On November 12, the SEC announced a deferred prosecution agreement (DPA) with a former hedge fund administrator, the agency’s first ever DPA with an individual. The DPA follows a November 2012 SEC enforcement action against a hedge fund and its manager, who allegedly misappropriated more than $1.5 million from the hedge fund and overstated its performance to investors. The SEC action derived from and was aided by information provided by the hedge fund administrator. In return for the assistance provided, the SEC agreed to enter the DPA instead of pursuing allegations that the settling administrator aided and abetted the fund’s securities law violations. The DPA requires the administrator to disgorge $50,000, and prohibits the administrator from, (i) serving as a fund administrator or otherwise providing any services to any hedge fund for a period of five years, and (ii) associating with any broker, dealer, investment adviser, or registered investment company. The SEC states the agreement demonstrates its commitment to rewarding proactive cooperation. According to the SEC, the agreement strikes a balance between holding the administrator accountable for his part in the alleged misconduct, while giving him credit for reporting the fraud and providing full cooperation without any assurances of leniency.
On November 15, the U.S. Supreme Court agreed to hear a challenge to the long-standing “fraud-on-the-market” theory, on which securities class actions often are based. Halliburton v. Erica P. John Fund Inc., No. 13-317, 2013 WL 4858670 (Nov. 15, 2013). Halliburton petitioned the Court after an appeals court relied on the theory to affirm class certification in a securities suit against the company, even after the appeals court acknowledged that no company misrepresentation affected its stock process. As explained in the petition, the theory at issue derives from the Court’s holding in Basic Inc. v. Levinson, 485 U.S. 224 (1988) that a putative class of investors should not be required to prove that they actually relied in common on a misrepresentation in order to obtain class certification and prevail on the merits. The petitioner argues that Basic instead allows putative class members to invoke a classwide presumption of reliance based on the concept that all investors relied on the misrepresentations when they purchased stock at a price distorted by those misrepresentations. Halliburton has asked the Court to determine (i) whether the Court should overrule or substantially modify the holding of Basic, to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory; and (ii) whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.
On November 11, a U.S. Magistrate Judge for the U.S. District Court for the District of Connecticut recommended that the District Court grant the U.S. Attorney’s motion, filed on behalf of the federal-state RMBS Working Group, to enforce a subpoena seeking information and documents from a firm that performed due-diligence work on mortgage loans and loan pools for numerous financial institutions. U.S. v. Clayton Holdings, No. 3:13mc116 (D. Conn. Nov. 11, 2013). In its opposition, the diligence firm objected to the subpoena as a “fishing expedition” that would require it to produce information for all 193 of its clients, even after it has cooperated as a third-party witness in connection with 16 companies the Working Group has identified as subjects of its RMBS investigations. Generally, the magistrate determined that the government’s request was not overly broad and burdensome, and recommended that the court order the firm to produce, for the period 2005 through 2007, (i) its entire database and all data used, maintained, or accessed in connection with due diligence services on mortgage loans and mortgage loan pools, and (ii) all communications, including e-mails, instant messages, or Bloomberg messages, concerning the provision of due diligence services on mortgage loans and mortgage loan pools. The recommended ruling does restrict the response to information and documents related to work performed for specific financial institution clients. The parties have until November 25 to object to the recommendation.
On November 12, FINRA released an enhanced version of BrokerCheck, its online system that allows investors to research the professional background of investment professionals. The enhancements allow investors to search both the BrokerCheck and Investment Adviser Public Disclosure record of any securities professional or firm directly on the FINRA homepage. Additional changes were made to present data in a more user-friendly format.
On October 25, the FHFA announced that a large bank agreed to pay $4 billion to avoid further litigation over allegations that the offering documents it provided to Fannie Mae and Freddie Mac in connection with the sale of billions of dollars in RMBS included materially false statements or material omissions, resulting in massive losses to the enterprises. The FHFA has now resolved four of the 18 RMBS suits it filed in 2011. The FHFA announcement also noted that the bank had reached separate settlements with Fannie Mae and Freddie Mac totaling $1.1 billion to resolve disputes over representation and warranties in whole loans purchased by those entities.
On October 28, the SEC announced enforcement actions against three investment advisory firms and certain executives for allegedly violating the “custody rule,” which was updated in 2010 and applies to SEC-registered investment advisory firms that have legal ownership or access to client assets or an arrangement permitting them to withdraw client assets. According to the SEC, in addition to other alleged securities violations, the firms allegedly failed to maintain client assets with a qualified custodian or engage an independent public accountant to conduct required surprise exams. To avoid further administrative proceedings, the firms and executives agreed to settle but did not admit the allegations. The firms and individuals collectively agreed to pay $535,000 in penalties, and one firm was required to disgorge nearly $350,000, inclusive of prejudgment interest. The firms also must submit to independent compliance reviews and implement certain specified compliance enhancements.
