Ernie Badway and Dan Schnapp have authored the article, "The Problem with SEC Obey-the-Law Injnuctions and Their Chances of Survival," in the most recent edition of the Journal of Taxation and Regulation of Financial Institutions. The link follows: http://www.civicresearchinstitute.com/online/article_abstract.php?pid=2&aid=3846&iid=539.
The SEC’s Office of Compliance Inspections and Examinations announced that it will increase their examinations of newly registered private fund advisers starting this summer.
These examinations are being done in conjunction with those hedge fund and private equity advisers previously registered with the Commission as a result of the Dodd-Frank Act. The SEC Staff made it abundantly clear that these newly registered advisers will be examined, pursuant to a set of risk factors and not by the traditional OCIE exam cycle. The OCIE Staff will also look at the level of risk and determine the number of times new registrants will be examined in the future. For this determination, the SEC Staff will look at past regulatory or legal violations; aberrational performance; the size of the fund determines the risk; the advisors complexity; problems internally; when the last exam occurred; and significant changes and assets for business. Nonetheless, the SEC Staff cautioned that they will look at both quality and quantity factors, and that these risk factors are very similar to those already in place for previous registrants.
In short, OCIE intends to utilize risk based assessment examinations in the future.
At a recent corporate counsel meeting, the SEC’s New York Regional Director made a highly critical statment of the Dodd-Frank provision requiring the SEC either to bring a case or to inform the Enforcement Director that no case shall be filed within 180 days of a Wells Notice.
As many are aware, the Dodd-Frank Act required that the SEC make a decision within 180 days once a Wells Notice is issued. A Wells Notice is when the SEC Staff provides a potential person involved in an investigation with notice that it intends to recommend or is considering recommending to the Commission that some action or proceeding should be filed against that person. The New York Regional Director seems to suggest that there is simply not enough time for the SEC Staff to decide if such an action should be brought. He further opines that this limitation is detrimental to the SEC's enforcement program since it may be the case the SEC has not completed its factual investigation.
Apparently, the New York Regional Director simply forgot the "clock" is within the SEC Staff's control. That is, if the investigation is not complete, the SEC Staff should not issue a Wells Notice. Further, one wonders the reason for issuing a Wells Notice prior to the SEC Staff completing its investigation, one would think the SEC Staff would wait!!
Clearly, as far back as the inception of the Wells process, it has always been contemplated that, before the SEC Staff issued a Wells Notice to a potential defendant or respondent, the SEC Staff was ready to proceed with the matter. It is troubling that the New York Regional Director claims that there should be more investigation after a Wells Notice is issued. Such an approach leaves much to be desired.
In sum, the Dodd-Frank Act provision seems reasonable in light of accepted practice, and should be considered as a method for ensuring actions proceed expeditiously.
The battle lines are being drawn over Congressman Bachus' bill which would authorize one or more self-regulatory organizations for investments advisers. Many have believed that FINRA would be the obvious choice to take on this new role. Not Congresswoman Maxine Waters, the second-highest ranking Democrat on the Financial Services Committee; she favors the SEC keeping oversight over investment advisers. Her stated preference is to properly fund the SEC so that it can effectuate proper oversight of investments advisers.
Congresswoman Waters thinks that the SEC charging a reasonable user fee would be the most cost effective approach. This approach was also endorsed through the cost analysis of Boston Consulting Group who concluded that funding a new SRO or having FINRA serve in that capacity would be significantly more expensive than properly funding the SEC. Conversely, FINRA has circulated its own cost analysis, which attacks the Boston Consulting Group study arguing that it underestimated FINRA's ability to leverage existing staff, district offices and technology. In other words, the ramp-up costs for FINRA to be the SRO are not as great as that being claimed.
As the debate heats up, cost will likely be a driving factor to the decision regarding who will serve as the SRO for investment advisers. Considering the institutional knowledge that the SEC has over investment advisers, it seems to me that the most likely and cost effective approach will be a better funded SEC serving as the SRO. The one thing that has remained clear throughout the debate, however, is that investment advisers will have an SRO at some point. That will surely be a reality.
The Board of Governors of the Federal Reserve, the SEC and the CFTC jointly confirmed recently that entities subject to the Volcker Rule would the have the full two year period provided by Section 619 of the Dodd-Frank Act to fully conform its activities and investments, unless the Board extends the conformance period. Banking entities now have until July 21, 2014 to fully conform their activities and investments to the Volcker Rule.
The Volcker Rule has caused significant debate among politicians, regulators and Wall Street, making it possible, if not probable, that the conformance period may be extended in the future. However, some regulators have stated that they expect a final Volcker Rule to be completed by September and possibly earlier.
In response to the Supreme Court’s decision in Morrison v. National Australia Bank where the Supreme Court said that there was no private right of action for lawsuits that involved transnational fraud, the SEC has taken a position that has angered some.
As many know, the Dodd-Frank Act confirmed the SEC's jurisdiction as it relates to potential foreign involvement. However, the SEC was not so quick to support such a stance for private litigants. In particular, the SEC believes that Congress could either clarify the Morrison test or take no action.
This no action position has engendered much criticism from SEC Commissioner Aguilar. Commissioner Aguilar believes that Congress should revert to the pre Morrison test of conduct and effect, and ignore the Supreme Court’s s decision.
Accordingly, it will be interesting to see if Congress responds to this recommendation from the SEC, since it required the SEC , through the Dodd-Frank Act, to conduct this study and make this report to Congress.
Recently, the SEC's newest commissioner, Commissioner Daniel Gallagher, discussed certain of his beliefs, including, among other things, that the SEC should use its exemptive authority derived from the Investment Advisers Act of 1940, to provide some relief for hedge fund and private equity investment mangers from the registration provisions of said Act.
Gallagher believes that the full registration regime should not have been imposed upon investment managers for hedge fund and private fund advisers. Essentially, he believes that the SEC should use its exemptive power to provide some "balm" to their predicament. He also indicated that the SEC should rethink certain registration requirements if it does not promote capital formation.
Additionally, Commissioner Gallagher commented on the recent case of Theodore Urban, and his belief that the Commission should clarify when it believes that legal personnel are considered supervisors. As many may know, the Commission deadlocked over the case, requiring the dismissal of the charges. Commissioner Gallagher believes that it is important for the SEC to provide the standard for charging in-house counsel and other legal personnel in these matters. Commissioner Gallagher hopes that the SEC will clarify this position through a Section 21A Report under the Securities Exchange Act of 1934. He, however, said that there has not been a suitable case to do so as of yet.
Commissioner Gallagher also has indicated that he believes that the SEC needs to provide a better framework to work with in-house legal and compliance officers of broker-dealers and investment advisers. He believes that the SEC should utilize these individuals to accomplish its mission. He also thinks that, if these individuals are engaged, as opposed to challenging them, or causing them liability, the SEC would be more likely to uncover fraud and protect investors.
Finally, as we move forward, it will be interesting to see if Commissioner Gallagher will influence the SEC to change.
Recently, SEC Chairman, Mary Shapiro, was called to task for the high number of reported administrative proceedings by Congress. In particular, the SEC was accused of reporting follow on administrative proceedings as if they were new actions when it announced the yearly enforcement statistics.
Such reporting gives the indication that the SEC is bringing more cases than theoretically possible. Essentially, the SEC is being accused of "double-counting," bringing an injunction action and an administrative proceeding arising from the same facts. Certain reports indicate that the SEC reported 30% of its 735 enforcement actions were merely follow on administrative proceedings to previously filed injunctive actions. (By the way, the number of enforcement actions in 2011 was the highest ever filed by the SEC.) Various members of Congress have questioned this practice and believe it provides a false impression.
In sum, although technically accurate, the SEC effectively is providing incomparable information. There is little extra work necessary to bring a follow on administrative proceeding to a previously filed injunctive action, without much additional regulatory benefit. In any event, I suppose Disraeli was correct, “there are lies, damn lies and then there are statistics.”
According to an internal SEC guidance report, the SEC is taking to heart the criticism that it does not employ enough of an economic analysis in its rule-making process. The guidance directed the SEC to take a cost-benefit approach to all rule-making, regardless if the rules are discretionary or mandated by Congress.
