Tag: financial services

The Murky Waters of Wash Trading Digital Assets – DOJ Charges 18 Individuals and Entities

The United States Attorney’s Office for the District of Massachusetts recently unsealed what it described as the “first-ever criminal charges against financial services firms for market manipulation and ‘wash trading’ in the cryptocurrency industry.” The SEC also filed parallel civil charges alleging violations of Securities for the same alleged schemes.

The government has charged eighteen individuals and companies, including four cryptocurrency market makers, with engaging in illegal market manipulation through “wash trading” digital assets. According to the DOJ and SEC filings, although these individuals purported to offer “market making services,” they were actually engaged in offering “market-manipulations-as-a-service” by engaging in artificial trading of digital assets to give the false appearance that there was an active (and heavily traded) market for those tokens.

How this case came to the DOJ’s attention is as novel as the legal theory behind the charging documents. According to DOJ spokespeople, the investigation started with a tip from the SEC about one of the companies at issue. Further investigations into that company—along with the help of cooperating witnesses—led authorities to set up a sham crypto firm, NextFundAI, and create a token associated with the firm. Posing as NextFundAI, the government communicated with the defendants—market makers who allegedly offered to trade and manipulate the price of NextFundAI’s token by wash trading, or trading the token back-and-forth between crypto wallets they controlled.

While there may be rules against wash trading in traditional securities markets (see, e.g., 26 U.S. Code § 1091), the rules are as clear in the digital asset space. Indeed, the regulatory vacuum facing the digital asset industry makes it difficult for those in the industry to avoid eventual regulatory action, and what many have referred to as “regulation by enforcement.” This is particularly true where the technological realities of digital assets do not fit squarely within the existing legal framework. There may be disagreement about the purpose or intent behind a cryptocurrency transaction where one individual is transferring cryptocurrency between wallets that person or entity controls. But there may not be a misrepresentation or fraudulent act inherent in this type of transaction. Indeed, the transaction itself (including the wallet address of the sender and recipient) is likely immediately and accurately recorded on the public blockchain. So, according to the government, the “fraud” is the intent behind the trades – to manipulate the market by artificially generating trade volume to signal interest and activity in the token.

The government’s allegations are also interesting because in addition to the wire fraud charges (18 U.S.C. § 1343), which generally do not require proof that the digital asset at issue is a security, the government has charged the defendants with conspiracy to commit market manipulation (18 U.S.C. § 371), which requires the government to prove that the token at issue is a security. This charge is significant because it will require the DOJ to prove at trial that the tokens at issue are securities.

Although several individuals involved have already pleaded guilty, there are several defendants who appear to be testing the government’s novel theory in court. We anticipate that this will be the first of many similar investigations and enforcement actions in the digital asset space.

©1994-2024 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. All Rights Reserved.
For more on Digital Assets, visit the NLR Securities SEC section.

Regulation Round Up March 2024

Welcome to the UK Regulation Round Up, a regular bulletin highlighting the latest developments in UK and EU financial services regulation.

Key developments in March 2024:

28 March

FCA Regulation Round-up: The FCA published its regulation round-up for March 2024.

26 March

AIFMD II: Directive (EU) 2024/927 amending the Alternative Investment Fund Managers Directive (2011/61/EU) (“AIFMD”) and the UCITS Directive (2009/65/EC) (“UCITS Directive”) relating to delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services, and loan origination by alternative investment funds has been published in the Official Journal of the European Union (“EU”). Please refer to our dedicated article on this topic here.

ELTIFs: The European Commission published a Communication to the Commission explaining that it intends to adopt, with amendments, ESMA’s proposed regulatory technical standards (“RTS”) under Regulations 9(3), 18(6), 19(5), 21(3) and 25(3) of the Regulation on European Long-Term Investment Funds ((EU) 2015/760) as amended by Regulation (EU) 2023/606.

Financial Promotions: The FCA published finalised guidance (FG24/1) on financial promotions on social media.

Cryptoassets: The Investment Association (“IA”) published its second report on UK fund tokenisation written by the technology working group to HM Treasury’s asset management taskforce.

25 March

Cryptoassets: ESMA published a final report (ESMA75-453128700-949) on draft technical standards specifying requirements for co-operation, exchange of information and notification between competent authorities, European Supervisory Authorities and third countries under the Regulation on markets in cryptoassets ((EU) 2023/1114) (“MiCA”).PRIIPS Regulation: the European Parliament’s Economic and Monetary Affairs Committee (“ECON”) published the report (PE753.665v02-00) it has adopted on the European Commission’s legislative proposal for a Regulation making amendments to the Regulation on key information documents (“KIDs”) for packaged retail and insurance-based investment products (1286/2014) (“PRIIPs Regulation”) (2023/0166(COD)).

Alternative Investment Funds: The FCA published the findings from a review it carried out in 2023 of alternative investment fund managers that use the host model to manage alternative investment funds.

