A very recent ruling by the Supreme Court came on June 27, 2024, in Securities and Exchange Commission v. Jarkesy, which held that the Seventh Amendment to the U.S. Constitution requires the Securities and Exchange Commission (SEC) to bring a civil penalty for securities fraud in the federal district courts before a jury, not through an administrative proceeding.

The SEC charged George Jarkesy, Jr. and his investment firm, Patriot28, LLC, with fraud in connection with the operation of their investment funds. If the SEC believes that someone has violated the securities laws, it has two options: It can bring the case in federal court or handle the matter internally through its administrative proceedings. In this case, the target for alleged violations of the securities law was adjudicated by the SEC itself. Thus, the action was handled by an administrative law judge—who works for the SEC—rather than a federal court.

This raises some very serious legal questions under the Seventh Amendment, which ensures there will be a trial by jury in certain civil cases. So, the real basic legal question of this case was whether under the Seventh Amendment, Jarkesy and his firm had a constitutional right to a jury trial in light of the SEC’s decision to handle prosecution of the charges in-house.

The Supreme Court has ruled that the SEC’s internal case handling method, which does not offer a jury trial, violates the Seventh Amendment. Now this could have a significant impact on how the SEC and potentially other federal agencies enforce their rules.

The SEC’s Enforcement Action

The SEC enforcement charged several instances of allegations for fraud-related activities.

• Misrepresentation of Investment Strategies. The SEC charged Jarkesy and Patriot28 with the misrepresentation of investment strategies to misled investors.
• False Information Regarding the Auditor and Broker. Jarkesy and his firm were also charged with false representations regarding an auditor and a prime broker for the funds.
• Inflating the Value of the Funds. Another grave allegation was that Jarkesy and his firm inflated the value of the funds under their management.

The SEC took the following enforcement actions in response to the allegations:

• Civil Penalties. A civil penalty of $300,000 was imposed by the SEC on Jarkesy and Patriot28. Civil penalties include money fines that the SEC can levy to punish wrongdoing and deter wrongdoers.
• Cease and Desist Order. The Commission ordered Jarkesy and Patriot28 to cease and desist from committing or causing any violations of the antifraud provisions of the securities laws. This is a standard regulatory step to prevent the believes from continuing whatever activity is charged as illegal under securities laws.
• Disgorgement. It was ordered that Patriot28 disgorge the ill-gotten gains by returning money or property gained in an illicit manner to the parties concerned.
• Industry Bars. Jarkesy has been barred from the securities industry and penny stock offerings.
• Adjudication Process. Instead of taking it before a federal court, the SEC chose to conduct the case internally within its administrative process. It involved an administrative law judge appointed by the SEC, which created much legal controversy as to the appropriateness of such denial of a jury trial in cases relating to civil penalties against securities fraud.

Seventh Amendment Overview

The legal analysis of the Seventh Amendment claims in SEC v. Jarkesy turns on whether defendants have the right to a jury trial when the SEC decides to pursue civil penalties in its internal administrative proceedings rather than in federal district court. The question at hand was centrally located within the determination of the constitutional limits of the different administrative enforcement actions by regulatory agencies like the SEC.

The Seventh Amendment grants the right to trial by jury in civil cases at common law if the amount in controversy be greater than twenty dollars.

The power of the SEC to enforce the securities laws either through administrative proceedings or through filing actions in federal court is long-established. When administrative proceedings are initiated, they typically do not involve juries, which raises a constitutional question.

In contrast, civil penalties, which are monetary in nature, are not merely compensatory and thus punitive in nature. They are intended to punish and deter wrongful conduct, and therefore have a punitive character. While actions for penalties could be tried by a jury at common law, similar actions under modern law may also require a jury.

In Granfinanciera, S.A. v. Nordberg (1989), the Supreme Court held that a statutory action of this nature, much like an action brought at common law, does grant the defendant the right to trial by jury under the Seventh Amendment if its judgment may lead to “personal liability” for money damages. The Court distinguished between actions that primarily concern public rights and those that primarily concern private rights disputes, which are more characteristic of the common law.

