SEC Spotlight: Enforcement and Regulatory Developments in the First Half of 2023
The U.S. Securities and Exchange Commission (SEC or Commission) was very active during the first half of 2023. As we discussed in prior reviews, the SEC’s Division of Enforcement (Enforcement) continues to focus on cryptocurrency enforcement, bringing settled and contested actions that find or allege frauds worth hundreds of millions of dollars. Beyond crypto cases, Enforcement focused on other, more traditional priorities, including instituting enforcement actions for insider trading and misleading disclosures. In addition, the Division of Examinations (Exams) announced its 2023 priorities, indicating that Exams will focus on compliance, ESG and impact investing, financial technology and crypto-assets, and information technology and operational resiliency. Finally, from a rulemaking perspective, a Commission proposed rule relating to the reporting of large security-based swap positions is currently in the comment period.
This Advisory continues our series of periodic SEC enforcement and regulatory highlights, with links to additional Arnold & Porter Advisories when available. We include our takeaways as former leaders and attorneys in the Enforcement Division, including as the former Chief of the Market Abuse Unit and Director of the Philadelphia Regional Office (Dan Hawke), former Chief of the Office of the Whistleblower (Jane Norberg), and former Assistant Chief Litigation Counsel (Christian Schultz).
Crypto. The SEC continued to focus heavily on cryptocurrencies and other crypto assets throughout the first half of 2023. For example, the SEC settled two actions against companies whose business models involved investors transferring crypto assets in exchange for interest or investment returns, finding in both cases that the companies were engaged in an unregistered offering of securities. On January 19, 2023, the SEC instituted an order in which Nexo Capital (Nexo) agreed to pay a US$22.5 million penalty in connection with its offer and sale of a retail crypto asset lending product, the Earn Interest Product (EIP). The EIP allowed U.S. investors to tender crypto assets to Nexo in exchange for Nexo’s promise to pay interest. Nexo would then use those assets to generate income and fund interest payments to investors. The Commission found that the EIP was a security that did not qualify for an exemption from SEC registration. Nexo also agreed to pay an additional US$22.5 million in fines to settle similar charges by state regulatory authorities. Similarly, on February 9, 2023, the SEC announced a settlement with Kraken entities that were involved in a crypto asset “staking service” whereby Kraken pooled certain crypto assets transferred by investors in exchange for an advertised annual investment return of as much as 21%. Commenting on the case, SEC Chair Gary Gensler stated “whether it’s through staking-as-a-service, lending, or other means, crypto intermediaries, when offering investment contracts in exchange for investors’ tokens, need to provide the proper disclosures and safeguards required by our securities laws.”
In April 2023, the SEC began charging crypto asset trading platforms as operating unregistered national securities exchanges, brokers, and clearing agencies. On April 17, 2023, the SEC charged crypto asset trading platform Bittrex, Inc. (Bittrex) and co-founder William Shihara. According to the complaint, since 2014, Bittrex held itself out as a platform that facilitated buying and selling of crypto assets that the SEC alleges were offered and sold as securities. The complaint also alleges Bittrex and Shihara coordinated with issuers to delete “problematic statements” that Shihara believed would lead regulators to investigate the crypto assets as securities.
On June 5, 2023, the SEC charged Binance with operating unregistered national securities exchanges, broker-dealers, and clearing agencies, and with the unregistered offer and sale of crypto assets. Binance and its founder, Changpeng Zhao (Zhao), also were charged with (1) secretly allowing high-value U.S. customers to continue trading crypto assets while publicly claiming U.S. customers were restricted from such transactions, (2) secretly controlling Binance.US while publicly claiming it was independent, (3) commingling customer assets, (4) misleading investors about nonexistent trading controls, and (5) concealing the fact that they were commingling billions of dollars of investor assets and sending them to a third party company owned by Zhao. On June 6, 2023, the SEC filed an emergency action and sought a temporary restraining order freezing assets, directing Binance to repatriate assets held for the benefit of customers, and seeking other emergency relief. On June 17, 2023, the district court in Washington, D.C. entered a consent order that did not include a full asset freeze but did require repatriation of customer assets and placed restrictions on Binance and Zhao’s access to those assets, among other restrictions.
Similarly, on June 6, 2023, the SEC charged Coinbase with operating its crypto asset trading platform as an unregistered national securities exchange, broker, and clearing agency, as well as failing to register the offer and sale of its crypto asset staking-as-a-service program. According to the complaint, since 2019, Coinbase served as an unregistered exchange by facilitating the buying and selling of crypto asset securities. Further, Coinbase is alleged to be engaging in an unregistered securities offering through its staking-as-a-service program, which allows customers to earn profits from the proof of stake mechanism of certain blockchain.
