Recently, attorneys from K&L Gates’ Government Enforcement practice group attended the Securities Industry and Financial Markets Association’s (“SIFMA”) Compliance and Legal Society Annual Seminar. We wanted to share with you the following summary of the highlights of what we “heard at the SIFMA conference” from various regulators about key enforcement issues.
Panelist Discussions About the Impact of the Yates Memo. The Yates Memo continues to be of interest to the defense bar. During the conference, other panelists stated that the impact of the Yates Memo remains to be seen. On the one hand, some stated that long before the Yates Memo, corporations and individuals were on notice that the government has been looking very hard at individual accountability in financial fraud cases and that this has been particularly true in major financial fraud investigations brought by the United States. On the other hand, the Yates Memo now generally prohibits global waivers that cover individuals; that part of the Memo is new. One panelist expressed concern that the Yates Memo encourages more cooperation between the civil and criminal sides of the DOJ and that there is a risk that civil settlements will be extracted by threatening criminal prosecution. Others stated, however, that there has long been cooperation and communication between the civil and criminal sides of DOJ. One practical result of the Yates Memo may be a greater reluctance of company executives to cooperate in internal investigations.
Sung-Hee Suh, Deputy Assistant Attorney General, Criminal Division of the DOJ, addressed regulatory “pile-on.” She said the DOJ is working to coordinate with other regulators “from the get-go.” She noted that the number of declinations related to the Foreign Corrupt Practices Act (“FCPA”) has increased because the SEC is addressing many of the cases, instead, and that “the adequacy of remedies such as civil or regulatory enforcement actions” is one of the Filip factors the DOJ considers in determining whether to prosecute. Also, the DOJ considered the amounts banks paid to other regulators when levying penalties in connection with the recent LIBOR actions.
B. SEC Continues to Involve Specialized Units in Enforcement EffortsAndrew Ceresney, Director, Division of Enforcement of the SEC, noted that the Enforcement Division has created a new unit to evaluate complex financial instruments. The unit covers the creation, sale, usage, and valuation of commercial mortgage-backed securities (“CMBS”) and credit default swaps (“CDS”), among other things. It also focuses on issues relating to structured and convertible notes, including fee disclosure, actual fees, and suitability. Mr. Ceresney noted that the Enforcement Division is using FINRA TRACE data to mine for potential misconduct.
Mr. Ceresney also discussed the Enforcement Division’s current focus on market structure. Mr. Ceresney noted that the SEC recently brought cases against exchanges, dark pools, and alternative trading systems (“ATS”). Among other things, Mr. Ceresney also discussed a settlement involving a high-frequency trading firm charged with fraudulent trading to manipulate closing prices. Also, Mr. Ceresney noted that the SEC has brought six spoofing cases in the last six years.
Mr. Ceresney briefly mentioned that the Asset Management Unit has participated in several recent cases concerning private equity fee disclosures. He subsequently discussed a recent proceeding involving a compliance officer. Investment Company Act Release No. 31558 (April 20, 2015). Mr. Ceresney affirmed that compliance officers are not targets, noting that the Enforcement Division has brought cases involving compliance officers (1) after personal misconduct, (2) if the company misled regulators, or (3) if the compliance officer failed to carry out his or her responsibilities. He distinguished this conduct from cases alleging a failure of policies and procedures under Rule 206(4)-7 of the Investment Advisers Act.
J. Bradley Bennett, Executive Vice President, FINRA Enforcement, said FINRA contends with the same problems and concerns every year, regardless of market conditions. These include issues arising in connection with outside business activities, private securities transactions, and concerns relating to the elderly. Mr. Bennett noted that approximately 800 registered representatives were barred in 2015 (about the same number as 2014).
Later, Susan Axelrod, FINRA Executive Vice President of Regulatory Operations; Michael G. Rufino, FINRA Executive Vice President, Head of Member Regulation; Bill Wollman, FINRA Executive Vice President, Member Regulation; Robert Colby, FINRA Executive Vice President and Chief Legal Officer; Thomas Gira, FINRA Executive Vice President, Market Regulation; and Brad Bennett, provided additional insight into current FINRA concerns. The panel briefly revisited the earlier discussion of FINRA’s ongoing “firm culture” review. Mr. Bennett reiterated that the review is “not a tool for enforcement.”
With respect to “Private Client Regulatory Enforcement,” Susan Schroeder, FINRA Deputy Chief of Enforcement, noted that FINRA has observed that firms may have guidance in place regarding suitability, but FINRA is finding that firms may not be adequately implementing their suitability guidance. She stated that a firm’s suitability program must be robust and iterative. Firms should revisit their programs periodically.
When discussing “The Inside Job and Outside Threat: Protecting Your Firm and Clients Against Fraud,” Cameron Funkhouser, Executive Vice President, FINRA’s Office of Fraud Detection and Market Intelligence, highlighted instances in which a firm’s quick reporting of suspicious activity allowed FINRA to identify individuals engaging in insider trading and other improper activity in “real time.” He stated that firms play an important role as a neighborhood watch group.
D. CFTC Continues Post-Dodd Frank Enforcement EffortsAitan Goelman, Director, Division of Enforcement of the U.S. Commodity Futures Trading Association (“CFTC”), said the CFTC is focusing on anti-manipulation, spoofing, and reporting. Mr. Goelman also noted that the CFTC intends to bring more cases as administrative proceedings if the CFTC is able to hire administrative law judges. Mr. Goelman noted the CFTC’s relatively small budget and lamented the agency’s need to receive, store, and analyze vast quantities of data with few financial resources. He stated that budget pressures may cause the CFTC to consider bringing enforcement actions against firms who produce “bad data.”