In Atlas Roofing Co. v. Occupational Safety and Health Review Commission (1976) the Supreme Court had held that it was within congressional power to assign the determination of statutory rights created by Congress to an administrative agency, with no right to a jury. However, this has been interpreted to apply to cases where the statutory framework creates new legal rights and obligations distinct from traditional common law actions.

In Tull v. United States (1987) the Supreme Court again restated that the right to a jury trial depends on the remedy sought. When relief is sought through penalties or action punitive in nature—characteristics traditional to common law—the right to trial by jury is preserved.

The critical legal question of SEC v. Jarkesy lies in the query: Did the SEC’s pursuit of civil penalties through its in-house, administrative processes without providing a right to a jury violate the Seventh Amendment?

Additionally, the arguments presented in the case hinge on whether the SEC’s action can be classified as a public rights adjudication, which typically does not require a jury, or rather, a private rights dispute that is subject to a jury trial. Given that the penalties in question are punitive and that the fraudulent nature of the actions otherwise alleged is grounded in common law history, it would be strongly in line with the Seventh Amendment to call upon a jury to determine the case.

Court’s Decision and Reasoning

The Supreme Court ruled that defendants have a right to a jury trial under the Seventh Amendment when the SEC seeks civil penalties for securities fraud.

The Court noted that the civil penalties sought by the SEC are, in fact, punitive rather than remedial. The basic purpose of such penalties is not so much to compensate the victim as to punish the offender and deter others from similar wrongdoing. It is this punitive nature that brings them more accurately within the concept of traditional common law actions, where the right to a jury trial is preserved.

Additionally, the SEC’s enforcement actions were based on allegations of fraud. The Court pointed out that fraud, historically a common law claim, involves deception and misrepresentation—actions traditionally adjudicated by juries. The SEC’s use of terms like “fraud” and “deceit” in its enforcement actions invokes common law principles, which necessitate a jury trial under the Seventh Amendment.

The “public rights exception” to the Seventh Amendment allows some legal claims to be decided without a jury, namely those involving public rights that Congress commits to resolution by administrative agencies or specialized courts. But the Court held this exception did not apply here, at least for the following reasons:

• Private vs. Public Rights. The Court distinguished between public rights, which are integral to a public regulatory scheme and typically do not require jury involvement, and private rights, which involve personal interests and are closely tied to the historical use of juries. The SEC’s action, involving allegations of private misconduct (fraud) and seeking punitive penalties, was categorized as a matter concerning private rights.
• Historical Precedent and Legislative Intent. The Court considered the historical contexts in which the public rights exception was applied, namely to customs duties, public land disputes, and certain government benefits, and stated that these cases typically involve legislative or sovereign functions or statutory schemes that by their very nature are governmental in character. Conversely, securities fraud is concerned with private dealings and harm to private investors.
• Jury Trial Precedents in Comparable Circumstances. The Court relied on cases like Granfinanciera, S.A. v. Nordberg and Tull v. United States to mandate the need for a jury trial when statutory actions have elements and features of common law actions, particularly when punitive measures are pursued.

Paradigm Shift in Power

SEC v. Jarkesy raises important questions about the future of the SEC’s administrative proceedings in general, and particularly those that do not involve fraud or seek civil penalties. Along with other recent decisions of the Supreme Court in Ohio v. EPA and Loper Bright Enterprises v. Raimondo, these decisions suggest a transfer of powers by paradigm shift, from the executive branch to the judiciary and, more specifically, to the Supreme Court.

Furthermore, the Loper Bright Enterprises v. Raimondo case saw a significant shift in approach, with the “Chevron Doctrine” being removed. This suggests a reduction in deference to administrative agencies like the SEC when interpreting ambiguous legislation. It also indicates a more rigorous level of judicial review for agency decisions, which could have a significant impact on securities regulation enforcement in general.

