On February 21, the SEC released an administrative order against a foreign financial institution that provided cross-border securities services to thousands of U.S. clients. The SEC asserted that the institution’s employees traveled to the U.S. to solicit clients, provide investment advice, and induce securities transactions despite not being registered to provide brokerage or advisory services. The order states that over a period of at least seven years, the institution served as many as 8,500 U.S. client accounts that contained an average total of $5.6 billion in securities assets. The institution admitted it was aware of federal broker-dealer and investment adviser registration requirements related to the provision of certain cross-border broker-dealer and investment adviser services to U.S. clients. After another foreign institution became subject to a federal investigation for similar activities, the institution began to exit the business, though the SEC order states it took years to do so. The order requires the company to disgorge more than $82 million, pay more than $64 million in prejudgment interest, and pay a $50 million civil penalty. In addition, the institution must retain an independent consultant to, among other things, confirm the institution has completed the termination of the business, and evaluate policies and procedures that could detect and prevent similar activity in the future.
On February 25, the SEC re-opened the comment period on two asset-backed securities proposals. Prior to passage of the Dodd-Frank Act, the SEC proposed to require that, with some exceptions, prospectuses for public offerings of asset-backed securities and ongoing Exchange Act reports contain specified asset-level information about each of the assets in the pool in a standardized tagged data format. In 2011, the SEC re-opened the comment period on those proposals given additional requirements included in the Dodd-Frank Act. During that comment period, some commenters raised concerns about the reporting of certain sensitive asset-level data. The SEC is now seeking additional comment on a potential method to address privacy concerns related to the dissemination of such information. The proposed method would require issuers to make asset-level information available to investors and potential investors through a Web site that would allow issuers to restrict access to information as necessary to address privacy concerns. Comments on the proposal are due by March 28, 2014.
On February 26, the Supreme Court held that the Securities Litigation Uniform Standards Act of 1998 (Securities Litigation Act) does not preclude four state-law based class actions against firms and individuals who allegedly helped Allen Stanford conceal a multi-billion dollar Ponzi scheme because Stanford’s alleged misrepresentations were not material to the plaintiffs’ decisions to buy or sell a covered security and thus were not made “in connection with” the purchase or sale of a covered security. Chadbourne & Parke LLP v. Troice, No. 12-79, 2014 WL 714697 (2014). The Court explained that the Securities Litigation Act specifically forbids plaintiffs from bringing state-law based class actions if the plaintiffs allege “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” In this case, the plaintiffs were investors who purchased uncovered securities (certificates of deposit in Stanford International Bank) with the expectation that Stanford would use the proceeds to purchase covered securities (securities traded on a national exchange). Stanford instead used the proceeds to finance his Ponzi scheme and invest in speculative real estate ventures. The Court, by a 7-2 margin, concluded that Stanford’s misrepresentations were not made “in connection with” the purchase or sale of a covered security because the misrepresentations did not lead anyone to buy, sell, or maintain positions in covered securities. Rather, Stanford’s misrepresentations induced the plaintiffs to take positions in uncovered securities (the certificates of deposit). The court reasoned that the “in connection with” phrase suggests a connection that matters, and a connection only matters “where the misrepresentation makes a significant difference to someone’s decision to purchase or to sell a covered security, not to purchase or sell an uncovered security.” Thus, the Court determined that the Securities Litigation Act’s prohibition on state law-based class actions did not apply to the plaintiffs in this case, and affirmed the Fifth Circuit’s order reversing the district court’s dismissal of the plaintiffs’ claims.
On February 20, the SEC’s Office of Compliance Inspections and Examinations (OCIE) launched a previously-announced initiative directed at investment advisers that have never been examined, focusing on those that have been registered with the SEC for three or more years. OCIE plans to conduct examinations of a “significant percentage” of advisers that have not been examined since they registered with the SEC. The examinations will focus on compliance programs, filings and disclosure, marketing, portfolio management, and safekeeping of client assets. The SEC plans to host regional meetings for investment advisers to learn more about the examination process.
On February 14, the SEC announced that it will host a roundtable on March 26, 2014, to discuss cybersecurity challenges for market participants and public companies. The roundtable will be held at the SEC’s Washington, D.C. headquarters and will be open to the public and webcast live on the SEC’s website.
