Celebrities Caught Illegal Crypto Smuggling, SEC ‘Rolls Up’ on Private Fund Advisor Over Cannabis Fund Fraud, Female Compliance Leaders Share Advice and Inspiration: Lessons Learned and Worth Reading for April 2023 | ACA Group

Lesson

• Everyone else does! The SEC recently settled with eight celebrities for illegally naming crypto-asset securities on their Twitter feeds. Although Justin Sun and his three companies are allegedly the true villains in this story of offering and selling unregistered crypto-asset securities, Tronix (TRX) and BitTorrent (BT), the SEC has shown its breadth of jurisdiction by bringing cases against social media moguls as Kendra Lust, Lindsay Lohan, Jake Paul, Lil Yachtyand Ne-Yo. Two others and Soulja Boy and Auston Mahone, are also part of the SEC’s case against Justin Sun. The facts of the settlements are very similar – the celebrities were contacted by Justin Sun who agreed to pay them to tweet about TRX or BT to his many followers. Most received payments ranging from $10,000 to $25,019 for tweets like “Get a #TRX tattoo when it hits 50 cents” (Lil Yachty Boy), though Kendra Lust accepted a whopping $955. The SEC stated that the celebrities violated Section 17(b) of the Securities Act of 1934 by claiming the tokens without disclosing that they were paid and the amount of the payment.

The SEC further stated that it had issued at least two warnings, including one statement as of November 2017″[a]a celebrity or other person promoting a virtual token or coin that is a security must disclose the nature, scope and amount of compensation received in exchange for the promotion. Failure to disclose this information is a violation of the anti-touting provisions of the federal securities laws.” Assuming the celebrities failed to check the SEC’s Twitter feed that day. The celebrities who settled had to forfeit the payments received for the tweets, pay fines ranging from $2,865 to $126,000, and agreed not to tone any other crypto assets for compensation for three years.

The takeaway from these cases (as well as other recent cases) is that the SEC treats cryptoassets as securities and expects those involved to follow securities laws. Contributed by Jaqueline M. Hummel, Director of Thought Leadership, Regulatory Compliance.

• SEC Fines Adviser and Principal Owner $3 Million for Alleged Fraud and Misuse of Cannabis Investment Fund Assets. The SEC settled fraud charges against a Utah-based registered investment adviser (advisor) and its principal owner (principal) for $3 million for alleged fraud and misappropriation of assets in cannabis investment funds. The principal was also banned from the industry. In 2018, the advisor and principal raised $20 million from more than eighty investors for a private fund they managed that primarily invested in two cannabis-related holding companies.

The SEC’s order found that the adviser and principal defrauded the fund’s investors, including individual clients who were advised to invest in the fund, by misappropriating fund assets. Examples of embezzlement include repayment of former investors, payment of principal’s salary, payment of unauthorized administration fees and unauthorized loans to a sports team, a car dealership and a finance company. The SEC also found that the adviser and principal failed to disclose conflicts of interest and breached the fund’s limited partnership agreement.

This settlement shows how financial firms can lure investors by offering investments in hot industries, such as the production and distribution of cannabis products. The SEC recognized this problem and issued an investor alert in 2018 to warn retail investors about marijuana-related securities offerings. In this case, it appears that the adviser and its principal were actively engaged in misleading their clients and investors, which may not be easy for investors to detect. Although the settlement order does not reveal how the firm was ultimately taken, there is a reference to the auditor raising an issue in his initial audit of the fund that required an amendment to the limited partnership agreement.

Investors should carefully review the fund accounts and view changes to the limited partnership agreement with skepticism. In addition, The SEC severely punishes those who defraud investors, including depriving them of their livelihood. The principal in this case has been banned from the industry indefinitely. Contributed by Andrea Penn, Director.

• Auditors talked but failed to walk the walk in valuation testing. In this case, the SEC settled a public accounting firm and one of its partners for engaging in “professional misconduct” by failing to conduct audits of two private funds in accordance with applicable standards. According to the settlement order, the auditors identified a significant fraud risk in the valuation of three “distressed value” securities, but failed to follow up by testing the adviser’s valuation models.

What makes this case interesting is that the adviser has not been named and does not appear to have been sanctioned. Why? Probably because the adviser disclosed its valuation process in detail to the auditors in advance. The auditors agreed to sign off on the process, but only if they received evidence to support the adviser’s assumptions. But then they dropped the ball. Although the auditors checked the calculations, they were unable to test the assumptions used in the valuation models or obtain additional evidence.

For advisers, the settlement order emphasizes the importance of having a written valuation procedure for assets that are difficult to value. The adviser specifically discussed its valuation approach with the auditors, essentially asking whether it was reasonable. But the auditors whiffed and were nailed for not “showing due caution and professional scepticism”. Contributed by Jaqueline M. Hummel, Director of Thought Leadership, Regulatory Compliance.

Photo of Chris Brignola on Unsplash.