A non-US entity was accused by the Securities and Exchange Commission of engaging in layering and cross-market manipulation. Perhaps more significantly, the entity’s carrying broker-dealer was charged with facilitating its customer’s illicit activities. Additionally, a US appeals court ruled that Dodd-Frank’s anti-retaliation protections for whistleblowers also apply to employees of public companies who report securities law violations internally but not to the SEC. As a result, the following matters are covered in this week’s edition of Bridging the Week:
Lek Securities Corporation (“LEK”), a US-registered broker-dealer and Samuel Lek, its 70 percent owner and chief executive officer, were sued by the Securities and Exchange Commission for facilitating manipulative trading activity by its customer, Avalon FA Ltd, a non-US entity, and its two control persons, Nathan Fayyer and Serge Pustelnik.
According to the SEC’s complaint, Avalon engaged in two types of manipulative conduct: layering and cross-market manipulation involving equities and related options from December 2010 through at least September 2016.
The SEC alleged that on “hundreds of thousands of instances” during this period, Avalon placed false orders in various stocks on one side of a marketplace to drive a stock’s price up or down. It did this, said the SEC, “to trick and induce other market participants to execute against Avalon’s bona fide orders (i.e., orders that Avalon did intend to execute) for the same stock on the opposite side of the market.” After executing its legitimate orders at more favorable prices, Avalon cancelled its other-side-of-the-market layering or spoofing orders, the SEC claimed.
In addition, charged the SEC, from April 2012 through December 2015, Avalon bought and sold stocks at losses in order to influence the market for corresponding options on the stocks. Avalon then made a profit by trading these options at “artificial prices,” said the SEC.
The SEC alleged that Avalon generated more than US $28 million of profits during the relevant time period through its illicit trading activity.
In its complaint, the SEC charged that LEK and Mr. Lek were aware of Avalon’s improper activities when, among other things, Mr.Lek received an email in May 2012 explicitly describing the layering scheme from an individual who shortly afterwards became an Avalon trade group leader, as well as when regulators, exchanges and other market participants alerted LEK and Mr. Lek on various occasions from 2012 through 2016 that they were concerned that Avalon was engaging in layering. In many instances, said the SEC, the regulators provided LEK and Mr. Lek with “detailed descriptions” of Avalon’s supposed problematic conduct.
The SEC said that LEK and Mr. Lek received similar information from regulators that Avalon’s cross-market activity was also potentially manipulative beginning in August 2012 through the present. Mr. Lek also authorized the relaxation of triggering thresholds for software used by LEK to prevent layering activity for Avalon at the request of Mr. Pustelnik, charged the SEC. During the relevant time period Mr. Pustelnik was first a foreign finder for LEK and later a registered representative – while at all times retaining his association with Avalon.
The SEC filed its complaint in a federal court in New York City. Among other remedies, the SEC seeks injunctions, disgorgement and fines against each of the defendants.
Last year, a decision by the Financial Industry Regulation Authority to fine LEK US $100,000 for failing to establish and implement adequate anti-money laundering procedures was upheld by the National Adjudicatory Council – a FINRA committee that reviews initial decisions from disciplinary and membership proceedings. A FINRA panel found after a hearing in 2014, that from January 1, 2008, through October 31, 2010, LEK’s AML procedures were inadequate because they “contained little guidance with regard to manipulative trading that might require the filing of a suspicious activity report.” (Click here for details of this decision in the article, "Just Calling Sam Is Inadequate Substitute for Robust AML Procedures Even at Small Broker-Dealer Rules FINRA Adjudicatory Council" in the October 16, 2016 edition of Bridging the Week.)
Compliance Weeds: As the SEC’s action against LEK and Mr. Lek, as well as the Commodity Futures Trading Commission’s recent enforcement action against Advantage Futures LLC and two of its principals demonstrates, neither the SEC nor the CFTC appear hesitant to bring an enforcement action against a registrant if the registrant fails to take what the regulators consider to be responsible appropriate action in the face of well-supported allegations of wrongdoing by a customer. Advantage, Joseph Guinan, its majority owner and chief executive officer, and William Steele, who until May 2016 was Advantage’s chief risk officer, recently settled charges brought by the CFTC related to the firm’s handling of the trading account of one customer in response to three exchanges’ warnings regarding the customer’s possibly illicit trading conduct. According to the CFTC, between June 2012 and April 2013, three exchanges alerted Advantage to concerns they had regarding the trading of one unspecified customer’s account, which they thought might constitute disorderly trading, spoofing and manipulative behavior, in violation of the exchanges’ relevant rules. The CFTC claimed that, initially, Advantage failed “to adequately respond to the Exchange inquiries and did not conduct a meaningful inquiry into the suspicious trading.” Only after the three exchanges threatened to hold Advantage responsible for its customer’s conduct, did Advantage cut off the trader’s access to three exchanges. However, noted the CFTC, Advantage failed to augment its oversight of the trader’s remaining trading or control his access to other exchanges “despite knowing that he employed the same strategy across all markets.” (Click here for details of this enforcement action in the article “FCM, CEO and CRO Sued by CFTC for Failure to Supervise and Risk-Related Offenses” in the September 25, 2016 edition of Bridging the Week.) Registrants should consider developing databases that permit them to log all regulatory inquiries and other extraordinary matters regarding their customers so they can more systematically evaluate potential red flags regarding customers’ conduct.
