious misconduct that directly impacts retail “mom and pop” investors, destroying their nest eggs and financial security. These repeat offenders, despite accumulating dozens of customer complaints and disciplinary actions, have been able to remain in the industry by jumping from one disreputable firm to another and hiding behind false and misleading CRD filings and Form BD representations. They are, to be blunt, cockroaches, and it is in all of our interests to purge them from our markets.

This is, of course, not a new problem. After all, capital markets are risk-taking markets, and unfortunately a risk as old and as certain as time is that where there is opportunity, there will be unscrupulous characters trying to take advantage of the unwary. The SEC has been struggling for decades to find the best approach to rooting out recidivist misconduct by the worst of the bad apples, but unfortunately, there are no easy answers.

Illustrating this point, exactly 20 years ago this month, the SEC released a report in conjunction with the NASD and NYSE called the “Large Firm Project” that reviewed the hiring, retention, and supervisory practices of nine of the country’s largest broker dealers, which at the time were responsible for handling approximately 50% of all public customer securities accounts in the United States.[1] The report’s findings were grim, reflecting a number of significant concerns about the business activities and conduct of broker-dealers and their registered representatives. Some of the more noteworthy findings may sound depressingly familiar to you.

For example, the study found high turnover rates: over a third of the registered representatives selected as a sample set for the study had left the industry within the two-year examination period, including many who left involuntarily or were barred from the industry altogether.

It also reflected a high incidence of potential enforcement violations, with fully 25% of exams leading to enforcement referrals. The study showed that bad actors are concentrated in select firms: three of the nine firms examined accounted for 88% of the study group’s enforcement referrals. The study also revealed numerous findings of inadequate supervision. Perhaps most concerning is the fact that these bad actors were able to move between firms freely after customers registered complaints.

Do these findings—now two decades old—sound familiar to you? The sad truth is that these are exactly the same types of behavioral red flags we still see today. Only two months ago, for example, the Wall Street Journal reported the results of a study finding that more than 1,500 broker-dealer registered representatives had failed to report bankruptcy filings in their CRD disclosures, while over 150 had failed to report criminal charges or convictions.[2] In response, FINRA announced that it would perform a comprehensive vetting of public disclosures for the more than 600,000 investment professionals it oversees—brokers, not investment advisors—against public court records. FINRA will also propose rules requiring employee background checks.[3]

I recently asked staff in the Office of Compliance, Inspections, and Examinations to put together some statistics based on disclosure information submitted by broker-dealer registered representatives on FINRA’s BrokerCheck system. The results are eye-opening.

An astounding 20% of the 600,000 plus actively licensed registered representatives have between one and five disclosures for items such as customer complaints, regulatory violations, terminations, bankruptcy, judgments, and liens. One active—and currently employed—registered rep has disclosed a whopping 96 customer complaints and disputes. Another individual has made 21 financial disclosures relating to bankruptcies, yet still is licensed and working in the industry. At the firm level, 17% of broker-dealers had more than six total disclosures, and 5% had more than 20 disclosures.

These numbers illustrate a real and growing problem in the securities industry. These repeat offenders are swindling seniors out of their hard-earned retirement funds, looting our kids’ custodial accounts, and diverting assets from charities and religious organizations. But despite our best efforts, they manage to stay in the industry and continue to wreak havoc on the investing public.

I would be remiss if I did not point out that a common misconception is that this is exclusively or even primarily a broker-dealer problem rather than an investment adviser problem as well. In reality, there are plenty of repeat offenders at investment advisory firms who are engaging in misconduct. We’re just not finding them as quickly because the SEC allocates a disproportionate amount of resources to policing the activities of broker-dealers when compared to those we expend policing investment advisers. There are nearly three times as many investment advisors registered with the SEC than there are broker dealers: approximately 11,100 investment advisors versus about 4,300 broker-dealers. This is due in large part to unfunded mandates imposed upon the SEC by Title IV of Dodd-Frank. Even more importantly in the context of resource allocation, there is no SRO interposed between the adviser industry and the SEC like there is for broker-dealers.

I worry that this has created the unfortunate side effect of underreported investment advisor rule violations, inappropriately skewing our enforcement statistics by revealing a disproportionate amount of problems on the broker-dealer side. Simply put, it is impossible to separate the fact that we find many more broker-dealer violations than investment advisor violations from the fact that thanks to the assistance of the SROs, we examine a greater proportion of broker-dealers than investment advisors.

