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Spoofing is not new – it is illegal market manipulation

August 9, 2017

There is a great deal of consternation about the recent Seventh Circuit decision affirming the criminal conviction of a trader for “spoofing,” a type of market manipulation that has been illegal for a long time. While the criminal statute at issue is new, traders have long been on notice that this conduct violates Rule 10b-5. In the early 2000s, I supervised an investigation of traders engaged in spoofing, which is just one type of market manipulation. https://www.sec.gov/litigation/litreleases/lr18894.htm  The SEC brought Rule 10b-5 charges against the three traders. According to the SEC Litigation Release, The Commission’s Complaint alleges that approximately 75 times between September and December of 1999, Awdisho, Kundrat and Smolinski each manipulated the price of stock options by engaging in a scheme commonly referred to as “small lot baiting.” Small lot baiting or “spoofing” involves an order placed by a market participant with the intention of briefly triggering a market movement from which the participant or others may benefit by trading the opposite side of the original manipulative order. The Complaint further alleges that to carry out the scheme, Awdisho, Kundrat and Smolinski placed limit orders for a small number of options contracts on one options exchange to artificially raise or lower that exchange’s quoted bid or offer. Awdisho, Kundrat and Smolinski then purchased or sold much larger opposite positions on other exchanges that matched the artificially raised or depressed price displayed at the first exchange. After their larger orders were executed, the Awdisho, Kundrat and Smolinski immediately sent an order to cancel the initial bait order. As a result of the scheme, the Complaint alleges that Awdisho, Kundrat and Smolinski unfairly profited at least $25,000 by obtaining execution of their larger orders at more favorable prices than otherwise available in the market. This was a small case, but brought to send a message that this conduct is not legal. Apparently, the message did not get through. There have been other spoofing cases since then. http://www.businessinsider.com/what-is-spoofing-the-market-2015-4 Why is spoofing illegal? Because traders submit orders they intend to cancel before execution. The sole purpose of the orders is to change the price at which other orders the spoofers submit will be executed. That means spoofers are not arbitragers — whose activities make markets more efficient. Spoofers are engaged in illegal market manipulation. While the primary victims of this conduct are professional marketmakers, the practice undermines investor confidence in our capital markets. For an incredibly readable and interesting description of similar manipulations of complex financial markets read Michael Lewis’s best selling book, Flash Boys. https://www.goodreads.com/book/show/24724602-flash-boys The Seventh Circuit decision is available here: http://media.ca7.uscourts.gov/cgi-bin/rssExec.pl?Submit=Display&Path=Y2017/D08-07/C:16-3017:J:Ripple:aut:T:fnOp:N:2006533:S:0          

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SEC prepares to reverse the DOL fiduciary rule

August 9, 2017

In a speech to the Economic Club of New York, SEC chairman Jay Clayton took aim at the DOL Fiduciary Rule. According  to Investment News, Chairman Clayton said, “there is a lot of work to do, and [the fiduciary standard] issue is complex.”  While the fiduciary standard issue is complex,  there has already been a lot of work done — by the Department of Labor. The Department of Labor addressed thousands and thousands of comments on the proposed Fiduciary Rule from investment advisers, broker-dealers, investor advocates, and others. That is a lot of work already done by experts on this complex issue. In several lawsuits filed by opponents of the Fiduciary Rule, three different federal courts upheld the rule after considering the complexity of the issue and the work DOL had done. There is no need for the SEC to reinvent the wheel here. Chairman Clayton also said, “it is important that the commission make all reasonable efforts to bring clarity and consistency” to this issue. That is precisely what the Department of Labor did in issuing the Fiduciary Rule. After years of study, DOL concluded that the existing rules permitted brokers to mislead customers into believing that they would put customers’ interests ahead of their own. The DOL Fiduciary Rule creates a clear and consistent rule for retirement accounts. The SEC should extend that clear and consistent rule to non-retirement accounts which are — at present — subject to a byzantine patchwork of confusing laws, rules, and regulations. Chairman Clayton also said, “any action will need to be carefully constructed, so it provides appropriate and meaningful protections but does not result in Main Street investors being deprived of affordable investment advice or products.”  Wall Street brokers want to make sure they can continue to tell investors that their investment advice is in the customers’ best interest when it is really in the brokers’ best interest. Wall Street brokers want to make sure that Main Street investors are not “deprived” of investment products that are in the brokers’ best interest because they pay high commissions. Finally, Chairman Clayton said he asks himself: “What can the commission do to cultivate markets where Mr. and Ms. 401(k) are able to invest in a better future?” The absolute best thing you can do for Mr. and Ms. 401(k) Mr. Chairman is to leave the DOL Fiduciary Rule alone. http://www.investmentnews.com/article/20170712/FREE/170719977/secs-jay-clayton-makes-fiduciary-duty-a-priority-acknowledges-issue

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Where are the women and minorities in financial planning?

