Last week the Securities and Exchange Commission filed an enforcement action against nine defendants related to its 2017 discovery that its Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system used for receiving and retaining various corporate filings had been hacked and that persons likely had traded on material nonpublic information obtained through the cyber intrusion. A related criminal indictment organized by the Department of Justice was also filed. Separately, during the prior week, the first person convicted and sentenced to serve time in prison for spoofing under the Dodd Frank Wall Street Reform and Consumer Protection Act requested a new trial based on data he claimed was not made available for use by relevant exchanges during his initial trial. As a result, the following matters are covered in this week’s edition of Bridging the Week:
In its complaint, filed in a federal court in New Jersey, the SEC alleged that Mr. Ieremenko was the architect of the fraudulent scheme. According to the SEC, he initiated his purportedly nefarious activity in spring 2016 by first sending emails containing malware to sec.gov addresses that appeared to originate with SEC security personnel. Through this phishing attack, Mr. Ieremenko was able to (1) infect several SEC workstations when some SEC computer users opened emails with the malware; (2) illicitly penetrate the EDGAR system; and ultimately (3) gain access to test filings made by reporting entities on EDGAR, some of which contained nonpublic earnings information that would be publicized by the filing companies in the near future. Mr. Ieremenko then sold some of the earnings information to the other defendants, who bought and sold securities of the filing companies in advance of the public announcements of such information, hoping to benefit from their early knowledge. Ultimately, charged the SEC, this generated at least US $4.1 million in gross illicit gains.
The eight persons named in the SEC’s enforcement action in addition to Mr. Ieremenko were: Capyield Systems, Ltd.; Sungjin Cho, David Kwon, Ivan Olefir, Igor Sabodakha, Andrey Sarafanov, Spirit Trade, Ltd., and Victoria Vorochek. All the defendants were alleged to have ties with either Russia or the Ukraine, except for Mr. Cho and Mr. Kwon whose last known addresses were in California.
All the defendants, except for Spirit Trade and Mr. Kwon, were charged by the SEC in 2015 in connection with a similar cyber intrusion and trading program involving material nonpublic information illegally obtained from newswire services. (Click here for further details in the article “Hackers and Traders Charged by SEC and Department of Justice in International Securities Fraud Scheme” in the August 16, 2015 edition of Bridging the Week.)
In a parallel action, Mr. Ieremenko and Artem Radchenko – who allegedly recruited the parties that traded on the hacked information – were indicted in a criminal action initiated by the Department of Justice. The criminal action covers the defendants’ activities from February 2016 to March 2017.
Among other remedies, the SEC seeks disgorgement and penalties against the defendants. The DOJ seeks fines and imprisonment among other sanctions.
Compliance Weeds: In September 2017, in an innocuous press release entitled “SEC Chairman Clayton Issues Statement on Cybersecurity” the SEC first announced that it had discovered that its EDGAR system was hacked during 2016, and that persons may have profited from trading on unauthorized information obtained through such intrusion. (Click here for details in the article “SEC Discloses Trading May Have Occurred Based on Confidential Information Illicitly Obtained From Hack of EDGAR System in 2016” in the September 24, 2017 edition of Bridging the Week.) At the time, the SEC said that it did not believe that the hacking resulted in the compromise of personally identifiable information. Additionally, the SEC said that the hacking occurred through the test-filing component of the EDGAR system and that the vulnerability that allowed the hacking was patched “promptly after discovery.”
Just a short time later, the SEC acknowledged that, despite its prior understanding, the hack of the EDGAR system compromised two individuals’ personal information. (Click here for more information in the article “SEC Chairman Discloses Personal Information Also Compromised in EDGAR Hack” in the October 8, 2017 edition of Bridging the Week.) Moreover, in its complaint against defendants, it appears that the vulnerability in the EDGAR system that Mr. Ieremenko exploited was not shut down because of a detection of his illicit activity, but because of an unrelated incident. According to the SEC, “In October 2016, SEC IT personnel patched EDGAR software in response to a detected attack on the system, which also had the effect of preventing Ieremenko from accessing test filings” (emphasis added).
As this embarrassing episode at the SEC confirms, it’s not if a cyberattack may occur, it’s when it will occur. Unfortunately the bad folks are too creative and always seem to be one step ahead of the rest of us. As SEC Chairman Jay Clayton said in announcing the SEC enforcement action against the nine defendants, "[n]o system can be entirely safe from a cyber intrusion." (Click here to access Mr. Clayton's full statement on the SEC's enforcement action.)
