CFPB Update - Bank Short Term Loans "Payday" for Banks? CFPB Outlines Sweeping Proposal to Level the Playing Field Between Payday Lenders, Banks and Credit Unions

This post was written by Travis A. Sabalewski and Nicholas F.B. Smyth.

Direct from Richmond, Virginia: yesterday, I (Travis) visited the Greater Richmond Convention Center, where the Consumer Financial Protection Bureau (CFPB) announced at a field hearing a sweeping proposal for new rules regarding payday/deposit advance loans, auto title loans, and certain high-interest, longer-term loans. (A Fact Sheet summary is here.) After CFPB Director Richard Cordray outlined the CFPB’s proposal, the Bureau heard from, first, a panel of industry and consumer advocates and, then, members of the public. The hearing was packed and the audience ̶ comprised of payday lender employees, consumer advocates, and others ̶ lively, with one or another of those groups applauding after nearly every person’s turn at the microphone.

Click here to read the full issued Client Alert.

Bank Settles Criminal Bank Secrecy Act and Civil Fraud Charges Arising from Its Inadequate Anti-Money Laundering Program

This post was written by Bethany R. Brown and Kathleen A. Nandan.

On March 10, 2015, the U.S. Department of Justice (“DOJ”) announced a $4.9 million settlement of criminal and civil charges against CommerceWest Bank (“CommerceWest” or the “Bank”) brought pursuant to the Bank Secrecy Act (“BSA”), the Financial Institutions Reform, Recovery and Enforcement Act (“FIRREA”), and the Fraud Injunction Statute. The government alleged that, between December 2011 and July 2013, the Irvine, California-based Bank willfully facilitated consumer fraud by failing to report the suspicious activities of V Internet Corp. LLC (“V Internet”), a Las Vegas-based, third-party payment processor that maintained accounts with CommerceWest.

The CommerceWest settlement is the second case – and the first criminal action – arising from DOJ’s Operation Choke Point, an initiative first disclosed in March 2013 that aims to prevent fraudsters from accessing consumer bank accounts by choking off their access to the payments system. Under Operation Choke Point, DOJ targets banks’ business relationships with companies believed to be at higher risk for fraud and money laundering, including payment processors and payday lenders. The settlement is also notable for its use of the criminal provisions of the BSA, the civil money penalty provisions of FIRREA, and the injunctive provisions of the Fraud Injunction Statute to extract monetary penalties and impose injunctive relief upon a financial institution whose allegedly lax anti-money laundering program allowed a fraud to flourish.

The BSA requires financial institutions to establish and implement policies to detect and prevent money laundering. One of the BSA’s specific mandates is that banks file Suspicious Activity Reports (“SARs”) regarding, among other things, “any suspicious transaction relevant to a possible violation of law or regulation.” FIRREA authorizes the government to seek civil money penalties against those who have violated certain criminal statutes that affect financial institutions, and the Fraud Injunction Statute authorizes the government to file a civil action to enjoin banking law violations and to freeze assets traceable to those violations.

V Internet processed transactions for merchants that created demand drafts to withdraw money from consumers’ bank accounts without authorization. A demand draft (also called a remotely created check or remotely created payment order) is a check created by a third party using an account holder’s name and bank account information that contains a statement claiming that the account holder has authorized the check in lieu of the account holder’s signature. During the 15 month period addressed in the settlement, CommerceWest accepted more than 1.3 million demand drafts depositing more than $45 million from V Internet.

The government alleged that CommerceWest facilitated V Internet’s fraudulent scheme by failing to file SARs, despite numerous red flags pertaining to the transactions. These red flags included the reversal or “return” of about 50 percent of the demand drafts by the consumers’ banks for a variety of reasons, CommerceWest’s inability to obtain evidence that the processor processed legitimate transactions, and letters and calls from several other banks complaining of fraud and warning CommerceWest that the demand drafts were unauthorized. In response to the consumers’ banks’ communications, CommerceWest blocked demand drafts destined for the complaining banks, but allowed V Internet to continue charging to other banks.

To settle the criminal and civil charges, CommerceWest agreed: (1) to pay a $1 million civil penalty and an additional $1 million in lieu of administrative forfeiture; and (2) not to assert a claim to the approximately $2.9 million seized from V Internet’s accounts at the Bank. In addition, CommerceWest agreed to cooperate with the government’s investigation and consented to the entry of a permanent injunction requiring it to perform due diligence on third-party payment processors, and to implement fraud detection, compliance monitoring and reporting, and recordkeeping programs in compliance with the BSA. This settlement reflects coordination among various components of the DOJ, and this multi-pronged civil and criminal approach may well be used as a template for other enforcement actions.