This guidance report is in direct response to an earlier report that sharply criticized the SEC for not conducting the cost-benefit analysis for rules mandated by Dodd-Frank. As part of its response, Chairman Schapiro has noted that the SEC has hired 20 economists and is asking Congress form the funding to hire an additional 20 economists.
Although the SEC should be praised for taking criticism to heart, it also reflects a bit of self-preservation. If the SEC did not take this action, then it faced the risk of legislation that would require the cost-benefit analysis in rule-making. Some in Congress still want to press for such a statutory mandate. That way, there would be no room for confusion as to what is expected from the SEC.
Regardless of why the SEC is employing a cost-benefit analysis in its rule-making, it should only be seen as a positive development. In the absence of such an analysis, we could be faced with, for example, a uniform fiduciary duty for anyone providing investment advice regardless of its costs. Such a result would be problematic to say the least.
There was plenty of debate when the SEC adopted its new whistle blower bounty program. Many commentators thought that the program would result in an onslaught of whistle blowers directly reporting to the SEC instead of first contacting the subject corporation. The Quarterly Fraud Index reported, however, that the opposite may actually be taking place. The new program appears to have caused many corporations to improve their internal reporting mechanisms. If this effort continues, the fear of a mad rush to the SEC may have been irrational.
Among other things, the study found that the concern over the implementation of the program caused many companies to revamp their internal reporting policies and procedures. By re-focusing on these internal reporting programs, the corporate world has also seen an increase of internal fraud reporting, as opposed to an influx of reports to the SEC. Another positive result out of the whistle blower program is organizations implementing predetermined investigative templates and procedures, which will allow companies to act much quicker within the 90-day window in which a whistle blower can secure his standing with the SEC. Along these lines, many companies have predetermined arrangements with third-party providers, such as law firms and auditors, to avoid any time lag once they receive a report of fraud.
If these corporate reforms continue, I believe that companies will be able to steer fraud reporting to an internal platform and not be as exposed to the SEC whistle blower program as originally feared. The SEC whistle blower program has to be lauded to the extent that it was the impetus of corporate reform, but further study is needed to determine if the reporting ends with an internal report or continues to actual reporting to the SEC. Only then can we say that the SEC's whistler blower program resulted in wide-spread corporate reform
Today’s Wall Street Journal includes a story (subscription required) of an attorney for the SEC inadvertently “outing” a whistleblower while interviewing an executive of the whistleblower’s former employer. The SEC attorney apparently showed the executive the whistleblower’s notebook during the interview, and the executive recognized the whistleblower’s handwriting.
Outing whistleblowers is certainly not the best way to encourage them to come forward (though the risk of exposure is made more tolerable by Dodd-Frank’s financial incentives).
The SEC, for its part, says that it followed policy in interviewing the executive, but one can expect that its attorneys will be more cognizant of inadvertently outing whistleblowers in the future.
The SEC’s gaffe is a reminder to in-house and private counsel conducting corporate internal investigations to take care not to inadvertently out their sources. A confidential system for employees to report suspected wrongdoing is a key part of any robust internal compliance program, and often is what allows businesses an opportunity to root out and (potentially) self-report wrongdoing before the government makes the choice for them.
Sometimes effective investigation, required reporting to regulators, or other circumstances will dictate that the confidential source’s identity be directly or indirectly revealed. However, whenever possible, a source’s desire for anonymity should be respected, if for no other reason than to encourage others to come forward in the future.
The SEC issued an alert intending that firms detect and prevent unauthorized trading in brokerage and advisory accounts.
This release related to certain risks the SEC’s Office of Compliance Inspections and Examinations found in its investigations and examinations. OCIE had reports of unauthorized trades and rogue trading by traders, portfolio managers, brokers and others. The SEC warned firms that they must take action to ensure that such trading does not occur in the future.
Accordingly, firms must be cognizant that the SEC is looking at these issues, and will bring actions if need be.
The SEC and CFTC launched a working group to discuss and identify money laundering vulnerabilities.
These issues have lingered for awhile. Both agencies believe that there is an opportunity to clarify their positions relating to money laundering and if their programs could potentially uncover such events. This group will also include representatives from the Treasury Department, the Financial Crimes Enforcement Network, as well as a variety of self regulatory organizations and agencies.
This announcement demonstrates that the SEC and CFTC are very much interested in the effects of money laundering in their respective markets. Time will tell if this will impact examinations and enforcement actions, but the SEC and CFTC will, likely, concentrate on some of these issues in their future programs.
Recently, the SEC announced that it would take steps to bar felons and bad actors from any Regulation D offering.
This rule was mandated by the Dodd-Frank Act, and the SEC issued the proposal last May 2011. This new rule may be in place before the end of this year, but there is no certainty on timing at this point. This new rule is part of an overall effort by the SEC to attempt to remove bad actors from early stage offerings since these offerings usually involve raising capital for small companies.
Chairman Schapiro recently announced several technology enhancement initiatives that are designed to improve the SEC's enforcement efforts and business practices. These initiatives were certainly designed to enhance the SEC's ability to monitor activity to bolster its quiver of ammunition against improper activity.
Among other things, the SEC implemented new search capabilities that permit SEC staff to conduct more intuitive and and focused searches. This new system will also assist the SEC with identifying links between documents and disparate data. The SEC plans to ultimately link this system with other tools, such as audio-searching technology. This technology will allow the SEC to find relevant communications between brokers and customers without forcing the SEC to review hours and hours of audio files. The SEC is also testing technology that allows it to graph phone lines or lines of trading data into a visual schematic, which allows the SEC to find hidden relationships.
In other words, this developing technology will make the SEC more efficient in its surveillance capabilities. This is born out by the fact that the SEC is already using some of this technology in its current enforcement cases. In this day and age of tight budgets, the SEC has been forced to become leaner and meaner through the use of new and improved technologies. We should expect that the SEC will continue to roll out enforcement cases based upon information learned through this new technology. Just remember, the SEC is watching and listening.
In late February, a judge from the United States District Court for the Southern District of New York approved a settlement where a former executive and analyst cooperated with the SEC in a widespread insider trading investigation.
The SEC agreed that, given the cooperation, there was no need to impose a small penalty. As such, these employees, who provided substantive information on expert networking firms to the SEC, were, therefore, rewarded.
It appears that the SEC is following through on its promise to allow for cooperation to be a benchmark in avoiding certain penalties.
The SEC has indicated that it will continue to review potential aiding and abetting claims in light of the Janus Capital Group Inc. v. First Derivative Trader’s decision.
That decision limited the ability to bring primary liability claims against actors, pursuant to Securities Exchange Act of 1934 Rule 10b-5. Although the matter involved private litigation and not an SEC enforcement action, it could be interpreted to apply to the SEC.
Accordingly, it is likely the SEC will have to continue to review these types of matters on a case-by-case basis.
Much has happened in nearly one since since the Dodd-Frank Act became effective, and much more remains. According to the recent thoughts of one commentator, Kyle Colona of Compliance EX, Dodd-Frank may be doomed to fail as it faces it first year of existence.
Colona noted five factors working against the full implementation of the law: (1) the CFTC and SEC are far behind schedule; (2) the regulatory authority under the Act is shared by too many entities; (3) recent comments from the Federal Reserve Bank suggest that the Volcker Rule may not become law because of its impossibility to implement; (4) the financial services industry has unleashed a full-scale effort to defeat the full implementation of the Act; and (5) certain banks are trying to influence the public that implementation of the Volcker Rule would be bad.
I think that there is now a sixth factor that may work against the full implementation of the Dodd-Frank Act; namely, a presidential election this fall. With the politicalclimate becoming more and more focused on the election, it is only natural that there would be less attention devoted to a law that the financial services industry is committed to pealing back or doing away with altogether. If the President loses the election, there are some who believe that Dodd-Frank may be in trouble. Even if the President prevails, it is unlikely that there will be full implementation because attention will surely be focused elsewhere.
Although it is unlikely that there may ever be full implementation of the Act, we need to still anticipate that many provisions of the Act will come to pass. For example, at some point, the SEC will finally commit to the adoption of the uniform fiduciary duty rule and there will be a decision on who will serve as the SRO for investment advisors. Dodd-Frank is not dead; it just may limp along for the next year.