A. Cybersecurity Continues to be a Top Priority for all Regulatory and Firms As recent SEC and FINRA enforcement actions have shown, cybersecurity remains a top regulatory priority. Governments and regulators, both domestic and abroad, are taking different approaches in providing guidance on cybersecurity preparedness and responsibilities.
Leonard Baily, Special Counsel for National Security in the DOJ’s Computer Crime and Intellectual Property Section, commented on the Cybersecurity Information Sharing Act. Mr. Baily noted that the Act establishes a framework that incentivizes private sector sharing of cyberthreat information by providing, among other things, liability protection for information sharing for the purposes of cybersecurity. The Act also authorizes monitoring and the application of defensive measures on networks for cybersecurity purposes.
Mr. Shaikun reported that FINRA released selected “frequently asked questions” (“FAQs”) regarding FINRA Rules 2241 and 2242 on March 4, 2016. These new FAQs supplemented prior FAQs issued by FINRA on May 27, 2015, in the wake of FINRA’s settlement with ten firms in connection with the 2010 planned initial public offering of Toys “R” Us (the “Toys Settlement”).
Mr. Shaikun and others also commented on recent FINRA examination findings, highlighting the failure to treat certain desk commentary and other communications from outside of the research department as “research reports,” failure to make adequate disclosures and lack of prominence, lack of enforcement of policies around communications with subject companies, failure to treat research by the “mixed research team” as member research, and failure to have properly qualified principals review research.
Litigation UpdatePanelists discussed major developments in civil and criminal securities related litigation in the past year. Some of the key areas discussed follow:
A. Regulatory and Criminal CaseCollateral Consequences Make It Extremely Difficult for Large Financial Institutions to Litigate with Regulators. Potential collateral consequences (for example, losing the ability to serve as investment adviser to mutual funds) may make it next to impossible to litigate with regulators. Financial institutions often cannot risk that if they litigate and lose (rather than settle) regulators will not provide waivers of collateral consequences. Moreover, obtaining waivers is becoming more difficult, and parties may not know at the time of settlement whether the waivers will be granted, although an SEC panelist stated that respondents should generally have a good idea at the time of settlement whether waivers are likely to be granted. In many cases, the collateral consequences, if they are not waived, would be more draconian than the penalties imposed for the conduct in the case.
Concerns About DOJ’s Retrospective Look Backs. Panelists expressed concern that DOJ has several ongoing investigations involving a retroactive look at whether the company was sufficiently transparent during settlement negotiations. If the government concludes that lawyers for the company were not sufficiently transparent during the negotiations, they may rescind the settlements. This is a problem because hindsight is 20/20 and if a lawyer made a representation that turned out to be wrong or simply did not know something, there could be consequences for both the company and the lawyer. There is also a prospective concern – because a company with, for example, 50,000 employees will eventually have repeat violations. On the other hand, panelists expressed less concern about the prospective risk than the retrospective risk.
Second Circuit’s Reservations About Criminalizing Trader Conversations. In United States v. Litvak, No. 14-2902-cr(2d Cir. Dec. 8, 2015), the Second Circuit remanded the conviction of a trader who allegedly misrepresented to counterparties the costs of acquiring certain mortgage-backed securities. The Second Circuit accepted the theory that a trader who misrepresents material facts could be criminally liable for those misrepresentations, but held it was error to exclude testimony relevant to whether such misrepresentations would have been material to counterparties.
Supreme Court’s Decision in Salman Could Reverse Newman Insider Trading Standard. In United States v. Newman, 773 F.3d 438 (2d Cir. 2014), reh’g denied, Nos. 13-1837, 13-1917 (2d Cir. Apr. 3, 2015), the Second Circuit held that even when an insider and a tippee are friends, the government must prove that there was “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature” to the insider. This poses an obstacle to those insider trading cases where the insider simply gifted the information. In those cases, under Newman, the prosecution would fail because the insider (as opposed to the tippee) received no personal benefit from the tip. The government argues that Newman conflicts with the Supreme Court’s statement in Dirks v. SEC, 463 U.S. 646 (1983)that insiders personally benefit from disclosing confidential information when they “make a gift of confidential information to a trading relative or friend.” On January 19, 2016, the Supreme Court agreed to decide that issue in Salman v. United States, No. 15-628, involving an insider who allegedly tipped to a relative. The case, however, has been put off to the next Term, and thus could be decided as late as June 2017.
Rakoff Certifies Class Action in Petrobas Despite Individual Issues. On February 1, 2016, Judge Rakoff certified a class action in In re Petrobas Securities Litigation, No. 14-09662, despite a number of individual issues, including whether investors purchased in a domestic transaction would have to be established on an investor-by-investor basis. The court stated that whether a transaction is domestic is likely to be documented in a form “susceptible to the bureaucratic processes of determining who belongs to a Class.”
Courts Are Split on Removal of Claims Under the Securities Act of 1933. District courts are badly split on removal of Securities Act claims. District courts in the Southern District of New York permit removal; district courts within the Ninth Circuit do not permit removal and one court recently imposed sanctions against a party that sought to remove. Appellate courts have not weighed in on the issue.
The Pain of Benchmark Litigation. Litigation alleging collusion in setting benchmarks has led to six banks taking criminal guilty pleas, several traders being tried and convicted, and banks paying more than $5 billion in criminal penalties, $4 billion to resolve class actions, and $2 billion in regulatory fines. As one panelist stated, “There is no way to put lipstick on this pig.” Factors that have contributed to the large payments include loose and provocative chat rooms, a rush to cooperate with law enforcement, and competition among the regulators on who could be the toughest on financial institutions. Plaintiffs’ lawyers offer “discounts” to early settlers, with subsequent settlers having to pay more to settle, and that has created a race to settlement. Benchmark litigation is expected to continue for at least the next couple of years.
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