The SEC also brought more traditional securities cases arising in the crypto space, including a US$100 million crypto fraud scheme involving “Ponzi-like” payments and a multi-billion dollar crypto securities fraud scheme alleging false and misleading statements in connection with the purchase and sale of securities. In addition, the SEC brought a US$116 million market manipulation case wherein an individual allegedly sold futures in a digital token to himself, then engaged in large purchases of the thinly traded token in order to inflate the value of his futures, which he would then borrow and withdraw on. Finally, the SEC settled multiple actions with celebrities who illegally touted crypto assets without disclosing that they were compensated for doing so, in violation of section 17(b) of the Securities Act of 1933.
Insider Trading. The SEC continued to surveil for insider trading throughout the first half of 2023. On February 23, 2023, the SEC charged two cousins with insider trading, alleging that the cousins traded based on material nonpublic information related to two companies’ planned government partnerships to fight against COVID-19. This trading allegedly netted the defendants more than US$1.5 million in profits. On March 1, 2023, the SEC charged the executive chairman of a California-based healthcare treatment company with insider trading for selling more than US$20 million of stock while having material nonpublic knowledge that the company’s relationship with its then-largest customer was tenuous and on the verge of being terminated. Finally, on March 30, 2023, the SEC filed insider trading charges against a trader at a Canadian asset management firm and a partner at a U.S. broker-dealer for trading on the basis of material nonpublic information in advance of at least seven merger announcements involving special purpose acquisition companies, with illicit profits of more than US$3.5 million.
Whistleblower Protections. On February 3, 2023, the SEC announced that Activision Blizzard had agreed to pay US$35 million to settle charges that it failed to maintain disclosure controls and procedures to ensure that the company could assess whether its disclosures were adequate, as well as charges that it violated an SEC whistleblower protection rule by executing agreements requiring former employees to provide notice to the company if they receive a request for information from the Commission staff. In particular, the SEC alleged that the company failed to maintain disclosure controls reasonably designed to ensure that information related to internal whistleblower reports is provided to those within the company making disclosure decisions. We previously discussed the implications of this case here.
On May 23, 2023, the SEC issued an order reflecting a US$2 million settlement with Gaia Inc. The order included findings that the company (1) made material misstatements about the number of paid subscribers, (2) engaged in whistleblower retaliation against an employee who reported internally and to the SEC about overstating the number of its paying subscribers, and (3) impeded whistleblowing to the SEC by including language in severance agreements that required the employees to waive their right to monetary incentives. We previously discussed the implications of this order here.
Misleading Disclosures and Disclosure Control Deficiencies. The Commission also brought several multi-million dollar actions against companies for deficient or misleading disclosures during the first half. On February 21, 2023, the SEC announced charges against a non-profit entity operated by the Church of Jesus Christ of Latter-day Saints. The Commission found that the church failed to file forms that would have disclosed the church’s equity investments, and instead filed forms for shell companies that obscured its portfolio and misstated the non-profit’s control over the church’s investment decisions. As part of the settlement, the non-profit agreed to pay a US$4 million penalty and the church agreed to pay a US$1 million penalty.
On March 9, 2023, the SEC announced a US$3 million settlement with Blackbaud, a data management software company that provides donor data management software to non-profit organizations, for making misleading disclosures about a ransomware attack that impacted more than 13,000 customers. The data management company had announced that the attacker did not access bank account information or social security numbers and failed to correct this disclosure when employees later learned contradictory information due to the company’s failure to maintain reasonably designed disclosure controls and procedures.
On March 14, 2023, the SEC instituted a settled action against an IT services company relating to misleading disclosures about its non-GAAP financial performance. As part of the settlement, the company agreed to pay an US$8 million penalty and to undertake to develop and implement appropriate non-GAAP policies and disclosure controls and procedures, with the SEC noting the company’s cooperation during the investigation and remedial actions.
On April 18, 2023, the SEC announced a settlement with Betterment LLC (Betterment), finding material misstatements and omissions related to its automated tax loss harvesting service, failure to provide clients with notice of changes to its contracts, and failure to maintain certain required books and records from 2016 until 2019. As part of the settlement, Betterment agreed to pay a US$9 million civil penalty.
Foreign Corrupt Practice Act (FCPA). On March 6, 2023, the SEC announced a settlement with Rio Tinto plc for violations of the FCPA arising out of a bribery scheme involving a consultant in Guinea. According to the SEC, Rio Tinto hired a French investment banker and former senior Guinean government official to help the company retain mining rights in Guinea, and the consultant attempted to make an improper payment of at least $822,000 to a Guinean government official in connection with the efforts to retain the mining rights. None of Rio Tinto’s payments to the consultant were accurately reflected in its books and records, and the company failed to have sufficient internal accounting controls in place to detect or prevent the misconduct. As part of the settlement, Rio Tinto agreed to pay a US$15 million civil penalty.
