SEC Charges Fund Administrator for Missing Red Flags of Fraud Against Private Fund

Fund Administrator Charged For Missing Red Flags

The Securities and Exchange Commission today announced settled charges against Theorem Fund Services LLC (TFS), a fund administrator based in Boca Raton, Florida, for failing to respond to red flags relating to a fraud against a private fund and its investors.

According to the SEC’s order, TFS provided administration services to a fund managed by EIA All Weather Alpha Fund Partners and Andrew M. Middlebrooks, both of whom the SEC charged in May 2022 with fraud for allegedly engaging in a scheme that included the misappropriation and misuse of investors’ funds over a five-year period. According to the order, during TFS’s engagement, the fund suffered significant losses as a result of trading by EIA and Middlebrooks; however, TFS, at the direction of EIA and Middlebrooks, calculated the Net Asset Value, which did not recognize the losses, and sent investors account statements that materially overstated the value of their investments

Without Merit

When faced with litigation, companies often publicly opine that the case is “without merit.” But if the company loses the litigation, can investors then bring a securities class action alleging that opinion was false?

In City of Fort Lauderdale Police and Firefighters’ Retirement Sys. v. Pegasystems, Inc., 2023 WL 4706741 (D. Mass. July 24, 2023), the court considered a securities class action brought in the wake of a civil decision requiring Pegasystems to pay $2 billion for willfully and maliciously misappropriating trade secrets. The decision led to a stock price decline. The plaintiffs in the securities case alleged that Pegasystems deceived investors when it previously stated (a) it would “[n]ever use illegal or questionable means to acquire a competitor’s trade secrets,” and (b) that the trade secrets case was “without merit.”

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Quote of note: “An issuer may legitimately oppose a claim against it, even when it possesses subjective knowledge that the facts underlying the complaint are true. When it decides to do so, however, it must do so with exceptional care, so as not to mislead investors. For example, an issuer may validly assert its intention to oppose the lawsuit. It may also state that it has ‘substantial defenses’ against it, if it reasonably believes that to be true. An issuer may not, however, make misleading substantive declarations regarding its beliefs about the merits of the litigation.”

Crypto Companies Push High Court Doctrine Despite Terra Setback

The argument that crypto enforcement is a major question lost its first test last week, in a SEC lawsuit involving Terraform Labs Pte Ltd. Judge Jed Rakoff in the US District Court for the Southern District of New York found crypto wasn’t a major industry.

While Rakoff’s ruling was a win for the SEC, crypto companies are unlikely to abandon the argument. Coinbase said in a Aug. 4 court filing Rakoff got it wrong, and that the doctrine prohibits the SEC’s attempt to regulate digital assets.

SEC Calls In-House Judge Challenge Moot After It Dropped Case

An investment adviser’s second lawsuit challenging the SEC’s in-house judges on constitutional grounds should be dismissed as moot, the agency said Monday, citing a mix-up that led it to toss dozens of internal cases.

The Securities and Exchange Commission’s enforcement case against Christopher Gibson was among those affected by a database issue that failed to protect adjudication staff memos from access by enforcement staff, according to the brief, filed in the US District Court for the Northern District of Georgia.

Gary Gensler, SEC Chief, Worries About AI

A.I. models may put companies’ interests ahead of investors’.

The meme stock frenzy driven by social media and the rise of retail trading on apps highlighted the power of nudges and predictive algorithms. But are companies that use A.I. to study investor behavior or recommend trades prioritizing user interests when they act on that information?

The S.E.C. last month proposed a rule that would require platforms to eliminate conflicts of interest in their technology. “You’re not supposed to put the adviser ahead of the investor, you’re not supposed to put the broker ahead of the investor,” Mr. Gensler said. “And so we put out a specific proposal about addressing those conflicts that could be embedded in the models.”

Who is responsible if generative A.I. gives faulty financial advice?

“Investment advisers under the law have a fiduciary duty, a duty of care, and a duty of loyalty to their clients,” Mr. Gensler said. “And whether you’re using an algorithm, you have that same duty of care.”

Congress, Not the SEC, Should Set U.S. Digital Asset Policy

The United States blocking the emergence of the digital asset industry does not mean that the industry will not exist. It just means that it will flourish elsewhere. The E.U., U.K., Singapore and Australia have already passed regulatory frameworks for digital assets. The Hong Kong Monetary Authority has gone so far as to publicly tell banks to support licensed crypto exchanges.

Members of Congress from both sides of the aisle have seen the geopolitical importance and promise of blockchain technology and have promised legislation to protect it from our nation’s regulators. Among the most promising are bills focused on market structure and stablecoin issuance, which if passed will provide clarity on the key issues preventing banks and broker-dealers from participating in the digital asset market today.

These are public policy issues that should be addressed via legislation by our elected officials in Congress, not regulated in an opaque manner by the SEC.

FTX law firm Fenwick faces second lawsuit by crypto customers

A group of FTX customers on Monday sued law firm Fenwick & West for allegedly aiding fraud through its legal advice to the now-bankrupt cryptocurrency exchange founded by Sam Bankman-Fried.

The complaint alleges that Fenwick provided services to FTX that “went well beyond those a law firm should and usually does provide” and included structuring transactions to skirt regulatory scrutiny and setting up entities that Bankman-Fried and other FTX executives used to commit fraud.

A spokesperson for Fenwick did not immediately respond to a request for comment.

The proposed class action lawsuit is the second to target Fenwick, a California-founded firm with a focus on technology clients, related to its work for FTX.

Suspected North Korean Lazarus Crypto Hack Came From Fake Job Offer

In late July, a programmer at Estonia’s CoinsPaid, the world’s biggest crypto payment provider, met over video link with a recruiter who had reached out on LinkedIn with a lucrative job offer. During the 40-minute job interview, the engineer was asked to download a file to take a technical test, which he did on his work computer.

A few days later, on July 22, the CoinsPaid security team noticed a series of unusual withdrawals — money was quickly being drained from company accounts. By the time they were able to shut everything down and kick out the hackers four-and-a-half hours later, CoinsPaid had lost $37 million, and both the origin of the stolen crypto and the addresses of the digital wallets that received it had been carefully obscured.

2023 Mid-Year Securities Enforcement Update

The Commission has so far not slowed its enforcement strategy, and is unlikely to do so in the months ahead. In the Consolidated Appropriations Act of 2023, Congress agreed to give the Commission $2.2 billion in funding for the current fiscal year, a $210 million increase over the prior fiscal year. The Commission is planning to use the increased funding to hire 400 more staff members, including 125 new personnel for its Enforcement Division. Of those 125 new hires for the Enforcement Division, 33 will be joining the Crypto Assets and Cyber Unit, a sub-unit of the Commission that has already seen heightened activity this year. With a rapidly expanding workforce, the Commission could end up filing even more enforcement actions this year than the 760 it filed in fiscal year 2022—a 9% increase over the prior year.

With the funding to accomplish its goals, the Enforcement Division is bringing actions across the entire range of its jurisdiction, with special focus on some areas….