Archives: Dodd-Frank

The Securities and Exchange Commission released its 2015 Annual Report on its Whistleblower Program this week and announced another rise in the number of whistleblower tips that it received.  The SEC reported receiving 3,923 tips during its 2015 Fiscal Year, which is up from 3,620 in 2014 (as we previously reported), and up over 30% from 2012, which was the first full year that these numbers were reported.  Additionally, in its FY 2015, the SEC paid out $37 million to whistleblowers, which included a whopping reward of over $30 million to just one whistleblower.  The SEC’s Office of the Whistleblower (OWB) rewards whistleblowers for “their provision of original information that led to a successful Commission enforcement action with monetary sanctions totaling over $1 million” and can net tipsters between 10% and 30%, which is the statutory maximum allowed under the Dodd-Frank Act.

whistleblowerThe OWB determines the reward percentage for whistleblowers based on the particular facts and circumstances of each case, rather than any hard-set mathematical formula.  Some of the positive factors that may increase an award percentage include “the significance of the information provided by the whistleblower, the level of assistance provided by the whistleblower, the law enforcement interests at stake, and whether the whistleblower reported the violation internally through his or her firm’s internal reporting channels or mechanisms.”  Negative factors that may decrease an award percentage include “whether the whistleblower was culpable or involved in the underlying misconduct, interfered with internal compliance systems, or unreasonably delayed in reporting the violation to the Commission.”

A positive takeaway for companies from the OWB’s report is that 80% of the 2015 whistleblower award recipients initially raised their concerns internally to their supervisors or compliance personnel before reporting their information to the SEC.  The Dodd-Frank Act allows whistleblowers to do so, as it is designed to protect individuals who report internally to their companies, as well as those who report directly to the SEC.  Thus, for the most part, companies are still able to get an early notice of any wrongdoing prior to the SEC’s involvement, so that it can promptly respond, such as engaging counsel as early as possible to investigate and advise on the proper path forward.

As we predicted last month, the Securities and Exchange Commission adopted a final rule that requires a public company to disclose the ratio of the compensation of its CEO to the median compensation of its employees.  This measure was mandated under Dodd-Frank (section 953(b)), but the SEC maintains that its rule “provides companies with flexibility in calculating this pay ratio, and helps inform shareholders when voting on ‘say on pay.'”  Specifically, the new rule requires public companies to disclose:

  • The median of the annual total compensation of all its employees, except the CEO;
  • The annual total compensation of its CEO; and
  • The ratio of those two amounts.

However, companies are given flexibility in CEO treeselecting a methodology for identifying their median employee compensation, based on their own facts and circumstances.  In doing so, companies are permitted to take into account either their entire employee population or just a statistical sampling, as well as apply a cost-of-living adjustment.  Companies are also permitted to adjust this methodology once every three years.  However, companies are also required to disclose their methodology for determining their median employee compensation.

Companies are required to make these disclosures in their registration statements, proxy and information statements, and annual reports, which must already include executive compensation information as set forth under Item 402 of Regulation S-K.  However, companies are not be required to disclose the pay ratio information in reports that do not require executive compensation information, such as current and quarterly reports, nor update their disclosure for the most recently completed fiscal year.

The disclosure requirement applies to all companies required to provide executive compensation disclosure under Item 402(c)(2)(x) of Regulation S-K, but not smaller reporting companies, foreign private issuers, MJDS filers, emerging growth companies, and registered investment companies.  Such companies are required to disclose their pay ratio beginning on or after January 1, 2017.

Thus, companies subject to this disclosure should begin testing various methodologies for determining their median employee compensation, so as to be able to disclose a pay ratio that is the best fit for them by 2017.

According to Andrew Ackerman and Joann Lublin of the Wall Street Journal, the Securities and Exchange Commission is “poised to complete a rule requiring companies to disclose the pay gap between chief executives and employees”. Under the proposed rule, companies would be forced to disclose median worker pay as compared to their CEO compensation.  This rule was a measure included in Dodd-Frank, and could be approved by the SEC as early as next week.

A point of contention appears to be the money and calculatorexclusion of overseas workers.  The WSJ expects that the SEC will allow companies to exclude 5% of their international workers’ compensation from the pay-ratio calculation; however, companies are pressing for a larger exclusion.  There is also concern among stakeholders that the cost associated with compiling such information will outweigh the benefit of it.