FCA raises concerns over structured products

This post was written by Chris Borg and Tom Webley.

The UK’s Financial Conduct Authority (FCA) has published its Occasional Paper No. 9, setting out the results of the FCA’s research into how well customers understood structured products. The answer, according to the report, is not very well. The report found that, while investors’ expectations of growth in the FTSE were in line with the FCA’s assumptions, investors overestimated the likely returns on structured products based on the same indices.

Click here to read the full issued Client Alert.

CFPB Updates: CFPB Report Claims Arbitration "Less Beneficial To Consumers" than Individual or Class Litigation, Foreshadows Attempt to Impose Restrictions in Future

This post was written by Leonard A. Bernstein, Deepa J. Zavatsky and Nicholas F.B. Smyth.

On March 10, Director Richard Cordray of the Consumer Financial Protection Bureau (“Bureau” or “CFPB”) presided over a Field Hearing on Pre-Dispute Arbitration Clauses, discussing what he described as the “key findings” of the Bureau’s long-awaited 700-page Arbitration Report to Congress published earlier that morning. Reed Smith attorney Deepa Zavatsky attended the hearing, where Cordray expressed the CFPB’s view that pre-dispute arbitration is not a “better alternative” to litigation, and he foreshadowed the Bureau’s likely adoption of limitations to such mandatory provisions in consumer contracts.

Click here to read the full issued Client Alert.

FinCEN Targets Community Bank - $1.5 Million Penalty for Failure to File Suspicious Activity Reports

This post was written by Michael J. Lowell, Kathleen A. Nandan and Michael A. Grant.

On February 27, 2015, the Financial Crimes Enforcement Network (“FinCEN”) announced a $1.5 million civil penalty against the First National Community Bank of Dunmore, Pennsylvania (“FNCB”), arising from FNCB’s admission that it violated the Bank Secrecy Act (“BSA”) by failing to detect and report suspicious financial transactions. The penalty is concurrent with a $500,000 penalty and remedies imposed by the Office of the Comptroller of the Currency for related BSA violations.

This penalty highlights the government’s continued and ongoing focus on financial institutions’ potential role in facilitating money laundering, and those institutions’ compliance with the BSA. The FNCB penalty follows similar recent enforcement actions against a casino and a securities broker-dealer.

SAR Reporting Requirements

The BSA requires financial institutions to establish and implement policies to detect and prevent money laundering, effectively imposing upon financial institutions the role of gatekeeper to the U.S. banking system. Among other requirements, the BSA requires banks to file suspicious activity reports (“SARs”) for transactions with an aggregate value of more than $5,000 if the bank knows, suspects, or has reason to suspect that the transaction is “suspicious.” suspicious transactions include:

  • Funds derived from illegal activities, or conducted to disguise funds derived from illegal activities
  • Transactions designed to evade the reporting or recordkeeping requirements of the BSA, or
  • Transactions that have no business or apparent lawful purpose, or are not the sort in which the customer would normally be expected to engage, and the bank knows of no reasonable explanation for the transaction after examining the available facts, including background and possible purpose of the transaction

The Scheme

In 2009, Michael Conahan, a former judge from the Luzerne County Court of Common Pleas (Pa.), pleaded guilty in federal court to conspiring to impede the IRS in the collection of federal income taxes. Mr. Conahan and another judge used their positions to gain profits by sending juveniles to detention facilities in which they had a financial interest. Between 2003 and 2007, the judges concealed approximately $2.6 million in revenue through Pinnacle Group of Jupiter, LLC, an entity created by the judges to purchase a condominium. Mr. Conahan served on FNCB’s board of directors and controlled accounts at FNCB that he used to process funds from his illicit scheme. Ultimately, Mr. Conahan was sentenced to 210 months imprisonment, and the Pennsylvania Supreme Court overturned approximately 4,000 juvenile convictions.