AIFMD: Four Delegated and Implementing Regulations concerning cross-border marketing and management notifications relating to the UCITS Directive and the AIFMD have been published in the Official Journal of the European Union (here, here, here, and here).

22 March

Smarter Regulatory Framework: HM Treasury published a document on the next phase of the Smarter Regulatory Framework, its project to replace assimilated law relating to financial services.

21 March

Market Transparency: ESMA published a communication on the transition to the new rules under the Markets in Financial Instruments Regulation (600/2014) (“MiFIR”) to improve market access and transparency.

Retail Investment Package: ECON published a press release announcing it had adopted its draft report on the proposed Directive on retail investment protection (2023/0167(COD)). The proposed Directive will amend the MiFID II Directive (2014/65/EU) (“MiFID II”), the Insurance Distribution Directive ((EU) 2016/97), the Solvency II Directive (2009/138/EC), the UCITS Directive and the AIFMD.

19 March

ESG: The Council of the EU proposed a new compromise text for the Corporate Sustainability Due Diligence Directive, on which political agreement had previously been reached in December 2023.

FCA Business Plan: The FCA published its 2024/25 Business Plan, which sets out its business priorities for the year ahead.

15 March

Customer Duty: The FCA announced that it is to conduct a review into firms’ treatment of customers in vulnerable circumstances.

PRIIPS Regulation: The Joint Committee of the European Supervisory Authorities published an updated version of its Q&As (JC 2023 22) on the key information document requirements for packaged retail and insurance-based investment products (“PRIIPs”), as laid down in Commission Delegated Regulation (EU) 2017/653.

14 March

FCA Regulatory Approach: The FCA published a speech given by Nikhil Rathi, FCA Chief Executive, on its regulatory approach to deliver for consumers, markets and competitiveness and its shift to outcomes-focused regulation.

11 March

AML: HM Treasury launched a consultation on improving the effectiveness of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (SI 2017/692). The consultation runs until 9 June 2024 and covers four distinct areas.

08 March

ESG: The IA published a report on insights and suggested actions for asset managers following the commencement of reporting obligations of climate-related disclosures under the ESG sourcebook.

ESG: The House of Commons Treasury Committee published a report on the findings from its “Sexism in the City” inquiry.

Cryptoassets: The EBA published a consultation paper (EBA/CP/2024/09) on draft guidelines on redemption plans under Articles 47 and 55 of the MiCA.

05 March

Financial Sanctions: The Foreign, Commonwealth and Development Office published Post-Legislative Scrutiny Memorandum: Sanctions and Anti-Money Laundering Act 2018.

AML: The FCA published a Dear CEO letter sent to Annex I financial institutions concerning common control failings identified in anti-money laundering (AML) frameworks.

ESG: The European Commission adopted a delegated regulation supplementing the Securitisation Regulation ((EU) 2017/2402) with regard to regulatory technical standards specifying, for simple, transparent and standardised non-ABCP traditional securitisation, and for simple, transparent and standardised on-balance-sheet securitisation, the content, methodologies and presentation of information related to the principal adverse impacts of the assets financed by the underlying exposures on sustainability factors.

CRD IV: The European Commission adopted a Commission Implementing Regulation that amends Commission Implementing Regulation (EU) 650/2014 containing ITS on supervisory disclosure under the CRD IV Directive (2013/36/EU) (“CRD IV”).

01 March

Alternative Investment Funds: The FCA published a portfolio letter providing an interim update on its supervisory strategy for the asset management and alternatives portfolios.

Corporate Transparency: The Economic Crime and Corporate Transparency Act 2023 (Commencement No. 2 and Transitional Provision) Regulations 2024 (SI 2024/269) have been made and published.

Financial Sanctions: The Treasury Committee launched an inquiry into the effectiveness of financial sanctions on Russia.

EMIR: The FCA published a consultation paperin which it, together with the Bank of England, seeks feedback on draft guidance in the form of Q&As on the revised reporting requirements under Article 9 of UK EMIR (648/2012).

FCA Handbook: The FCA published Handbook Notice 116 (dated February 2024), which sets out changes to the FCA Handbook made by the FCA board on 29 February 2024.

FCA Handbook: the FCA published its 43rd quarterly consultation paper (CP24/3), inviting comments on proposed changes to a number of FCA Handbook provisions.

Amar Unadkat, Sulaiman Malik & Michael Singh also contributed to this article.

© 2024 Proskauer Rose LLP.
For more news on EU and UK Financial Services Regulation, visit the NLR Financial Institutions & Banking section.

Supreme Court Decides to Rule on FTC’s Disgorgement Authority

As previously blogged about here, the Supreme Court recently upheld the SEC’s disgorgement authority but imposed certain limits, including consideration of net profits.  FTC defense practitioners immediately began to consider how the ruling might potentially impact FTC investigations and enforcement actions, including how it might bear upon other judicial challenges to whether Section 13(b) of the FTC Act authorizes the FTC to obtain equitable monetary relief.

