Earlier this week, the Securities and Exchange Commission agreed to settle charges with a company related to prevention and detection of potential insider trading.  The SEC alleged that the company failed to enforce policies and procedures to prevent and detect securities transactions that could involve the misuse of material, nonpublic information, and that the company failed to adopt and implement policies and procedures to prevent and detect principal transactions conducted by an affiliate.  The agreed upon penalty was $15 million.

The SEC brought the charges under Section 15(g) of the Securities Exchange Act of 1934, which requires brokers and dealers to establish, maintain, and enforce policies and procedures to prevent the misuse of material, nonpublic information, as well as Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-(7), which require registered investment advisers to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules.

In addition to the financial penalty, the company agreed to retain a consultant to review and recommend improvements to its trade surveillance and advisory account order handling and routing.

This serves as a reminder that the SEC is not just looking for actual insider trading violations, but is also focused on ensuring that the proper safeguards are in place and being followed.  Companies should therefore ensure that their policies and procedures to prevent the misuse of material, nonpublic information are adequate, but are also followed and enforced.

It is bad enough that firms and publicly traded companies have to make sure that their respective IT architecture is safe and secure, but recent developments demonstrate that you have to be weary regarding the media outlet with who you share material, non-public information.19196909_s

The SEC and the DOJ in a joint effort have brought civil and criminal proceedings against individuals part of an international scheme who hacked the systems of certain media outlets to steal and then trade on material non-public information.

Unfortunately, these events only further demonstrate that, no matter how good your security system may be, you are ultimately at risk of a cyber-attack that may be perpetrated on one of your vendors, or a media outlet. As to the latter, it would seem as though the only foolproof protection is not to provide media outlets with this information.

I doubt that any media outlet would give you any sort of assurances going forward that their systems are not exposed to such a strike. Nevertheless, if you are sharing this information before a public announcement, do your homework.

Ask about the media outlet’s data security program. Explore whether and how frequently the outlet tests its systems against unwanted intrusions. Ask whether they have ever been subject to an attack.

Only after you have reasonable comfort should you share such information. Otherwise, just save it for your public announcement or submission with the SEC.

The U.S. District Court for the Southern District of New York dismissed a New York law malpractice and fraud claims by convicted inside trader Winifred Jiau against her former attorney.  See Jiau v. Hendon, http://www.bloomberglaw.com/public/document/Jiau_v_Hendon_Docket_No_112cv07335_SDNY_Sept_28_2012_Court_Docket.

Prosecutors contended that in her role as an employee of an expert network company, Jiau obtained inside information about public companies through professional and personal contacts and sold the information to portfolio managers at hedge funds, who traded on the inside data.  A jury convicted Jiau on conspiracy and securities fraud and the defendant then sued her lawyer for malpractice.  The court found no claim.

Although this turned out well for the lawyers, it should remind everyone of the potential dangers in these representations.

New York Attorney General Eric Schneiderman is pushing for better cooperation with the financial industry and federal lawmakers to combat emerging insider-trading threats.  While he commended competition among financial services firms, he also said competition has to be guided by an element of fairness, and regulators need to protect the market.

The NYAG has already launched investigations into emerging types of insider trading like the possibility that select investors may have early access to analyst assessments of publicly traded companies – assessments that have the potential to impact stock prices.  His office will review these arrangements.  The NYAG also lamented on the increased gridlock in Washington, making it difficult to combat insider trading with a combination of state and federal resources.

We will monitor this situation to see if there is, in fact, increased cooperation.

Now that 2014 is here, it is a good idea to understand what the Enforcement Division might focus on this year.  In a recent article that appeared in the BNA, David Marder, a partner with Robins, Kaplan, Miller & Ciresi identified fifteen things to expect in the coming year. 

The fifteen things he noted to expect include: 

  1.             Increased use of whistle-blowers;
  2.             Increase requiring defendants admit guilt in settlements;
  3.             Increasing the use of available technology;
  4.             Increase the number of easier to prove cases;
  5.             Push self-reporting of securities violations;
  6.             Increased focus on microcaps;
  7.             Continued focus on gatekeepers;
  8.             An emphasis on financial reporting;
  9.             Protection of market structure and integrity;
  10.             Increase the activity of specialized SEC units;
  11.             Continue attacking insider trading;
  12.             Investigate misconduct at hedge funds, private equity funds and mutual funds;
  13.             Increase the size of the trial unit to avoid losing at trial;
  14.             To further leverage the exam program; and
  15.             Increase administrative proceedings.

 Although this certainly seems like a robust agenda, expect the SEC under the leadership of Chair Mary Jo White to pursue it with particular vigor.   

It seems like the SEC has a lot to prove; in part, to justify it budget.  The question is whether the industry is adequately prepared to deal with a bulked up and more aggressive SEC.  Time will tell . . . .

There is concern over the increasing collaboration between the Securities and Exchange Commission’s Enforcement Division and Office of Compliance Inspections and Examinations.

