Federal regulators have smote an ETF entrepeneur and his 11-year-old Garden State shop, as expected. The $4.4-million settlement bars the entrepreneur from the industry, at least for now, and comes as another fund firm is poised to acquire the settling firm's ETF business by adopting its ETFs.

Samuel Ralph "Sam" Masucci III ETF Managers Group LLC Founder

Yesterday, Corey Schuster, co-chief of the asset management unit within the enforcement division at the U.S. Securities and Exchange Commission (SEC), unveiled charges against Summit, New Jersey-based ETF Managers Group LLC, Exchange Traded Managers Group LLC (ETF Managers Group's parent), and Sam Masucci, the founder and principal owner of the firms. Without admitting to the SEC's findings, Masucci and his firms agreed to a settlement that includes cease-and-desist orders, a $400,000 penalty (for Masucci to pay), and a $4-million penalty (for ETFMG to pay).

"After incurring approximately $10 million in legal fees, and faced with the daunting costs of challenging the SEC in court, the company and Mr. Masucci, without admitting or denying the SEC's allegations, consented to the SEC's entry of findings," Masucci and the ETFMG team states in a public response to the SEC's announcement.

The settlement bars Masucci from much of financial services (including working in the mutual fund business), with a right to reapply for entry in three years. Indeed, as previously reported, Masucci resigned last month from a host of ETFMG positions as part of settlement discussions with the SEC. And ETFMG, as previously reported, is poised to sell its entire 17-ETF lineup to Amplify ETFs.

The Masucci and ETFMG's SEC settlement stems from what the regulators describe as a coverup of a conflict of interest involving a securities lending deal for the ETFMG Alternative Harvest ETF (MJ), an ETFMG's "pure play marijuana ETF." The SEC accuses ETFMG and Masucci of breaching their duties of both care and loyalty to MJ.

"Investment advisers cannot mislead clients or leverage client assets for their own benefit," Schuster states.

According to the SEC, in 2019 and 2020 Masucci negotiated to get $20 million in financing for ETFMG from MJ's then-custodian in exchange for keeping the fund's securities lending business with that custodian, while ignoring other firms' securities lending deal bids that would have been more favorable to the fund. Then, according to the SEC, Masucci hid that conflict of interest from MJ's independent directors while telling them that the existing securities lending deal was still the fund's only viable option.

The SEC's 12-page settlement order yesterday does not identify the MJ custodian that Masucci negotiated the financing deal with, but SEC filings reveal that Wedbush Securities, Inc. served as MJ's custodian from September 2018 until being replaced in May 2021.

The settlement order describes the $20-million ETFMG financing deal as involving MJ's then-custodian (Wedbush) buying a 20-percent stake in ETFMG for $10 million, plus getting another 4.99-percent stake in exchange for a three-year, $10-million loan at three-percent interest. That two-part deal, the SEC explains, was driven on the ETFMG side by a 2019 loss in a different legal battle, a civil lawsuit.

In 2019, ETFMG was ordered to pay more than $78 million (plus interest) in damages to Nasdaq over ETFMG's 2017 breakup with Nasdaq and PureFunds. PureFunds and ISE (which Nasdaq bought in 2016) had previously worked with ETFMG on several ETFs (including HACK, which was a quick hit after its 2014 launch), but ETFMG split with Nasdaq and PureFunds in 2017 and both sides sued for breach of contract. ETFMG defeated an initial suit from PureFunds, but Nasdaq won its suit against ETFMG in 2019, and ETFMG settled with PureShares and Nasdaq in 2020. 

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