On July 9, 2020, the Supreme Court granted certiorari in the AMG Capital Management and Credit Bureau Center matters that should now decide the issues of whether Section 13(b) permits courts to award disgorgement.

In AMG v. FTC, the Ninth Circuit held that courts’ equitable powers include awarding equitable monetary relief, including disgorgement.  In contrast, the Seventh Circuit in FTC v. Credit Bureau Center recently disregard years of precedent when it held that the express terms of Section 13(b) illustrate that Congress only authorized injunctive relief, not equitable monetary relief or disgorgement.

The two matters have been consolidated and with a total of one hour allotted for oral argument.   The importance of these matters cannot be overstated as they conclusively resolve splits of authority relating to whether or in what circumstances FTC lawyers are entitled to seek equitable monetary relief in the form of disgorgement.

© 2020 Hinch Newman LLP

FTC Attorney Discusses Regulatory Focus on Payment Processing Industry

The Federal Trade Commission consistently seeks to expand the scope of potential liability for deceptive advertising practices.  From substantial assistance liability under the FTC’s Telemarketing Sales Rule to theories of agency or vicarious liability, ad agencies, ad networks, lead buyers and aggregators, lead purchasers, merchants and payment processors are all potentially accountable for facilitating the actions or omissions of those that they do business with.

Consider the latter and the FTC’s recent assault on the payment processing industry.  It amply highlights third party accountability remedial theories and the imposition of reasonable monitoring duties.

In January 2020, the FTC announced that an overseas payment processor and its former CEO settled allegations that they enabled a deceptive “free trial” offer scheme.  According to the complaint, the company, its principals and related entities marketed supposed “free trial” offers for personal care products and dietary supplements online, but instead billed consumers the full price of the products and enrolled them in negative option continuity plans without their consent.

To further the scheme, the defendants allegedly used dozens of shell companies and straw owners in the United States and the United Kingdom to obtain and maintain the merchant accounts needed to accept consumers’ credit and debit card payments, an illegal practice known as “credit card laundering.”

The FTC subsequently filed an amended complaint adding a Latvian financial institution and its former CEO to the case, alleging that they illegally maintained merchant accounts for the other defendants in the name of shell companies and enabled them to evade credit card chargeback monitoring programs.

In a press release, FTC attorney Andrew Smith, Director of the Bureau of Consumer Protection, stated that “[t]he FTC will continue to aggressively pursue payment processors that are complicit in illegal conduct, whether they operate at home or abroad.”

The FTC also recently announced that a payment processor for an alleged business coaching scheme settled charges that it ignored warning signs its client was operating an unlawful business coaching and investment scheme.  Here, according to the FTC’s complaint, the company for years processed payments for a purported scheme that charged consumers hundreds of millions of dollars for allegedly worthless business coaching products, and that the company ignored numerous signs that the business was allegedly fraudulent.

The red flags listed in the complaint include questions about whether the company was a domestic or international company, the nature of its business model, the company’s purported history of excessive chargebacks, and claims the company allegedly made in its marketing materials.

Notably, the complaint also alleged that the company failed to follow its own internal policies and failed to review its clients’ business practices in detail, which, according to the FTC, would have revealed numerous elements that should have eliminated the client under those policies.

According to the FTC, even after the company took on the client, the client’s processing data immediately raised red flags related to the quantity of charges it processed and the number of refunds and chargebacks associated with those charges.  When the client experienced excessive chargeback rates, instead of adequately investigating the causes of the chargebacks, the company responded by requiring the client to work closely with chargeback prevention companies, according to the FTC.  The FTC alleged that the company failed to monitor the products its client was selling and the claims it was making to sell those products.

Again, the Director of the FTC’s BCP conveyed that “[i]gnoring clear signs that your biggest customer is a bogus online business opportunity is no way to operate a payment processing business.”  “And, it’s a sure-fire way to get the attention of the FTC,” Smith stated.

Most recently, the FTC announced that a payment processor that allegedly helped perpetuate multiple scams has been banned under the terms of a settlement with the agency and the State of Ohio.  Here, the FTC alleged that the defendants used remotely created payment orders and remotely created checks to facilitate payments for unscrupulous merchants, allowing them to draw money from consumer victims’ bank accounts.

Reaffirming the FTC’s focus on the payment processing industry, FTC lawyer Andrew Smith stated that “[p]ayment processors who help scammers steal people’s money are a scourge on the financial system.”  “When we find fraud, we are committed to rooting out payment processors and other companies who actively facilitate and support these fraudulent schemes,” Smith stated.

The FTC is aggressively policing payment processors that bury their heads in the sand or go a step further and help cover up their clients’ wrongdoing.  Either course of conduct could land them in legal hot water.