One way to address this imbalance would be to provide for third party examiners of investment advisors—including, potentially, defining the term “third party” to include SROs in order to allow the SROs currently involved in broker-dealer oversight to conduct examinations of “dual hatted” investment advisors as well.[4] In the past, questions regarding the wisdom of creating an SRO for investment advisors have been addressed in a binary sense: should the Commission push Congress to create an SRO for investment advisors, or keep things as they are? Leveraging the current resources and expertise of broker-dealer SROs to assist in investment advisor examinations could greatly facilitate our ability to examine advisors without undertaking the daunting project, with Congress, of creating a new investment advisor SRO out of whole cloth.

Regardless of how we do so, enhancing our ability to examine investment advisors would also serve the critical purpose of allowing us to have informed deliberations on Section 913 of Dodd-Frank Act. Section 913, as you may know, authorized, but did not require, the Commission to adopt rules establishing a duty of care for brokers-dealers that is no less stringent than that which applies to investment advisors and to undertake further efforts to harmonize the two regulatory regimes.[5]

Mind you, as with so many Dodd-Frank requirements, Section 913 has absolutely nothing to do with the financial crisis, but as we proved in the case of conflict mineral disclosure, that may not dissuade the Commission from pursuing a rulemaking. Indeed, it is becoming painfully obvious that many special interest groups and members of the Administration believe this is a terrific election year issue to pursue. As an independent agency, the SEC should never be persuaded by such political forces.

And, although many in Washington seem to have concluded after the high profile issuance of the Volcker Rule that Dodd-Frank rulemaking is “done,” the Commission still needs to complete almost 60 mandated Dodd-Frank rulemakings. In addition to these rulemakings, which include key elements of Title VII derivatives regulation and the removal of references to credit ratings from Commission rules, the Commission still has significant—and well overdue—work to do on implementing the JOBS Act. And, by the way, we still have eight decades worth of securities laws to administer on a daily basis and critical projects on the horizon such as a much needed holistic equity market structure review, and critical reforms in the fixed income markets, such as the disclosure of riskless principal markups.

In light of this agenda, I question the wisdom of rushing into purely discretionary Section 913 rulemaking, especially when the purported substantive impetus is the potentially false narrative that broker-dealers represent a greater potential threat to retail investors than investment advisors. The truth is that we simply don’t know whether or not that is the case. There have been far too many laws and regulations that stemmed directly from false narratives of the financial crisis and its causes. The Commission should slow down and get all of the facts before adding to the long list of rules resulting from these false narratives.

* * *

So what is the SEC doing to curb the abuses perpetrated by the recidivist bad actors I mentioned, whether on the broker-dealer or investment advisor side? I am pleased to report that in recent years, the agency has made great strides in developing programmatic and technological tools aimed at efficiently ferreting out the most egregious misconduct and identifying those individuals and firms most likely to be recidivists.

Some of the most exciting developments are coming out of OCIE under the able leadership of Drew Bowden. Drew’s dedicated and talented staff has developed a number of innovative tools that have moved the examination program into the 21st Century and enabled the staff to surgically and efficiently zero in on potential abuses.

For example, OCIE’s Risk Assessment and Surveillance group, which is responsible for identifying candidates for examination among registered entities, has developed new analytics to track the migratory patterns of registered representatives. Using public disclosures—including U4 and U5 filings and other data from the SROs—the team can track industry professionals who are hopping from firm to firm and single out firms that appear to be havens for individuals with long rap sheets of customer complaints and disciplinary actions. This targeted approach to risk assessment enables our examiners to immediately identify the statistical outliers who are most likely to engage in misconduct.

OCIE’s boots-on-the-ground examiners also have been deploying a new analytics tool, the National Exam Analytics Program, that allows them to review massive amounts of registrant data in a matter of minutes. Rather than relying on a small sample of activity for a few dozen accounts over a compressed time period, OCIE examiners can import a registrant’s entire trade blotter for multiple years and immediately generate over 50 types of customized reports identifying potential red flags for account churning, excessive commissions, P&L irregularities, suspect asset allocation, front running, and even insider trading.

Complementing these efforts is OCIE’s Risk Analysis Examination initiative, which uses advanced analytics to examine data from the largest clearing firms and broker-dealers to identify potentially problematic trends industry-wide. In 2013 alone, this group reviewed hundreds of millions of transactions by more than 500 firms, including trading data that enables OCIE to target for examination broker-dealer firms that appear to be systematically engaged in high pressure sales tactics and excessive trading. With this data, we are able to zero in on firms that are, in essence, nothing more than a criminal enterprise designed to separate investors from their money.