Whether the SEC takes action on this rule next week or not, it is expected to implement a pay-ratio rule in the not-so-distant future.  Thus, companies should continue to provide their comments to the SEC now before the rule passes, and prepare for its eventual impact.

The number of whistleblower tips to the Securities and Exchange Commission (SEC) continues to rise, according to the SEC’s 2014 Annual Report to Congress on the Dodd-Frank Whistleblower Program.  In the November 17, 2014 report, Sean X. McKessy, Chief, Office of the Whistleblower, notes that his office received 3,620 whistleblower tips in Fiscal Year 2014, which is more than a 20% increase from two years prior.  Indeed, the SEC’s Office of the Whistleblower received 3,001 tips in the 2012 fiscal year and 3,238 in the 2013 fiscal year, so the 2014 number (which is almost 400 tips greater than the previous year) also represents a larger leap forward year-over-year.

The SEC maintains their growing whistleblower operation by incentivizing whistleblowers with an award that can range from 10%-30% of the SEC’s recovery.  According to SEC counsel (at a 2014 Securities Litigation & Regulatory Update CLE in Philadelphia) the whistleblower will even get credit for any information gathered from a company’s internal investigations, although the date that the whistleblower informs the SEC is the date that is used to start the clock on the whistleblower’s award.whistle

Not to be outdone, FINRA also has an Office of the Whistleblower, which, created in 2009, actually predates the SEC’s 2010 Office of the Whistleblower that was established under Dodd-Frank.  However, unlike the SEC, FINRA does not financially incentivize whistleblowers.  Thus, according to FINRA’s counsel, it only receives approximately 1,000 whistleblower tips per year, with between 200-300 referrals.

Counsel for the SEC and FINRA (at the 2014 CLE noted supra) agreed that self-reporting is considered a mitigating factor that is taken into consideration for fine determination.  However, both the SEC and FINRA cautioned that self-reporting will not preempt a fine for wrongdoing, as both agencies can still impose hefty fines even where a company self-reports a violation.

The takeaway here is that whistleblowers continue to be a growing source of information for the SEC and FINRA to begin investigations and enforcement actions.  As the SEC continues to incentivize whisleblowers and publicize large awards, the number of tips they receive is expected to continue to increase annually.  Moreover, while there is some incentive for companies to self-report, the risk of being hit with a large fine still looms large.  Additionally, as we noted earlier this year, the SEC discourages incentivizing whistleblowers to keep complaints in-house.  Thus, if faced with a possible violation, it is important for companies and in-house counsel to engage experienced outside counsel as early as possible to investigate and advise on the proper response and path forward.

In what is sure to add more “fuel to the fire,” it was recently reported that the SEC has won every case brought in its administrative courts over the last year.  The SEC has not been so successful with its federal court cases, winning 61% of those cases over that same period.

Of course, regular blog readers know that the Dodd-Frank Act expanded the SEC’s powers to permit it to bring more cases in its administrative courts.  These SEC proceedings restrict discovery, testimony and evidence while federal court proceedings permit the full panoply of discovery as well as the protections afforded when appearing before a federal judge.   One should also keep in mind that the SEC appoints the administrative law judges while federal judges are appointed by the President and confirmed by the United States Senate.

Ultimately, it is the SEC that makes the call on where the case is brought, however, these statistics are telling.  If you are the respondent in a SEC administrative action, your chances of success are minimal as opposed to being a defendant in federal court.  Accordingly, it may be worthwhile to start thinking settlement if you find yourself in a SEC administrative court.

Although it has been many years since Yogi Berra uttered this famous line, it seems like he must have been thinking about the debate regarding the adoption of a uniform fiduciary duty standard.  All kidding aside, one SEC commissioner recently expressed his doubts regarding the SEC proposing such a rule for those who give retail investment advice. buyholdsell.jpg

From all accounts, there appears to be a split, along party lines, of the SEC Commissioners on the adoption of such a rule.  Some argue that a rule should be adopted because investors do not understand the difference between the duties of investment advisors and broker dealers. 

In my view, the confusion has been spawned by the ongoing debate.  For broker-dealers, separate confusion can also be found with FINRA arbitration panels, some of which do not know that broker-dealers do not have a fiduciary duty to their customers.  So where does this leave us? 