Recently, the Department of Justice and the Federal Bureau of Investigation indicated that they are working on enough insider trading cases regarding the hedge fund industry to take them five years or more to complete. This clearly indicates that the DOJ and FBI are going to continue to find insider trading actions with hedge funds. This appears to be a “growth industry” for lawyers.
Additionally, although the DOJ has recently been the subject of much criticism because certain FCPA cases have collapsed, it has indicated that it will vigorously continue to prosecute FCPA actions. The DOJ believes that this is part of a broader issue requiring enforcement.
Thus, there is no relief for the weary on the horizon.
The new SEC Rule 13h-1, the large trader reporting rule, became effective.
Starting on April 30, 2012, broker dealers will be required to maintain records of large trader trading, similar to records maintained relating to the electronic blue sheet system. Further, supplemental information will also be required.
This new large trader rule could implicate investment advisers, banks, broker dealers, insurance companies and foreign entities. All may be required to self-identify by filing a Form 13H with the SEC, and provide unique information to the SEC. Broker dealers will also be required to maintain information relating to these trading records supplemented with the time of order, execution and the trader’s ID number if the SEC so requests. Broker dealers will also be required to file a Form 13H if they are large traders.
Although the definition of a large trader is enunciated in the rule, there is some factual assessment that goes into it. That is, it relates to any person, who directly or indirectly, exercises investment discretion over one or more accounts through NMS securities and registered broker dealers in a certain activity level. The large trader must file an initial Form 13H promptly after it crosses the trading thresholds, and it has been considered that promptly means within ten days. There are also annual filings that must be done within 45 days after each calendar year. Confidentiality was also critical in assessing this information, and the SEC expects firms to realize that it will maintain the confidentiality of said information. However, it may have an obligation to disclose it to Congress, other federal agencies and pursuant to a federal court order.
Accordingly, firms should be aware that these issues may arise, and should be ready to file and maintain the appropriate records.
The Co-Chief of the SEC’s Asset Management Enforcement Unit, recently, informed the public that the Staff will be paying particular attention to private equity firms.
The SEC Staff will be using the information it compiled from its risk assessment review of private equity firms in this endeavor. These reviews will take note of valuations as well as other items including fees charged, broker dealer fees and tax and audit fees allocated to funds and investors. No doubt much of the Asset Management Unit's focus will be a review of investment advisers/managers as well as fund structures.
Nonetheless, the unit will, specifically, use the Aberrational Performance Initiative, the study that flagged hedge fund performance that appeared inconsistent with a fund's strategy or benchmarks. The SEC Staff believes that this initiative will allow it to detect fraud earlier or prevent it, as the case may be. The SEC Staff also warned that investment advisers with less than $25,000,000 in assets under management still must have strong compliance programs. Essentially, the SEC Staff is suggesting no one is exempt.
In sum, we should expect to see more private equity funds on the SEC Staff's radar in the future.
The SEC published a small entity compliance guide for investment advisers relating to the new Form PF. These new reporting requirements affect SEC registered investment advisers with at least $150 million dollars in assets under management. Some of these new guidelines will also apply to CFTC commodity pool operators and commodity trading advisers.
The SEC registered advisers will be divided into 2 groups, small advisors and large advisers. The definitional requirements for large advisers are specific and may require certain calculations, however. Clearly, large advisers have assets under control of anywhere between a billion dollars and more. For the purposes of the Form PF, all other advisers would be considered small private advisers.
Generally, an investment adviser is a small business pursuant to the Investment Advisers Act and the Regulatory Flexibility Act if it has assets under management of less than $25 million dollars. As such, these advisers will, generally, have no reporting requirements on a Form PF. However, for those advisers, who are not defined as a small business, there may be certain reporting requirements. For example, advisers with over $150 million dollars in private fund assets under management, but are not large advisors must file a Form PF once a year within 120 days at the end of the fiscal year. Large private advisers must file a Form PF within 60 days. Moreover, the requirements for advisers with over $150 million dollars, but who are not large advisers, are less than those of large private fund advisers. Essentially, the more money you have under management, the more information you must provide.
In short, advisers should consult with securities counsel to ensure accurate reporting in the future.
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We want to take this opportunity to urge all investment advisers for private equity and hedge funds, as well as venture funds, leveraged buyout funds and the like, that the time the SEC permitted for these entires to transition to registered investment adviser status will expire on March 30, 2012. That is, registration will be required at that time.
Notably, there is a revised Form ADV that investment advisers will be required to complete with many descriptions being in “plain English.” Further, it is essential that there be a quality compliance program in place headed by a chief compliance officer. The SEC has made it very clear that it will require proper supervision for all of these newly registered investment advisers.
As a result, we strongly urge these investment advisers to contact us to discuss the impact of these registration requirements as well as for assistance that we may be able to offer to them.
The SEC approved a number of rule changes promulgated by the MSRB to facilitate risk-based examinations for participants in the municipal securities industry. These municipal securities industry participants are, generally, FINRA members.
In particular, the new rules, G-9 and G-16, relate to record preservation and periodic examinations, respectively. It is believed that these new rules will allow FINRA to focus on the municipal securities industry participants who pose the greatest risk to the market. FINRA will now be allowed to examine these participants every four years as well as require that certain records be maintained for four years rather than three.
The new periodic examinations were immediately effective while the changes to record keeping are effective June 16, 2012.
Late last week, one of my colleagues sent me an e-mail where he copied 8 other people, half of them I could not identify if my life depended upon it. I then heard about the person who had a Twitter account with over 17,000 follwers, and was now being sued by his former employer over ownership of the account-- really, does anyone think the person knows 17,000 people? Firms and persons working in financial services industries generate trillions of e-mails every year, encompassing the mundane to the critical.
These firms and their employees also seem to be involved in numerous civil, regulatory and criminal investigations and litigations. Much of the vast amount of money in legal fees paid to defend these firms and their employees (sums that sometimes greatly exceed the GDP of several developing countries) often relate to e-mail review and production. General counsels and firm management looking for ways to save money on these bills should, initially, read my article that was published in the New Jersey Law Journal, outlining the "CC" problem and ways of clamping down on this terrible plague afflicting our society, http://www.foxrothschild.com/newspubs/newspubsArticle.aspx?id=4294970187.
Once read, please do your part in stopping this madness because the dollar you save maybe your own!!
Over the last several weeks, the SEC staff made it abundantly clear that registered investment advisors must address social media communications in their compliance programs.
In particular, investment advisors should consider the frequency of monitoring content. The SEC staff said that "after the fact" review may not be sufficient. That is, the SEC may, ultimately, require that certain communications be reviewed before posting. Accordingly, the SEC would require procedures in a registered investment advisor's compliance program to consider if the content should be approved before or after posting.
Registered investment advisors must also dedicate compliance resources that are sufficient to this endeavor, or consider employing outside monitors for these social media outlets. Registered investment advisors must also adopt policies to address conducting firm business on personal or third parties sites, and if the social media sites pose any information security risks.
Additionally, these procedures must also address if client testimonials are posted on social media sights, including if it is acceptable, the client’s experience with or endorsement of an investment advisor. Thus, the use of “plug-ins” or a “like” button may be testimonial in nature, and may not be permitted under the Investment Advisors Act.
We strongly urge investment advisors to consider these items in assessing their compliance programs and note that counsel may be able to assist in revising these programs to comply with these requirements.
The GAO has indicated to the SEC that it should consider the codification of the analyst conflict pact it entered into with other regulators in 2003.
As many recall, in 2003, a group of regulators, including the SEC, struck a deal with a number of Wall Street firms concerning their equity research analyst's conduct. These firms agreed to pay $1.4 billion in penalties and disgorgement. The GAO is now recommending that the SEC codify this pact (although at the time, the NASD and NYSE finalized rules relating to this pact), in the SEC’s rules and regulations.
The SEC responded through its Director of Trading and Markets Division, who indicated that the SEC Staff believes this recommendation makes sense, and will plan accordingly.