The best part of the story is that all of these tools were developed in-house by the SEC staff. They have revolutionized the way our teams conduct examinations and have done much to level the playing field in terms of our ability to root out potential misconduct by recidivists.

And, OCIE isn’t the only arm of the agency making progress in this area. Under the strong leadership of Director Andrew Ceresney, the Division of Enforcement has made several programmatic changes that have greatly enhanced the SEC’s efforts in identifying and combatting the worst recidivists.

Perhaps most noteworthy is the creation of a task force late last year, a group near and dear to me, to focus on broker-dealer enforcement issues. Among other initiatives, this new task force will coordinate with OCIE and FINRA to target misconduct by “rogue” registered representatives with prior disciplinary histories or customer complaints.

My hope and expectation is that the task force will complement the work of the two specialty units created by the Division of Enforcement in 2010: the Asset Management Unit, which investigates misconduct by investment advisors, investment companies, and private funds, and the Market Abuse Unit, which focuses on difficult-to-detect frauds in which honest investors are bilked without ever knowing anything is amiss. Working collaboratively both inside and outside of the agency, these groups are making substantial progress in identifying and rooting out misconduct by the worst of the bad actors.

* * *

There is no question that we are making real progress on these issues, but more needs to be done to send a forceful message to the bottom dwellers of the securities industry that their behavior will not be tolerated. As I’ve illustrated today, the SEC has a number of tools to combat abuses by recidivists, but we need to make sure that we are using them in the most efficient manner possible and that the tools we have are sufficient for the task.

Most importantly, the agency needs to take aggressive action aimed at permanently expelling the worst offenders from the securities industry. All too often, we see the same individuals and firms featured prominently in examination reports and enforcement actions. As an agency, we need to seek out the repeat offenders and revoke their licenses and registrations rather than repeatedly mete out injunctions that can be violated and penalties that can be paid from the fruits of misconduct. Unless we put these offenders out of the industry for good, they will continue to take advantage of retail investors.

With respect to the most egregious and recidivist violations of our securities laws and regulations, whether by broker-dealers or investment advisors, we need to ask ourselves a fundamental question: should the violating entity retain the privilege of participating in our capital markets? Unbeknownst to many, both the Exchange Act and the Investment Advisers Act authorize the Commission to deregister entities if it finds such action to be in the public interest, although we have rarely done so.[6] This authority, of course, should only be invoked after full due process has been afforded to the entity in question, but it should indeed be invoked when appropriate. I have seen several instances in which I believe it would be appropriate since I’ve been a Commissioner.

As a federal agency charged with protecting investors, the SEC needs to make such existential threats—and, where appropriate, deliver on them—in the most egregious circumstances. Otherwise, the cockroaches of the industry will continue to abuse the system, shrugging off the well-meaning but all too often ineffective remedial actions taken against them.

* * *

In closing, I want to convey my sincere belief that most of the men and women who work as professionals in the securities industry have proven themselves worthy of that privilege by conducting themselves with honesty and integrity. The unparalleled strength of our capital markets is in large part the product of the work ethic and high moral character of the professionals who work with the millions of individual and institutional investors that participate in those markets.

Unfortunately, the stability, security, and attractiveness of our markets are all too easily tainted by the misconduct of a handful of reprehensible miscreants who abuse the system time and time again. Working as a registered broker-dealer representative or an investment adviser representative, holding a securities license, or operating a securities firm are privileges that carry with them a heavy responsibility, privileges that can and should be taken away in cases of abuse. As an agency, the SEC needs to lead the way in targeting and eradicating the worst offenders from the markets altogether.

Once again, thank you for this opportunity to share my thoughts with you, and I wish you an enjoyable and productive conference.


[1] The Large Firm Project, A Review of Hiring, Retention and Supervisory Practices, Divisions of Market Regulation and Enforcement, United States Securities and Exchange Commission, May 1994, available at http://www.sec.gov/news/studies/rogue.txt.

[2] Regulator Deletes Red Flags From Brokers’ Records, Says Study, Wall St. Jrnl., March 7, 2014, available at http://online.wsj.com/news/articles/SB10001424052702304554004579423270046013550.

