SEC Spurs Meeting of San Francisco, CA Compliance Roundtable

In Case You Missed It…

On Friday, June 19, the San Francisco, California Compliance Roundtable met at the request of the SEC, who had recently finalized an enforcement action involving Sand Hill Exchange, a business operating in Silicon Valley offering security-based swaps contracts to retail investors. These activities were being conducted outside the required regulatory framework of a national securities exchange and without an effective registration statement.

What Happened:

The discussion started with a description of how the Sand Hill matter came to the attention of the SEC, how quickly the investigation progressed as well as comments related to the business at Sand Hill. Enforcement and the “Complex Products” groups coordinated, notifying one another of “interesting” businesses and products. Mr. Busey, with the Office of Derivatives Policy and Trading Practices called Mr. Muoio from the SEC Enforcement Division about Sand Hill, and within a few days, Mr. Muoio contacted Sand Hill, asking for information. Initially, Sand Hill was not represented by counsel. Sand Hill operated for about 7 weeks, and closed within days of the first contact by the SEC.

Sand Hill changed its business model several times, but essentially the firm was creating fantasy swaps based on the value of private, pre-IPO companies. The company was also setting “prices” or values for these security based contracts, which seem to have not been fictional. Also, when first contacted by the SEC, the principals of Sand Hill evidently denied structuring swaps, indicated they were registering with the SEC as an exchange, and made other incorrect statements. Profits could be paid in Bitcoin or dollars.

What We Confirmed:

  1. Honesty – If contacted by the SEC, be honest. Do not attempt to mislead the investigators.
  2. There was nothing in the actions of Sand Hill that was innovative – the actions were the same as the bucket shops of the past. There was no innovation. They simply used the internet instead of paper and a phone.
  3. While the SEC’s focus to date on the derivatives-related provisions of Dodd-Frank has been institutional, they are very concerned about any retail related activities.
  4. Swaps related provisions of Dodd-Frank: The definition of a swap is very broad, but the discussion included 3 essential prongs:
    • Includes every type of option-like contract;
    • Is an event driven contract, and it can be any type of event;
    • It includes the components of a traditional swap, whereby there are payments between the parties to “true up” the contract during the life of the contract.

Additional Swap Information:

Swaps are regulated by the CFTC (the basic definition comes from that agency) which is also the basis for the ‘34 Act definition of security based swaps. The entire regulatory regime for swaps is very complicated.

Security based swaps can only be sold to non-institutional investors who are “eligible contract participants”, or individuals with investible assets of $10 million. Swaps may be sold to eligible contract participants via a registration statement and may be effected only on a national securities exchange.

Red Flags:

  1. If a firm has a website offering security valuations, check because it may meet the swap definition.
  2. Per the ’34 Act, if you are selling a swap, you have to register as a national exchange.
  3. Eligible contract participant, or “ECP” has to have investible assets of $10 million, $5 million if hedging.
  4. If security based swaps are being sold to retain investors, securities laws are probably being violated.
  5. Swap Execution Facilities “SEF” are for institutional transactions only.

Problematic business models:

These included gaming or fantasy structures related to stocks, buying private, pre-IPO shares from existing shareholders and new structures that are being created to allow founders of companies some liquidity. Often, these structures sounds like traditional collars or OTC calls/puts. Funds, websites and some BDs are being formed for these purposes.

The Complex Product group is now focused on:

  1. Asset backed products and markets, which so far seem to be pretty clean;
  2. Retail structured products, which are required to be properly registered;
  3. Market smart complex products.

What Firms Can Do:

What can firms do to make sure they are acting in a legal and responsible manner?

  1. Engage qualified counsel
  2. Review or request a no-action letter
  3. Contact the Title 7 Offices, which may provide information /comfort. This should be done only after steps 1 and 2 have been taken
  • Office of Capital Markets Trends – Amy Star
  • Office of Derivative Policy – Carol McGee

We hope to arrange more discussions on this complicated topic in the near future.

Our next meeting 9/10/15.

For more information on the San Francisco California Compliance Roundtable, contact Oyster Senior Consultant Harriet Britt at or view Harriet’s bio.