Top 5 SEC Enforcement Developments for January 2024

Each month we publish a roundup of the most important SEC enforcement developments for busy in-house lawyers and compliance professionals. This month, we examine:

• The SEC’s approval of spot bitcoin ETPs;
• SEC charges against a $1.7 billion alleged crypto Ponzi scheme;
• A new SPAC rule and SPAC enforcement actions;
• Two SEC “affinity” fraud settlements; and
• An FCPA anti-bribery case with disgorgement of almost $100 million.

1. The SEC Allows Exchanges to List and Trade Spot Bitcoin ETPs

In a move almost certainly prompted by a January 10, 2024 adverse ruling by the U.S. Court of Appeals for the District of Columbia, the SEC approved a proposed rule change application, permitting several exchanges to list and trade shares of 11 spot bitcoin exchange-traded products or ETPs. As discussed in our August 2023 edition, the SEC previously denied exchange applications to list spot bitcoin ETPs, including NYSE Arca, Inc.’s application to list shares of Grayscale Bitcoin Trust. Grayscale Investments, LLC (“Grayscale”) petitioned the D.C. Circuit for review and argued that the SEC acted arbitrarily and capriciously in denying the listing of Grayscale’s proposed spot bitcoin ETP, particularly given the SEC’s recent approval of the listing on national exchanges of two bitcoin futures funds. The D.C. Circuit agreed. On August 29, 2023, a three-judge panel concluded that the SEC’s treatment of spot bitcoin ETPs was arbitrary and capricious because the SEC failed to explain this differential treatment.

In approving the proposed rule change, the SEC found that the proposals were consistent with Section 6(b)(5) of the Securities Exchange Act of 1934, which requires exchanges to have rules to be designed to prevent fraud and protect investors. The SEC concluded that because spot bitcoin and futures bitcoin prices were highly correlated and because each applying exchange had a comprehensive surveillance-sharing agreement with the Chicago Mercantile Exchange or CME, which lists futures bitcoin ETPs, any manipulation of spot bitcoin would affect the price of futures bitcoin and be detected and shared by the CME.

SEC Chair Gensler issued a statement cautioning that the SEC’s action was “cabined to ETPs holding one non-security commodity, bitcoin” and “in no way signal[s] the [SEC’s] willingness to approve listing standards for crypto asset securities.” Commissioner Pierce lauded the approval after a “decade-long persistence,” linked it directly to the D.C. Circuit’s ruling, and claimed the SEC “offer[ed] a weak explanation for its change of heart.”

For more information, read our full client alert diving deeper into the SEC approval of ETPs and analyzing how this development may impact other digital assets.

#BetterLateThanNever #SECOKsBitcoinETPs

2. The SEC Brings Charges in Connection with a $1.7 Billon Crypto “HyperFund”

On January 30, 2024, the SEC charged two individuals—Xue Lee (a.k.a. Sam Lee) and Brenda Chunga (a.k.a. Bitcoin Beautee)—for their involvement in a purported blockchain technology conglomerate called the “HyperFund.” According to the SEC, the defendants raised $1.7 billion from U.S. and foreign investors via “membership packages” and promised what the SEC characterized as “exorbitant passive returns” that were supposedly derived from the HyperFund’s crypto asset mining operations. According to the SEC, HyperFund used aggressive multilevel-marketing recruitment tactics, including popular YouTube videos, which promised lucrative financial rewards for investing in HyperFund and for recruiting other investors. The SEC alleged, however, that the HyperFund was a pyramid and Ponzi scheme that did not engage in large-scale crypto mining, had no revenues other than funds raised from investors, and paid investor withdrawals with new investor deposits. The fund collapsed in late 2022, when investors were no longer able to make withdrawals.