Legal Weeds: The SEC has recently brought and settled multiple enforcement actions against companies for including in their severance agreements standard language that required employees to waive monetary recovery for discussing any matter regarding their employment with a government agency with jurisdiction over the companies. The SEC claimed that this language violated applicable whistleblower protections under law and its rules. In light of these recent actions, companies that are SEC registrants or SEC regulated, as well as Commodity Futures Trading Commission registrants and entities subject to CFTC rules, are encouraged to review their form employment and severance agreements and employee policies to ensure that they do not contain confidentiality requirements that could be interpreted by the SEC or the CFTC as preventing an employee from making a whistleblower complaint. (Click here for background and more practical advice in a February 23, 2017 Advisory by Katten Muchin Rosenman LLP entitled “Whistleblower Protection: Recent Cautionary Tales and New Best Practices.”)
Compliance Weeds: Not only must registrants cooperate fully with regulators, but documents registrants file with regulators must be accurate and not misleading. In a recent enforcement action against Advantage Futures LLC by the Commodity Futures Trading Commission, the agency charged that when Advantage submitted its risk management policies manual, credit and risk policies and procedures manual and chief compliance officer annual report to it on “multiple occasions” between November 2013 and May 2015, two senior officers of the firm “knew that the documents did not accurately represent Advantage’s actual practices” and therefore contained false or misleading statements in violation of applicable law. (Click here to access Commodity Exchange Act Section 6(c)(2), 7 USC §9(2).) (Click here for details regarding the Advantage Futures enforcement action in the article “FCM, CEO and CRO Sued by CFTC for Failure to Supervise and Risk-Related Offenses” in the September 25, 2016 edition of Bridging the Week.)
My View: FINRA’s proposed examination rule amendments will somewhat address two practical issues: only persons associated with a FINRA member can currently take qualification examinations and persons must retake qualification examinations after leaving a FINRA registrant after two years. The development of a core examination that people can build upon once they join a broker-dealer will be a benefit to both member firms and prospective employees as potential hires will be able to demonstrate basic competence prior to joining a member firm. Moreover, employees of financial services firms will not have to worry that, when transferring to an affiliated entity, they might have to transfer back within two years or be required to retake their qualification examinations should they do so later. However, the circumstances under which individuals are waived from retaking their qualification examinations seems too narrow. FINRA should formalize other circumstances where individuals may leave a member firm for related work and return to either the same or a different member firm years later without having to retake qualification examinations (e.g., where a person leaves a registrant but continues to engage in securities industry-related work for a non-FINRA member). Currently, such a person may be able to obtain a waiver from examination requirements but solely upon specific application.
And more briefly:
For more information, see:
CBOE Futures Privilege Holders Resolve Disciplinary Actions:
CTA and Principal Barred From NFA Membership for Failing to Cooperate in Examination:
Federal Appeals Court Holds Companies Can’t Retaliate Against Internal Whistleblowers Even When No SEC Reporting:
Federal Impasse Panel Orders Increase in CFTC Employees’ Pay:
FINRA Proposes Comprehensive Overhaul of Competency Testing Requirements:
HK SFC Sanctions Securities and Futures Broker for AML Breaches in Handling Third-Party Payments:
ICE Europe Reminds Members and Participants of Revised Large Trader Reporting Requirements Effective March 27:
NFA Conforms Financial Requirements Regarding Withdrawals of FCM Residual Interest to Recent CFTC No-Action Letter:
Singapore MAS Working to Use Distributed Ledger Technology for Fixed-Income Securities Settlements and Cross-Border Payments; SEC Denies Bitcoin ETF:
US Broker-Dealer, Its CEO and a Non-US Client Sued by SEC for Layering and Other Manipulative Schemes:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of March 11, 2017. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.