The settlement terms of the matters above include permanent bans, hefty monetary judgments and the surrender of assets.

© 2020 Hinch Newman LLP

Did Economic Uncertainty Make My PPP Loan Necessary?

The United States Department of the Treasury (Treasury) and the Small Business Administration (SBA) continue to issue information and guidance with respect to the Paycheck Protection Program (PPP) and the loans made available under it by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). One of the most recent items of note is the SBA’s updated PPP Loan FAQs, which in particular added FAQ 31 and FAQ 37. The answers to these two questions purport to provide guidance, retroactively, on one of the particular certifications that applicants were required to make in the PPP loan application process. This guidance, not coincidentally, came on the heels of negative press regarding the fact that larger companies (notwithstanding the CARES Act’s waiver of affiliation rules and employee sizes that made them otherwise eligible) were some of the recipients of funds appropriated to the PPP loan program.

So, what are the borrowers in the PPP to make of this? Below is an outline that may be helpful to a borrower that is evaluating next steps in light of this new “guidance” and how it plays into the certification initially made at loan application time.

Good Faith Certification

The PPP loan documents required the applicant to certify in good faith to several items. One of those certifications (Loan Necessity Certification) provided that: “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant?” Without having the commentary now available in the PPP Loan FAQs, early borrowers understood that the CARES Act did not require that the business had no other means of obtaining credit. That certainty and clarity was provided by the CARES Act itself, which provided that the requirement that an applicant be unable to obtain credit elsewhere was not applicable to the PPP loans. However, no other guidance or definitions were provided with respect to the Loan Necessity Certification.

Guidance

The SBA’s updated version of its PPP Loan FAQs includes, in pertinent part, the following new items:

31. Question: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.

37. Question: Do businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: See response to FAQ #31.

These new FAQs, in effect, modify the Loan Necessity Certification such that additional factors are now part of that certification. Whether these new factors are applicable to all borrowers, or just the “businesses owned by large companies”, is unclear. However, the answers seem to indicate that all borrowers should assess their economic need for the loans with these other factors in mind: (a) their current business activity, and (b) their ability to access other sources of liquidity to support their ongoing operations in a manner that is not significantly detrimental to the business.

Suggested Steps and Response

So, what should a borrower do in light of these new factors, and apparent change or at least qualifier thrown in midstream?

Unless or until additional information or guidance is provided, we suggest that a borrower revisit the certification that it initially made, and do so with additional attention to the facts and circumstances existing as of the date of the Loan Necessity Certification. If those facts and circumstances have changed since that date to the positive for the borrower and its economic position, then it might be prudent to evaluate the Loan Necessity Certification at two additional points in time: (a) the time it received the loan proceeds, and (b) the date of the newest guidance.

If a borrower revisits its Loan Necessity Certification, and does not feel good about the initial certification, the government is allowing a borrower to return the PPP loan proceeds on or before May 7, 2020, and that borrower will be deemed to have made the Loan Necessity Certification in good faith. This means that the borrower will avoid the possibility of civil or criminal enforcement with respect to that certification.  Although we believe testing of the good faith certification should as of the date it was made, the recent developments and problematic guidance make it unclear whether other points in time might have bearing on the evaluation of a borrower’s Loan Necessity Certification. That is the reason for the mention of testing at additional points of time.

To assist in revisiting the initial Loan Necessity Certification, a borrower should consider working backwards to the point of time in question, and borrower should reduce to writing the consideration and analysis of the economic uncertainty and its needs for the PPP loan. Issues or factors that might be useful in the analysis include:

  • The current and projected impact of COVID-19 to the business, and the uncertainties surrounding those projections, including any communications from customers or clients regarding their level of business with the borrower and their respective economic conditions;
  • Recent history of the business and its performance in the wake of other economic downturns;
  • Existing levels of cash reserves or cash equivalents, and the borrower’s ability to access other sources of capital and what the terms and conditions of such sources of capital might be;
  • Current or projected plans for retention or reduction of workforce or payroll costs of such workforce, and the ability of borrower to reinstate such workforce to pre-COVID-19 levels;
  • Reaction and measures taken by competitors to COVID-19;
  • Actions or measures that borrower is considering, or has already taken, to address the economic uncertainty outside of workforce or payroll reduction.

For the borrower that revisits the Loan Necessity Certification and determines that it did make the certification in good faith, the written work product should be saved in case that part of a borrower’s PPP loan is questioned in the future. In that regard, the Treasury has advised that borrowers receiving $2 million or more of PPP loan proceeds will be audited. The audit will likely focus on the Loan Necessity Certification, as well as other aspects of the loan and loan process, including (i) number of employees, (ii) the determination of the size of the loan, and (iii) use of the loan proceeds.

If the consideration and analysis of the Loan Necessity Certification makes a borrower uncomfortable, then it should consult its advisors and maybe also consider returning the amount of any loan proceeds by May 7th.