On February 10, Better Markets, a public interest non-profit organization, announced the filing of a lawsuit in the U.S. District Court for the District of Columbia challenging a November 2012 settlement obtained by the DOJ and several state attorneys general, which resolved allegations that a large bank and certain institutions it acquired misled investors in connection with the packaging, marketing, sale, and issuance of certain RMBS. The suit claims, in short, that by resolving the allegations through a civil settlement without seeking any judicial review and approval, the DOJ violated the Constitution’s separation of powers doctrine. In addition, the suit claims, the DOJ’s failure to commence a civil action (i) violated the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, and (ii) constituted an arbitrary and capricious action in violation of the Administrative Procedures Act. The complaint asks the court to declare the agreement unlawful and invalid and to issue an injunction that would prevent the DOJ from enforcing the agreement until the agreement is reviewed and approved by a court.
On February 5, FINRA announced its largest ever fine for alleged AML-related violations. The self-regulatory agency ordered a securities firm to pay $8 million for allegedly failing to (i) implement an adequate AML program to monitor and detect suspicious penny stock transactions; (ii) sufficiently investigate potentially suspicious penny stock activity brought to the firm’s attention; and (iii) fulfill its SAR filing requirements. Further, the firm allegedly did not have an adequate supervisory system in place to prevent the distribution of unregistered securities. In addition to the monetary penalty against the firm, FINRA suspended the firm’s former Global AML Compliance Officer for one month and fined him $25,000. FINRA explained that penny stock transactions pose heightened risks because low-priced securities may be manipulated by fraudsters. In this case, it believes that, over a four-and-a-half year period, the firm executed transactions or delivered securities involving at least six billion shares of penny stocks, “many on behalf of undisclosed customers of foreign banks in known bank secrecy havens.” The firm allegedly executed these transactions despite the fact that it was unable to obtain information essential to verify that the stocks were free trading and in many instances did so without even basic information such as the identity of the stock’s beneficial owner, the circumstances under which the stock was obtained, and the seller’s relationship to the issuer. During this time, penny stock transactions generated at least $850 million in proceeds for the firm’s customers. The firm did not admit to or deny the allegations.
On January 30, the U.S. District Court for the Southern District of New York denied the SEC’s motion for an order authorizing alternative means of service for two Chinese nationals residing in the People’s Republic of China. SEC v. China Intelligent Lighting & Electronics, Inc., No. 13 CIV. 5079, 2014 WL 338817 (S.D.N.Y. Jan. 30, 2014). The SEC moved for the order after it was unable to serve two individual defendants in a securities fraud case by means of the Hague Convention on the Service Abroad of Judicial and Extra-Judicial Documents in Civil and Commercial Matters. The court agreed that alternative service would be appropriate, but rejected the SEC’s proposed method of alternative service: publication in the International New York Times and via email. The court held that alternative service is acceptable if it (i) is not prohibited by international agreement, and (ii) if it comports with constitutional notions of due process. Although no international agreement would prevent the SEC’s proposed methods of service, the court held the SEC failed to demonstrate such service was “reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections.” The court held that the SEC failed to provide evidence that either method of service would actually reach the defendants—it did not provide any information about the distribution of the newspaper and failed to provide evidence the email addresses were accurate and in use by the defendants. The court denied the SEC’s motion without prejudice.
On January 27, SEC Chairman Mary Jo White outlined in remarks to the 41st Annual Securities Regulation Institute her agency’s 2014 agenda, promising “incredibly active enforcement” across “the entire industry spectrum.” Within that enforcement push, the Commission will pay particular attention to financial fraud, including by working to complete its major investigations stemming from the financial crisis while ramping up investigations by its new Financial Reporting and Accounting Task Force. As part of the broader enforcement agenda, the SEC will continue its new stance on seeking admissions from alleged wrongdoers, a policy change that Ms. White first announced publicly last June. Chairman White cited public and media pressure as part of the reason for the change, and explained that “admissions can achieve a greater measure of public accountability.” Outside of the agency’s enforcement plans, Chairman White highlighted numerous other SEC initiatives, including finalizing new disclosure requirements for asset-backed securities. The Commission also will continue to implement the National Examination Program’s new trading data analytics tool—just one example of the “transformative changes at the SEC in 2014” necessary to keep up with evolving market technology.