[3] Plan to Fix Cracks in Broker Records — Wall Street Regulator to Propose Rules for Background Checks, Measures to Identify Red Flags, Wall St. Jrnl., Apr. 16, 2014, available at http://online.wsj.com/news/articles/SB20001424052702303887804579503653564597512?mg=reno64-wsj%26url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB20001424052702303887804579503653564597512.html.

[4] See Jim Angel, On the Regulation of Investment Advisory Services: Where Do We Go from Here?, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1951991.

[5] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 913, 124 Stat. 1376, 1824 (2010) (requiring analysis and rulemaking regarding fiduciary obligations of investment advisers and broker-dealers).

[6] See 15 U.S.C. 78o(b)(4) (stating that the Commission “shall . . . revoke the registration of any broker or dealer if it finds . . .[that such] revocation is in the public interest and that such broker or dealer” committed certain actions enumerated in the statute); 15 U.S.C. 80b-3(e) (stating that the Commission “shall . . . revoke the registration of any investment adviser if it finds . . .[that such] revocation is in the public interest and that such investment adviser” committed certain actions enumerated in the statute).

SEC CHARGES RETIREMENT PLAN ADMINISTRATOR WITH DEFRAUDING INVESTORS WITH IRA ACCOUNTS

FROM:  SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today announced fraud charges and an asset freeze against a Utah-based retirement plan administrator who defrauded investors in self-directed individual retirement accounts (IRAs), causing them to lose millions of dollars of savings.

The SEC alleges that American Pension Services Inc. (APS) and its founder, president and CEO Curtis L. DeYoung squandered more than $22 million of investor funds on high-risk investments.  DeYoung hid the losses by issuing inflated account statements, allowing him to continue collecting fees and further victimizing his customers.

“This misconduct jeopardized retirement security for thousands of APS customers,” said Karen L. Martinez, director of the SEC’s Salt Lake Regional Office.

According to the SEC’s complaint unsealed yesterday in federal court in Salt Lake City,  DeYoung’s scheme dates back to at least 2005 and targeted customers with retirement accounts holding non-traditional assets typically not available through traditional 401(k) retirement plans or other IRA custodians.  Although APS has no authority to direct customer trades, DeYoung allegedly used forged letters and signatures to invest on behalf of customers, including in promissory notes issued by a friend whose businesses never turned a profit.  DeYoung continued to recommend that APS customers invest in the notes, and he sent customer funds to the friend until at least April 2013 without disclosing to investors that the friend had defaulted on the notes in 2010 and DeYoung had forgiven the debt.

The SEC further alleges that investments in other bankrupt ventures, including an office building in Wichita, Kan., caused APS customers to lose more money.  APS concealed those losses and issued account statements that inflated the value of customer holdings, allowing APS to levy fees based on the full value of the holdings even when they were worthless.

According to the SEC’s complaint, when DeYoung was questioned by the SEC about a $22 million gap between actual holdings and those showing on account statements, he invoked his Fifth Amendment privilege against self-incrimination and refused to answer.

The Honorable Robert J. Shelby granted the SEC’s request for a temporary restraining order to freeze the assets of APS and DeYoung.  The court appointed Diane Thompson of Ballard Spahr LLP as the receiver in this case to recover investor assets.

SEC COMMISSIONER PIWOWAR'S REMARKS AT ANNUAL INTERNATIONAL INSTITUTE FOR SECURITIES MARKET DEVELOPMENT

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

SPEECH

 Welcoming Remarks at the SEC 24th Annual International Institute for Securities Market Development

Commissioner Michael S. Piwowar
Washington, DC

April 7, 2014

Thank you, Paul [Leder], for that kind introduction, and I want to welcome you back to the Commission.  Paul previously worked at the Commission for more than a decade from 1987 to 1999 and now has been with the Commission as Director of the Office of International Affairs for almost two months.  I have enjoyed working with you and look forward to continuing to work with you in the international arena to promote investor protection, cross-border securities transactions, and fair, efficient and transparent markets.  I also want to thank the Office of International Affairs staff who worked so hard to organize this two-week training initiative and all of the speakers, moderators, and panelists who have generously invested much time and effort in making this program so worthwhile.    

I am excited to be here with you this morning to welcome you to Washington, DC and to the SEC’s 24th Annual International Institute for Securities Market Development.  In my previous tour at the Commission as an economist in what is now the Division of Economic and Risk Analysis (DERA), I had the privilege of participating in this program.  I, therefore, know from firsthand experience the importance and usefulness of this global training program.  In fact, this program is an integral part of the Commission’s longstanding commitment to promote the adoption of high quality regulatory standards worldwide.