For example, the Dodd-Frank Act contains what has been dubbed the “Volcker Rule”, which prohibits banks from making certain types of speculative investments that are not in the best interest of their clients. Previously, some regulatory agencies, including the SEC, had the ability to have discretion in interpreting and changing the details of these prohibitions to ensure they remain relevant for current financial markets and practices. But with the power of fine-tuning vested in the SEC, these investment restrictions began to be redrawn afresh with the new judicial posture invoked. This may even result in a scaling back or rigorous implication of such regulatory frameworks, impacting their flexibility within which these banks are supposed to avert risks and set an innovative financial strategy.

Additionally, these decisions reflect a broader skepticism about the “administrative state” and its power. The weakening of deference toward administrative agencies could result in a significant increase in litigation, as decisions previously left to expertise-heavy agencies will now be subject to greater judicial scrutiny. This could significantly impact the workload of the federal courts and provide an opportunity for legal professionals at a time when litigation is expected to increase.

Logic suggests that under these changes, there could be increased judicial scrutiny and control over regulatory actions; nonetheless, there is no assurance that outcomes will evidence any improvement over those produced by agency expertise. A change of this nature can fundamentally alter not only the ways in which regulatory practice takes place but also the meaning given to laws within a wide variety of areas.

Michael and Thomas Connelly were brothers who co-owned Crown C Supply, Inc., a building supply corporation. Michael held a significant majority of the company with 77.18% of the shares, while Thomas owned the remaining 22.82%. To protect the future of their business and ensure it remained in the family, they crafted a specific agreement.

This agreement was a legally binding arrangement known as a buy-sell agreement. It outlined that if either brother passed away, the other would have the first option to buy the deceased brother’s shares. If the surviving brother chose not to buy these shares, then the company was required to purchase them. This clause was crucial to prevent the shares from being sold outside the family or to other investors, maintaining control within the existing ownership.

To financially support this agreement, the brothers took out life insurance policies on each other, with the company as the beneficiary. Each brother was insured for $3.5 million. The idea was that the payout from the life insurance would provide the necessary funds for the company to buy back the deceased brother’s shares without impacting the company’s operating capital.

Event Triggering the Dispute

When Michael Connelly passed away, the agreement he had with his brother Thomas came into play. Thomas, who also acted as the executor of Michael’s estate, chose not to buy Michael’s shares in Crown C Supply. As per their earlier agreement, the company then had to buy back those shares. To do this, Crown C Supply used the $3.5 million from the life insurance policy it had on Michael, which was specifically set aside for such a purpose.

Thomas then had to deal with the tax implications of Michael’s death and the transfer of his shares. He filed a tax return for Michael’s estate, where he valued the shares that were bought back by the company at $3 million. This valuation was agreed upon amicably between Thomas and Michael’s son, avoiding an external valuation, which was originally envisaged in their agreement.

IRS Disagreement

When the IRS audited the tax return filed by Thomas, they challenged the $3 million valuation he reported for Michael’s shares in Crown C Supply. The IRS’s position was based on the belief that the entire value of the company should be considered when determining the value of Michael’s shares. This included the life insurance money, which was received upon Michael’s death and used by the company to purchase his shares.

The IRS calculated that with the additional $3 million from the life insurance proceeds added to the company’s assets, the total valuation of Crown C Supply amounted to $6.86 million. Based on this total company valuation, the IRS recalculated the value of Michael’s 77.18% shareholding and concluded it was worth approximately $5.3 million, significantly higher than the $3 million Thomas had declared.

This difference in valuation had a direct impact on the estate tax bill. The higher share valuation increased the taxable estate, resulting in a higher estate tax liability. Thomas disputed this higher valuation, leading to a legal battle over the correct interpretation of tax laws relating to estate valuation.

The central legal issue revolved around how to correctly apply the tax regulations governing the valuation of a decedent’s property. According to IRS regulations and established case law, the fair market value of an asset is generally considered to be the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts (26 CFR §20.2031–1(b)).

