On November 5, 2018, the U.S. Court of Appeals for the Second Circuit overturned the insider trading conviction of a former investment banker accused of providing stock tips to his father in a 2-1 decision. Sean Stewart was convicted in 2016 on nine fraud and conspiracy counts for allegedly passing certain tips about mergers in the healthcare industry to his father, who, together with others, traded and profited on that information. Stewart was later sentenced to three years in prison. At trial, Stewart did not deny providing material, non-public information to his father, who was charged with Stewart and pleaded guilty to conspiracy to commit securities fraud prior to trial. Indeed, Stewart acknowledged that he “routinely confided in [his father], and even occasionally mentioned potential deals”; however, he contested knowing that his father would trade on the information he provided.
The government’s case relied in part on a recorded conversation between Stewart’s father and a co-conspirator who was cooperating with the government. In that recorded meeting, Stewart’s father recounted to the cooperating witness how Stewart had complained to him that he did not take advantage of certain information provided by Stewart, saying: “I handed you this on a silver platter and you didn’t invest in this.” Stewart sought to introduce post-arrest statements his father made to the FBI, which Stewart argued could have supported his defense that he never intended that his father would trade on the information. In these statements to the FBI, when confronted with the “silver platter” comment, Stewart’s father suggested that he was referring to Stewart’s pride in working on the deals, or that Stewart had been drinking when he made the comment. The trial judge denied Stewart’s evidentiary request, on the ground that the post-arrest statement did not specifically contradict that the “silver platter” comment had been made, and therefore could not be used to impeach Stewart’s statements to his father, which were admitted against Stewart as statements against his penal interest.
The Second Circuit determined the trial judge improperly excluded Stewart’s father’s post-arrest statements. The Court cited the importance of the “silver platter” statement to the government’s case, which prosecutors referred to at trial as “devastating,” noting that the “silver platter” comment was the most suggestive evidence of Stewart’s intent that his father should trade on the tips that he provided his father. It found the district court’s exclusion of the impeachment evidence to be non-harmless error that could have “undermined the silver platter statement in the eyes of the jury,” and “at minimum, [might] have tempered the statement’s ‘devastating’ effect.” The Court thereby vacated the trial court’s judgment of conviction against Stewart and ordered a new trial.
SEC Reaches First Settlement in connection with an Unregistered CryptoCurrency Exchange
On November 8, 2018, the U.S. Securities and Exchange Commission (“SEC”) announced that it settled charges against Zachary Coburn, the founder of blockchain token trading platform EtherDelta, concerning operating an unregistered securities exchange. The SEC’s cease-and-desist order to Coburn describes EtherDelta’s website as a user-friendly interface resembling online securities trading platforms. The order states that over 3.6 million trades in digital assets were placed on EtherDelta between its launch on July 12, 2017 and December 15, 2017, when Coburn stopped collecting transaction fees. Further, 92% of those trades occurred after the SEC released the DAO Report on July 25, 2017. As noted in the order, the SEC advised in the DAO Report that platforms trading in digital assets constituting securities may be “exchanges” under federal securities laws requiring either registration with the SEC or exemption from registration. The SEC determined that during the relevant period, EtherDelta met the criteria of an “exchange” under federal securities laws, but was not registered with the SEC or operating pursuant to a registration exemption. In turn, Coburn’s actions in founding EtherDelta, writing and deploying the site’s smart contract, and overseeing the site’s operations contributed to violations of the federal securities laws.
Without admitting or denying the allegations, Coburn agreed to pay a $75,000 fine and $313,000 in disgorgement and interest. Notably, the order makes no allegation of fraud or misrepresentation. It also does not address the amount or proportion of trades that occurred within the U.S. versus abroad; instead, the order simply states that “the EtherDelta platform was available to anyone, including U.S. persons.”
Wells Fargo Settles RMBS Trustee Litigation for $43M
On November 9, 2018, Wells Fargo Bank, N.A. announced a settlement resolving two class action lawsuits in federal and state court initiated by institutional investors alleging the bank failed as the trustee for 271 residential mortgage-backed securities trusts created more than a decade ago. The lawsuits claimed that Wells Fargo, as trustee, caused billions of dollars in losses to investors during the 2008 financial crisis by failing to meet its contractual duty in servicing agreements to require lenders to repurchase or cure delinquent home mortgage loans bundled into securities, despite knowing the bonds it oversaw contained faulty loans. Wells Fargo maintains that the bank’s duties were limited to administering the trusts and that it had no role in the origination or servicing of the mortgages at issue. Under the settlement, Wells Fargo will pay certain institutional investors $43 million without admitting or denying the claims in the litigation. Separate from the bank’s settlement amount, up to $70 million from certain trust reserve accounts established in connection with the litigation will be released. Though still subject to court approval, this appears to be the first class action settlement in a wave of noteholder suits against banks that served as trustees for residential mortgage-backed securities trusts, and may set the tone for settlement of other RMBS trustee litigation not covered by this agreement.
SEC Issues Guidance Regarding Application of Securities Laws to Blockchain Technologies
On November 16, 2018, the Divisions of Corporation Finance, Investment Management, and Trading and Markets of the U.S. Securities and Exchange Commission (“SEC”) issued a Statement on Digital Asset Securities Issuance and Trading, summarizing recent SEC enforcement actions “involving the intersection of long-standing applications of our federal securities laws and new technologies.” While underscoring the SEC’s ongoing support for technological innovation, the Statement also emphasized that market participants must “still adhere to our well-established and well-functioning federal securities law framework when dealing with technological innovations, regardless of whether the securities are issued in certificated form or using new technologies, such as blockchain.” The Statement described five enforcement actions as illustrative of three categories of recurring compliance issues within the SEC’s purview: (1) ICOs and other initial offers and sales of digital asset securities; (2) investment vehicles for investment into digital asset securities, and those who advise others about such investments; and (3) trading of digital asset securities on secondary markets.
The Statement also outlined the settlement structure for resolving cases against companies who conducted ICOs that the SEC has deemed to be unregistered sales of securities in violation of Section 5 of the Securities Act of 1933. The settlement structure involves the following components:
- The payment of a civil penalty;
- Registration of the token as a security under Section 12(g) of the Securities Exchange Act of 1934; and
- The institution of a claims process, whereby the company will compensate investors who purchased tokens through the unregistered offering, if the investor elects to make a claim for a refund.
The SEC’s Statement provides useful guidance as to the scope and application of its approach to blockchain issuers and other market participants, including this settlement framework. The Statement also emphasizes the SEC’s continued focus on ensuring the enforcement of the federal securities laws as applied to these new technologies.