SEC Administrative Judge Censures Accounting Firms Over Failure To Produce Work For China-Based Companies
On January 22, an SEC administrative law judge (ALJ) prohibited the Chinese affiliates of four major accounting firms from practicing or appearing before the SEC for six months for allegedly failing to turn over certain documents sought by the SEC. BDO China Dahua CPA Co., Ltd., Initial Decision Release No. 553, File Nos. 3-14872, 3-15116 (Jan. 2014). The SEC brought the case in December 2012, alleging that the companies violated the Securities Exchange Act and the Sarbanes-Oxley Act, which requires foreign public accounting firms to provide the SEC upon request with audit work papers involving any company trading on U.S. markets, by refusing to produce audit work papers and other documents related to China-based companies under investigation by the SEC for potential accounting fraud against U.S. investors. The ALJ’s decision centered on Sarbanes-Oxley section 106(e), which provides that a “willful refusal to comply . . . with any request by the Commission . . . under this section, shall be deemed a violation of this Act.” The ALJ rejected the firms’ interpretation of willful refusal to require evidence of bad faith or intent, and instead held that “willful refusal to comply” means choosing not to act in response to a request, without regard to good faith. The ALJ determined that each company received a constructive notice of a request pertaining to a client or former client, and willfully refused to comply. The ALJ added that the SEC was permitted to not allow alternate production of the requested materials, explaining that “[n]othing compels the [SEC] to use one avenue rather than another, and it should have discretion to seek documents in whatever fashion the law permits.”
On January 9, the SEC National Examination Program (NEP) published its examination priorities for 2014. The NEP’s market-wide priorities include (i) fraud detection and prevention; (ii) corporate governance and enterprise risk management; (iii) technology controls; (iv) issues posed by the convergence of broker-dealer and investment adviser businesses and by new rules and regulations; and (v) retirement investments and rollovers. The NEP also identifies priorities for specific program areas, including (i) investment advisers and investment companies; (ii) broker-dealers; (iii) clearing and transfer agents; (iv) market oversight program areas; and (v) clearance and settlement. For example, for the investment advisers and investment companies program area, the NEP plans to focus on certain emerging risks including (i) advisers who have never been previously examined, including new private fund advisers, (ii) wrap fee programs, (iii) quantitative trading models, and (iv) payments by advisers and funds to entities that distribute mutual funds.
On January 17, New York Attorney General (AG) Eric Schneiderman announced that Gary Fishman will lead a new Criminal Enforcement and Financial Crimes Bureau. The bureau, which expands the Attorney General’s former Criminal Prosecutions Bureau, will focus on combating complex financial crimes in (i) bank and financial institution fraud; (ii) securities and investment fraud; (iii) money laundering; (iv) tax crimes; (v) mortgage fraud; (vi) investment schemes; and (vii) insurance fraud. The bureau also intends to form a Financial Intelligence Section that will review banking, regulatory, law enforcement, and open-source data to identify trends that will enhance the investigation and prosecution of financial crime schemes. Mr. Fishman has served as Senior Investigative Counsel since joining the AG’s office in 2012. Prior to joining the AG’s office, Mr. Fishman was the Managing Director of Investigative Group International and before that served as a New York County District Attorney’s Office prosecutor for more than 15 years, including as the Principal Deputy Chief of the Major Economic Crimes Bureau in the Investigation Division.
On January 3, the SEC announced that George Canellos, co-director of the SEC’s Enforcement Division, will leave the agency this month. Mr. Canellos has been in the position since April 2013, after serving as acting director for several months prior. The Enforcement Division now will be led solely by Andrew Ceresney, who also was appointed co-director last April. On January 6, the SEC named Michael J. Osnato, Jr. chief of the Complex Financial Instruments Unit of the Enforcement Division. Mr. Osnato joined the SEC in 2008 and has served as an assistant director in the New York Regional Office since 2010. The SEC stated that he has played a key role in a number of significant SEC enforcement actions and will now lead a unit comprised of attorneys and industry experts investigating potential misconduct related to asset-backed securities, derivatives, and other complex financial products.
On January 2, the FHFA announced that it has obtained nearly $8 billion in connection with its RMBS litigation initiative. In 2011, the FHFA filed lawsuits against 18 financial institutions involving allegations of securities law violations and, in some instances, fraud in the sale of private label securities to Fannie Mae and Freddie Mac. The total recovered to date includes a recently announced $1.9 billion settlement, the FHFA’s sixth RMBS settlement thus far.
On January 2, FINRA outlined certain specific areas of concern the independent regulator intends to focus on in 2014. The topics are largely consistent with FINRA’s 2013 priorities and are grouped in several categories: (i) business conduct; (ii) fraud; (iii) financial and operational; and (iv) market regulation. Under business conduct, for example, FINRA explains that it remains concerned about the suitability of recommendations to retail investors for complex products whose risk-return profiles may be difficult for investors to understand. FINRA lists numerous specific products it intends to scrutinize with regard to suitability. FINRA also intends to focus on, among other things, conflicts of interest, cybersecurity, anti-money laundering, and senior investors.