On October 23, the CFPB, the OCC, the FDIC, the Federal Reserve Board, the NCUA, and the SEC proposed joint standards for assessing the diversity policies and practices of regulated institutions. Section 342 of the Dodd-Frank Act required the Office of Minority and Women Inclusion (OMWI) at each agency to develop the standards. The Act specifically prohibits the standards from imposing requirements on or otherwise affecting the lending policies and practices of any regulated entity, or requiring any specific action based on the findings of an assessment, and the agencies state that the assessments will not occur within the standard examination or supervision process. The standards, which the agencies believe are designed to promote “transparency and awareness,” cover four general areas: (i) organizational commitment to diversity and inclusion, (ii) workforce profile and employment practices, (iii) procurement and business practices to promote supplier diversity, and (iv) practices to promote transparency of organizational diversity and inclusion. The agencies state that the standards account for variables including asset size, number of employees, governance structure, income, number of members or customers, contract volume, location, and community characteristics, and the agencies recognize the standards may need to change and improve over time. The proposed standards are subject to a public comment period, which will run for 60 days once they are published in the Federal Register.
On October 22, the DOJ and the SEC announced parallel criminal and civil actions against a U.S. company for allegedly violating the FCPA by paying bribes and falsifying documents in connection with selling ATMs to bank customers in China, Indonesia, and Russia. The federal authorities allege that from 2005 to 2010 the company provided approximately $1.8 million of value to employees of its bank customers in China and Indonesia, including state-owned banks, in the form of payments, gifts, and non-business travel. The company allegedly attempted to disguise the benefits by routing the payments through third parties designated by the banks and by recording leisure trips for bank employees as “training” expenses. The government also alleges that from 2005 to 2009, the company entered into false contracts with a distributor in Russia for services that the distributor was not performing. Instead, the distributor allegedly used the approximately $1.2 million in payments to bribe employees of privately-owned Russian banks to secure ATM-related contracts for the company. The company entered into a deferred prosecution agreement with the DOJ, agreeing to pay a $25.2 million penalty, and it consented to a final judgment in the SEC action, pursuant to which it will disgorge approximately $22.97 million, inclusive of prejudgment interest. The company agreed to implement numerous specific changes to its internal controls and compliance systems and to retain a compliance monitor for at least 18 months. The government acknowledged the company’s voluntary disclosure, cooperation, and extensive internal investigation.
On October 24, the SEC released a cease-and-desist order that resolves FCPA allegations against a Michigan-based medical technology company. The SEC alleged that the company’s subsidiaries in five different countries—Argentina, Greece, Mexico, Poland, and Romania—bribed doctors, health care professionals, and other government officials to obtain or retain business. The alleged activities involved approximately $2.2 million in direct payments, travel and conference expenses, and donations to a university associated with a foreign official made over a four-and-a-half year period. The SEC investigation found that the payments were incorrectly described as legitimate expenses in the company’s books and records and were described as, among other things, charitable donations, consulting and service contracts, travel expenses, commissions, and legal expenses. Without admitting the allegations, the company agreed to disgorge approximately $7.5 million in profits obtained through the alleged activities, and to pay a $3.5 million civil penalty plus an additional $2.3 million in pre-judgment interest.
On October 23, the SEC announced penalties totaling $400,000 against three investment advisory firms and their executives for allegedly repeatedly ignoring problems with their compliance programs, which the SEC deemed inadequate to prevent misleading statements in marketing materials or inadvertent overbilling of clients. The penalties ranged from $25,000 for individuals to $100,000 for one of the firms. Among other things, the SEC highlighted the following deficiencies, which varied among the firms: (i) failing to complete annual compliance reviews, (ii) making misleading statements on company’s website and investor brochures by overstating the amount of assets under management while contradicting the amount the firm presented in its SEC filing, (iii) failing to adopt and implement written compliance policies and procedures, (iv) making false and misleading disclosures about historical performance, compensation, and conflicts of interest, (v) repeatedly over- and under-billing clients, (vi) failing to disclose known compliance deficiencies to potential clients in response due diligence questionnaires or requests for proposals, (vii) inflating the amounts of assets under management in SEC filings, and (viii) improperly removing and retaining nonpublic personal client information by an executive who left one of the firms. In addition to agreeing to the penalties, the firms agreed to hire compliance consultants and adopt specific compliance enhancements. The SEC took the actions as part of its Compliance Program Initiative, which targets firms that fail to effectively act upon SEC warnings about compliance deficiencies.