On May 11, 2023, the SEC announced a settlement with Koninklijke Philips N.V. for violations of the Foreign Corrupt Practices Act arising out of its sales of medical diagnostic equipment in China using special price discounts to distributors that created a risk that excessive distributor margins could be used to fund improper payments to government employees. The SEC also found employees, distributors, or sub-dealers engaged in improper conduct to influence hospital officials and other improper bidding practices. As part of the settlement, Philips agreed to pay US$15 million in civil penalties and more than US$47 million in disgorgement and prejudgment interest.
ESG Disclosures. On March 28, 2023, the SEC announced that Vale S.A., a publicly traded Brazilian mining company, agreed to pay US$55.9 million to settle charges that the Commission brought in April 2022 stemming from allegedly false and misleading disclosures about the safety of its dams. As discussed in our Advisory at the time the case was filed, this is the first action emphasizing false and misleading ESG disclosures since the Division of Enforcement formed its Climate and ESG Task Force in March 2021.
Fraudulent Activity. On April 3, 2023, the SEC announced charges against Chatham Asset Management LLC (Chatham) and its founder, Anthony Melchiorre (Melchiorre), with improper trading of certain fixed income securities. According to the SEC, from 2016 until 2018, one Chatham-advised client sold certain bonds while a different client purchased those same bonds. Since Chatham and Melchiorre proposed the prices of the trades it had the effect of increasing the price of the AMI bonds at a higher rate than prices of similar securities. Chatham and Melchiorre’s trading in these bonds also accounted for the vast majority of the trading and, therefore, had a material impact on the price. Chatham and Melchiorre agreed to pay more than US$19.3 million in combined disgorgement, prejudgment interest, and civil penalties.
On May 2, 2023, the SEC announced charges against Brett Bartlett (Bartlett), Scott Miller (Miller), and their companies for fraudulent securities offerings that raised at least US$20.5 million. According to the complaint, from June 2018 until May 2020, Bartlett and Miller raised funds by selling promissory notes, stock, and fraudulent gold contracts through various companies. Bartlett and Miller made more than US$11 million in Ponzi-like payments, sent investors US$21 million in bad checks in order to stave off demand for cash payouts, and misappropriated more than US$1.2 million for personal use.
On May 15, 2023, the SEC announced charges against Red Rock Secured LLC, its CEO, and two of its former senior account executives in connection with a fraudulent scheme that involved convincing investors to sell securities in their retirement accounts to buy gold and silver at prices that included markups far greater than the defendants promised. According to the complaint, since 2017 the defendants solicited investors by telling them to “protect” their retirement savings by selling securities and investing in gold or silver coins at only a 1%-5% markup. In reality, Red Rock charged as much as a 130% markup, allowing them to pocket more than US$30 million of the more than US$50 million they received from investors.
On May 23, 2023, the SEC obtained an emergency order to halt an alleged ongoing offering fraud and Ponzi-like scheme by Integrated National Resources Inc. (INR), which does business as WeedGenics, and its owners. INR and its owners are alleged to have raised more than US$60 million from investors in order to expand their cannabis operations, but instead used the majority of funds to make Ponzi-like payments and to enrich themselves. According to the complaint, since 2019, the owners promised investors they would use raised funds to expand WeedGenics facilities while, in reality, they never owned or operated any facilities. The order included a temporary restraining order against INR and its owners, an order freezing their assets, and the appointment of a temporary receiver.
On June 12, 2023, the SEC charged investment adviser Sabby Management LLC and its managing partner Hal Mintz with fraud in connection with a long-running scheme involving misrepresentations and violations of rules for short selling and order making, as well as other violative trading. According to the complaint, from March 2017 until May 2019, the defendants engaged in illegal “naked short selling” by intentionally and improperly placing short sales when they knew or were reckless in not knowing that they had not borrowed or located the shares, then failed to timely deliver the shares. The complaint also alleges that, on occasion, the defendants used their naked short selling to deflate the price of securities, allowing them to obtain more shares at a cheaper price. The complaint further alleges the defendants tried to conceal their fraudulent trading by using securities acquired after the trades to appear as if they had borrowed or located them prior to the trade.