There are numerous well-publicized measures a financial services firm should take to help reduce the likelihood of a cyberattack, including training (which should include mock phishing exercises). Equally important are the measures a firm should take to respond to a cyberattack, including taking all reasonable measures to understand the nature and scope of an attack and securing systems and data as soon as possible. Key is to have developed in advance a well thought through formal attack response plan and follow it when an attack occurs. Recent publications by the Financial Industry Regulatory Authority and amendments to National Futures Association’s guidance related to Information Systems Security Programs are good starting documents to review to gain better insight into effective cybersecurity measures. (Click here for information regarding the FINRA publication in the article “FINRA Publicizes Effective Practices at Members to Mitigate Cybersecurity Risks” in the January 6, 2019 edition of Bridging the Week, and here regarding NFA’s revised NFA guidance in the article “NFA Proposes Guidance Amendments to Enhance Cybersecurity” in the December 9, 2018 edition of Bridging the Week.)
Earlier this year, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations said that digital assets, cybersecurity and anti-money laundering programs would be among its top priorities during its 2019 reviews of registrants. (Click here for details in the article “Offer and Sale of Digital Assets and Cybersecurity Among the Focus of SEC OCIE 2019 Examination Priorities” in the January 6, 2019 edition of Bridging the Week.)
IIROC is the self-regulatory organization which oversees all investment dealers and trading activity on debt and equity marketplaces in Canada.
In additional legal developments regarding cryptoassets:
Mr. Coscia was sentenced to three years’ imprisonment for spoofing and commodity fraud following a criminal trial in 2015 for three months of trading activity in 2011; he previously settled civil charges related to the same matter with the Commodity Futures Trading Commission, the Financial Conduct Authority, and certain CME Group exchanges.(Click here for background in the article “Michael Coscia Sentenced to Three Years’ Imprisonment for Spoofing and Commodity Fraud” in the July 17, 2016 edition of Bridging the Week.)
The US Supreme Court declined to hear a proposed appeal of Mr. Coscia’s conviction during May 2018. (Click here for details in the article “Supreme Court Declines to Hear Appeal by the First Person Convicted Under New Anti-Spoofing Law” in the May 20, 2018 edition of Bridging the Week.)
My View: As I wrote at the time of Mr. Coscia’s sentencing, it was somewhat draconian that Mr. Coscia was sentenced to three years in prison for violating what was at the time a new law for which he already paid substantial civil sanctions; which on its face appeared to prohibit at least some legitimate trading practices; and which, at the time, may not have given him adequate notice of prohibited conduct. When the Financial Industry Regulatory Authority announced its issuance of its first cross-market equities report cards aimed at helping member firms identify potential spoofing and layering activity in 2016, it defined spoofing as “entering orders to entice other participants to join on the same side of the market at a price at which they would not ordinarily trade, and then trading against the other market participants’ orders.” This is a comprehensive practical definition. Contrariwise, the relevant provision under which Mr. Coscia was convicted prohibits “spoofing” but defines it as “bidding or offering with the intent to cancel the bid or offer before execution.” However, many legitimate orders, including stop loss orders, are placed with the goal or hope not to have the order executed, as that would mean the value of a position is declining. Unfortunately for Mr. Coscia, the judge hearing his case – as well as a US Court of Appeals – did not have a problem with the clarity of the relevant statute and, in any case, believed that Mr. Coscia should have known his specific trading was prohibited. (Click here for background on the FINRA report cards in the article “FINRA Will Grade Members on Culture, Supervision and Liquidity Management; BDs Not Managing Spoofing Likely to Get Bad Scores” in the January 10, 2016 edition of Bridging the Week.)
For further information:
Canadian Regulatory Organization Also Emphasizes Digital Assets and Cybersecurity in Latest Priorities Report:
Congressmen Reintroduces Bill to Exempt Certain Crypto Companies from State Money Transmitter Statutes:
First Person Convicted and Sentenced Under Dodd-Frank Anti-Spoofing Law Seeks New Trial:
NFA to Members: Be Careful Dealing With Exempt CTAs and CPOs During First Quarter 2019:
Nine Persons Charged by SEC in EDGAR Hacking and Illicit Trading Scheme; Two Persons Additionally Named in Criminal Indictment:
SEC Study of CorporateTrading Plans to Avoid Insider Trading Abuses Required by House Committee Members in Proposed Law:
Wyoming Proposes Laws to Permit Companies to Issue Digital Tokens in Lieu of Stock Certificates and for Banks to Provide Custodial Services for Digital Assets:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of January 19, 2019. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or other employees.