The IRS argued that a hypothetical buyer of the shares would consider all assets of the company, including the life insurance proceeds, thus increasing the fair market value of Michael’s shares at the time of his death.

Buy-Sell Agreement

In the Connelly brothers’ case, the buy-sell agreement stipulated that if one brother died, the surviving brother would have the first option to purchase the deceased’s shares. If the surviving brother chose not to exercise this option, then the company itself was obligated to buy back the shares. This setup ensures that the shares remain within the control of people already involved in the business—either the surviving brother or the company itself—thus preventing external parties or unwanted partners from gaining a stake.

Legally, such agreements are significant because they pre-define the handling of shares, greatly reducing potential disputes among heirs or other stakeholders. They also help in succession planning by clarifying the process and valuation methods for transferring shares, which can be particularly critical in ensuring the continuity of the business.

In implementing a buy-sell agreement, various legal considerations must be managed, such as determining the fair market value of the shares at the time of the shareholder’s death and ensuring that the terms of the agreement comply with relevant business laws. The agreement typically specifies a methodology for valuing the shares, which might involve an appraisal by an independent third party, or a pre-agreed formula or process.

In the context of the Connelly case, when Michael died, the value of his shares as determined according to the agreement (or through negotiation between Thomas and Michael’s son) was directly contested by the IRS. The IRS’s challenge highlighted that while buy-sell agreements can plan for the transfer of shares, the valuation still needs to align with tax laws, specifically the regulations that define fair market value for tax purposes. The IRS scrutinizes these valuations to ensure they reflect realistic market conditions and aren’t just favorable estimations designed to minimize tax liabilities.

Courts Decisions

The courts, including both the District Court and the Appeals Court, sided with the IRS’s interpretation of the tax laws.

The courts determined that the life insurance proceeds received by the company upon Michael’s death should be included in the company’s overall valuation. This inclusion is critical because those proceeds, even though they were earmarked for buying back Michael’s shares, were considered an asset of the company at the moment of Michael’s death.

The courts interpreted the regulations (specifically 26 CFR §20.2031-1(b)) to mean that any asset that enhances the value of the company should be included in its valuation, regardless of its designated use post-death.

Furthermore, the courts pointed out that the contractual obligation to use the insurance proceeds to buy back shares does not diminish the fact that at the time of Michael’s death, those funds increased the overall value of the company. Essentially, a hypothetical buyer of the company would consider all assets, including the life insurance proceeds, when determining how much to pay for the company or its shares.

The U.S. Supreme Court in Connelly v. United States, 602 U.S. (2024) affirmed the decision of the lower courts, agreeing with the IRS that the life insurance proceeds should be included in the valuation of Crown C Supply. The Supreme Court held that the corporation’s contractual obligation to redeem shares did not reduce the company’s value for purposes of federal estate tax. They concluded that a fair-market-value redemption of shares does not affect any shareholder’s economic interest and should not be treated as a liability that decreases the company’s value.

The Court further explained that life insurance proceeds, even if earmarked for redeeming shares, are an asset of the corporation at the time of the shareholder’s death and increase the company’s fair market value. As such, these proceeds should be considered in the estate’s valuation for tax purposes.

On June 6, 2024, New York Attorney General Letitia James initiated a significant legal action against NovaTechFx, AWS Mining, and their founders for conducting illegal pyramid schemes that resulted in substantial financial losses for numerous investors, prominently including over 11,000 New Yorkers.

