Susan DeSantis Managing Director and Deputy Chief Compliance Officer DTCC

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1 Microcap Fraud and Lessons from Enforcement Susan DeSantis Managing Director and Deputy Chief Compliance Officer DTCC Jim Fiebelkorn Director, Anti Money Laundering Compliance Pershing LLC, A BNY Mellon company Jay Lippman Vice President, Compliance Surveillance Strategy Group Goldman Sachs & Co. Michael McNally Vice President Fidelity Investments Michael Paley Assistant Regional Director U.S. Securities and Exchange Commission

2 Agenda 1. Lessons from Recent Enforcement Actions 1. Oppenheimer FINRA fine 2. COR Clearing FINRA fine 3. SEC vs. John Rizzo 4. SEC vs. Gibraltar Global Securities 2. The Regulatory Landscape 1. SEC Priorities 2. FINRAExam Priorities 3. Hot topics & Trends 1. Foreign securities 2. Bank Custody 3. Trading Surveillance

3 Enforcement Actions FINRA AWC for Oppenheimer & Co (2013) Failure to Adequately Supervise the Sale of Unregistered Securities 20 Penny stocks names 13 customers (names withheld) Inadequate monitoring of Penny Stock Transaction for AML Compliance No system or procedure or follow up to determine if stocks were freely tradable or restricted Inadequate AML Compliance Program Procedures fails to adequately detect, monitor, analyze, investigate and report suspicious activity in penny stock trades or red flags relation to penny stock transactions.

4 Enforcement Actions FINRA AWC for Oppenheimer & Co (2013) Comprehensive review of the Firm s policies, systems and procedures within 60 days by an independent consultant Require independent consultant to submit a written report to FINRA within 120 days Adequacy of policies, systems, procedures and training related to the receipt or purchase and journal or sale of penny stock Supervision of Foreign Financial Institutions AML procedures Recommendations for modification Implementation of recommendations (or alternative procedure) within 60 days

5 Enforcement Actions FINRA AWC for Oppenheimer & Co (2013) Stranger appearing at a branch office carrying certificates for penny stocks Deposits of penny stocks constituting a large percentage of the float Shortly after opening account Recently issued Sold large amounts of the securities after depositing; wired out proceeds shortly after sale Customer appeared to be acting as an agent for an undisclosed principal Customer was the subject of NASD for SEC actions or the subject of negative news indicating possible regulatory violations Customer had multiple accounts under a single name for multiple names for no apparent reason, with a large number of inter account or third party transfers Customer promoting the stock and sole in the midst of a sudden spike in investor demand Issues were non SEC reporting and had several name changes Penny stock deposits presented by a Foreign Financial Institution domiciled in the Bahamas Transacting in penny stock liquidations on behalf of customer unknown to the B/D.

6 Enforcement Actions FINRA: COR Clearing LLC (fka Legent Clearing LLC) Offer of Settlement From in/around January 2009 through early 2013, COR Clearing LLC allegedly had a number of significant ifi taml Program deficiencies, i i including the near complete collapse of its surveillance program, resulting in its failure to identify and investigate suspicious activity. In addition, FINRA claimed dthat t the firm failed dto comply with supervisory requirements by not conducting adequate due diligence on two transactions involving transactions in microcap securities a sale and a transfer. FINRA i d $1 fi d d d th fi t t i i d d t FINRA imposed a $1mm fine and ordered the firm to retain an independent consultant

7 Enforcement Actions US v. John G. Rizzo (2013) US DOJ and the SEC charged John G. Rizzo with orchestrating a fraud involving a penny stock company, itracker Systems Inc. (itracker). Rizzo, the former CEO of itracker, used offshore boiler rooms to solicit foreign investors as he attempted to evade U.S. securities registration requirements in the sales of millions of shares of itracker that t he owned. The boiler rooms raised approximately $2.5 million from investors living in the United Kingdom. Rizzo sold the securities through an offshore shell company he created to conceal the diversion of investor funds to the boiler rooms and the fact that he was selling the shares. Rizzo plead guilty to wire fraud and was sentenced to 30 months incarceration. The SEC case is pending.

8 Enforcement Actions SEC v. Gibraltar Global Securities (2013) 1. SEC charged a Bahamian Broker Dealer and Its President for operating illegally in the United States and participating in an unregistered offering. 2. Gibraltar solicited US customers and enabled them to deposit physical certificates of microcap securities into offshore accounts with nominee names 3. Gibraltarre registered re registered shares into its own name, and sold them through U.S. broker dealers 4. Gibraltar sold over $100 million worth or securities

9 The Regulatory Landscape SEC Priorities 1. Exam priority: Transfer Agents that service microcaps 2. Trading Suspensions 3. Microcap Fraud Task Force

10 The Regulatory Landscape FINRA Exam Priorities Focus on Institutional Business DVP/RVP accounts Liquidating large blocks of low priced securities Analysis challenges given the nature of the accounts Reasonable Review Requirement How much is enough? CIPis required for DVP/RVP accounts absent reliance agreement or exception Depending on account characteristics/activity additional DD may be required Risk based approach is appropriate

11 The Regulatory Landscape FINRA Exam Priorities Continued Microcap Fraud Focus Appropriate risk based policies and procedures in place Heightened supervision associated with potential employee conflicts/misconduct Fair and impartial business research conducted on microcaps Core AML Responsibilities Related to Microcap Fraud Monitoring (ex. physical deposits, liquidations without investment) Facilitating distribution of unregistered securities Suspicious Activity Reporting as appropriate Broker Solicitation / Suitability

12 Hot Topics & Trends 1. Foreign Securities 2. Bank Custody model 3. Trading Surveillance