The SEC’s Office of Compliance Inspection and Examinations, recently, publicized that its examination program will focus on those securities firms where OCIE believes senior management and boards of directors are not setting the "proper compliance tone" or implementing appropriate risk and control functions. The SEC staff also indicated that it will be distributing to its Staff a National Examination Manual to further standardize its examination program.
The OCIE believes that boards and management must ensure compliance at all levels, and assess risk and controls. The OCIE believes that this new manual will allow for firms to understand OCIE’s key policies and processes as well as allow for a standardized exam process across all of the SEC’s offices. This publication is in addition to the work that the OCIE has done over the last year to restructure itself to streamline processes and allow for consistent practices. In particular, the OCIE has indicated that risk assessment and surveillance will be major review components for its examinations in light of the economic crisis and the Dodd-Frank Act.
In sum, OCIE apparently will be emphasizing compliance, risk assessment and internal controls. If firms are lacking, OCIE has indicated that an Enforcement call will be in those firms' future.
The SEC's delay in adopting an uniform fiduciary duty will only be prolonged but yet another analysis that the SEC will commission. Chairman Schapiro recently announced plans to issue a public request for information regarding "retail financial advice and the regulatory alternatives". With respect to the adoption of the uniform fiduciary duty standard, the SEC suggested that it was still in the information gathering stage of rule-making. Interpretation; the SEC is no closer to adopting a uniform fiduciary duty standard. Although the SEC has not ruled rule-making for 2012, it is not likely.
The SEC has advised the House Financial Services CapitalMarkets subcommittee that it has three economists working on the initiative. Among other things, the economists have reviewed available market information for the retail financial advice market, including the differences between broker-dealers and registered investments advisers. Notwithstanding the work of the economists to date, the SEC noted that the rule-making associated with the uniform fiduciary duty will require an analysis of information that may not be publicly available such that it will be particularly important for the SEC to solicit the public to provide information and/or empirical data.
Of the information that the SEC will seek in its public request for information, broker-dealers should expect that some of the data sought will cover a cost-benefit analysis of whether the adoption of a uniform standard will outweigh the cost of doing so. Although delayed, the SEC is, it appears, trying to have a full and complete analysis to ultimately justify a uniform fiduciary duty. In light of the manner in which many courts and arbitration panels treat broker-dealers, this whole exercise could be seen as making something "official" that has already been in place for many years. The question that remains is whether the cost to make the standard an "official" one is worth it considering the prevailing view of many that it may already exist.
A year ago, the SEC published its study commissioned under Dodd-Frank and recommended the implementation of a uniform fiduciary duty standard. Much debate has prevailed since that announcement. Will registered representatives be subject to the same fiduciary duty as investment advisors? Will registered representatives be subject to some form of hybrid fiduciary duty standard? According to a recent SEC announcement that went without much fanfare, in 2012, at least, the answer will be none of the above.
The SEC has punted once again on making a definitive conclusion regarding the implementation of a uniform fiduciary duty standard. Broker-dealers should not assume that there will never be such a standard, only that a formal adoption will be at least another year away. In that time, the SEC will surely complete the long-debated cost benefit analysis of the need for such a standard. Indeed, the SEC may ultimately conclude that the adoption of FINRA Rule 4530 and the changes to the suitability and know your customer standards were more than adequate such that there may be no need to have a formal standard. Registered representatives may already be effectively subject to their own fiduciary duty. Indeed, depending upon where you reside, courts have already concluded that you are subject to a fiduciary duty.
Regardless of what happens in 2013, once thing is for certain. FINRA is increasing its enforcement efforts and will surely focus on conformity with its new rules. The safest course for broker-dealers is to make sure you have adequate compliance programs to address this heightened regulatory environment, or you will be totally unprepared when there is a formal uniform fiduciary duty standard.
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In a letter to certain senators, SEC Chairman Mary Schapiro has requested new statutory power to enhance the SEC’s Enforcement program’s effectiveness. In particular, the SEC is seeking statutory upgrades in five areas.
The first new power would be to increase the SEC's ability to impose fines on individuals and entities up to $1 million per violation for individuals and $10 million per violation for entities. Similarly, the SEC also seeks to increase the maximum Tier 3 penalty, authorizing penalties equal to three times the gross amount of pecuniary gain from a charged individual or entity. The SEC believes this new enhancement would eliminate the current disparity between the penalty relief available in federal district court actions and SEC administrative proceedings. The third proposed change would authorize a Tier 3 penalty based upon the amount of investor losses in both civil and administrative actions, allowing the SEC to consider more directly investor harm. Seemingly, such a change may result in uncertainty as to actual investor losses, and bring the SEC squarely down as the investors’ recovery mechanism as opposed to a regulator interested in fair, transparent and orderly markets.
The SEC also seeks a penalty enhancement whereby the penalty would be increased threefold if the defendant were to have been criminally convicted or had an order imposed against it in any SEC action alleging fraud. Finally, the SEC requested a legislative change to authorize a civil penalty for violations of a federal injunction obtained by the SEC, in place of the SEC filing a civil contempt proceeding.
In short, the SEC believes that, by increasing penalties, it will prevent future securities violations. However, there does not appear to be any evidence that increasing said penalties would provide the deterrent effect the SEC seeks.
The SEC adopted a rule requiring hedge fund and private equity fund advisors to report systemic risk data. The new Form PF was jointly developed by the SEC and the CFTC in consultation with members of the Financial Stability Oversight Council, to satisfy Dodd Frank Act Sections 404 and 406.
In particular, for hedge, private equity, and liquidity funds, the information required on the Form PF is tiered so that detailed information will be required from larger private advisors as opposed to smaller ones. The minimum reporting requirement will be for those funds with $150 million dollars of assets under management, and smaller private fund advisors will not be required to file the form at all. Further, there will be additional information required of those advisors managing at least $1.5 billion dollars. According to the SEC, this requirement will only effect approximately 230 advisors in the United States. Many of these advisors will have 60 days from the end of the quarter to prepare this information while smaller advisors will have 120 days to file such information. For the largest advisors, filings must begin by June 15, 2012, while all others must file after December 15, 2012.
Of course, there is no certainty that this information will be effectively used to assess risk, or that there will be any benefit from these filings.
As some may have heard, on last Friday afternoon, the SEC decided to inform the world of its intention to change the settlement language in its cases. The SEC has now determined that, if a person or entity has plead to or been found guilty of a crime, the SEC will no longer allow the party to "neither admit nor deny" the underlying factual allegations contained in a parallel SEC action as part of a settlement of that SEC action. Of course, where there is no such criminal action, the old language will remain.
Obviously, this policy change resulted from Judge Rakoff's decision in the Citi case where he rejected the SEC proposed settlement. Interestingly, despite Judge Rakoff's criticism and the SEC's subsequent appeal of his decision, this new policy STILL DOES NOT address Judge Rakoff's concerns because, in that case, there was no underlying criminal action against Citi!!! In typical SEC fashion, the solution simply does not fit the problem.
The SEC's approach to this problem does not correct the serious deficiencies contained in its settlement process. For example, despite the fact the SEC is a government agency, it is only a civil agency and has no criminal authority. As such, the allure of an admission of "guilt" in SEC settlements truly misses the point. It is true that federal judges almost always will not accept a guilty plea in a criminal case where the defendant refuses to acknowledge their guilt-- sometimes referred to as an Alford plea. However, the SEC is not seeking a criminal plea in its cases. This new policy clearly is seeking to blur the lines between the SEC's civil jurisdiction and the implications derived from criminal prosecutions. The SEC, thus, has an obligation to not confuse its role in this process by attempting to undertake a "criminal" resolution of its civil settlements.
Additionally, the SEC'ssettlement language change does not address the significant problems with its "Obey-the-Law" injunctions. That is, the SEC's "Obey-the-Law" injunctions do nothing more than require the person or entity subject to said injunction to follow the statute or regulation cited in the settlement. Query: doesn't everyone have to follow the law anyway? The language change does not correct the overbroad character of the SEC's injunctions, or the fact the SEC, rarely-- if ever-- obtains a contempt sanction against a person or entity that may violate a previously issued SEC injunction. Instead, the SEC, generally, obtains another injunction against that person or entity. One wonders how changing the settlement language to obtain an admission addresses these significant structural problems with the SEC's "Obey-the-Law" injunctions or deters potential recidivists.