Overview of the Case

The lawsuit alleges that these companies engaged in deceptive practices by promising high returns on cryptocurrency investments that were not based on genuine business profits but were instead funded by the capital of newer investors—a classic hallmark of a pyramid scheme. The legal claims focus on the violation of both federal and state laws that regulate securities and business practices

Specific Legal Allegations

1. Pyramid Scheme Violations. Pyramid schemes are fundamentally illegal under both New York State law and federal securities laws. The companies are accused of failing to engage in legitimate investment activities; instead, funds from new investors were used to pay returns to earlier investors, which is unsustainable and illegal.
2. Targeted Fraud. The companies are accused of specifically targeting vulnerable communities, using language and cultural references to gain trust. This strategy not only increased the impact of the fraud but also violated specific laws against deceptive practices that protect consumers from financial scams that exploit their cultural or religious beliefs.
3. Misrepresentation and False Advertising. NovaTechFx and AWS Mining misrepresented their operational legitimacy and regulatory compliance. They claimed to be registered hedge fund brokers and licensed to trade cryptocurrencies in the U.S., which were untrue. Such misrepresentations are clear violations of securities law, which require truthful disclosure of business operations to investors.
4. Unsustainable Financial Promises. The promised returns—ranging from 15% to 20% monthly and up to 200% returns within 15 months—were implausibly high and not backed by actual trading or mining outputs. Promising these returns without a legitimate basis can be seen as a form of securities fraud. 

Legal Consequences Sought in the Lawsuit
The Attorney General’s office is not only seeking penalties for these illegal activities but also aims to prevent the defendants from operating any similar business within New York. This includes:

• A permanent injunction that would prohibit business activities related to securities or commodities;
• Disgorgement of the funds received through these fraudulent activities, which legally compels the defendants to return the profits gained from their wrongdoing;
• Additional financial damages to compensate the defrauded investors, calculated based on the losses suffered by them.

Implications of the Case

The lawsuit against NovaTechFx and AWS Mining is poised to have lasting impact on the regulatory landscape of the cryptocurrency industry in New York. This legal action signals a definitive stance against the misuse of cryptocurrency platforms, especially pyramid schemes, which are clearly defined as illegal under both federal and state laws. By targeting companies that exploit the loosely regulated nature of the crypto sector, this case could drive a significant increase in regulatory scrutiny and enforcement across similar businesses.

For the cryptocurrency industry, which has often benefited from regulatory ambiguity, this case may lead to potentially increasing the costs of compliance but also stabilizing the market by weeding out deceptive practices. Moreover, the focus on investor protection, particularly within vulnerable communities, highlights a key role of state authorities in policing new financial technologies to prevent widespread financial harm. 

If the court sides with the Attorney General, the outcome could be pivotal for the cryptocurrency industry. A favorable ruling would not only confirm and enforce the legal boundaries against pyramid schemes but also provide much-needed clarity on what constitutes legitimate business practices within this sector. As a result, businesses could align their operations with legal standards, thereby fostering a safer investment landscape. For investors, this could translate into increased confidence, knowing that clearer regulations are in place to protect their interests and prevent fraudulent schemes. Ultimately, such a development could lead to a more robust and reliable cryptocurrency market.

The Securities and Exchange Commission (SEC) has taken significant legal actions against Mass Ave Global Inc. (MassAve) and its co-founder, CEO, and Chief Investment Officer, Winston Feng. The legal issues revolve around violations of the Investment Advisers Act of 1940 and the Investment Company Act of 1940. Here is a detailed breakdown of the legal implications:

Violations of the Investment Advisers Act of 1940

MassAve and Feng made materially false and misleading statements about the holdings and exposures of their flagship fund and other related funds from February 2020 through August 2022. These violations involved the dissemination of inaccurate information in various investor communications, such as monthly tear sheets, summary portfolio snapshots, and reports on top ten contributors and detractors to fund performance.

According to the SEC, MassAve’s actions violated Section 206(2) of the Investment Advisers Act, which prohibits any investment adviser from engaging in transactions, practices, or courses of business that operate as a fraud or deceit upon clients or prospective clients. The SEC determined that MassAve’s and Feng’s actions were fraudulent, as they knowingly provided false information to investors. This can be established through negligence, not necessarily intent. Furthermore, Section 206(4) and Rule 206(4)-8 of the Investment Advisers Act make it unlawful for any investment adviser to a pooled investment vehicle to make any untrue statement of material fact or to omit necessary information, resulting in misleading statements to investors. MassAve and Feng’s modifications to the underlying portfolio data, which were not reviewed by compliance, led to significant misrepresentations.

