Securities Regulation Daily Simulated trading accounts were security-based swaps
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Friday, October 23, 2020

Simulated trading accounts were security-based swaps

By Amanda Maine, J.D.

While supportive of the SEC’s action in this case, Commissioner Peirce spoke favorably of the "gamification" of educational experiences to promote learning about investing.

A day-trading education company will pay a $130,000 civil penalty to settle SEC charges related to unregistered security-based swap transactions. The SEC determined that simulated trading packages that included funded trading accounts through which customers could receive payouts were security-based swaps under the securities laws. By offering and selling the packages to retail investors without registration and failing to transact on a registered national exchange, the company violated the Securities Act. Commissioner Peirce, while agreeing with the SEC’s enforcement action against the firm, extoled the value of simulated trading experiences and left open the possibility that providing cash prizes as an incentive to learning might not run afoul of the SEC’s rules (In the Matter of Tradenet Capital Markets Ltd.Release No. 33-10878, October 23, 2020).

Education packages. Tradenet Capital Markets Ltd., an Israel-based education firm, offered and sold different "Day Trading Education Packages." These packages, which cost between $500 and $9,000 each, included a book, videos, and access to Tradenet representatives, as well as access to a "funded trading account." The amount of money in the funded trading accounts varied by the type of package and allowed people to create a portfolio of securities and to receive possible payouts tied to the performance of the portfolio.

While no securities were bought or sold in the funded trading accounts, the trades were simulated and payments were made to customers whose portfolios increased in value based on the price movements of the underlying securities. These payouts ranged from 70 to 85 percent of the simulated profits generated in the account depending on the package. If the portfolio value decreased by a certain amount, the funded trading account would be permanently closed.

Security-based swaps. According to the SEC, the agreements through which Tradenet provided the funded trading accounts were security-based swaps because they provided for the exchange of contingent payments based on the value of U.S. securities without conveying ownership of the underlying securities. Tradenet offered and sold these security-based swaps without an effective registration statement with the Commission and without effecting the transactions on a registered national securities exchange.

The SEC alleged that Tradenet took no steps to determine whether the people who contracted to open the accounts were eligible contract participants (ECPs) under the securities laws. In fact, Tradenet understood that many buyers were novice investors that bought the education packages to learn about trading securities.

The SEC stated that Tradenet violated Securities Act Section 5(e) because it sold security-based swaps to more than 5,000 retail investors who were not ECPs and where no registration statements were in effect for the offer and sale of the swaps. In addition, Tradenet violated the Securities Act by effecting transactions with U.S. retail investors in security-based swaps that were not transacted on a registered national securities exchange.

To settle the SEC’s charges, Tradenet agreed to pay a $130,000 penalty and to cease and desist from further violations. The SEC acknowledged Tradenet’s remedial efforts and cooperation with the staff in determining to accept the offer of settlement.

"Companies seeking to sell U.S. retail investors synthetic exposure to stocks must ensure compliance with the federal securities laws," said Daniel Michael, Chief of the Complex Financial Instruments Unit.

Tradenet did not admit or deny the findings in the Commission’s order.

Peirce’s reservations. Commissioner Hester Peirce issued a statement explaining that while she supported the SEC’s action against Tradenet, she did so with some reservations. She pointed out that while Tradenet’s product offering did have an educational component, it was primarily about the simulated funded account, which could not have been offered to U.S. retail investors without violating existing securities rules.

However, Peirce stressed that "gamification" of educational experiences, including programs that give investors the opportunity to simulate trading and assemble portfolios, can promote learning and that the use of awards or prizes—including cash prizes—can enhance the value of the experience by providing an incentive to take the game seriously. She urged firms, schools, and entrepreneurs who want to offer investment learning opportunities through simulated trading experiences with financial incentives to engage with the SEC to explore ways to ensure that the program is consistent with SEC rules.

The release is No. 33-10878.

Companies: Tradenet Capital Markets Ltd.

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