Further, there was nothing in the SEC's pronouncement that would indicate the SEC would be willing to compromise on other aspects of relief the SEC ordinarily seeks in these cases. There was no mention if the SEC would forego an officer or director bar, disgorgement or civil penalties, among other relief, from a defendant in exchange for agreeing to this new language. Does the SEC really think a person or entity is going to agree to this language change without receiving something in exchange? We really hope the SEC is not under that belief.
However, assuming the SEC has nothing but the purest intent and its shifting position is because it believes it may do some good in subsequent private civil lawsuits, that belief, unfortunately, is sorely misplaced. From an evidentiary standpoint, the SEC's settlement language change will have minimal to no bearing on subsquent private civil lawsuits. The SEC's insistence on an admission provides no added benefit for a subsequent civil plaintiff since any subsequent civil plaintiff could easily rely upon the criminal conviction without any reference to SEC activity in such a private lawsuit.
Finally, the SEC's insistence on this language change will, most likely, make SEC civil settlements less likely. There would be no point or advantage gained by a potential defendant settling with the SEC under these terms. The person or entity could simply ignore the SEC action, and allow the SEC to obtain a default judgment against the the person or entity. The defendant would, therefore, have avoided admitting to any factual allegation proposed by the SEC, and, as discussed above, there would be no appreciable change in the relief granted to the SEC.
Accordingly, the SEC's change in its settlement language may result in the reverse effect for SEC settlements. That is, instead of the SEC settlement adding to deterrence, the agency's work would be less relevant since defendants would simply bypass the agency, and ignore any efforts by the SEC to obtain a judgment. Consequently, we are still waiting for the SEC to seriously address the systemic problems in its settlement process. Our guess is we will be waiting for sometime.
At a recent conference, federal regulators, including the DOJ and the SEC, stated that they are aggressively pursuing investigations into private equity and hedge funds and their FCPA compliance.
Most likely, we will see a spike in enforcement issues for these funds regarding the FCPA as the new year begins. The government will undoubtedly look to see if these funds have significant FCPA compliance programs, and if there is any activity that implicates a violation of the FCPA.
Although the SEC and DOJ have suggested a concern over compliance programs, the SEC and the DOJ will still look to prosecute if such a prosecution is merited.
The SEC and FINRA issued new broker-dealer branch inspection guidelines to securities firms so as to improve their supervision systems.
In particular, the SEC and FINRA have advised broker-dealers to use risk analysis to identify if individual, non-supervising branches should be inspected more frequently. The SEC and FINRA will be using risk analysis to identify such requirements for future inspections. Currently, FINRA requires a minimum three year cycle, but may conduct more frequent branch inspections.
Firms are required to conduct re-audits when routine inspections reveal a high level of repeat deficiencies or serious deficiencies. In many cases, these inspections will then allow for audits or cause examinations.
Securities firms should use surveillance reports, as well as technology and investigative techniques to identify the risks. Both the SEC and FINRA recommend custom approaches for these inspections, and comprehensive check lists developed from previous findings, trends and internal reports. Further, the SEC and FINRA advised that firms should conduct unannounced branch inspections either randomly or based on risk factors. These surprise exams may result in a more realistic picture of the firm’s systems and reduce the risk of certain individuals, who may try to falsify, conceal or destroy records.
The firm should also use qualified senior personnel for these examinations, and make branch office inspection findings part of management information or risk management systems. Additionally, the results should be placed in a comprehensive compliance database so as to be helpful in supervision, especially as it relates to independent contractor registered representatives in national firms. Branch and compliance managers should also be provided with these findings, and they should be required to take and document any corrective action. The firm should also track all corrective action in response to these findings.
Finally, the SEC and FINRA are recommending that firms elevate the frequency of branch inspections, and their scope, particularly, where registered personnel conduct business activities other than broker-dealer associated person activities. Essentially, if the firm permits activity, or business away from the firm, its supervisory systems should be more vigilant.
These new guidelines demonstrate the focus for SEC and FINRA investigations in the upcoming year. As such, firms should prepare and consider their response now before it is too late.
Responding to numerous complaints, especially, regarding companies operating from the People’s Republic of China, the SEC has determined that it will tighten the listing requirements for companies involved in reverse mergers. In particular, these new regulations will effect those companies listed on the Nasdaq, New York Stock Exchange, and the NYSE Amex.
As many know, a reverse merger occurs when a shell company is acquired by a private company, and the two entities merge. The SEC has estimated that since 2007, more than 600 of these “back door registrations” have occurred.
The SEC had determined that obtaining reliable information from these types of entities, has not been easy. In fact, the SEC was forced to suspend trading in many of these reverse merger companies since there was outdated or inaccurate financial information. It is believed that, with these heightened requirements and the necessity to file the information prior to these companies becoming listed, the SEC will provide greater protections to investors.
Now, with the new listing rules, these companies will have to endure a one year trading period in the over the counter market, or other U.S. or foreign regulated exchange after the reverse merger. These companies will also have to provide additional financial and other records to the SEC prior to listing. Further, the company will be required to keep a minimum share price for a period of time of at least 60 trading days before its application and listing are approved. However, certain companies will be exempt from the new rules where the reverse merger companies are listing as part of a firm commitment underwriting, public offering or whose mergers occurred previously and where the company has already filed annual reports with audited financial information.
In sum, the SEC is cracking down on these reverse merger companies because it believes the companies are fraught with fraud. Those wishing to conduct these types of transactions should be advised accordingly.
Although the use of social media has been embraced by many industries, it is of particular concern for investment advisors and broker-dealers.
In many situations, the use of these outlets touch upon several areas. For investment advisors and broker-dealers, the advertising requirements under the Investment Advisors Act of 1940 and certain Securities Exchange Act of 1934 provisions may be implicated when one uses social media, including various features on Linked In or Facebook. Additionally, recordkeeping is a critical function required by both acts since this information must be maintained. Further, it is likely that those who work for either and use social media sites, may require supervision. Additionally, when one uses these types of communications, there are various regulations that require the firms to monitor these third party communications to ensure that, among other things, non-public information is not disclosed. Firms would also be required to apply their audit function to these media policies and procedures internally, to determine if the procedures are effective. Moreover, the SEC, FINRA and the states may begin to regulate these types of social media in amore forceful manner.
As such, although social media venues may present certain benefits, the risk is palpable.
Please join us for this program on Thursday, January 5, 2012.
C:\Documents and Settings\ebadway\Local Settings\Temporary Internet Files\OLK8F\cle_GovernmentAndInternalInvestigations.html
Not a good day for those whose livelihood is in the buying and selling of public shells.
http://www.sec.gov/news/press/2011/2011-262.htm
It’s December, so its time for the usual blizzard of End-of-the-Year lists, reviews, recaps and predictions. Since I was already digging through a heap of these on corporate law, I figured I would save you the trouble of doing the same. So here it is, your corporate governance Review and Preview Review, highlighting the major regulatory themes of 2011 and expectations for 2012.
Say-on-Pay (SOP): This was the inaugural year for Section 951 of the Dodd-Frank Act, which requires public companies to hold advisory shareholder votes on named-executive compensation practices. Already, it’s had a major impact on the relationship between pay and performance, leading many compensation committees to reduce the amount of non-performance-based pay, increase shareholder alignment and increase disclosure in the Compensation Discussion and Analysis required in proxy statements.
In 2011, over 40 companies received negative say-on-pay advisory votes. That sounds bad, until you realize that this is less than 2% of companies holding a SOP vote. That said, 10 of these 44 companies have be subsequently struck with shareholder derivative suits, leading some to believe that negative votes lead to lawsuits. Personally, I wonder if this is more correlation than causation, but it’s a trend to watch out for regardless. Still, the average SOP vote received 92.1% approval.
According to ISS, the major contributory factor to a negative vote was pay-for-performance concerns. Basically, a combination of higher pay but lower performance compared to peer firms caused shareholders to express their displeasure.