From at least September 2022 through February 2023, MassAve failed to disclose a significant conflict of interest. This conflict arose from the operation of a separate hedge fund in China by MassAve’s other co-founder, which overlapped with MassAve’s investment activities. Investment advisers are required to disclose any material conflicts of interest to their clients. The failure to inform investors about the co-founder’s separate hedge fund, which diverted attention and potentially impacted MassAve’s operations, constituted a breach of this duty. By not disclosing this conflict, MassAve and Feng again violated the antifraud provisions, misleading investors about the integrity and focus of their investment management.

MassAve also failed to adopt and implement adequate policies and procedures designed to prevent inaccurate information from being disseminated to investors. This failure was evident in the unreviewed modifications made by Feng, which were then shared with investors. Section 206(4) and Rule 206(4)-7 of the Investment Advisers Act require registered investment advisers to establish and enforce written policies and procedures reasonably designed to prevent violations of the Investment Advisers Act. MassAve’s inability to enforce these procedures allowed for the distribution of false information, violating this requirement.

Remedial Sanctions and Cease-and-Desist Orders

The SEC has imposed several sanctions on MassAve and Feng. MassAve is ordered to cease and desist from committing or causing any further violations of the Advisers Act and related rules. The firm must also pay a civil money penalty of $350,000 and has been formally censured. Winston Feng is similarly ordered to cease and desist from any future violations of the relevant provisions, must pay a civil money penalty of $250,000, and is suspended from association with any investment adviser, broker, dealer, and other financial entities for 12 months. This suspension prevents him from serving in various key roles within the financial industry.

Additionally, both MassAve and Feng cannot argue for offsetting their penalties in related private investor lawsuits, preserving the deterrent effect of these penalties. For purposes of bankruptcy proceedings, the findings in these orders are admitted by Feng, ensuring these penalties are not dischargeable.

Press Release

Location: Brooklyn, New York

We are pleased to announce that Ishimbayev Law Firm, P.C. has achieved a significant victory on behalf of our client, Elena Khotovitskaya, in the United States District Court for the Eastern District of New York. In the case of Elena Khotovitskaya v. Albert Shimunov and David Shimunov (18-CV-7303), the Honorable Judge Nicholas G. Garaufis granted summary judgment in favor of our client, awarding a total of $4,885,982.86.

Case Overview

Our client brought a breach of contract action against the Defendants related to promissory notes and guaranties with a principal amount of $2,000,000. These notes, executed between December 2012 and September 2014, were due for repayment by December 2015 with an interest rate of 8% per annum. Despite the clear terms of the promissory notes, the Defendants failed to repay any portion of the principal or interest.

Court Findings

The court found in favor of our client, establishing that:

• The promissory notes were valid and enforceable.
• Our client was the rightful holder of these notes.
• The Defendants defaulted on their payment obligations.

The Defendants’ argument that the transactions were investments rather than loans, and their claim of being fraudulently induced to sign the notes, were thoroughly examined and found unsubstantiated by clear and convincing evidence.

Award and Next Step

The court awarded our client $2,000,000 in principal, $2,883,034.86 in pre-judgment interest, and $2,948 in costs related to attending a second deposition. The total judgment amounts to $4,885,982.86. Additionally, the court granted leave for our client to file an application for legal fees and costs within thirty days of the entry of this judgment.

This judgment underscores the importance of holding parties accountable to their contractual obligations and reinforces the principle that financial agreements must be honored as written, correctly qualifying these transactions as loans rather than securities or investments. We are proud to have represented Ms. Khotovitskaya in this matter and to have secured a just outcome on her behalf.

Contact Information

For further information, please contact Mr. Kemal Lepschoque at kl@ishimbayev.com.