August 9, 2017

The CFP Board is taking steps to remedy the lack of diversity in the ranks of financial advisors.  This is good for everyone.   The CFP Board has created several programs including the Women’s Initiative, which seeks to bring more women into the profession, and the “I Am CFP Pro” campaign to encourage more women and people of color to become financial planners. The center also announced its partnership with iRelaunch to create the Financial Planning Re-Entry Initiative, which helps women financial planners return to the profession after taking time off.   Thanks to Tatiana Walker-Morris and Pacific Standard Magazine for their reporting. https://psmag.com/economics/where-are-the-women-and-minorities-in-financial-planning

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More on the long strange trip – Martin Shkreli trial

August 2, 2017

More on the Martin Shkreli trial The jury has been deliberating for days now. Yesterday, they submitted a few questions to the judge. This is always exciting and cause for much speculation and pontificating in legal circles. One question was a request for the definition of “fraudulent intent.” According to the New York Times, the defense considered that a good sign given their position that everything Shkreli did was in good faith. How could they not take heart that the jury was wrestling with the issue of intent? Another question was a request for the definition of “assets under management” and clarification whether that includes just assets in the funds at issue or other funds. There was evidence that Shkreli told investors that he had $30 to $40 million of assets under management when he reported to the SEC that he only had $3 million under management. Shkreli may have been including assets of a wealthy investor who had withdrawn his funds. I see this as another positive for the defense. https://www.nytimes.com/2017/08/01/business/dealbook/martin-shkreli-fraud-trial.html?_r=0 See my earlier July 17, 2017 post for more on the Shkreli trial.

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SEC awards government employee $2.5 million for whistleblower tip

August 2, 2017

Government employees are eligible to recover awards under the SEC’s whistleblower program Generally speaking, if you are an employee of a federal, state, or local government agency, you may be eligible for an award under the SEC whistleblower program. But, you must satisfy two conditions. The first is that you not work for a banking or securities regulatory agency. The law prohibits paying a whistleblower award to an employee of “an appropriate regulatory agency.” Exchange Act § 21F(c)(2)(A)(i), 15 U.S.C. § 78u-6(c)(2)(A)(i). Exchange Act Rule 21F-4(f) defines an “appropriate regulatory agency” by reference to Section 3(a)(34), which in turn defines an “appropriate regulatory agency” as the Commission and any of the various banking agencies listed in the definition, including the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation. The second condition requires that you not work for the law enforcement section of your agency if your agency is considered “a law enforcement organization.” Exchange Act § 21F(c)(2)(A)(v), 15 U.S.C. § 78u-6(c)(2)(A)(v), and Exchange Act Rule 21F-8(c)(1), 17 C.F.R. § 240.21F-8(c)(1). Neither the Exchange Act nor the whistleblower rules define “law enforcement organization.” According to the SEC, the term is generally understood as having to do with the detection, investigation, or prosecution of potential violations of law. Exchange Act §24(f)(4)(B) and (C), 15 U.S.C. § 78x(f)(4)(B) and (C) (defining foreign and state law enforcement authorities as those that are “empowered … to detect, investigate, or prosecute potential violations of law”). This would probably bar anyone who works for the Department of Justice, FBI, etc. from being a whistleblower — since the entire organization would likely be deemed a “law enforcement organization.” But, you might be eligible if you worked for the Department of Education, HHS, CMS, or another regulatory agency that does law enforcement that is organizationally separate from where you work and that you have nothing to do with. The SEC is concerned about paying an award to a claimant who seeks to get around the potential responsibilities that the government agency (their employer) might have to investigate or otherwise take action for the misconduct. The SEC is not interested in making an award to someone who was just doing their job. Bottom line: If you are a government employee, don’t assume that you are not eligible to receive a whistleblower award. https://www.sec.gov/rules/other/2017/34-81200.pdf

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Using mom’s brokerage account for insider trading

July 21, 2017

The Securities and Exchange Commission announced insider trading charges against an MIT research scientist who allegedly searched the internet for “how sec detect unusual trade” before making a pre-acquisition trade that the SEC flagged as suspicious. https://www.sec.gov/news/press-release/2017-125 The SEC’s complaint alleges that Fei Yan purchased stocks and options based on material nonpublic information obtained from his wife, an associate at a law firm that worked on the acquisitions. According to the SEC’s complaint, Yan made approximately $120,000 in illicit profits by selling his holdings in two public companies following public announcements that they would be acquired by other companies.

