On October 16, 2016, the Securities and Exchange Commission (“SEC”) instituted cease-and-desist proceedings (the “Order”) against mobile phone application (“App”) Forcerank LLC (“Forcerank”) pursuant to violations of Section 8A of the Securities Act of 1933, and Section 21C of the Securities Exchange Act of 1934. In response to the Order, Forcerank has submitted an Offer of Settlement (the “Offer”), without admitting or denying any wrongdoing but accepting SEC jurisdiction over regulation.
According to the Order, Forcerank is an App that allows users to attempt to predict the outcome of a basket of securities by ranking these securities based on their performance relative to each other. While this usage may have functioned as a “game,” it was in essence an over-the-counter derivative trade: a payout was to be made not on the underlying value of any of these securities, but on a “derivative of” their value, in this case their value relative to each other. The SEC alleges Forcerank structured the game in week-long segments, during which time players won points for each security for which they guessed the price. Based on the accuracy of their prediction, at the end of the competition players who were most accurate received cash prizes. Forcerank kept 10% of the entry fees, and maintained a data set of user behavior and bets that it intended to sell to hedge funds or other wealth managers as insight into crowd perception of certain securities. Forcerank was a creation of Estimize, a private New York based company that collects and sells data about securities and trading, primarily through developing websites and Apps through which it can crowdsource user behavior.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”) specifically regulates the derivatives market. Whether or not the creators of Forcerank were aware that their product constituted a financial derivative is not material to the fact that they were required to file an effective registration statement covering their derivative offering with the SEC. Given that Dodd-Frank requires that derivative type transactions occur only on exchanges, subject to the highest level of regulation and cleared with registered clearing agencies, so that investors are provided with public price discovery mechanisms, it is unlikely Forcerank would be able to operate its “swap” trading game even if it had registered properly. Pursuant to reforms under Dodd-Frank that sought to limit the sale of security-based swaps, entities that are not “eligible contract participants” may not engage in this type of derivative trading. In order to qualify as an “eligible contract participant,” among many categories required are monetary thresholds, mandating that an individual need to have at least $5 million invested on a discretionary basis to qualify as a seller of security-based swaps.
Forcerank executives did not believe their game constituted security-based swap trading, and issued a statement that Forcerank “[is] not a security or security based swap, and is a skill based contest, it is not currently regulated by the federal government, any state government, or financial regulatory authority. Forcerank has been in close contact with various financial regulatory authorities both before and after launching Forcerank contests.” According to the SEC Order, no regulatory authority had cleared the Forcerank contests or were in contact with Forcerank executives regarding whether their app constituted swaps or security-based swaps. According to the Order, Forcerank must within five (5) days of the entry of the Order pay a civil penalty of $50,000 to the SEC.
Lax & Neville LLP has nationally represented small broker-dealers, financial services professionals, and securities industry companies in regulatory matters and securities-related and commercial litigation. Please contact our team of attorneys for a consultation at (212) 696-1999.