The Commodity Futures Trading Commission (CFTC) took action against Falcon Labs Ltd. for operating as an unregistered Futures Commission Merchant (FCM) and providing U.S. customers access to digital asset derivatives trading platforms without the required registration. This is the first instance of the CFTC targeting an intermediary for such violations.

Case Background
Falcon Labs offered a product called “Edge,” providing institutional customers, including U.S. clients, with direct access to digital asset exchanges for trading derivatives. They created main accounts on exchanges and sub-accounts for customers, allowing trading without disclosing customer identities. This practice generated significant revenue from U.S. customers.

Findings and Violations
From October 2021 to March 27, 2023, Falcon Labs solicited and accepted orders for digital asset derivatives from U.S. customers. Acting as an intermediary, Falcon Labs provided direct access to digital asset exchanges but failed to register as an FCM, violating Section 4d(a)(1) of the Commodity Exchange Act (CEA). They also did not disclose customer identities to the exchanges, further breaching regulatory requirements.

According to the CEA, any entity that accepts orders for futures or swaps and accepts money to margin trades must register as an FCM. Falcon Labs’ activities fit this definition, making their unregistered status a clear violation. 

Enforcement and Compliance
The CFTC’s action against Falcon Labs sets a precedent for enforcing compliance among intermediaries. By cooperating with the investigation and enhancing their customer identification processes, Falcon Labs received a reduced penalty. This cooperation included improving their Know-Your-Customer (KYC) procedures and off-boarding non-compliant customers.

Penalties and Settlement
Falcon Labs agreed to cease its unregistered activities and pay $1,179,008 in disgorgement and a $589,504 civil monetary penalty. These penalties reflect the profits made during the violation period and the reduced amount due to Falcon Labs’ cooperation and remediation efforts. They also committed to fully cooperating with the CFTC in any related investigations or proceedings.

For businesses operating in the digital asset market, this case is another wake-up call. It shows just how crucial it is to be properly registered and to follow CFTC regulations. If your company is taking orders for digital asset derivatives from U.S. customers, you need to be registered as a Futures Commission Merchant (FCM). Not doing so can lead to hefty fines and legal actions.

Falcon Labs’ situation also teaches an important lesson: cooperating with regulators and improving compliance can help reduce penalties. It’s a good idea for businesses to take a hard look at their practices and strengthen their compliance programs. By doing so, you can avoid similar pitfalls and ensure you’re meeting all regulatory requirements.

The Securities and Exchange Commission (SEC) and the Financial Crimes Enforcement Network (FinCEN) have jointly proposed new regulations requiring registered investment advisers (RIAs) and exempt reporting advisers (ERAs) to create and maintain detailed customer identification programs (CIPs). This initiative is part of a broader effort to enhance the fight against money laundering and the financing of terrorism within the U.S. financial system.

The proposed rules would oblige these advisers to establish procedures to effectively identify and verify the identities of their clients. The aim is to ensure that RIAs and ERAs can confirm the true identities of their customers, thereby making it harder for individuals using false identities to use financial advisers for illicit activities such as laundering money, financing terrorism, or other criminal acts.

This proposal complements another from February 2024, which suggested labeling RIAs and ERAs as “financial institutions” under the Bank Secrecy Act. This designation would subject them to additional anti-money laundering (AML) and counter-financing of terrorism (CFT) obligations, such as the requirement to report suspicious activities.

What does this mean for the industry?

• Increased Compliance Costs. Investment advisers will likely face higher costs due to the need to implement and maintain these new identification systems and procedures.
• Enhanced Oversight. The proposals indicate a move towards stricter regulation and oversight of the investment adviser sector, which could lead to more rigorous examinations and audits.
• Market Entry Barriers. New and smaller advisories might find these new requirements more challenging, potentially raising barriers to entry in the sector.
• Improved Industry Reputation. By helping to ensure that the investment adviser sector is not a vehicle for financial crime, these measures could improve the overall reputation of the industry.
• Operational Changes. Firms will need to adjust their operational processes to comply with these rules, which may include upgrading technology systems or training staff to handle new compliance tasks.