© 2007-2020 Hill Ward Henderson, All Rights Reserved

For more on PPP loan administration, see the National Law Review Coronavirus News section.

Texas Governor Announces $50 Million Loan Program for Texas Small Businesses through Goldman Sachs/LiftFund Partnership

As discussed in our previous alert on this issue, the CARES Act established a $349 billion U.S. Small Business Administration (SBA) Paycheck Protection Program (PPP) to provide immediate access to capital for small businesses who have been impacted by COVID-19. On April 13, 2020, Texas Governor Greg Abbott provided additional guidance to Texas employers when he announced that investment banking, securities and investment management firm, Goldman Sachs, will partner with San Antonio-based nonprofit organization, LiftFund, to provide $50 million in loans to small businesses. Specifically, Goldman Sachs will provide the capital, and LiftFund and other community development financial institutions will administer the funds. Texas business owners can now apply for a PPP loan and find more information about the program on the LiftFund website.

“What this capital will do [is] provide these companies the resources they need to keep employees on the payroll for the remaining few weeks or so until businesses can begin [the] process of opening back up,” Governor Abbott said. Notably, Governor Abbott indicated that he intends to issue an executive order that will outline strategies to begin the gradual process of reopening businesses in Texas.

This is a matter that is evolving regularly.

Copyright © 2020, Hunton Andrews Kurth LLP. All Rights Reserved.

For more on small business loans for COVID-19-relief, see the National Law Review Coronavirus News section.

Regulators Provide No Meaningful Relief or Guidance to Financial Institutions Struggling with Bank Secrecy Act and Compliance Due to COVID-19

While many disclosure and reporting requirements imposed on regulated entities are being relaxed in response to the COVID-19 pandemic, the Financial Crimes Enforcement Network (FinCEN) has taken a different approach with respect to financial institutions’ duties to comply with the Bank Secrecy Act (“BSA”). In an April 3, 2020, release – one of just two issued by the agency in response to COVID-19 – FinCEN recognized that “financial institutions face challenges related to the COVID-19 pandemic,” but confirmed that it “expects financial institutions to continue following a risk-based approach” to combat money laundering and related crimes and “to diligently adhere to their BSA obligations.” 1

Thus, even as financial institutions reduce personnel to attempt to weather the economic downturn caused by the COVID-19 and limit in-office personnel to comply with state quarantine orders, financial institutions must maintain adequate staff and resources to ensure BSA compliance. In the world of broker-dealers in securities, these BSA obligations generally revolve around complying with anti-money laundering (AML) compliance program requirements, analyzing transactions for potentially suspicious activity and preparing and timely filing suspicious activity reports (SARs).

As detailed below, with very limited exceptions, regulators have offered broker-dealers no relief from these obligations as a result of business disruptions caused by COVID-19.  Indeed, these already onerous burdens may be heightened by the increased risks of fraud, insider trading and other unusual financial activity by customers in these times of financial uncertainty. This “business as usual” attitude denies the reality that companies are coping with stay-at-home orders in the best-case scenarios and employees at home infected and unable to work in the worse-case scenarios.

FinCEN Requires Broker-Dealers to Implement Anti-Money Laundering (AML) Programs and SAR Reporting

In the PATRIOT Act of 2001, Congress required that all broker-dealers establish and implement AML programs designed to achieve compliance with the Bank Security Act (BSA) and the regulations promulgated thereunder, including the requirement that broker-dealers file Suspicious Activity Reports (SARs) with FinCEN.2

Under FinCEN’s regulation, a broker-dealer “shall be deemed” to satisfy the requirements of Section 5318(h) if it, inter alia, “implements and maintains a written anti-money laundering program approved by senior management” that complies with any applicable regulations and requirements of the U.S. Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) for anti-money laundering programs.3 Required program requirements include the implementation of “policies, procedures and internal controls reasonably designed to achieve compliance with the BSA,” independent testing, ongoing training, and risk-based procedures for conducting ongoing customer due diligence.4  FinCEN also required broker-dealers to establish and maintain a “customer identification program” (CIP) designed to help broker-dealers avoid illicit transactions through “know your customer” directives.5  FINRA largely duplicated these requirements in FINRA Rule 3310.

