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Many years ago, decades really, I attended a rug auction. It was shortly after the Islamic revolution that cut off commerce from Iran, and the auctioneer was playing that to the hilt. He was showing one Persian rug after another, in each case pronouncing loudly that it was likely the last of its kind, unable to be obtained in the future, and an investment worthy of passing down the generations. At one point, he urged us to "sell all your stocks and all your bonds and buy these rugs."I don't know if those rugs truly were the "last of their kind." More likely, he had a whole stack of them back at his warehouse. I doubt that he was telling the whole truth. Nevertheless, I remember he sold a quite a few rugs that day for some pretty high prices. No doubt some of his purchasers did sell securities to pay for them. So my question is this: Was that auctioneer engaged in securities fraud?Let's try it another way. Suppose a charismatic huckster convinces you to part with some of your money. Perhaps, like Harold Camping, he is forecasting the end of the of the world and needs your money to convince the unbelievers. Or perhaps, like Harold Hill, he is forecasting the end of public decency unless you buy his band instruments. In either case, he urges you to "sell all your stocks and send your money to me." Are they committing securities fraud?Let's try one more. Let's bring my rug dealer into the 21st century. He gets his hands on one of those CGI-enabled avatar makers, and transforms himself into a well-known financial celebrity -- say, for example, Jim Cramer. Mimicking Cramer's style as well as his face, he puts out a TikTok video ranting that the stock market is going to hell in a bucket, pounding his red button three or four times yelling "Sell! Sell! Sell!" and urging his audience to buy a Persian rug from our auctioneer instead. Is that securities fraud?Note in all these cases, no particular security is singled out for sale. In all these cases, we are being urged simply to sell securities and use the money elsewhere. Let's take it as given that all these characters are doing something at least shady and even fraudulent. That's not the question. The question is are they engaged in securities fraud? If you answered no to each of those questions, I tend to agree with you. But how then do we explain the case that the SEC brought last week in federal court against two Israeli web designers? Shlomo Nir and Tzachi Rahamim contracted to redesign the website for an unnamed but supposedly famous financial celebrity. Unbeknownst to their client, Shlomo and Tzachi allegedly added some code that highjacked their client's website, allowing them to redirect visitors to another website that they controlled. Their website had the same look and feel as their client's, but, the SEC alleged, "encouraged investors to liquidate their retirement accounts, which included securities, and rollover the funds to purchase the fixed indexed annuities" sold by an insurance agency that paid hidden commissions to Shlomo and Tzachi. See https://www.sec.gov/litigation/complaints/2022/comp25432.pdf and https://www.rrbdlaw.com/6526/securities-industry-commentator/#nirLet's assume that this was a fraudulent scheme. It certainly sounds dodgy based on the SEC's allegations. But note that what was being sold, and what investors bought, were fixed indexed annuities. Fixed indexed annuities provide a minimum guaranteed return, plus the potential for upside appreciation based on market performance. Like most fixed annuities, these products are not securities, and the SEC's complaint never says they were. Rather, they are insurance products, and they are governed by state insurance laws. In other words, the SEC has no more business regulating them than it does the sale of Persian rugs.
The SEC's fraud charges don't relate to the sale of the annuities, but only to the the "encouragement" that investors sell securities to buy them. Like the auctioneer and the hucksters and the fake Jim Cramer in my examples above, Shlomo and Tzachi did not identify any particular securities or say why any particular securities should be sold. They just said, in effect, sell this and buy that. More likely, buy these annuities, even if you have to sell securities to do so.
No matter how you look at it, this is a stretch. Under prevailing law, securities fraud requires deceptive conduct, or material misstatements or omissions, "in connection with the purchase or sale of securities." The fraudster's object is understood to be some unfair advantage derived from a victim's purchase or sale of particular stocks. Material misstatements and omissions require facts to be misstated or omitted, facts about the securities being purchased or sold. That's what it means for a deception, misstatement or omission to be "in connection with" the purchase or sale of a security.
In all of my examples above, and as alleged against Shlomo and Tzachi, the purchase or sale of securities was totally incidental - it was not the object of the fraud. They all had an entirely different aim, which was to induce the victim to buy another thing, one over which the SEC has no jurisdiction. There is no tether between the alleged conduct and the sale of any security, except that a security might be sold in order to raise the cash needed for another purpose. But that could be said of anything that calls for cash to be raised. Under the SEC's theory, any scam that takes money from the sale of securities could be a securities fraud, even if the fraudster is just selling snake oil.
The potential breadth of that is jaw-dropping. Last week the Supreme Court struck down an EPA rule that the "best way" to regulate coal-fired power plants was to shut them all down. The Court noted that administrative agencies can't interpret their statutory authority quite so expansively. The SEC's case against Shlomo and Tzachi is nowhere near that level, but it does raise the same concerns about administrative overreach.
And it is dangerous because it is so small. According to the SEC complaint, Shlomo and Tzachi made $126,000 from annuity purchases funded from stock sales. They sought refuge in a $450,000 settlement, which only makes sense given the paltry sums at stake. In the aftermath hardly anyone will notice what the SEC did. But every form of refuge has its price, and in this case and others like it, that price will be yet another precedent for expanding the SEC's reach well beyond its proper statutory limits.
Aegis Frumento co-heads the Financial Markets Practice of Stern Tannenbaum & Bell, New York City. He represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations). He has decades of experience representing SEC, CFTC and FINRA regulated firms and persons in regulatory enforcement investigations, hearings and lawsuits. Drawing on his five years managing the Executive Financial Services Department of Morgan Stanley Smith Barney, Aegis has rare depth of experience in the securities and corporate governance laws affecting senior executives of public corporations. When not litigating, Aegis enjoys working with new and existing broker-dealers, registered investment advisers, and private equity funds, covering all legal aspects from formation to capital raising. Those clients now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises, including the use of cryptosecurities to represent equity and debt interests.
Aegis's long and distinguished career includes having been a Managing Director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP. He graduated from Harvard College in 1976 and New York University School of Law in 1979. Aegis is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments. He is the current Chairman of the New York City Bar Association's standing Committee on Professional Responsibility.
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