Broker and OTC Market Maker Vandham Securities settles with SEC over penny stock violations

On September 16, 2019, Vandham Securities Corp settled with the SEC. See Vandham Securities BrokerCheck report. In July 2018 Vandham was bought or merged with Wall Street Access (see its BrokerCheck report). Vandham (technically Wall Street Access now) continues to act as an OTC market maker with the market maker ID “VNDM” but I am unsure of how active it is in that line of business. According to the settlement, Vandham’s “primary business during the relevant period [January 2016 to April 2017] involved facilitating the sale of thinly traded, low priced over-the-counter stocks into the market by other broker-dealers, principally Broker-Dealer A and Broker-Dealer B.” Also according to the settlement, in 2016 Vandham reported revenue of approximately $9 million and in 2017 it reported revenue of approximately $10m.

There are three different types of violations covered by the settlement, which covers Vandham’s actions from January 2016 to April 2017. The first type of violation was of Rule 203(b)(1) of Reg SHO which relates to how Vandham sold shares for its client brokers on behalf of their clients liquidating shares in OTC stocks. Rather than simply sell the shares, Vandham would sell short shares in its own account first and then cover its short into the sell orders of its clients. Because Vandham was short in its own account it was required to locate shares it sold short but it failed to do that on “over 10,000 short sales.”

The second type of violation is of rule 15c2-11 which should be familiar to this blog’s readers after I blogged about an SEC suit against Spartan Securities and an SEC settlement with Canaccord Genuity for violations of 15c2-11 and the SEC’s plan to change rule 15c2-11. It is the rule that requires brokers that make a market in an OTC stock to obtain and review information about the companies they are trading. In the settlement the SEC describes the rule:

Rule 15c2-11 promulgated under the Exchange Act prohibits a broker-dealer from publishing, or submitting for publication, any quotation for any security in any quotation medium, unless the broker has in its records certain documents and information about the issuer, as specified in the Rule, and reviews such information to form a reasonable basis under the circumstances for believing that such information is accurate in all material respects and is from a reliable source.

SEC settlement, page 4

There is an exception to rule 15c2-11 for unsolicited customer orders, but that exception did not apply when Vandham was trading in its own account. When Vandham went short in its own account prior to selling client shares and also when it would sometimes buy client shares in its own account at a discount and then sell those shares the unsolicited customer order exception did not apply even thought he ultimate purpose of those orders was to sell the client shares.

The third type of violation mentioned in the settlement is in my opinion the most important, and those are AML (anti-money laundering) violations, specifically failures to file SARs (Suspicious Activity Reports). Even though Vandham was trading on behalf of other US-based brokers (whose clients owned the shares being sold), it still had a duty to inquire about suspicious activity and file SARs about suspicious activity. Keep in mind that suspicious doesn’t mean illegal — much legal activity is suspicious, but financial institutions are bound by the Bank Secrecy Act to file SARs. What qualifies as suspicious? From the settlement:

The Bank Secrecy Act (“BSA”) and implementing regulations promulgated by Financial Crimes Enforcement Network (“FinCEN”) require that broker-dealers file SARs with FinCEN to report a transaction (or patter of transactions of which the transaction is a part) conducted or attempted by, at or through the broker-dealer involving or aggregating to at least $5,000 that the broker dealer knows, suspects, or has reason to suspect: (1) involves funds derived from illegal activity or is conducted to disguise funds derived from illegal activities; (2) is designed to evade any requirement of the BSA; (3) has no business or apparent lawful purpose and the broker-dealer knows of no reasonable explanation for the transaction after examining the available facts; or (4) involves use of the broker-dealer to facilitate criminal activity. 31 C.F.R. §1023(a)(2) (“SAR Rule”)

SEC Settlement, page 5

Vandham’s AML policies described in detail red flags relating to “transactions involving penny stock companies.” These included issuers that have:

– “no business, no revenues, and no product;”
– “officers or insiders … associated with multiple penny stock issuers;”
– “undergo[ne] frequent material changes in business strategy or its line of business;”
– “officers or insiders … [with] … a history of securities violations;”
– “not made proper filings;”
– “been the subject of prior trading suspensions;” or
– been the subject of “chat room conversations indicative of suspicious activity.”