FinCEN also promulgated broker-dealer SAR filing requirements that largely mirror those applicable to banks. In short, a broker dealer is required to file a SAR on any transaction “conducted or attempted by, at or through a broker-dealer,” involving an aggregate of at least $5,000, where the broker-dealer “knows, suspects or has reason to suspect that the transaction” or “a pattern of transactions” involves money laundering, structuring, unusual and unexplained customer activity or the use of the broker-dealer to “facilitate criminal activity.”6  Broker-dealers must file SARs within “30 calendar days after the date of the initial detection” by the broker-dealer “of facts that may constitute a basis for filing a SAR.”7

These requirements are strictly enforced and sanctions for noncompliance can be extreme for both broker-dealers and their responsible officers and employees. Enforcement actions for “willful” noncompliance frequently result in civil money penalties against firms exceeding $10 million. In December of 2018, the U.S. Attorney’s Office for the Southern District of New York brought the first ever criminal action against a U.S. broker-dealer for a willful failure to file a SAR to report the illicit activities of one of its customers.8 In addition, because the primary purpose of an AML program is to detect and report suspicious activity, a failure to file SARs frequently gives rise to separate claims for violations of both the SAR filing and AML compliance program requirements.

Regulators Offer No Meaningful Relief from BSA Obligations Regardless of the Logistical issues Resulting from the COVID-19 Crisis

Despite recognizing the challenges broker-dealers and other financial institutions face in responding to the COVID-19 pandemic, to date regulators have offered no meaningful relief from the regulatory burdens imposed by the SAR and AML program requirements of the BSA. These steps are currently limited to:

  • FinCEN has created an “online contact mechanism” for “financial institutions to communicate to FinCEN COVID-19 related concerns while adhering to their BSA obligations,” but indicated that volume constraints may limit it to responding “via an automated message confirming receipt to communications regarding delays in filing of BSA reports due to COVID-19.”9

  • FinCEN also opaquely encouraged “financial institutions to consider, evaluate and, where appropriate, responsibly implement innovative approaches to meet their BSA/anti-money laundering compliance obligations.”10

  • FINRA “reminded” broker-dealer members that they have until December 31, 2020 to perform the annual independent testing of the member’s AML compliance program.11

The creation of a hotline and a directionless suggestion to “innovat[e],” at the risk that doing so incorrectly may expose a firm to criminal charges or regulatory enforcement actions, are of little practical use or comfort to firms. In short, it is business as usual for broker-dealers and other financial institutions with respect to their AML and SAR obligations under the BSA, even as they grapple with heightened compliance challenges because of COVID-19.

Heightened BSA Compliance Challenges Surrounding COVID-19

The AML program and SAR reporting requirements under the BSA create substantial compliance burdens even in the best of times. These obligations are resource-heavy, requiring yearly testing, ongoing monitoring of customers and transactions at the broker-dealer for potentially suspicious activity and dedicated personnel and systems to review transactional and customer information and to prepare SARs.

In addition, determining when a SAR filing is required is no easy task. The SAR regulation, as detailed above, is both expansive and vague, equally applying to transactions that may be criminal in any respect, may involve funds from other illegal activity or that may simply be unusual for a customer. Most broker-dealer compliance personnel are not trained in law enforcement, and yet are expected to analyze a host of characteristics about a particular customer and a particular trade to determine whether the transaction crosses an ill-defined threshold of suspiciousness, and to do so within 30 days. Law enforcement and regulators, such as the SEC, by contrast, frequently take years to investigate potentially illicit activity. While guidance issued by regulators has identified a number of “red flags” designed to help compliance personnel identify suspicious transactions, any of these red flags may seem innocuous or explainable in a given transaction, particularly in the limited time provided for review, leaving firms and compliance personnel open to regulatory second-guessing, with the benefit of hindsight, and at the risk of significant sanctions for interpreting the situation incorrectly.

A recent GAO report from August 2019, evaluating the effectiveness of BSA reporting, indicated that affected industry participants have raised questions about “the lack of a feedback loop or clear communication from FinCEN, law enforcement and supervisory agencies on how to most effectively comply with BSA/AML requirements, especially BSA reporting requirements.”12  Representatives from the securities industry in particular raised concerns that “compliance expectations are communicated through enforcement actions rather than through rulemaking or guidance.13

Of course, these are not the best of times. On March 16, 2020, FinCEN warned financial institutions to “remain alert about malicious or fraudulent transactions similar to those that occur in the wake of natural disasters.”14 As relevant to broker-dealers, FinCEN warned about an increase in insider trading, imposter scams, and COVID-19 related “investment scams,” such as promotions that falsely claim the products or services of publicly traded companies can prevent, detect or cure coronavirus.15

While this conduct, if occurring, is undoubtedly criminal, it is often unclear what steps a broker-dealer must take and what indicia of suspicion it must find before it is required to identify a trade as sufficiently suspicious for SAR reporting.  For example, with respect to the COVID-19 related “investment scams,” at what point does the broker-dealer, in the exercise of due diligence, unearth enough indicia that this issuer may be misrepresenting the efficacy of its product or services in preventing or treating COVID-19 to create at least a “reasonable suspicion” of fraud?  The signs may be very subtle and overlooked by compliance personnel at the time, but characterized as glaring red flags by regulators after the fact.