Liquidity Rule. On May 6, 2023, the SEC announced the first-ever case enforcing the Liquidity Rule, which prohibits mutual funds from investing more than 15% of their net assets in illiquid investments, requires funds to take certain prompt and remedial steps if they hold illiquid investments above this percentage limit, and requires funds to adopt a liquidity risk management program to assess their liquidity risk. The complaint against Pinnacle Advisors LLC, two independent trustees, and two officers alleges that, from June 2019 to June 2020, the fund held approximately 21%-26% of its net assets in illiquid investments. The defendants classified the fund’s largest illiquid investment as a “less liquid” investment — against the advice of fund counsel and auditors. The complaint alleges that the defendants did not present the fund’s board with a plan to reduce the illiquid investments and that certain defendants misled the SEC’s Division of Investment Management about the basis for the liquidity classifications.
Recordkeeping Violations (“off-channel communications”). On May 11, 2023, the SEC announced settlements with HSBC Securities (HSBC) and Scotia Capital for widespread and longstanding failures to maintain and preserve electronic communications. According to the SEC, there was pervasive and longstanding use of off-channel communications at both firms that were not maintained or preserved, including discussions about securities business matters on personal devices and messaging platforms such as WhatsApp. HSBC and Scotia Capital agreed to pay penalties of US$15 million and US$7.5 million respectively, and separately settled with the Commodities Futures Trading Commission for related conduct. These penalties were more modest than the penalties included in the settlements entered into with other institutions for similar violations. The SEC announcement suggests that the efforts of HSBC and Scotia Capital to self-report and self-remediate were a factor in the settlement negotiations. The firms also agreed to retain compliance consultants to, among other things, conduct comprehensive reviews of their policies and procedures relating to the retention of electronic communications found on personal devices and their respective frameworks for addressing non-compliance by their employees with those policies and procedures.
Whistleblower Awards. On May 5, 2023, the SEC awarded the largest-ever whistleblower award — US$279 million. According to reporting by The Wall Street Journal, this award more than doubles the SEC’s previous record award of US$114 million. According to the SEC release, the whistleblower’s information did not prompt the opening of the investigation but did expand the scope of the misconduct charged.
In addition to this award, the SEC awarded more than US$63 million to eight other whistleblowers during the first half of 2023. The awards granted include:
- An award of more than US$5 million to a whistleblower who provided a tip and additional information that helped SEC staff, and had also internally reported concerns prior to submitting information to the SEC
- An award of approximately US$18 million to three whistleblowers whose information led to the opening of an investigation into a fraudulent scheme and whose assistance led to a successful enforcement action
- An award of more than US$28 million to joint whistleblowers who provided critical information, substantial analysis, and ongoing assistance to the SEC which resulted in the return of millions of dollars to investors
- An award of more than US$12 million to two whistleblowers whose information prompted the opening of an investigation and who contributed by identifying key witnesses, helping staff understand complex fact patterns and issues, and making persistent efforts to remedy the issues
In February 2023, Exams announced its priorities for the coming year. As discussed in more detail in Arnold & Porter’s prior Advisory, Exams will focus on the following areas: (1) compliance with the new Marketing Rule; (2) compliance with Investment Companies rules; (3) private funds, including policies and practices regarding the use of alternative data; (4) Environmental, Social, and Governance (ESG) or impact investing; (5) broker-dealers; (6) financial technology (FinTech) and crypto-assets; and (7) information security (InfoSec) and operational resiliency. These priorities reflect both the SEC’s longstanding mission of promoting compliance, preventing fraud, monitoring risk, and informing policy, as well as the SEC’s intent to address new and emerging areas of risk.
While our discussion below does not cover all rules proposed during the first half, a full list of which can be found here, the following chart identifies certain proposed rules where the deadlines have not yet passed:
| Position Reporting of Large Security-Based Swap Positions
|| August 21, 2023
Position Reporting of Large Security-Based Swap Positions. On June 20, 2023, the SEC reopened the comment period for its proposed amendments related to reporting of large security-based swap positions that exceed certain thresholds. The proposed rule would require public reporting of, among other things, (1) certain large positions in security-based swaps, (2) positions in any security or loan underlying the security-based swap position, and (3) positions in any other instruments relating to the underlying security or loan or group or index of securities or loans. Along with this reopening, the SEC’s Division of Economic Risk and Analysis also released a memorandum providing supplemental data and analysis regarding the proposed reporting thresholds in the equity security-based swap market. The comment period will remain open until August 21, 2023.
The SEC began the year with an aggressive enforcement agenda. While the full scope of the SEC’s stated enforcement and regulatory priorities will only be revealed with time, companies, individuals, and other market participants should be aware that crypto, insider trading, cybersecurity, privacy, and ESG disclosures are likely to continue to be hot areas for Commission enforcement and regulation in the months to come.
We will continue to monitor and report on the key enforcement and regulatory developments at the SEC. In the meantime, please reach out to any author of this Advisory or your regular Arnold & Porter contact with any questions about the issues discussed herein or the state of play at the Commission.
© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.