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Presidential tweets – how to get them into evidence

July 20, 2017

How does one get the tweets of @realDonaldTrump into evidence? This is an interesting question raised by Kelly Twigger in Above the Law this week. Above the Law – Are Donald Trump’s Tweets Self-Authenticating  It is a question that litigators face in seeking to admit all kinds of social media but it is more fun to apply the rules to the President’s tweets. There are two hurdles that must be jumped to get the tweets into evidence. Kelly Twigger addresses whether the tweets are self-authenticating. I will address that hurdle as well as the hearsay hurdle. The Authentication Hurdle: To use the tweets, you need to show that they they are what they purport to be — statements of President Trump. According to Federal Rule of Evidence number 901, “[t]o satisfy the requirement of authenticating or identifying an item of evidence, the proponent must produce evidence sufficient to support a finding that the item is what the proponent claims it is.” How do you do that? (1) You could show that the statement is from a government office where items of this kind (presidential statements) are kept. FRE 901(b)(7). President Trump, Sean Spicer, and others have said that the statements of @realDonaldTrump are made by the President. This might be enough. OR (2) You could show that the tweets bear the distinctive characteristics of President Trump. Under FRE 901(4), you can prove authenticity through evidence of “[t]he appearance, contents, substance, internal patterns, or other distinctive characteristics of the item, taken together with all the circumstances.”  This would seem to be a winner for many @realDonaldTrump tweets. The Hearsay Hurdle:  While hearsay objections are a staple of all those police and law television series, that is not much of a problem here. Hearsay is an out of court statement offered to prove the truth of the matter asserted. FRE 801(c). A tweet may not be hearsay at all. Or it may fall within an exception to the hearsay rule. (1) Not hearsay: If you are not seeking to admit the tweet for the truth of the matter asserted, then it is, by definition, not hearsay. You may be seeking to admit a tweet to show that President Trump was watching a particular television broadcast or that he was aware of a particular fact addressed in the tweet — things that do not hinge on the truthfulness of the statements in the tweet. If you are seeking to use a tweet against President Trump, then the tweet is likely not hearsay. Statements of a party-opponent are not hearsay. Under FRE 801(d)(2), an out of court statement is not hearsay if the statement was made by the party-opponent, is one the party-opponent adopted, was made by a person whom the party authorized to make a statement on the subject, was made by the party’s agent or employee on a matter within the scope of that relationship and while it existed, or was made by a co-conspirator during and in furtherance of the conspiracy. (2) Exception to hearsay: There are a number of exceptions to hearsay that may apply to President Trump’s tweets. FRE 803. These […]

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Investor trust is important, but how important?

July 19, 2017

According to a Cornell University study of investments after the Bernie Madoff Ponzi scheme was revealed, people who knew Madoff’s victims or who lived in areas where victims were concentrated dramatically changed their investment behavior. According to the  study, investors withdrew $363 billion invested with financial advisors — even though many had nothing to do with Madoff. A significant portion of the withdrawals were put in safe assets like bank deposits. Even four years after the fraud was revealed, investors had not reinvested these funds in the markets. Financial advisory firms take note:  the $363 billion in investment withdrawals is nearly 20 times the $17 billion in restitution the courts ordered Madoff to pay his investors. According to one of the study’s authors Steve Yonker, “That’s a pretty big effect. The withdrawals were so hefty in some areas that some investment firms ended up shutting their doors and going out of business.”  Investment firms with clients in regions that were affected by the fraud were over 40 percent more likely to close than firms in a control group. “We show the importance of trust in investors’ allocation decisions,” Yonker said. “At the macro level, economic growth critically depends on the efficient allocation of capital.” “Capital flows stemming from distrust in intermediaries instead of the underlying investment opportunities can potentially lead to suboptimal allocations.” Fraud is bad for business. Investors fled when they lost trust in the markets. Perhaps the brokerage industry should work harder to maintain the trust of investors rather than opposing investor protection regulation. It’s good business. The Cornell study is published in The Review of Financial Studies. Thanks to BusinessInsider.com for its reporting on this study. http://markets.businessinsider.com/news/stocks/bernie-madoff-ponzi-scheme-363-billion-dollar-exodus-investment-funds-2017-7-1002183521 http://mediarelations.cornell.edu/2017/07/18/madoff-rip-off-shattered-trust-changed-investment-behavior/