The SEC charged Lee and Chunga with violating Sections 5(a) and 5(c) of the Securities Act of 1933, alleging that the HyperFund “memberships” were securities that were neither registered nor qualified for a registration exemption. The SEC also charged the defendants with violating Securities Act Section 17(a) and Exchange Act Section 10(b) and Rule 10b-5, alleging that they made materially misleading statements about the HyperFund’s operations and revenue sources, operated a scheme to defraud investors, and ignored numerous red flags.

Chunga settled the SEC charges, with disgorgement and civil penalties to be determined by the U.S. District Court for the District of Maryland at a later date. The charges against Lee, who is allegedly a resident of the UAE, will be litigated.

The day before, on January 29, 2024, the DOJ announced criminal charges against Lee and Chunga, as well as against a Miami-based HyperFund promoter. Chunga pleaded guilty to conspiracy to commit securities fraud and wire fraud and faces a sentence of up to five years in prison. If convicted, Lee will face a similar sentence.

#BitcoinBeauteeBillionsBust #HyperFraud #CryptoNoNo

3. The SEC Adopts Final SPAC Rules and Brings Two SPAC Enforcement Actions

On January 24, 2024 the SEC adopted, by a 3-2 vote, final rules prescribing additional procedural and disclosure requirements on IPOs by special purpose acquisition companies or “SPACs” and in de-SPAC business combinations. This fulfills a longstanding goal of the SEC to substantially align the rules for SPACs with those applicable to traditional IPOs. The rules are lengthy (coming in at nearly 600 pages) but there are key takeaways.

First, the rules impose disclosure requirements on both SPAC IPOs and de-SPACs concerning potential conflicts of interest, compensation paid to SPAC sponsors, and dilution of shareholder interest, among other things. Second, the rules deem any combination with a reporting shell company, including a SPAC, to be a sale of securities requiring registration under the Securities Act and make clear that de-SPACs may no longer use the Private Securities Litigation Reform Act of 1995 “safe harbor” to avoid liability for forward-looking statements. Third, the rule amends previous SEC guidance to address the reliability of projections and adds new guidance for projections associated with de-SPAC transactions. Fourth, the SEC did not adopt the proposed draft “safe harbor” rule within the Investment Company Act of 1940, which would have allowed SPACs to avoid registering as investment companies if they satisfied certain requirements. Instead, the SEC provided guidance on how SPACs may approach the five-factor Tonopah test,[1] which may be used to determine whether a SPAC is considered an investment company under the Investment Company Act. In its guidance, the SEC cautioned against lengthy delays in de-SPAC transactions. The SEC noted that the longer a SPAC takes to complete a de-SPAC transaction, the harder it is to distinguish the SPAC from an investment company.

In addition to the new rules, the SEC brought two enforcement actions related to SPACs in January:

• SEC Charges an Audit Firm Partner in Connection with SPAC Audits
  
  On January 18, 2024, the SEC charged Edward F. Hackert, CPA, a partner at Marcum LLP, for allegedly violating Sections 4C1 and 21C of the Exchange Act, and Rule 102(e)(1)(ii) of the Commission’s Rules of Practice. Per the SEC, Hackert engaged in improper professional conduct and failed to follow PCAOB audit standards over a period of 10 years. During that period, Hackert’s work largely consisted of SPAC audit activities. According to the SEC’s order, in 85% of audits performed by Hackert, he failed to supervise work, failed to assemble audit documentation, and failed to exercise due care. Hackert was involved with audits for 88 public companies and 152 SPACs during the relevant period. Read our previous client alert for our discussion of the SEC’s June 2023 charges against Marcum.
• SEC Brings IPO-Related Disclosure Charges Against SPAC
  
  On January 15, 2024, the SEC settled charges against Northern Star Investment Corp., a SPAC, for violations of Securities Act Section 17(a)(2) for making material misrepresentations in its IPO-related disclosures. According to the SEC Settlement Order, Northern Star had discussions with its merger target, Apex Clearing Holdings, LLC. But because Northern Star stated in its prospectus, S-1, and elsewhere that it had not engaged in meaningful discussions with potential target companies, the SEC alleged that Northern Star had misled investors. To settle the charges, Northern Star was required to pay a civil monetary fee of $1.5 million.

