On June 4, the U.S. Court of Appeals for the Second Circuit vacated and remanded a district court’s decision to reject a proposed settlement between the SEC and a financial institution in a securities fraud suit. SEC v. Citigroup Global Markets Inc., No. 11-5227, 2014 WL 2486793 (2d Cir, Jun. 6, 2014). In November 2011, the SEC and the financial institution entered into a consent judgment to resolve allegations that the institution violated securities laws in connection with certain mortgage-backed securities. Consistent with the SEC consent judgment convention at the time, the institution did not admit or deny any of the allegations as part of the agreement. Judge Jed Rakoff of the Southern District of New York rejected the agreement and held that because the parties agreed to settle without the institution having to admit or deny any of the underlying factual allegations, the settlement would deprive the public “of ever knowing the truth in a matter of obvious public importance,” and the court lacked evidence sufficient to determine whether the agreement was in the public interest. On appeal, the Second Circuit held that the proper standard for reviewing a proposed enforcement agency consent judgment is whether the proposed consent decree is fair and reasonable, and in the event the agreement includes injunctive relief, whether “the public interest would not be disserved.” The court held that in evaluating whether an SEC consent decree is “fair and reasonable” one must review (i) the basic legality of the decree; (ii) whether the terms are clear; (iii) whether the decree resolves the actual claims in the complaint; and (iv) whether the decree is “tainted by improper collusion or corruption.” The court also ruled that the district court abused its discretion by requiring that the agreement establish the “truth” of the allegations, explaining that trials are meant to determine truth, while consent decrees are about “pragmatism.” Finally, the court held that the district court abused its discretion to the extent that it withheld approval of the settlement because it believes the SEC failed to bring the proper charges, which is the exclusive right of the SEC to decide.
On July 8, FINRA released a targeted examination letter it sent to 10 firms to assess their compliance with requirements related to order routing and execution quality of customer orders in exchange listed stocks during the period of January 1, 2014 to present. The letters include numerous requests for information, including requests that each firm explain: (i) how it uses reasonable diligence to ascertain the best market for orders that the firm routes for execution to an exchange, or broker-dealer, so that the resultant price is as favorable as possible for its customer under prevailing market conditions; (ii) how the firm’s exchange order-routing decisions are made for customer non-marketable, customer market, and marketable limit orders; and (iii) how the firm reviews the execution quality of such orders. The letters also include requests related to each firm’s use of the “Smart Order Router.”
On May 19, the Senate Banking Committee’s chairman and ranking member, Senators Tim Johnson (D-SD) and Mike Crapo (R-ID), sent a letter to the leaders of the Treasury Department, the SEC, the CFTC, the OCC, the FDIC, and the Federal Reserve Board regarding recent developments in the use of virtual currencies and their interaction with the global payment system. The Senators ask the regulators a series of questions related to the role of virtual currencies in the U.S. banking system, payment system, and trading markets, and the current role of federal regulators in developing local, national, and international enforcement policies related to virtual currencies. The Senators also seek the agencies’ expectations on virtual currency firms’ BSA compliance, and ask whether an enhanced regulatory framework for virtual currencies is needed.
On April 14, the DOJ and the SEC announced additional charges in a previously announced case against employees of a U.S. broker-dealer related to an alleged “massive international bribery scheme.” The DOJ announced the arrest of the CEO and a managing partner of the New York-based U.S. broker-dealer on felony charges arising from an alleged conspiracy to pay bribes to a senior official in Venezuela’s state economic development bank in exchange for the official directing financial trading business to the broker-dealer. The SEC, whose routine compliance examination detected the allegedly illegal conduct, announced parallel civil charges against the same two executives. Broker-dealer employees charged earlier in the case pleaded guilty last August for conspiring to violate the FCPA, the Travel Act, and anti-money laundering laws, as well as for substantive counts of those offenses, relating, among other things, to the scheme involving bribe payments. In November 2013, the Venezuelan bank senior official pleaded guilty in Manhattan federal court for conspiring to violate the Travel Act and anti-money laundering laws, as well as for substantive counts of those offenses, for her role in the scheme.
On April 15, the SEC’s Office of Compliance Inspections and Examinations announced that it will be conducting cybersecurity examinations of more than 50 registered broker-dealers and registered investment advisers. The examinations will assess each firm’s cybersecurity preparedness and collect information about the industry’s recent experiences with certain types of cyber threats. Specifically, examiners will focus on (i) cybersecurity governance; (ii) identification and assessment of cybersecurity risks; (iii) protection of networks and information; (iv) risks associated with remote customer access and funds transfer requests; (v) risks associated with vendors and other third parties; (vi) detection of unauthorized activity; and (vii) and experiences with certain cybersecurity threats. The SEC included with the announcement a sample document and information request it plans to use in this examination initiative.
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 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 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 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 14, the Federal Reserve Board, the CFTC, the SEC, the OCC, and the FDIC issued an interim final rule to permit banking entities to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities (TruPS CDOs) from the investment prohibitions of section 619 of the Dodd-Frank Act, known as the Volcker rule. The change allows banking entities to retain interest in or sponsorship of covered funds if (i) the TruPS CDO was established, and the interest was issued, before May 19, 2010; (ii) the banking entity reasonably believes that the offering proceeds received by the TruPS CDO were invested primarily in Qualifying TruPS Collateral; and (iii) the banking entity’s interest in the TruPS CDO was acquired on or before December 10, 2013, the date the agencies finalized the Volcker Rule. With the interim rule, the Federal Reserve, the OCC, and the FDIC released a non-exclusive list of qualified TruPS CDOs. The rule was issued in response to substantial criticism from banks and their trade groups after the issuance of the final Volcker Rule, and followed the introduction of numerous potential legislative fixes. On January 15, the House Financial Services Committee held a hearing on the impact of the Volcker rule during which bankers raised concerns beyond TruPS CDOs, including about the rule’s potential impact on bank investments in other CDOs, collateralized mortgage obligations, collateralized loan obligations, and venture capital. Committee members from both parties expressed an interest in pursuing further changes to the rule, including changes to address the restrictions on collateralized loan obligations.
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 8, Senate Banking Committee members Elizabeth Warren (D-MA) and Tom Coburn (R-OK) released the “Truth in Settlements Act.” The legislation would mandate that for any criminal or civil settlement entered into by a federal agency that requires total payments of $1 million or more, the agency must post online in a searchable format a list of each covered settlement agreement. The list must include, among other things: (i) the total settlement amount and a description of the claims; (ii) the names of parties and the amount each settling party is required to pay; and (iii) for each settling party, the amount of the payment designated as a civil penalty or fine, or otherwise specified as not tax deductible. The bill also would require that public statements by an agency about a covered settlement describe: (i) which portion of any payments is a civil or criminal penalty or fine, or is expressly specified as non-tax deductible; and (ii) any actions the settling company is required to take under the agreement, in lieu of or in addition to any payment. The bill would exempt disclosure of information subject to a confidentiality provision, but would in cases where partial or full confidentiality is applied, require the agency to issue a public statement about why confidential treatment is required to protect the public interest of the U.S. The bill also would require public companies to describe in their annual and periodic SEC reports any claim filed for a tax deduction that relates to a payment required under a covered settlement. In announcing the legislation, Senator Warren stated that the bill is needed to “shut down backroom deal-making and ensure that Congress, citizens and watchdog groups can hold regulatory agencies accountable for strong and effective enforcement that benefits the public interest.”