The SEC views this collaboration as efficient while others view it in the extreme.  SEC officials have acknowledged the increasingly close working relationship between OCIE and the Enforcement Division. OCIE assists the SEC’s insider trading enforcement efforts, and the examination function finds evidence.  However, some suggest exam function has become confrontational.

Given this dynamic, broker-dealers should consider having counsel present during the examination.

The SEC’s Office of Compliance Inspections and Examinations has issued a report on broker-dealers’ handling of confidential information.  The SEC’s examiners looked at broker-dealers’ compliance with the requirements governing the misuse of material nonpublic information, and evaluated new business practices, technologies and controls relating to compliance.

Broker-dealers have access to nonpublic information, and owe a duty of trust and confidence to the client or other involved parties. Registered broker-dealers must have policies and procedures that are reasonably designed to prevent its misuse, and, when broker-dealers are dually registered as investment advisers, they must consider additional controls as well.

The Staff is concerned about the lack of documentation regarding material nonpublic information provided to senior executives, and incentives relating to business success. The absence of monitoring or other controls raises serious concerns about the broker-dealers’ ability to prevent the misuse of the information in firm and customer trading.  The Staff also found that, in some instances, broker-dealers were not conducting focused reviews on the trading that occurred after traders were provided with material, nonpublic information.  The Staff found various gaps in oversight at most of the broker-dealers, for example, some broker-dealers did not conduct any reviews when the information came from activities outside of their investment banking department.  The Staff also noted that these concerns are not necessarily violations, but broker-dealers should consider this issue when reviewing their policies and procedures.

The Staff also pointed out effective practices as well.  For example, some broker-dealers created tailored exception reports to reflect the different types of information they receive, and expanded the range of instruments they reviewed for misuse of material nonpublic information.

In short, the Staff will, most likely, monitor these practices in future examinations for potential enforcement actions.

The Securities and Exchange Commission has not reached a conclusion if there will be change to the Exchange Act Rule 10b5-1 stock trading plans, if it should amend the rule, or to provide additional guidance.

Given the SEC’s focus on insider trading, the Enforcement Division would “love to catch” a chief executive officer abusing an Exchange Act Rule 10b5-1 plan. Exchange Act Rule 10b5-1 stock trading programs allow corporate insiders to trade their companies’ securities without violating Exchange Act Rule 10b-5.  Exchange Act Rule 10b5-1(c) provides an affirmative defense against insider trading liability if corporate executives demonstrate that the trades were made pursuant to an Exchange Act Rule 10b5-1 plan.

The SEC already regulates corporate inside stock transactions by baring short-swing profits.  The Sarbanes-Oxley Act of 2002 also requires executives to report within two business days to the Commission if they buy or sell their companies stock.

The fact that the executives may fare better in their insider transactions than the average shareholder is not that surprising.  Although Exchange Act Rule 10b5-1(c) provides an affirmative defense, it is not insurance. If a particular transaction raises the staff’s suspicions, the executive would have to show that his or her trade was legitimate.

In sum, Exchange Act Rule 10b5-1 plans are under the SEC microscope.

A court has held that the privacy rights of thousands of high-level federal employees could be violated if a provision of the Stop Trading on Congressional Knowledge Act (“STOCK Act”) were enforced.  The STOCK Act requires online disclosure of employees’ financial information, and it would have become effective but for the United States District Court for the District of Maryland.  See Senior Executives Association v. United States, D. Md., No. 12-2297, 3/27/13; www.bloomberglaw.com/public/document/Senior_Executives_Association_et_al_v_ United States of America_et.

The STOCK Act disclosure provisions would have impacted approximately 28,000 executive branch employees.  The court’s latest ruling indicated that it would at least delay the provision from becoming effective.  The challenge to the STOCK Act was launched last year by the Senior Executives Association, several other federal employee organizations, and individual government workers.  There were claims that this provision could lead to blackmail, and an invasion of privacy.

There is no timetable on the final analysis so stay tuned in that those in power may have dodged scrutiny.

The SEC has announced it is monitoring if there is abuse of so-called Securities Exchange Act of 1934 Rule 10b5-1 stock trading plans. 

The SEC stated that it will monitor the situation, and, if it finds that there is abuse, the SEC will consider action, especially if it is a high level executive.  The SEC has indicated it would like to send a “message” to these parties.  Rule 10b5-1 stock trading programs allow corporate insiders to trade their companies’ securities without violating Rule 10b5-1.  Rule 10b5-1(c) is an affirmative defense against insider trading liability if corporate executives show that the trades were made pursuant to a Rule 10b5-1 plan.

The SEC regulates corporate insider stock transactions by barring short-swing profits. Further, the Sarbanes-Oxley Act of 2002 requires executives to report within two business days to the SEC if they buy or sell stock in their companies. 

In sum, the SEC simply does not like these plans, and, given its push against insider trading, changes in the Rule could be in the works.