Anti-Anti-Takeover: “Among governance proposals, the biggest story of this year was the greater support for shareholder proposals that seek board declassification. These resolutions averaged 73.5% support, up more than 12% from 2010, and won majority support at 22 out of 23 large-cap firms.” Moreover, shareholders and proxy advisors both fought to remove poison pills – according to a Conference Board survey, now only 20% of companies have a shareholders rights plan in place.
Say-On-Pay: Laurel Hill’s Francis Byrd wants compensation committees to “prepare with a similar level of intensity as last year” noting that institutional investors revise their voting guidelines annually. He's right, they do, and have: the Glass Lewis Proxy Season Preview warns “absent evidence that a board is actively engaging shareholders on [say-on-pay votes] and responding accordingly, we will recommend holding compensation committee members accountable.” The ISS 2012 Policy Update goes into gross detail on how exactly it will determine whether an executive is getting paid too much. Tax gross seem to be in the crosshairs of many governance advocates this year.
Clawbacks: §954 of Dodd-Frank will lead to a clawback requirement for companies listed on the national securities exchanges. Listed companies need to develop and implement a policy providing for the clawback of a named-executive officer’s incentive-based compensation awarded during a 3-year period preceding an accounting restatement. 954 overlaps somewhat with SOX 304, but unlike SOX it does not require misconduct and only claws back the “extra” compensation erroneously awarded, rather than everything.
Clawbacks will be one of the hardest of Dodd-Frank’s governance provisions to implement, and it intends on tackling it sometime during the first half of 2012. Some companies have already begun to update their previous clawback policies in expectation for this change, but many compensation committees still need to address this issue in the coming year.
Anti-Management Entrenchment: Activist Shareholders and hedge funds will continue the fight to remove poison pills and declassify boards.
Proxy Access: SEC revisions to Rule 14a-8 came into effect in September, and a few activist investors have already filed proposals. Expect more of these in 2012. Both Glass Lewis and ISS say they will review these proposals on a case by case basis.
Environmental and Social Issues: We can expect continued fallout from the Supreme Court’s Citizen United decision. Already, a collection of big names in the academic world – the folks who wrote everyone’s Sec Reg book, basically – has petitioned the SEC for a rulemaking to require corporations to disclose spending on political activity. Laurel Hill notes that public pension funds and labor-related pension funds are looking to make more proposals this year. Glass Lewis will vote in favor of proposals requiring more disclosure. ISS is changing its policy from case-by-case to generally being in favor of these proposals.
We wanted to share with you a recently published article on broker-dealer registration enforcement. Enjoy.
The Securities Industry and Financial Market Association (“SIFMA”) indicated to its membership that those who engage expert networks – entities referring paid industry professionals to third parties for fees – should have in place policies, procedures, and training for their employees or others who engaged those services. These expert networks have drawn regulatory attention, especially in insider trader investigations.
These expert networks have found themselves in certain insider trading cases where it was alleged they tipped hedge funds or other investors in return for a cash payments. Of course, this is more the breach than the rule, and the vast majority of expert networks would never do such a thing. However, expert networks have become important in the financial system since they assist broker-dealers to design or implement investment strategies. Nonetheless, broker-dealers should take precautions, as well as devise procedures to ensure that there is not even an appearance of impropriety.
In sum, SIFMA believes that its membership should have policies to find and detect “red flags.” These red flags will allow broker-dealers to ensure that their policies are being followed, especially, regarding material non-public information. See Best Practices for Use of Expert Networks at http://www.sifma.org/uploaded files uploadedfiles/issues/legal_compliance_and_administration/expert_networks/expert-network-policy-bestpractices.pdf.
The SEC scored a victory in a Michigan federal court when the court refused to lift an asset freeze so that a private equity manager could pay for its legal defense.
The private equity manager was accused of pilfering public pension funds, and using this money for personal and other business expenses. The SEC sought and obtained an asset freeze as well as a preliminary injunction, with the consent of the private equity manager. However, the private equity manager sought to pay for legal expenses during this time, and the court rejected his attempt. Additionally, the court also rejected the manager’s motion for indemnification or advancement of legal fees pursuant to an agreement with another entity. The court stated that the request was denied because it was premature.
The case, SEC v. Onyx Advisors LLC, is indicative of the difficulty a SEC defendant has in obtaining relief when the SEC has an asset freeze in place. Courts are not electing to upset a freeze until the hearing. Such an ability provides the SEC with a great advantage in these cases.
Recently, an unregistered broker-dealer was able to retain its finder’s fees in a lawsuit brought by a SEC Receiver. The Receiver was appointed as a result of an SEC action brought against an investment advisory group. The Receiver sought to recover a finder’s fee, claiming that the party was acting as an unregistered broker-dealer for the defendant charged in the SEC action.
The court, ultimately, ruled that the Receiver’s action was untimely, and had violated the statute of limitations. The Receiver was unable to convince the court that the action should have been equitably tolled because the Receiver had not been appointed before the statue of limitations had run. Essentially, the court determined that, although the defendant was not a registered broker-dealer, the defendant in the SEC case could have determined if the finder was a registered broker-dealer, and, since there was no allegation of fraud, the court allowed the finder to keep the finder’s fee because it would not run afoul of the Securities Exchange Act of 1934.
This action is interesting because not all cases involving unregistered broker-dealers will result in the forfeiture of finder’s fees. In this case, the SEC Receiver was unsuccessful in convincing a court to force repayment. Unfortunately, however, the SEC did not comment on this action. Nonetheless, this matter may be indicative of future matters involving unregistered broker-dealers or finders, and the retention of their fees.
Recently, Judge Pauley of the United States District Court for the Southern District of New York harshly criticized the SEC’s management of a private claims administrator, who was hired to distribute funds from a settlement received from the Zurich Financial Services Group.
The fund administrator requested $1 million dollars in fees and expenses for a $25,000,000 settlement fund. Judge Pauley criticized the SEC’s management as to how such expenses could even be incurred. The record indicated that the SEC had conducted no meaningful oversight over the fund’s administrator, and that it had acted “in ostrich like fashion.” Judge Pauley indicated that, for similar securities class action matters, fees were literally half those in this particular case. The SEC was ordered to respond to the court’s criticisms by October 28, 2011, in a decision that denied without prejudice the request for fees and expenses.
Interestingly, the Court allowed the SEC an opportunity to respond to this “calling out” of its administration. We are certain that there will be more to tell of this story when the SEC responds.
My colleague, Josh Horn, has written an amazing article that should be on every compliance officer’s desk. It details methods for investigating and responding to ponzi schemes.
In this day and age, we are met with another Ponzi scheme occurring or being uncovered almost every day. Josh’s article is an exceptional primer since it details the steps for a proper investigation, as well as, disseminating the investigation results to the appropriate authorities. Further, Josh lays out an approach to avoid litigation, and, if litigation does strike, responding to it. This article appeared in the September – October 2011 Special Edition for the National Society of Compliance Professionals, in its publication, N.S.C.P. Currents, and may be viewed at www.foxrothschild.com/newspub/newspubArticle. aspx?id=4294970030.
I hope everyone considers it.
Thought you might be interested in a recent podcast I did concerning my securities law practice. http://web.me.com/cordpar/Client_Development_Tips/Law_Consulting_Coaching_Podcast/Entries/2011/10/28_Developing_a_Securities%2C_White_Collar_and_Complex_Litigation_Practice.html
Everyone loves small businesses, even if they might not be the job-creating economic saviors we want them to be. No one likes bailing out Wall Street, but Main Street? That’s something we can all agree on!
On Wednesday, a subcommittee of the House Committee on Financial Services advanced a few interesting bills aimed at reducing regulatory burdens for small cap corporations.
While some were approved by voice votes, suggesting broad bipartisan appeal, two ran down party lines, portending a difficult path ahead.
Surprisingly, the subcommittee’s Democrats voted against H.R. 2930, or the “Entrepreneur Access to Capital Act,” a bill which will undoubtedly go by the pithier “Crowdfunding Act.” (Note: by “undoubtedly” I mean “hopefully,” and by “pithier” I mean “coined-by-Jim-Saksa”). “Crowdfunding” refers to the idea of letting a large number of investors give small amounts of money to a start up without the hassle of registering with the SEC. Right now, non-profits can raise money this way from websites like Kiva and DonorsChoose. Crowdfunding basically says: why not let start-ups raise capital this way, too? (For a quick introduction to the concept, read Annie Lowrey’s article on Slate). This bill would allow new businesses to raise up to $5 million before triggering registration requirements, provided that individual investments were limited to the lesser of $10,000 or 10% of the investors income. These smaller companies could make general solicitations online without having to go through the pains of an IPO.