#SPACingAin’tEasy #SPACDisclosures

4. The SEC’s Affinity Fraud Crackdown Continues

In January 2024, the SEC brought two actions in connection with affinity offering frauds targeting members of specific communities. One sought emergency relief and asset freezes involving a purported venture capital fund targeting the Indian-American community. The SEC filed charges against a second allegedly fraudulent investment offering targeting religious affiliates within the Nigerian-American community. Between 2022 and 2023, the SEC has filed over 30 affinity fraud-related enforcement actions. This year is on track to continue this enforcement trend.

• An Alleged Ponzi Scheme Concealed as a Venture Capital Opportunity
  
  On January 5, 2024, the SEC obtained a TRO, an asset freeze, and a preliminary injunction in federal district court in Texas against Gopala Krishnan, Manivannan Shanmugam, Sakthivel Palani Gounder, Nanban Ventures, and related entities for purported violations of Exchange Act Section 10(b), Rule 10b-5, Securities Act Section 17(a), and Sections 209(d) and 214 of the antifraud provisions of the Investment Advisers Act of 1940. According to the SEC, Krishnan and his associates perpetuated a $130 million investment fraud scheme targeting the Indian-American community by raising investor funds for purported venture capital investments and promising 18% returns using investments in options contracts, Fintech companies, and real estate. Instead of investing in legitimate investment opportunities, the SEC alleges that the defendants made Ponzi payments to investors and invested the funds in self-owned entities.
• An Alleged Offering Fraud That Promised 50% Monthly Profits
  
  On January 25, 2024, the SEC filed a complaint in federal district court in Georgia against Prosper Beyond Moore and Prosperity Investment & Solutions LLC for violating the registration and antifraud provisions of the Securities Act and Exchange Act. The SEC alleged that Moore raised $1.4 million from fellow church members via unregistered securities offerings and touted that that Prosperity was an elite financial organization which could generate up to 50% in monthly profits. The SEC contends that, instead of making investments, Moore created false account statements and used the funds for personal gain, and to pay earlier investors. The complaint also alleged that Moore did not file a registration statement related the purported securities sales. According to the SEC, Moore used social media and religious networks within the Nigerian-American Christian community to recruit investors for Prosperity, many of whom were unaccredited investors.

#UnrealReturns #AffinityFraudForce

5. The SEC Settled FCPA Charges Against SAP SE

On January 10, 2024, software company SAP SE settled FCPA-related charges with the SEC. According to the SEC, SAP SE engaged in conduct violating Exchange Act Section 30A, which prohibits bribery and certain books and records and internal accounting controls provisions under Exchange Act Section 13(b)(2). The SEC alleged that for more than five years, SAP SE used intermediaries and subsidiaries to pay bribes to officials in South Africa, Malawi, Kenya, Tanzania, Ghana, Indonesia, and Azerbaijan and then recorded these bribes as legitimate transactions. Although, during the relevant period, SAP SE had detailed policies and procedures in place to prevent bribery through third-party intermediaries, the SEC alleged that employees of SAP’s wholly owned subsidiaries in SAP South Africa, SAP Africa, SAP Indonesia, and SAP Azerbaijan failed to follow these policies. In settling the charges, SAP SE agreed to pay a disgorgement and prejudgment interest of over $98 million and to cease and desist from causing future violations.

The same day SAP SE settled charges with the SEC, SAP SE also settled charges brought by the DOJ and the South African National Prosecuting Authority. In that matter, SAP agreed to pay a $118.8 million criminal fine and a $103 million forfeiture, of which $85 million will be satisfied by its disgorgement payment to the SEC.

For more on the SAP resolution, see our Top 10 International Anti-Corruption Developments for January 2024.

#BigBooksAndRecords #EnforcingRoundTheWorld

[1] In the Matter of Tonopah Mining Co., 26 S.E.C. 426 (July 21, 1947).