The Red Flags

FNCB did not file any SARs related to Mr. Conahan’s accounts until after Mr. Conahan’s first guilty plea in 2009, and only at the behest of an OCC examiner. In its Assessment of Civil Money Penalty, FinCEN identified multiple instances where FNCB failed to detect or adequately report suspicious transactions. FinCEN identified several red flags that should have been detected, investigated, and reported by FNCB, including:

  • Receipt of a law enforcement subpoena
  • Large, round-dollar transactions often occurring on a single day
  • Abnormal volume of activity compared with the account balance
  • Unusual and substantial reported increase in the value of the condominium over a short period of time
  • Full cash-out refinancing out of the condominium just 12 weeks after purchase
  • Dramatic (4x) increase in income over a one-year period
  • Rental payments that were disproportionate to the value of the property ($70,000 per month in rental payments in comparison with a $800,000 purchase price)

FinCEN Director Jennifer Shasky Calvery commented on FNCB’s involvement in Mr. Conahan’s illicit scheme, stating: “The criminal case affected the lives of thousands of children and parents … Banks have a duty to spot suspicious activity and to report it. Law enforcement relies on this valuable information. FNCB’s failure to file timely suspicious activity reports may have deprived law enforcement of information valuable for tracking millions of dollars in related corrupt funds.”


The deficiencies outlined in the FNCB announcement and other recent FinCEN settlements reflect the concerns articulated by FinCEN in its August 11, 2014, Advisory to U.S. Financial Institutions on Promoting a Culture of Compliance. There, the agency encouraged financial institutions to strengthen their AML programs by educating staff and leadership as to how their BSA reports are used, facilitating the flow of information between departments within an organization (particularly with compliance staff), and enlisting leadership’s “demonstrable support” for a robust compliance department sufficiently autonomous to address risks arising from the business line. While a “culture of compliance” cannot eliminate the risk of enforcement actions, its value to the regulators should not be understated.

How Many SARs Does It Take to Find Yourself in Regulators' Crosshairs? Answer: None

This post was written by Lisa G. Blackburn, Kathleen Nandan, and Kiran Somashekara.

Securities and Exchange Commission (“SEC”) Enforcement Division Director Andrew Ceresney, recently drew attention when he announced that the SEC intends to include among its enforcement priorities compliance with the Bank Secrecy Act (the “BSA”). Ceresney’s comments, made during SIFMA’s 2015 Anti-Money Laundering and Financial Crimes Conference, focused on broker-dealers and the SEC’s concern that broker-dealers have not implemented adequate anti-money laundering (“AML”) programs to comply with the BSA’s reporting and recordkeeping requirements. BSA enforcement actions against financial institutions – and the significant penalties and forfeitures associated with those actions – have garnered significant press in the past few years. Broker-dealers have historically avoided much of this scrutiny, as the SEC has generally viewed AML lapses as attendant to other violations. Those days, however, appear to be numbered. This issue has received recent attention by Financial Industry Regulatory Authority (“FINRA”) enforcement, as well as by the SEC’s Office of Compliance Inspections and Examinations.

Click here to see the full post on our sister blog Financial Regulatory Report.

Trump Taj Mahal Fined Record $10 Million for Inadequate AML Program

This post was written by Kathleen Nandan and Amy Tonti.

As disclosed recently in a bankruptcy court filing, on January 27, 2015, the Financial Crimes Enforcement Network (“FinCEN”) imposed a $10 million civil money penalty pursuant to the Bank Secrecy Act (the “BSA”) on Trump Taj Mahal Associates LLC. Trump Taj Mahal consented to the imposition of the penalty (subject to the bankruptcy court’s approval) and admitted that its conduct violated the BSA. This $10 million penalty, reported to be the largest BSA penalty ever imposed upon a casino, highlights the government’s ongoing focus on the gaming industry.

The BSA requires financial institutions, which include casinos, to establish and implement policies to detect and prevent money laundering. Casinos must implement anti-money laundering (“AML”) programs that require, among other things, the creation of internal controls to ensure compliance with the BSA, independent testing of their AML programs, AML training for personnel, the designation of individuals responsible for AML compliance, and the implementation of procedures to identify suspicious transactions and determine whether records must be made or maintained under the BSA. Trump Taj Mahal admitted that it failed to implement such an AML program.

With respect to these failures, Trump Taj Mahal admitted that its violations were “willful,” as that term is used in civil enforcement of the BSA. Trump Taj Mahal did not admit that it knew that its conduct violated the BSA or that it otherwise acted with an improper motive or bad purpose. Instead, the casino acknowledged that it acted with either reckless disregard or willful blindness.