I’m dumbfounded by Democratic opposition to this bill. Crowdfunding has an innate connection to the green and creative economies – markets that Democrats like to support with public funds. Why don’t we skip the Leviathan/middle man and let a community of small investors give their money directly to risky small ventures? Moreover, at least one Democrat seems to dig the idea: there’s a version of it in President Obama’s Jobs Act. And the same Democrats who voted no on Crowdfunding then voted yes for a few complementary bills.
One, H.R. 2167, raises the shareholder threshold for mandatorily registering with the SEC from 500 to 1,000 shareholders (for companies with market capitalization under $10 million). Both this and the Crowdfunding act address the complaint that regulatory costs related to raising capital is too high for many small businesses – and the need to protect investors too low – to justify obligatory SEC registration. If anything, the Crowdfunding bill is less deregulatory, as its individual investor amount limits protect potentially naïve investors from betting everything on the next Pets.com.
Another bipartisan winner, H.R. 2940, directs the SEC to expand the registration exemptions under Rule 506, allowing issuers to market securities to accredited investors via general solicitation under Regulation D. This law change is potentially huge. Right now, Rule 506 allows a company to raise an unlimited amount of money from an unlimited amount of accredited investors (plus 35 non-accredited individuals, provided that they are “sophisticated”, which sadly has very little to do with being able to appreciate the delicate complexities of Louis XIII de Rémy Martin). The only real limitation preventing this from becoming a way to do a wealthy-person-only IPO (minus a whole host of reporting requirements) is the prohibition on general solicitation. Think about this: the Crowdfunding Act could help the next Facebook get off the ground; this law could help the current Facebook stay underground.
Finally, the “Small Company Job Growth and Regulatory Relief Act” also passed down party lines, but Democratic opposition was less-than-unexpected this time around, as it aims to substantially weaken Section 404(a) of the Sarbanes-Oxley Act. Section 404 requires management and the external auditor to both sign off on the adequacy of a reporting company’s internal controls in its 10-K. Right now, the SEC exempts companies with market capitalization rates under $75 million. Representative Fincher’s bill wants to raise that amount just a teensy bit, to $500 million. Personally, I don’t see Democrats backing a bill that makes life easier for CEOs and CFOs anytime soon.
These bills have only just emerged from subcommittee, so they are all a long ways away from passage. The House Committee on Financial Services must give them the OK before it can be put before the entire House, and then a companion bill must make its way through the Democratically-controlled Senate. Regardless, should any of these bills make it through the legislative warzone that is the 112th Congress, they could have a major impact on how small businesses raise initial capital.
The SEC recently joined the FDIC, the OCC and the Federal Reserve in advancing the Volcker Rule for public comment. The Volcker Rule is shaping up to be one of Dodd-Frank’s most contentious and confusing new regulations.
Volcker Rule proponents hope that it will, like the late-great Glass-Steagal Act before it, rein in risk-relishing bankers by prohibiting short-term proprietary trading of securities. Opponents fear it will be overly broad, capturing market-making activities and needlessly raising the cost of capital. Both want big changes, clouding any predictions on what the final version will look like.
So, basically, Wall Street has a few months to respond to a 298-page rule proposal jointly issued by four Federal regulators that asks nearly 400 questions which could cost millions of dollars. Hence the impression some folks get that the only thing certain about the Volcker Rule is the uncertainty surrounding it. Some analysts seem terrified of this zombie regulation – once dead, now crawling out of the grave with a sickly hunger for brains profits.
Then again, this resurrected rule might not be so scary. Stock prices of the major US financial institutions that will fall under its purview remained steady despite the announcement. The Volcker Rule really is just the watered-down second coming of the law from 1933 until 1999. The uncertainty of the law is really only found around its margins – trying to determine exactly where market-making ends and proprietary trading begins. In other words, the devil – that scary boogieman, uncertainty – remains in the details.
Sure, it seems like everyone is unhappy with the proposal, which took over a year to draft but only minutes to attract detractors. It has either too many exemptions or too few, depending on who you ask. But I’ve found that when two groups that never seem to agree on anything suddenly agree on something, you should take that something and do the exact opposite. A rule that upsets everyone for different reasons tends to be one that is moderate, sensible and likely to have a real and lasting impact.
In the mean time, we will follow the developments closely. Histrionics about how awful/amazing the finalized rule will look aside, it will be one of the more arcane of Dodd-Frank's new regulations. Anyone falling under its penumbra would do well to tread cautiously and with counsel.
In a recent letter from SEC Enforcement Director, Robert Khuzami, to United States Senator Charles Grassley, the SEC for the first time said that the destroyed documents did not have any effect on current or future investigations.
In fact, Khuzami said that the SEC saved electronic data allowing them to "connect the dots" for current investigations. Further, the Enforcement Director minimized the value of some of the documents that were destroyed, and said the information could be re-obtained from public information. Nonetheless, Khuzami acknowledged that some of the investigations' preliminary documents, regarding investigations into major banks and Madoff, were, in all likelihood, destroyed.
However, as Senator Grassley pointed out, the SEC may say the documents were not significant, but no one will ever know since the documents are gone. This was, of course, not the reaction the SEC hoped to obtain from Congress. Instead, the SEC will continue to operate under a cloud regarding the loss of this material.
In short, the SEC needs to provide a credible and appropriate reason for this destruction as well as implement procedures to ensure that it will not occur in the future. Until such time, the SEC should expect continued skepticism over its operations.
Approximately 2 years ago, the SEC implemented a new e-mail security protocol for its communications regarding non-public investigations, among other things.
This system required defense counsel to fill out a webpage form, enter e-mails and passwords to meet the SEC security requirements. Ultimately, the recipient would only be able to read and reply to the e-mail over this secure network.
Of course, the thought that the SEC wishes to encrypt e-mails and protect such information is laudatory, but it has created a problem for users, who do not have easy access to Internet Explorer and Outlook. Further, many of the e-mails are time sensitive, and, as such, do not allow for instantaneous communication. Additionally, the system only retains e-mails for approximately 90 days, and it is not clear if the SEC is taking precautions to keep the e-mails for longer periods of time.
Like much of the SEC's attempts to modernize its systems, this e-mail system has a number of "bugs." The SEC may have to consider another system or changes to the current one if it continues down this path. If it does not, the SEC may lose important information, and continue its run of bad press over document retention and preservation policies.
Over the last few days, a handful of eye-roll-inducing, easily-ignored activists calling themselves Occupy Wall Street grew into a large, multi-state movementthat demands our attention. Thousands of protesters now gather in New York, Boston, Chicago, LA and other cities, protesting… well, something. The inchoate mass lacks a singular focus – activists carry signs ranging from “Pepper Spray Goldman $achs” ($ instead of S – clever!) to tried-and-true standbys like “Free Mumia” and “Meat is Murder.”
Still, these protests are united by an undercurrent of anger at an economic system that has, in their eyes, rewarded the investment banks while the rest of us suffer through a recession that they caused. It’s good old fashioned populism - the slightly late liberal counterpart to the Tea Party Movement.
Both Occupy Wall Street and the Tea Party are reactions to the 2008 financial crisis and its long, ugly aftermath. We shouldn't expect Occupy Wall Street to fade away anytime soon, as it has the potential to become a powerful, polarizing brand on the left, just like the Tea Party has been on the right. With unions joining the protests in solidarity, this isn't just another excuse for kids who couldn't score Burning Man tickets to beat on some bongos: it's the start of a liberal movement which is seperate and distinct from Barack Obama. As long as the economy remains in the doldrums, we can expect populist anger to remain frothy and available in every flavor.