SEC Settlement, page 6

It appears to me that Vandham’s AML policies were appropriate to its business of liquidating large blocks of OTC stocks. However, according to the settlement, Vandham “failed to implement those policies so as to address the risks posed by its business model.” According to the settlement, “it was Vandham’s practice to refrain from asking its broker-dealer customers about the identity of the customers for whom those broker-dealer customers placed sell orders with Vandham.” In fact, despite having been sanctioned by FINRA in 2014 for AML failures, Vandham filed only one SAR from 2014 to April 2017 relating to a customer’s large volume of sales of an OTC stock and only four SARs in total.

Vandham Ignored Clearing Firm Warnings

According to the settlement, Vandham’s clearing firm expressed concerns about Vandham’s trading in one particular stock (referred to as “Issuer C”):

Vandham’s clearing broker informed Vandham that its trading in Issuer C, in just January 2017 alone, coincided with significant price volatility and a spike in trading volume in Issuer C’s stock. The clearing broker also informed Vandham that:
– “It appeared that [the seller] used [Broker-Dealer A, Vandham’s counterparty on the trades at issue] to immediately ‘dump’ the shares of [Issuer C] back into the market” after receiving, according to Forms 8-K filed by Issuer C, over 45 million shares of Issuer C from December 28, 2016 through January 17, 2017; and
– The owner of the selling entity, a Florida-based trading vehicle, “has been mentioned on multiple penny stock blogs and bulletin boards as a potential penny stock fraudster.”

SEC Settlement, page 9

And what did Vandham do? Nothing:

Vandham either ignored or did not learn of these facts prior to being informed thereof by the clearing broker because of, among other things, its practice to not inquire into the identity of and investigate the customers for whom its broker-dealer customers placed sell orders with Vandham. Even after these facts, which constituted additional red flags, were conveyed to Vandham, it still neither filed a SAR nor produced any written analysis or other records supporting the reasonableness of why SARs did not need to be filed.

SEC Settlement, pages 9-10

The Penalties

As is usual with SEC settlements, Vandham has to cease and desist from violating the law and is censured. The firm was also ordered to pay a civil monetary penalty of $200,000.

Other Details

As is usual with FINRA and SEC actions, there are some interesting details in the settlement. The two largest broker-dealer clients of Vandham (Broker-Dealer A & Broker-Dealer B) in its business of liquidating shares of OTC stocks both “focused primarily on thinly traded, low priced over-the-counter stocks.” Also, both were “headquartered in Utah,” according to the settlement. I will leave it to my readers to guess the identity of those brokerages.

Also, the settlement lists trading in four different stocks as being particularly suspicious and those details always make for fun reading. I will only quote the red flags with one of the four, “Issuer C” (already mentioned above in the warning from Vandham’s clearing firm):

32. From June 2016 through January 2017, Vandham facilitated the sale by customers of Broker-Dealer A of nearly one hundred million shares of Issuer C, a thinly traded microcap stock. During this period, Issuer C’s stock price fluctuated from a low of $0.0017 to a high of
$0.88 per share on an average daily volume of approximately 20 million shares. In the six months prior to June 2016, the average trading daily volume in Issuer C’s stock was less than 1,000 shares, and on many days during that period the stock did not trade at all. Vandham had no activity in the stock until June 2016.

33. For example, on 23 trading days during this period, Vandham bought from Broker-Dealer A and sold into the market approximately 96 million shares (split adjusted) of Issuer C’s stock. Vandham’s aggregate trading over these 23 days represented approximately 25% of the issuer’s most recently reported outstanding share amount. On four of these trading days, Vandham’s trading constituted more than 30% of the total trading volume in Issuer C for the day; on two of those days, it constituted over 40% of the day’s total trading volume.

34. Notwithstanding the foregoing circumstances, Vandham did not conduct any follow-up inquiry into the issuer, or the identity of the owners of the shares that were being sold into the market. Had Vandham done so, it likely would have identified additional red flags, including that Issuer C (a) was the subject of numerous internet promotional campaigns during the period in which its trading volume spiked; (b) was delinquent in its public filings; and (c) had an accumulated operating deficit exceeding $6 million as of May 2016, with increasingly minimal revenue since 2015; and (d) was experiencing a rapid and extreme dilution of its stock,
with outstanding shares increasing from 3.4 million following an October 2016 reverse split to 300 million as of December 31, 2016, an increase of nearly 10,000 percent.

SEC Settlement, pages 8-9

Disclaimer: No position in any company mentioned and no relationship with any person or entity mentioned. This blog has a terms of use that is incorporated by reference into this post; you can find all my disclaimers and disclosures there as well.

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