Similarly, a sudden spike in trading volume and price could be indicative of a pump-and-dump scheme, particularly where media coverage and a microcap stock are involved. However, with the current volatility of this market, large volume and price swings are increasingly common. And, the media is adding to the frenzy, and following the lead of the administration, by rushing to report any and all potential COVID-19 treatments.  Such developments can make it difficult for firms to separate suspicious trading activity from innocuous activity, causing them to either fail to file a SAR where they should or filing a SAR where they should not.

Compounding the difficulty of the analysis, the broker-dealer’s customer – and the putative subject of the SAR – will not be the issuer, but generally someone who is trading in the stock.  Accordingly, even if the there is a reason to suspect that the issuer or persons associated with the issuer are involved in an “investment scam,” this does not necessarily mean that the transaction at issue is suspicious within the meaning of the SAR regulation. The trading customer may simply be reacting to the news in buying or selling the securities at issue, as either an opportunistic trader or a victim of a potential issuer fraud, neither of which would appear to raise any indicia of suspicion for SAR reporting.

An examination of the totality of the circumstances of a transaction can help firms make the crucial distinctions between transactions that warrant a SAR and those that do not.  For example, determining the source of the publicity –is it a CNN article or a paid newsletter – or whether the customer is affiliated in some way with the issuer or the promotion are questions, among many others, that must be investigated.

It is unfortunate that FinCEN has failed to provide any meaningful or practical guidance for financial institutions dealing with these heightened risks of fraud during a period when they may have difficulty in even staffing their offices. Performing this work remotely creates its own challenges, given high level of confidentiality of SAR filings under Section 5318(g)(2), and the consequences – including criminal liability – for violating these confidentiality provisions.

Nonetheless, that is the situation broker-dealers are in, and this is likely the point:  FinCEN, law enforcement and regulatory agencies do not want to relax these requirements because of the heightened risks of financial crime during the pandemic and the government has become accustomed to this front-line reporting from private businesses. Even in these unprecedented times of economic disruption, broker-dealers must protect themselves from regulatory criticism and enforcement actions by continuing to follow their AML compliance programs and conducting the necessary due diligence on each transaction they process.

1  https://www.fincen.gov/news/news-releases/financial-crimes-enforcement-network-provides-further-information-financial

2  31 U.S.C. §5318(h), (g)

3  31 C.F.R. § 1023.210

4  Id.

5  31 C.F.R. § 1023.220

6  31 C.F.R. § 1023.320(a)(2)

7 31 C.F.R. § 1023.320(b)(3)

8 https://www.justice.gov/usao-sdny/pr/manhattan-us-attorney-announces-bank-secrecy-act-charges-against-kansas-broker-dealer.

9 https://www.fincen.gov/news/news-releases/financial-crimes-enforcement-network-provides-further-information-financial

10  Id.

11  https://www.finra.org/rules-guidance/key-topics/covid-19/faq#aml

12   See GAO-19-583, Agencies and Financial Institutions Share Information but Metrics and Feedback Not Regularly Provided (August 2019), at pp. 3-4.

13   Id. at 24

14  https://www.fincen.gov/news/news-releases/financial-crimes-enforcement-network-fincen-encourages-financial-institutions.

 15  Id.

Copyright © 2020 by Parsons Behle & Latimer. All rights reserved.

For more on COVID-19’s financial implications, see the National Law Review Coronavirus News section.

Japan’s New Crypto Regulation – 2019 Amendments to Payment Services Act and Financial Instruments and Exchange Act of Japan

Japan will fundamentally change its crypto asset regulations effective in spring of 2020.

In May, 2019, the National Diet, the Japanese national legislature, passed an amendment bill to the Payment Services Act (the “PSA”) and the Financial Instruments and Exchange Act (the “FIEA”), which was promulgated on June 7, 2019 (the “2019 Amendment”).  The 2019 Amendment will become effective within one year from promulgation, following further rulemaking by the Japan Financial Services Agency (the “JFSA”) to implement the 2019 Amendment, which is anticipated sometime soon and includes public comment process.

Key Takeaways of the 2019 Amendment

The 2019 Amendment, coming into force within one year of the promulgation, will bring certain significant and fundamental changes to how crypto assets are regulated in Japan.  Key takeaways are:

  • Crypto asset margin trading and other crypto asset derivative transactions will become subject to Japanese regulations on derivative transactions generally.  Broker-dealers and exchanges will likely need to revisit and update their registration status and policies and procedures.  While it may be possible to rely on a limited grandfathering provision for 6 months after the effective date, a notification must be submitted to a relevant local Finance Bureau within two weeks after the effective date of the 2019 Amendment.
  • Certain crypto assets distributed through distributed ledger technologies (such as blockchain) will be expressly regulated as Type I securities.  Consequently, solicitation and offering of such crypto assets, including Initial Coin Offerings, to Japanese investors will require careful review and structuring to avoid any regulatory pitfalls.
  • Crypto asset-related custodial activities will be subject to licensing.
  • Crypto asset trading activities will be subject to various prohibitions on unfair trading and practices.
  • A detailed rulemaking process will follow and involve opportunities to submit comments during the public consultation process.