Noticeably and not-unexpectedly, few of the news reports I have read quote either Tea Party members or Wall Street Occupiers waxing philosophical on the latest rules and regulations emerging from the Dodd-Frank act. While corporations, the SEC, the CFTC and others discuss how to implement what many call the most sweeping financial reforms since 1934, a large and diverse public does not seem satisfied. Can we expect further legislation in the build up to the 2012 elections?
In “This Time is Different” Carmen Reinhart and Ken Rogoff analyzed the financial crises of the last 800 years and found that they create a long period of sloth-like growth. Normally, unemployment remains high for four to five years. So far, they have been dead-on: good for them, bad for everyone else.
And perhaps really bad for anyone hoping for less economic uncertainty. Robust recovery appears to be over a year away. A suddenly re-energized left, with elements of Ron Paul libertarianism thrown in, combined with a mobilized Tea Party could cause some havoc if they can inspire Congress to channel this incoherent anger. More likely, however, is even more partisan gridlock, at least until November 2012. Either way, the yawning disconnect between policy makers and the public continues to grow without signs of abating anytime soon, and that will make it even harder for businesses already mired in economic uncertainty.
At the recent American Bar Association gathering, the SEC’s and the Department of Justice’s recent activities regarding insider trading were heavily discussed.
During this conference, defense attorneys on the panel suggested that both regulators were pushing insider trading law to its limits. Many believed at the conference that the SEC should now consider defining insider trading.
As many know, the SEC has, for many years, refused to define insider trading, feeling that such a definition would engender ways to avoid enforcement. However, commentators at this conference seem to suggest the time had come given the SEC and DOJ’s increased use of a variety of insider trading theories as well as its impact on hedge funds and raising capital. For example, with the recent Galleon case and SEC v. Dorozkho, a computer hacking and insider trading case, many believe that these cases are expanding the bounds of insider trading, and is only the beginning of the SEC’s and DOJ’s continued exploitation in this particular area.
In sum, the SEC and DOJ have made it clear that they will continue to effect these enforcement actions both on the civil and criminal side, and that the industry needs to consider alternatives other than a legislatively defined insider trading approach.
Reuters recently reported that the SEC and FINRA were asking trading firms specific details regarding their trading strategies and/or their secret computer codes.
This new effort by the SEC and FINRA is part of a joint investigation into suspicious market activity as well as to examine compliance with securities regulations. The specific requests relating to computer code, obviously, have irked many in the industry since the requests have to do with targeting stock trading firms and hedge funds. These inquiries relate to trading information and computer coding information that may have been shared or “borrowed” with others, and used for illegal activity. Clearly, the SEC and FINRA are focusing on this information to better understand the trading markets, but, of course, if they find anything of an illegal nature, it may result in enforcement examinations.
FINRA executives, recently, told a SIFMA conference that FINRA did not make these requests “lightly.” However, this worries many since the information is privileged and proprietary, and may find its hands into competitors. Although, the SEC and FINRA both have policies in place to protect such information, once the information is out, companies may find themselves in a predicament. Counsel should certainly handle these particular issues.
In yet another investigation being conducted by the SEC’s Inspector General, the conduct of SEC officials in overseeing the Stanford Receiver has come into question.
Although the Stanford ponzi scheme resulted in multibillion dollar losses, the Stanford Receiver apparently has recovered only approximately $120,000,000. However, according to a variety of reports, the Receiver has spent over $118,000,000 for his attorneys and himself. The Inspector General’s investigation appears to be focused in on the SEC’s lack of oversight of the Receiver’s fees and expenses given the time spent on this matter.
The Receiver’s counsel has claimed that the Inspector General has not contacted the Receiver to discuss this particular issue, and has stated that the Receiver paid out a total of nearly $100,000,000 to investors. Further, the Receiver’s counsel claimed that only $47,000,000 was paid for necessary expenses to wind down Stanford’s operations.
This situation does not bode well for the public’s view of the SEC. The SEC seems to be, once again, “asleep at the switch,” and not properly supervising those that serve as its fiduciaries.
Recently, the SEC was severely criticized for violating the Department of Treasury’s offset program when it sent a notice of intent to use this program to a wrong address of a securities violator. This program allows government agencies to seize various assets that may be attributable to those it has a judgment against.
The Court criticized the SEC because it ignored the defendant’s filing of a change of address. Instead, the SEC sent the notice to the defendant’s last known address – the one he had used before he started serving a prison term for securities fraud. A fact the SEC knew well since it had provided the evidence as part of the criminal investigation.
As a result, the Court ordered the SEC to cease using this program, and reimburse the defendant for monies wrongfully seized. The Court required the SEC to use the proper notice if it plans on using the Treasury’s program again.
The Wall Street Journal reported that the SEC and the CFTC are owed approximately $4.5 billion in fines and disgorgement. These figures date back as far as 2005.
Interestingly, the SEC and CFTC have let this debt continue for so long, and it causes one to wonder why the fines were imposed initially. That is, to impose fines and disgorgement on entities and persons, who are unable to pay such sums, makes no sense. Instead, the SEC and CFTC should consider the practical aspects of its regulatory authority, and assess the ability to pay such fines and disgorgement before imposition.
Customarily, the SEC and CFTC impose fines and disgorgement on parties regardless of their financial ability to pay. This results in these large debts accruing, and , periodically, the SEC and CFTC are taken to task for not collecting. However, collections from "a stone" are not realistic.
Further, the SEC and CFTC have repeatedly been unwilling to consider waivers of disgorgement or penalties. Typically, although there are no formal standards, the SEC and CFTC have refused to consider waivers if parties are notorious violators or there is SEC policy involved with the particular violation.
As such, it is time for the SEC and CFTC to consider alternative forms of relief as opposed to the continuous imposition of debt that will never be paid.
In an interesting speech, SEC Chairman Mary Shapiro stated that she believes securities violations are often the result of peer pressure and not individual greed.
Chairman Shapiro was referring to the recent guilty verdicts in the Galleon insider trading matter, as well as numerous other insider trading convictions. Chairman Shapiro seemed to suggest that individuals are engaging in insider trading to “return a favor,” or enhance their reputations in their businesses. Further, she claims that the penultimate approach to performance is a motivating factor for many, and the old adage that “everybody was doing it” is a driving force.
Although Chairman Shapiro seems to sincerely believe her words, this may be an overly simplistic approach to insider trading. Many individuals, who have been convicted, earned large sums of money, and it is unlikely that they were solely motivated to increase their reputational standing or that they were returning favors to friends. At the very least -- or to be as generous as possible to Chairman Shapiro -- peer pressure may play some part, but the overwhelming evidence seems to suggest that the pursuit of money plays a much larger role in insider trading.
In a mixed result, the SEC met with partial success with two discovery orders from New York and Chicago courts.
In the New York matter, the federal court ordered a former investment advisor to produce to the SEC 60 e-mails that he had sent to his wife. The court held that the former investment advisor had no expectation of privacy since the e-mails were sent on the firm’s e-mail system, and, as such, were open for disclosure. The court focused on the fact that the former investment advisor was aware of the firm’s policy that these e-mails were subject to inspection and may be disclosed if the issue arose.
However, the SEC was less successful when an Illinois federal court issued a protective order that barred the SEC from disclosing certain discovery materials it had obtained. The court held that the protective order was necessary since the SEC had made very broad discovery requests and that the defendants would have to produce numerous confidential financial and business materials that would uncover various businesses strategies. The court did permit the SEC to share the material within the Commission and with other government agencies.
These two cases highlight the fact that, in federal court actions, the SEC’s tactics will not be “rubber stamped.” Consequently, those engaged in SEC litigation should take some solace that the federal courts are not letting the SEC run amok.
Recently, the SEC charged an ex-board chairman, who bought shares in his company, prior to the company’s announcement that it intended on buying back said shares.
The SEC charged him with fraud, alleging that he purchased shares of his company stock prior to the announcement of the buy back, causing the company to overpay $36,000 to repurchase its own securities. He allegedly realized a $124,000 profit, and, apparently, according to the SEC’s allegations, did not file a proper Form 4 so as to avoid SEC detection. The SEC alleged that the former board chair’s broker had, actually, informed him that he needed to file such a form.
This case demonstrates the SEC’s increased vigilance of corporate directors and officers, and the SEC will continue activity at regulating their conduct.