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Fed employee nest eggs – less safe than you would think

July 18, 2017

When federal government employees recommend an investment adviser who steals employee retirement funds, “sovereign immunity” prevents recovery against government. In many ways the retirement savings of federal employees are safer than employees of private companies. The Thrift Savings Plan and other 401(k)-like plans offered by the federal government have fewer of the inappropriate investment options that are in many private employer retirement plans. But, as a recent Eleventh Circuit Court of Appeals decision reveals, federal employee retirement savings are still at risk. Alvarez v. U.S., Case No. 16-16479 (11th Cir. July 17, 2017), available at http://media.ca11.uscourts.gov/opinions/pub/files/201616479.pdf According to the Eleventh Circuit: In the late 1980s, Kenneth Wayne McLeod began contracting with various federal agencies to provide retirement advice to federal law enforcement employees in Florida. McLeod founded and ran the Federal Employee Benefits Group, Inc. (“FEBG”) Bond Fund. Most of the federal employee investors met McLeod at retirement seminars hosted by their agency employer, where McLeod spoke generally about finances and retirement and also pitched his fund. McLeod would sometimes follow up with individual employees, promising high, secure returns in the FEBG Bond Fund. Not surprisingly, federal employees invested in the FEBG Bond Fund.  In 2010, when investigators questioned McLeod, he admitted the FEBG Bond Fund was a Ponzi scheme and committed suicide. In an attempt to recover $30 million in losses, investors filed suit alleging that federal agency employees had failed to exercise reasonable care and made misrepresentations in recommending McLeod and the FEBG Bond Fund. So far, this is similar to many cases against private companies who recommend investment advisers to their employees. But, unlike private employers, the government must consent to be sued. It has discretion to invoke the defense of sovereign immunity — a doctrine that protects the government against lawsuits that it does not expressly authorize. Investors brought claims that the federal government was negligent in contracting with McLeod and that by doing so it gave the appearance of undue confidence in McLeod. They sought to fall within the Federal Tort Claims Act (“FTCA”), which authorizes certain tort claims against the federal government. But, as the Eleventh Circuit said, a court must strictly observe the ‘limitations and conditions upon which the Government consents to be sued’ and cannot imply exceptions not present within the terms of the waiver.” One such exception is the [FTCA] intentional tort exception, which bars: [a]ny claim arising out of assault, battery, false imprisonment, false arrest, malicious prosecution, abuse of process, libel, slander, misrepresentation, deceit, or interference with contract rights . . . The Eleventh Circuit ruled that that the alleged omissions during McLeod’s seminars, which gave investors “undue confidence in McLeod’s credibility,” constituted misrepresentations. The court found that all of the alleged negligent conduct of the agency employees from their failure to stop McLeod’s solicitation (non-communications) and their endorsement of McLeod was fundamentally based upon misrepresentations. As a result, the federal government is immune from liability for recommending this scoundrel to its own employees. Federal employees beware! http://law.justia.com/cases/federal/appellate-courts/ca11/16-16479/16-16479-2017-07-17.html

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The long strange trip that is the Martin Shkreli trial

July 17, 2017

It is a little weird that Martin Shkreli is being prosecuted for criminal securities fraud even though investors did not lose money. That is no bar to criminal prosecution, but unusual. The jury could decline to find guilt without losses. The New Yorker’s Sheelah Kolhatkar also notes this unusual prosecution of fraud with no investor losses. It is a gutsy move on the part of the prosecutors (these are not members of the Chickenshit Club). http://www.newyorker.com/sections/business/the-strange-defense-of-martin-shkreli. Kolhatkar also took notice of the unusual Benjamin Brafman defense strategy — calling client Shkreli “strange” and like “Rain Man.” This strategy make sense to me. Even if it were possible to have  Shkreli change his persona for trial, it would not be credible. This is making this most of the client you have — rather trying to make over the client. While we are on the subject, there is something even weirder that the LA Times reported. A Shkreli mentor sent an email about wanting to touch Shkreli’s “soft skin.” I did not make this up. You can verify it here:  http://www.latimes.com/business/la-fi-martin-shkreli-trial-20170713-story.html   http://www.latimes.com/business/la-fi-martin-shkreli-trial-20170705-story.html  Will a skin care line be next for Shkreli? Its been a long strange trip already.    

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