SEC Announces Enforcement Action Regarding Illegal Offering of Security-Based Swaps; Issues Investor Alert
Commentary by Bob Zwirb
The SEC announced an enforcement action against a company for offering complex derivatives products to retail investors without the required registration statements.
According to the SEC, the Silicon Valley-based Sand Hill Exchange ("Sand Hill") invited Web users to buy and sell contracts referencing pre-IPO companies and their value. Sand Hill also sought people to fund accounts using dollars or bitcoins.
According to the SEC, the two entrepreneurs who began the company did not ask Web users about their financial holdings or limit offerings to users with any specific amount of assets. The SEC alleged that the individuals also understood that they were buying and selling derivatives linked to the value of private companies while falsely claiming that their own company was in the process of seeking regulatory approval for its contracts.
An SEC investigation found that Sand Hill was offering and selling security-based swaps contracts to retail investors outside the regulatory framework of a national securities exchange and without the required registration statements. As a result, the SEC found that Sand Hill violated Securities Act Section 5(e) and Exchange Act Section 6(l). According to the SEC, the violations were detected shortly after the offering process began, and the platform was shut down "before any investor harm occurred". Sand Hill cooperated with the regulators.
The company agreed to cease and desist from committing or causing any future violations of securities laws, and agreed to pay a $20,000 penalty.
In concert with the enforcement action, the SEC also issued an Investor Alert to warn investors about fantasy stock trading Web sites and similar online scams. According to the Investor Alert, even when a site presents a transaction as a "fantasy" trading game or competition, and even if it only involves small amounts of money, investors should understand that the site might be violating laws.
See: SEC Order; SEC Press Release.
See also: SEC Investor Alert Regarding Fantasy Stock Trading Web Sites.
Commentary
The Sand Hill exchange was operated by two 33-year-old individuals, one of whom has an MBA from the Sloan School of Management at the Massachusetts Institute of Technology, and the other, a Ph.D in electrical engineering from Stanford University, where she created models for counterparty risk in credit default swap pricing – not exactly the type of individuals that one would expect to prey on the investing public. Moreover, Sand Hill reportedly limited investor accounts to deposits of $250 and required a 100 percent margin – elements not usually associated with operations designed to take advantage of retail investors. As in the case of events or prediction markets – recall what happened to Intrade when it ran afoul of the CFTC's ban on trading off-exchange options – and especially in this Dodd-Frank environment, where nearly everything is either a swap or a security-based swap, it behooves those who would offer innovative ways to trade or invest to consult with a lawyer grounded in derivatives law first.