In my experience defending retail broker-dealers, I have found that most customers assume that there is such a duty on their brokers, only to be shocked to hear in closing argument that it does not exist.  Nevertheless, there is a take away from this improper assumption most customers make. 

While the debate rages, broker-dealers should be taking a harder look at the suitability of their investment recommendations.  By taking a harder look, not only do you satisfy your legal obligations, but also may also satisfy the “expectations” of your customers.  Doing that may help you avoid the likelihood of customer claims and, if you have one, a better suitability defense on top of that.

 

* photo from freedigitalphotos.net

Now that summer has come to its unofficial end, it seems as though the SEC forgot to check its calendar back I May because it has been conducting exams at a breakneck pace as reported in the Investment News.  These exams have focused, in part, on those investment advisors who have never been examined. 

You may recall at the beginning of the year that the SEC made it an exam priority to focus on investment advisors who, for one reason or another, have never been subject to an examination.  The SEC has targeted about 1,000 of those entities, which should represent about a quarter of the 15% of all investments advisors who have never been examined. 

What should be the take away from the SEC’s focus on investment advisors being examined for the first time? buyholdsell.jpg

For one, it is a clear message that you should jump start the review of your operation.  Are your WSPs up to date?  Have you reviewed your policies and procedures regarding AML, custody of client funds, use of social media, and avoidance of insider trading? 

If the answer to any of these questions is no, now is the time to take preventative action and revisit these, among other issues, to make sure that your house is in order.  Either you do it now, or have the SEC do it for you later.   The decision is yours.

* photo from freedigitalphotos.net

As we all know, the SEC and FINRA have made cyber-security an exam priority in 2014, but what does it mean when the audit of your regulator shows that it is susceptible to a data breach.  A recent audit of the SEC found that its cyber-security was far from perfect. 

I am sure that there are some who rejoice in the fact that the SEC is having these types of issues.  In reality, however, this should be a valuable lesson to everyone in the industry.   robber.jpg

If the SEC (who has some of the most sophisticated systems) has a cyber-security weakness, what does that say for your systems.  The issues found during the SEC audit should serve as yet another wakeup call for the industry. 

Undoubtedly, no systems are perfect when it comes to cyber-security.  Nevertheless, you need to do all you can to ensure your systems are as protected as they can be. 

You should be asking yourself, when was the last time you had your systems audited for cyber-security weaknesses.  If it has been more than a year, it has been too long. 

Don’t be a victim.  Take affirmative action now to do what you can to secure your systems and the client information that you hold so dear.  Otherwise, expect to see your name in the paper as yet another victim of a data breach.  What will our clients think then?

* photo from freedigitalphotos.net

The SEC and three other regulators requested comment on a proposed policy statement that would establish joint standards for assessing the diversity policies and practices of the entities they regulate.  http://www.sec.gov/rules/policy/2013/34-70731.pdf.

The diversity measures are required by Section 342 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  In a joint release, the agencies said the proposed assessment standards would cover four key areas: (1) Organizational commitment to diversity; (2) Workforce profile and employment practices; (3) Procurement and business practices; and (4) Practices to promote transparency of organizational diversity.

Comments are still being accepted.

In an Investment News article written by Mark Schoeff, he reported that the push for a uniform fiduciary standard for broker-dealers and investment advisors has become a bit stagnant. In fact, it was reported that the prospects for such a uniform rules have waned over the years notwithstanding the general consensus that there should be such a standard.

Considering that there does not appear to be a uniform fiduciary duty standard looming in the immediate future, should retail broker-dealers even care any further. I think that the answer is still a resounding yes.

For one, in my experience, arbitration panels still struggle with the fact that broker-dealers are not subject to a fiduciary duty. As such, you may be held to that standard without really knowing it.

Where you do business is also of import. Depending upon the level of control you have over a customer’s account, some jurisdictions may impose a fiduciary duty on you as a matter of law. So where does this leave retail broker-dealers?buyholdsell.jpg

For one, you need to stay up on your compliance policies and procedures; promote a culture of compliance from the top down. Second, know where your clients are to be certain that you may not be considered a fiduciary without knowing it.

Although the uniform fiduciary duty appears to be stayed for now, do not lose your vigilance when it comes to your compliance and customer relations. Otherwise, you may be held to be something that you are not.

* photo from freedigitalphotos.net