The settlement proposes to treat the $10 million penalty as an unsecured claim in the Trump Taj Mahal bankruptcy case. Under the Bankruptcy Code, certain penalties assessed by the government are to be accorded “priority,” to be paid before general unsecured creditors. Based on current law, the penalty assessed for a BSA violation does not fall within the priority treatment, and any payment of the penalty would be based on a pro-rata distribution to general unsecured creditors. Notably, a criminal penalty assessed for a violation that occurred during the pendency of a bankruptcy (unlike the civil penalty here) might be treated as having priority by certain courts, but not all courts. Courts that deny priority to a penalty do so to enhance recovery for all creditors.

Recent enforcement actions against others in the gaming industry, as well as FinCEN Director Jennifer Shasky Calvery’s recent speeches cautioning casinos not to let the entertainment component of their business color their view of their AML obligations, suggest that the industry will remain under FinCEN’s scrutiny for the near future. As Director Shasky Calvery noted in June 2014, casinos are “complex financial institutions with intricate operations that extend credit, and that conduct millions of dollars of transactions every day. They cater to millions of customers with their bets, markers, and redemptions. And casinos must continue their progress in thinking more like other financial institutions to identify AML risks.”*



China Auditor Update: SEC and Chinese Audit Firms "Settle" for the Status Quo

This post was written by Jennifer L. Achilles and John Tan.

In an Order of Settlement released February 6, 2015, the SEC agreed to stay the administrative action against the Chinese affiliates of the “Big Four” accounting firms for refusing to turn over their audit work papers relating to several U.S.-listed Chinese companies. As we wrote earlier here, the Chinese affiliates of the audit firms had been facing a six-month bar from appearing before the SEC, which would have disrupted their business and the business of countless U.S.-listed Chinese companies. The Order acknowledges that the requested documents have been provided, and allows the audit firms to continue representing U.S.-listed companies. The Order also requires each firm to pay a $500,000 fine and agree to abide by certain procedures regarding the SEC’s document requests for the next four years. If the audit firms follow the procedures set forth in the Order, the administrative action will be dismissed after a four-year period.

Throughout the administrative proceeding, the Chinese affiliates of the “Big Four” argued that they were caught between a rock and a hard place. If they produced audit work papers directly to the SEC, they could be subject to civil and/or criminal action in China for divulging state secrets. And if they did not produce the requested documents, they could be barred from appearing before the SEC and effectively lose their ability to audit U.S.-listed Chinese companies. The terms of the settlement now require the audit firms to respond to the SEC’s future document requests within 90 days. However, the firms will produce documents to the China Securities Regulatory Commission (CSRC), not the SEC. Both the firms and the CSRC will then be permitted to make redactions to the documents before providing them to the SEC. Additionally, the audit firms may refuse production altogether if they determine, along with the CSRC, that the requested documents should be withheld under China’s state secrets regulations.

This settlement appears to send the SEC right back where it started: unable to review the work papers of Chinese audit firms without the consent of Chinese regulators. The settlement also appears to be a complete win for the audit firms. They are no longer required to produce documents directly to the SEC and risk violating China’s state secrets laws, and they no longer have to fear being barred from appearing before the SEC – at least not for the next four years.

Second Circuit Reverses Major Insider Trading Convictions (or Preet Bharara's Terrible, Horrible, No Good, Very Bad Day)

This post was written by Jennifer L. Achilles, Lisa G. Blackburn, and Brandon D. Cunningham.

In a widely anticipated decision, the Second Circuit on Wednesday clarified the standard for insider trading actions against tippees, downstream recipients of inside information who trade on that information. The court overturned the criminal convictions of two hedge fund portfolio managers who were convicted in 2013 as part of a massive sweep by New York federal prosecutors targeting insider trading on Wall Street and beyond. The court held that it is not enough for the government to prove that a tippee knew the corporate insider disclosed confidential information; it must also prove that the tippee knew the tipper did so in exchange for personal benefit. This decision calls into question the multiple insider trading convictions recently secured by the Manhattan U.S. attorney’s office, and may pave the way for other similarly situated defendants, including former SAC Capital Advisors LP manager Michael Steinberg, to seek an acquittal.