Before I continue, I need to provide the standard disclaimer that my remarks are my own and that they do not necessarily reflect the views of the Commission or my fellow Commissioners.  As you participate in this great program over the next two weeks, I hope you keep a couple of things in mind.

First, the benefits from this program are not a one-way street.  This program provides the Commission with the opportunity to build relationships with regulators from around the world that help us in our work to protect our markets and investors.  We often require assistance from regulatory authorities abroad for cross-border enforcement and oversight efforts.  Many of our investigation and enforcement efforts require banking, brokerage or telephone records, testimony, and other evidence from jurisdictions outside the United States.  The contacts we have forged through this program over the past several years have considerably advanced our investigations and examinations, including arrangements for freezing fraud proceeds.  I also hope that the program provides you with the ability to build relationships with other participants as well as with us that will help in your enforcement and oversight efforts.

Second, when it comes to securities markets regulation, one size does not fit all.  The program has been carefully designed to include sessions that use terms like “best practices” and “key concepts,” as well as workshops featuring case studies and panel discussions with regulators from multiple jurisdictions.  I hope that none of you leave the conference with the notion that your markets should have the same regulations as us or as each other.  Rather, each of you should take the lessons that you find valuable from this program and use them to tailor your regulations to the particular characteristics and circumstances present in your own securities markets.

I would also like to take this opportunity to briefly elaborate on the effects of regulation on securities market development and the importance that these markets have on economic growth.  The participants in the securities markets, of course, include the issuers of securities, the investors that buy and sell those securities, and the institutions – brokers, dealers, exchanges, alternative trading venues, clearing agencies, etc. – that help facilitate transactions in those securities.

Many of our regulatory efforts are viewed through the lens of investor protection.  It is through this lens that we evaluate the duties of securities issuers to disclose meaningful information to potential investors so that they can make informed investment decisions, and the duties of market participants to treat investors fairly when transacting in securities.  Through the investor protection lens, we also determine the appropriate risk-based methods to monitor compliance with those duties and to enforce them.

But, the Commission’s core mission goes beyond protecting investors and maintaining fair, orderly, and efficient markets.  The third part of our statutory mission is to promote capital formation.  I hope that, even if your regulatory mandate does not explicitly include promoting capital formation, you always seek to balance the needs of businesses with the needs of investors.

As U.S. Senator Mike Crapo (R-ID), Ranking Member of the U.S. Senate Committee on Banking, Housing, and Urban Affairs, which is the authorizing committee of the Commission and the other financial regulators, likes to say “Capital is the lifeblood of…businesses, which in turn are the engines of job creation and economic growth.”[1]  Conversely, regulation that is overly burdensome or restrictive will inhibit capital formation and economic growth.

 I want to focus the remainder of my remarks on capital markets.  By capital markets, I mean the stock and bond markets.  While capital markets are only a component of the overall securities markets, they are, in fact, the lifeblood of businesses, which are the drivers of economic growth.  

Effective Regulation Promotes Capital Market Development

An overarching theme of this program is that a jurisdiction’s institutional and regulatory policy framework can strongly influence capital market development.  The notion that there is a close relationship between financial regulation and capital markets is not new.  The specialized field of economics known as “law and finance” has established, for example, that countries with better investor protections, measured by both the character of legal rules and the quality of enforcement, tend to have larger and deeper capital markets.[2]  The academic law and finance literature has produced many other findings with key policy implications.  While I do not have time today to properly review all of the findings in this area, I do want to mention one important paper released last month entitled Capital Markets and Economic Growth: Long-Term Trends and Policy Challenges, which, among other things, looks at a particular interaction involving a country’s financial regulatory system and its tax system, and the resulting effects on capital market development.[3]

In that paper, two German finance professors, Christoph Kaserer and Marc Steffen Rapp, find that the regulatory and tax systems governing retirement savings in an economy play an important role in capital market development.[4]  The professors posit that more favorable tax and regulatory frameworks for retirement savings cause domestic stock markets to be larger and are likely to exert a positive influence on capital market depth.  They estimate that increasing the size of pension funds by 10 percentage points of gross domestic product (GDP) would lead to an increase in stock market size of 7 percentage points of GDP.  Kaserer and Rapp recommend that retirement savings rules and tax laws be designed in a way that encourages a larger part of national savings to be invested through the capital markets.