If implemented, these regulations will significantly change the operational landscape for investment advisers by mandating thorough identity verification measures. The rules will require investment advisers to adapt by developing sophisticated systems to ensure they know the true identities of their clients, aligning them more closely with the stringent regulatory standards applied to other financial institutions.

On May 3, 2024, the Securities and Exchange Commission (SEC) announced that it has charged BF Borgers CPA PC and its owner, Benjamin F. Borgers, with serious misconduct. They were found to have repeatedly failed to meet required auditing standards in their reviews and audits, which were part of over 1,500 filings to the SEC from January 2021 to June 2023.

The charges include:

• Misleading their clients by claiming that their audits met official standards when they did not
• Falsifying audit documents to appear as though they were compliant
• Incorrectly stating in reports that their audits were up to standard

As a result, BF Borgers has agreed to pay a $12 million fine, and Benjamin Borgers will pay $2 million. Both are also banned from working as accountants for any entities regulated by the SEC.

The SEC pointed out that this misconduct has jeopardized investor trust and the integrity of the financial markets because accurate and reliable financial statements are crucial for investment decisions. The SEC highlighted the failure of the firm to properly oversee the audit process, maintain accurate records, or perform necessary quality reviews.

Ultimately, these actions led to a large number of inaccurate public filings. The investigation into these activities was managed by the SEC’s Chicago office.

The U.S. Supreme Court made a significant decision affecting how lawsuits can be filed against public companies under specific securities laws (Macquarie Infrastructure Corp. v. Moab Partners).

Macquarie Infrastructure Corporation, a company involved in various infrastructure projects, didn’t disclose how a new regulation (IMO 2020) would negatively affect its business. This regulation aimed to stop the use of a certain type of fuel oil, which Macquarie stored and handled.

Investors sued Macquarie (under Rule 10(b) and Rule Rule 10b5), claiming the company should have told its shareholders that the new regulation would hurt its business. They argued this under a rule that requires companies to report anything that could significantly impact their financial health.

Initially, a lower court dismissed the lawsuit, but the appeals court disagreed, suggesting the case could proceed based on the company’s failure to disclose these important details. This led to different opinions among various courts, creating a need for a definitive ruling from the Supreme Court.

The Supreme Court decided that just failing to mention something important (pure omissions) isn’t enough to be sued under the specific securities law they were considering. Therefore, this decision makes it harder for shareholders in the future to sue companies unless they can prove that the company’s failure to disclose certain information made their other public statements untrue or misleading.

The Securities and Exchange Commission (SEC) has taken legal action against 17 people involved in a fraudulent scheme linked to CryptoFX LLC, a company based in Houston, Texas. This scheme targeted over 40,000 investors, promising them big profits from investments in cryptocurrency and foreign exchange markets. However, instead of investing the money as promised, the scheme operated like a Ponzi scheme, using new investors’ money to pay fake returns to earlier investors and lining the pockets of those running the scheme. Even after the SEC stepped in to stop the fraud in 2022, some of the defendants continued to solicit investments and even tried to cover up their wrongdoing.

The SEC’s complaint, filed in court, accuses these individuals of breaking laws related to fraud, securities registration, and broker registration. The SEC is seeking legal orders to stop these individuals from continuing their activities, as well as to require them to return any ill-gotten gains and pay financial penalties. Two of the defendants have already agreed to settle the charges without admitting or denying guilt, and they will pay penalties and give back some of the money they made from the scheme.

The SEC’s investigation into this matter was led by its Fort Worth Regional Office and supervised by experienced staff. If you’re someone who invested in CryptoFX or have information about this scheme, you can contact the SEC staff via email or reach out to the court-appointed receiver for assistance. The SEC advises investors to be cautious and thoroughly research anyone offering investment opportunities, using the free search tool on Investor.gov to check backgrounds and learn more about investment risks. Additionally, investors can stay informed about potential risks associated with unregistered offerings by reading alerts issued by the SEC’s Office of Investor Education and Advocacy.