Reminding financial institutions that a multitude of enforcers are at their doorstep, the Securities and Exchange Commission (SEC) announced a $3 million deal with an online lender.

In a separate case, the Financial Crimes Enforcement Network (FinCEN) banned the operator of a peer-to-peer virtual exchange from the industry and issued a civil money penalty for willful violations of the Bank Secrecy Act (BSA).

What happened

According to the SEC’s order, the California-based marketplace lender arranges consumer loans through its website and sells securities linked to the performance of those loans to investors. The company earns revenues by collecting transaction fees linked to originations and servicing fees on the consumer loans.

When investors opened accounts with the lender, it gave them access to individual account pages that provided information on their loans and the performance of the securities. The lender calculated the annualized net returns (ANRs) for each investor’s portfolio of securities through an automated process and reported them prominently on each online account page, the SEC said.

From approximately July 2015 until May 2017, the lender excluded securities linked to certain charged-off consumer loans from its calculation of ANR, the SEC alleged, and failed to identify and correct the error despite the lender’s lack of understanding about how the ANRs were calculated and despite knowledge by its employees about investor complaints of possible errors.

As a result, the lender miscalculated and overstated the ANR it reported to a total of more than 30,000 investors (a majority of the total number of its investors) during the roughly two-year period, according to the order. The lender also solicited new investments in its securities based on the miscalculated ANR in “tens of thousands” of emails sent to potential investors.

Only after receiving a complaint from a large institutional investor in April 2017 did the lender identify the error and notify investors. In the interim, the SEC alleged that tens of thousands of investors made additional investments in the securities, based in part on the inaccurate ANR reported by the lender on the online account pages and/or the email solicitations.

The SEC accused the lender of violating Section 17(a)(2) of the Securities Act. The lender submitted an offer of settlement, neither admitting nor denying the charges, and the agency accepted. 

Pursuant to the deal, the lender will pay a $3 million civil money penalty. The fine recognizes the cooperation afforded to the SEC and the remedial acts promptly undertaken by the lender (such as management supervision of the ANR calculation and data owners, quarterly reviews of any changes that could have an impact on the data used in the ANR calculation, and semiannual testing of the ANR calculation).

“As this case shows, we are committed to holding fintech companies to the same standards applicable to other participants in the securities markets,” Daniel Michael, chief of the SEC Enforcement Division’s Complex Financial Instruments Unit, said in a statement.

In a separate case, FinCEN brought its first enforcement action against a peer-to-peer cryptocurrency exchanger.

Since 2001, the BSA and its implementing regulations have required money services businesses (MSBs) to register with FinCEN. In 2011, FinCEN issued a final rule amending definitions and other BSA regulations relating to MSBs to provide that money transmission covers the acceptance and transmission of value that substitutes for currency. Through guidance issued in March 2013, FinCEN clarified that a person in the business of exchanging virtual for real currency, funds or other virtual currency for others is a money transmitter, and therefore an MSB subject to the BSA’s registration, anti-money laundering (AML) program and suspicious activity reporting requirements.

Between December 6, 2012, and September 24, 2014, the individual conducted more than 1,700 transactions as a money transmitter, acting as a peer-to-peer exchanger of the convertible virtual currency bitcoin, purchasing and selling bitcoin to and from others.

The individual also advertised his intent to purchase and sell bitcoin for others in online posts and participated in online discussions pertaining to AML compliance, including specific conversations about registering as an MSB, demonstrating his awareness of the relevant BSA requirements, FinCEN said.

However, he failed to register.

In addition, the individual failed to meet several other requirements of the BSA and its implementing regulations, including the development, implementation and maintenance of an effective written AML program reasonably designed to prevent the MSB from being used to facilitate money laundering and the financing of terrorist activities. 

“In fact, in March 2013, [the individual] publicly stated on the Internet that he would assist customers that wanted to circumvent AML obligations,” FinCEN said. “Further, while acting as a virtual currency exchanger, [the individual] did not file any BSA reports and had no written procedures for doing so.”

The individual’s own records show that he conducted 49 transactions aggregating over $86,000 with a customer who had an email address with the suffix “@tormail.org,” an anonymizing torrent service. While use of the service in and of itself is not suspicious, “transactions through a torrent service may be a strong indicator of potential illicit activity when no additional due diligence is conducted to determine customer identity and whether or not funds are derived from illegal activity,” FinCEN explained.

On other occasions, the individual conducted transactions totaling $170,000 with a customer after the individual appeared in news media commenting on alternate ways to access darknet marketplaces following the shutdown of Silk Road, according to the order; another time, he offered to exchange convertible virtual currency for fiat currency, knowing that the fiat currency constituted the proceeds of illegal activity.

The individual also failed to file a single currency transaction report (CTR) although 243 of his transactions should have resulted in such filings, FinCEN said.

Having determined that the individual willfully violated the registration, program and reporting requirements of the BSA and its implementing regulations, FinCEN determined a $35,350 civil money penalty was appropriate.

The individual, who admitted to the facts set forth in the order, also agreed to immediately and permanently cease providing money transmission services and not engage in any activity that would make him an MSB for purposes of regulations implementing the BSA.

To read the SEC order, click here.

To read the FinCEN civil money penalty, click here.

Why it matters

The enforcement actions provide a cautionary tale to financial institutions about the multiple regulators overseeing the industry, from the SEC to FinCEN to various state regulators, as well as the continued focus on holding individuals accountable whenever possible, as the FinCEN civil money penalty demonstrates.