Capital Market Development Promotes Economic Growth

Capital markets are a significant source of financing for the corporate sector and play an integral role in economic growth.  Equity markets, in particular, are of prime importance for economic development.  More liquid stock markets – where it is less expensive to trade equities – reduce the disincentives to investing in long-duration projects because investors can easily sell their ownership interest in the project if they need their savings before the project matures. Therefore, enhanced liquidity facilitates investment in longer-run, higher-return projects that boost productivity growth.[5]

Due to the limited availability of debt-based financing for high-risk projects, access to equity financing also may spur innovation.[6]  Moreover, the fact that shareholders are residual claimants means they have a much stronger incentive to exert control over the investment decisions of a company than debt holders.  Active investors, including institutional investors, may use their expertise to push for changes that could lead to enhanced performance and stock price growth.

It is also important to note that stocks, unlike debt in many cases, are information sensitive, which leads to more information gathering incentives by outside investors than debt financing does.[7]  Kaserer and Rapp argue that the availability of funds for long-term risky investments combined with the incentives for improving corporate governance would result in an estimated one-to-one relationship between stock market growth and the long-term real growth rate in GDP, i.e., stock market growth of one-third would increase real economic growth by one-third.[8]  Overall, they estimate that growing capital markets by one-third would increase the long-term real growth rate in per capita GDP by about 20%.[9]

Importantly, the Kaserer and Rapp study shows that the balance between capital market finance and bank lending matters.  An overreliance on banks comes at a cost in terms of reduced economic growth.  The study also documents that capital markets are good for research and development (R&D).  European firms’ R&D intensity is positively correlated with the level of equity financing.  In contrast, firms in bank-based economies have less flexibility in their financing decisions and therefore follow a more conservative financing strategy, which might lead to underinvestment in R&D.

A Virtuous Circle

To sum up, effective regulation leads to capital market development.  Capital market development, in turn, leads to economic growth.  Economic growth improves standards of living of people in your jurisdictions in a number of ways, including reducing poverty and promoting savings, investment, innovation and job creation.

But, it doesn’t stop there.  Growing your capital markets not only benefits your own economy, but it also benefits markets and economies globally.  Better developed capital markets and more dynamic economies provide consumers with the ability to purchase more products and services from around the world and investors with the ability to invest globally, which provides businesses access to additional sources of capital.  A rising tide lifts all boats.

If we all adopt high quality regulatory standards in our own jurisdictions and work together to promote high quality standards worldwide, we can create what economists call a “virtuous circle” – a positive chain of events that reinforces itself through a feedback loop – in which everyone benefits.  This two-week program represents an important step in establishing such a virtuous circle to improve standards of living worldwide.

Thank you for your attention.  Enjoy the program.


[1] See, e.g., News Release: Ranking Member Crapo's Statement at FSOC Annual Report Hearing (May 21, 2013), available at http://www.crapo.senate.gov/media/newsreleases/release_full.cfm?id=342841.

[2] See, e.g., Rafael La Porta et al., Legal Determinants of External Finance (July 1997), available at http://scholar.harvard.edu/shleifer/files/legaldeterminants.pdf and Rafael La Porta et al., Law and Finance (Dec. 1998), available at http://www.jstor.org/stable/pdfplus/10.1086/250042.pdf?acceptTC=true&jpdConfirm=true.

[3] I thank former SEC Commissioner Kathleen Casey for bringing this paper to my attention.

[4] Christoph Kaserer & Marc Steffen Rapp, Capital Markets and Economic Growth: Long-Term Trends and Policy Challenges (Mar. 2014), available at http://www.aima.org/en/education/research-into-capital-markets-and-economic-growth.cfm.      

[5] See Ross Levine and Sara Zervos, Stock Markets, Banks, and Economic Growth (June 1998), available at http://www.isid.ac.in/~tridip/Teaching/DevEco/Readings/07Finance/06Levine%26Zervos-AER1998.pdf.

[6] See Po-Hsuan Hsu et al., Financial development and innovation: Cross-country evidence (Feb. 2013), available at http://ac.els-cdn.com/S0304405X13003024/1-s2.0-S0304405X13003024-main.pdf?_tid=b0301ee2-be61-11e3-a531-00000aacb35d&acdnat=1396881432_07b3612fbfae3e71a910a56125ccfd26.  

[7] See Christoph Kaserer and Marc Steffen Rapp, Capital Markets and Economic Growth: Long-Term Trends and Policy Challenges (Mar. 2014) .  

[8] Id.

[9] Id.