On October 17, Nevada Attorney General (AG) Catherine Cortez Masto announced that she had finalized an agreement with a financial institution that requires the financial institution to pay $11.5 million, without admitting fault, to resolve the AG’s investigation into the financial institution’s role in purchasing and securitization of subprime, Alt-A, and payment option adjustable rate mortgages. The investigation focused on whether certain lenders had deceived borrowers about the actual interest rate and payments on their loans, and had originated loans with multiple risk features that led to approval of loans without proper consideration of the borrowers’ ability to repay. The investigation also examined the extent to which the financial institution was aware of the lenders’ allegedly deceptive practices when it bought the loans, and whether the financial institution facilitated these lending practices by financing and purchasing such loans. In addition to the monetary penalty, the agreement stipulates that the financial institution will: (i) only finance, purchase, or securitize subprime mortgage loans in Nevada if it has engaged in a review of such loans and determined that the loans comply with the Nevada Deceptive Trade Practices Act and (ii) not securitize loans where upon review it has reason to believe that the lender has not adequately disclosed to the borrowers the existence of an initial teaser rate, the potential for negative amortization on a loan, the maximum adjusted interest rate or payments, and the potential for payment shock if payments increase after a loan reset or recast.
On October 14, FINRA released a report on conflicts of interest in the broker-dealer industry, stating that the report is intended to identify potential problem areas and highlight effective conflicts management practices that may go beyond current regulatory requirements. The report identifies the components of an effective conflicts management framework, which include, for example (i) identifying and managing conflicts on an ongoing basis through an enterprise-level approach that is scaled to the size and complexity of a firm’s business, (ii) establishing new product review processes that provide independent perspectives and identify potential conflicts raised by new products, (iii) minimizing conflicts in compensation structures between customer and broker or firm interests where possible, and (iv) including “best-interest-of-the-customer” standards in codes of conduct that apply to brokers’ personalized recommendations to retail customers.
This week, federal authorities announced the assessment of civil money penalties against two financial institutions for alleged Bank Secrecy Act/Anti-Money Laundering (BSA/AML) compliance failures. In the first action, FinCEN and the OCC alleged that a national bank failed to file suspicious activity reports (SARs) from April 2008 to September 2009 for activity in accounts belonging to a law firm through which one of the firm’s principals ran a Ponzi scheme. The agencies claim that the bank willfully violated the BSA’s reporting requirements by failing to detect and adequately report suspicious activities in a timely manner, even when the bank’s anti-money laundering surveillance software identified the suspicious activity (the bank subsequently filed five late SARs related to this conduct in 2011). FinCEN and the OCC assessed concurrent $37.5 million penalties. The FinCEN penalty is the first assessed by that agency’s recently created Enforcement Division. In addition, the SEC charged the bank and a former executive with related securities violations and ordered the bank to pay an additional $15 million penalty and to cease and desist from the alleged activity, including providing misleading information to investors as to amounts of money in particular accounts and actions the bank had taken to limit fraudulent activity.
In a second action, coordinated among FinCEN, the OCC, and the U.S. Attorney for the District of New Jersey, federal authorities assessed $8.2 million in total penalties against a now defunct community bank for compliance failures related to Mexican and Dominican Republic money exchange houses. The government alleged that the bank willfully violated the BSA by (i) failing to implement an effective AML program reasonably designed to manage risks of money laundering and other illicit activity, (ii) failing to conduct adequate due diligence on foreign correspondent accounts, and (iii) failing to detect and adequately report suspicious activities in a timely manner. FinCEN and the OCC assessed concurrent $4.1 million penalties, and the DOJ will collect an additional $4.1 million through civil asset forfeiture.
On September 23, the NCUA announced that it filed separate lawsuits against nine financial institutions on behalf of five insolvent credit unions for alleged violations of federal and state securities laws in the sale of $2.4 billion in mortgage-backed securities. The complaints, which the NCUA filed in the U.S. District Court for the District of Kansas, claim that the securitizer made numerous misrepresentations and omissions in the offering documents regarding adherence to the originators’ underwriting guidelines, which concealed the true risk associated with the securities and routinely overvalued them. The NCUA claims that when the allegedly risky securities lost value, the credit unions were forced into conservatorship and liquidated as a result of the losses sustained. The NCUA has filed numerous similar suits, and it has previously settled similar claims for more than $335 million with four financial institutions.
On September 24, a firm that handles due-diligence matters for financial institutions filed its opposition to a motion filed by the U.S. Attorney’s Office for the District of Connecticut, on behalf of the federal-state RMBS Working Group, to compel production of documents and information the group sought in a July subpoena. In its brief, the firm reviews its cooperation to respond to “six years of subpoenas, investigatory demands, and formal and informal requests for information,” and summarizes the volume and types of information it has provided to the DOJ and the Working Group to date as a third-party witness in connection with the 16 companies the Working Group has identified as subjects of its RMBS investigations. The firm notes the “substantial expense” it has incurred “to educate an ever-growing, and often-changing, number government attorneys and investigators.” The firm argues that the Working Group’s most recent subpoena, which seeks “every document and communication for all 193 clients and for almost 5,000 e-mail custodians,” constitutes a “fishing expedition” and violates the firm’s rights under the Fourth Amendment.