Copyright 2019 K & L Gates

ARTICLE BY Tsuguhito Omagari of K&L Gates.
More on cyprocurrency regulation on the National Law Review Financial Institutions & Banking law page.

Court Finds Medical Bill Reimbursement Claim Subject to “Biblically-Based Mediation and Arbitration”

A Mississippi federal court granted a motion to compel arbitration of a claim for reimbursement of medical expenses from the defendant, a company that provides health care sharing plan alternatives to those of Christian faith. The plaintiff had signed a membership agreement stating that he would abide by the defendant’s guidelines, under which members, such as the plaintiff, were required to exhaust an “appeals” process for challenging bill-sharing decisions before resorting to any sort of legal procedures against the defendant. If the appeals process did not resolve the dispute, a “biblically-based mediation and arbitration” clause in the guidelines stated that any and all disputes arising out of the membership agreement shall be settled by “biblically-based mediation.” If that mediation fails, the member may submit the dispute to an independent and objective arbitrator for binding arbitration but otherwise waives his or her right to file a lawsuit.

Addressing the defendant’s motion, the court first held that the provision above constituted a valid arbitration agreement and that the subject dispute fell within the scope thereof. The court noted that the plaintiff had indeed agreed that he “will bring no suit, legal claim or demand of any sort … in the civil court system, with the sole exception of enforcing any favorable arbitration award or mediated agreement.” As such, the court explained that arbitration was required unless a federal statute or policy rendered the plaintiff’s claim non-arbitrable. Because the plaintiff failed to identify any such statute or policy, the court granted the defendant’s motion to compel arbitration.

Pettey v. Medi Share, No. 2:19-cv-00059 (S.D. Miss. Oct. 1, 2019).

©2011-2019 Carlton Fields, P.A.

ARTICLE BY Alex B. Silverman of Carlton Fields.

Payment Processor Held Accountable by FTC

The Federal Trade Commission and the Ohio attorney general recently initiated legal action against a payment processor arising from alleged activities that enabled its customers to defraud consumers.

According to the FTC, the defendants generated and processed remotely created payment orders (“RCPOs”) or checks that allowed unscrupulous merchants, including deceptive telemarketing schemes, to withdraw money from their victims’ bank accounts.

The FTC’s Telemarketing Sales Rules specifically prohibits the use of RCPOs in connection with telemarketing sales.  RCPOs are created by the processor and result in debits to consumers’ bank accounts without a signature.

“To execute their payment processing scheme, Defendants open business checking accounts under various assumed names with banks and credit unions, the majority of which are local institutions,” according to the complaint.  Within the last five years, the defendants opened at least 60 business checking accounts at 25 different financial institutions, mainly in Texas and Wisconsin, to enable their activity, the regulators said. “Defendants often misrepresent to the financial institution the type of business for which they open the account, and routinely fail to disclose the real reason for which they open the account—processing consumer payments for third-party merchants via RCPOs.  Red flags about Defendants’ practices have led at least 15 financial institutions to close accounts opened by Defendants.  When that happens, Defendants typically open new accounts with different financial institutions.  ”

According to the Ohio AG and FTC lawyers, the defendants specifically market their RCPO payment processing service to high risk merchants.  The complaint also alleges that the defendants are aware that some of their largest merchant- clients sell their products or services through telemarketing.

The FTC and Ohio AG also allege that the defendants violated the TSR by charging consumers advance fees before providing any debt relief service, failing to identify timely and clearly the seller of the purported service in telemarketing calls, and failing to pay to access the FTC’s National Do Not Call Registry.

The Ohio AG previously had previously filed suit against the defendants for similar violations.

According to the FTC CID attorneys, the telemarketing operations that defendants supported included, among others, student debt relief schemes, and a credit interest reduction scheme.  The FTC and Ohio allege that using RCPOs, the defendants have withdrawn more than $13 million from accounts of victims of these telemarketing operations since January 2016.

“The FTC will continue to pursue such schemes aggressively, and hold accountable payment processors that are complicit in the illegal conduct,” FTC lawyer Andrew Smith said in a statement about the case.

The complaint alleges violations of the FTC Act and Ohio state law, and seeks injunctive relief plus disgorgement of alleged ill-gotten gains.

At the same time, the FTC and state of Ohio filed another enforcement action against one of the processor’s biggest clients based in Canada and the Dominican Republic.

Federal and state regulators have evidenced a willingness to both go after merchants that engage in unfair and deceptive practices that are injurious to consumers, as well as the payment processors that enable merchants to engage in such conduct.

© 2019 Hinch Newman LLP

Fore more FTC finance enforcement actions, see the National Law Review Financial Institutions & Banking law page.