Todd Newman and Anthony Chiasson were both charged in 2012 with violations of sections 10(b) and 32 of the 1934 Act, Rule 10b-5, Rule 10b5-2, 18 U.S.C. § 2, and 18 U.S.C. § 371. Newman and Chiasson allegedly received the May and August 2008 earnings numbers of Dell and NVIDIA before public release, and subsequently executed trades capitalizing on this information to a profit of $4 million and $68 million respectively. At trial, the government presented evidence that the two received inside information from financial analysts who were themselves two and three levels removed from the actual corporate insiders at Dell and NVIDIA. The government presented no evidence that either defendant knew he was trading on information obtained from insiders in violation of those insiders’ fiduciary duties to shareholders. Instead, the government argued that as sophisticated traders, Newman and Chiasson must have known that the information was not disclosed for any legitimate corporate purpose. The traders were subsequently convicted of insider trading and sentenced to 54 months’ and 78 months’ imprisonment, respectively.

On appeal, the Second Circuit held that the government and the district court had applied the wrong standard for tippee liability. In doing so, the court relied on the U.S. Supreme Court’s 1983 ruling in Dirks, which held that tippee liability is derivative of the related tipper liability, and that a personal benefit to the tipper is therefore a required element of tippee liability as well. While Dirks did not specifically consider whether a tippee must have knowledge of the tipper’s personal benefit, it did define a tipper’s breach of fiduciary duty as a breach of the duty of confidentiality in exchange for a personal benefit. Because a tippee’s knowledge of a breach of a fiduciary duty is an element of tippee liability, it follows naturally that a tippee must know the tipper disclosed confidential information for personal benefit. As for what constitutes sufficient evidence of a “personal benefit,” the court noted that mere friendship between the tipper and tippee, such as what was presented at the trial of Newman and Chiasson, was not enough. Instead, proof is required of a “meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary of similarly valuable nature.”

In its appeal, the government relied on prior Second Circuit decisions that enumerated the elements of tippee liability without mentioning knowledge that the tipper disclosed the information for personal gain. The Second Circuit made short work of that argument, blaming any ambiguity in the law not on its prior decisions but on the “doctrinal novelty” of the government’s recent insider trading prosecutions, “which are increasingly targeted at remote tippees many levels removed from corporate insiders.” The court also noted that while it had been accused of being “somewhat Delphic” with respect to the elements of tippee liability, Judge Sullivan’s opinion in fact was the only district court opinion to hold that tippee knowledge of the tipper’s benefit was not required.

The Second Circuit’s opinion highlights the reality that the wrongfulness of insider trading lies not in the unequal access to market information, but in the knowingly wrongful use of that information. The court noted, “Although the Government might like the law to be different, nothing in the law requires a symmetry of information in the nation’s securities markets.”

EY Appeals Hong Kong Court Order To Produce Audit Working Papers Notwithstanding Holding That EY 'Deliberately Withheld From SFC' and State Secrets Not at Issue

This post was written by Joan Hon.

More than a year ago, we began following the so-called Ernst &Young (“EY”) State Secrets Case in Hong Kong.  On 23 May 2014, the High Court of Hong Kong finally concluded that there was no “reasonable excuse” for EY’s failure to comply with Securities and Futures Commission (“SFC”) notices seeking information and documents, and that EY had “deliberately withheld from SFC.” Though EY has since produced a disc of documents it held in Hong Kong, EY filed a Notice of Appeal 20 June taking issue with the Court’s position on documents held in the Mainland by its PRC affiliate, Ernst & Young Hua Ming (“HM”).

When this case kicked off in April 2013, many watched carefully, wondering how the Court might deal with Chinese state secrets and archives laws, in addition to others, that supposedly prevented the cross-border transmission of certain documents, and accordingly, EY’s ability to comply with the SFC notices.  These laws have also been the purported excuse for non-cooperation in regulatory investigations in the United States, and have resulted in bans and censures of Chinese accounting firms in the United States.*  However, the Hong Kong Court emphasized that it is “concerned with and only with the obligation of EY as a firm in Hong Kong to comply with the Notices issued under the SFO as part of the laws of Hong Kong,” suggesting a strong reluctance to interpret the controversial Chinese laws.

In an interesting “eve of trial” twist, EY suddenly discovered a laptop in Hong Kong that had been used by the EY partner involved in the engagement with HM.  Incidentally, identification of this engagement partner was only revealed by affirmation filed in relation to these proceedings, despite numerous previous requests by the SFC for such identification.  These “sudden,” last-minute discoveries, which included two additional hard drives, alongside EY’s production of a single witness who repeatedly claimed he either had no personal knowledge or memory of the relevant facts, led Mr. Justice Peter Ng Ka-fai to conclude EY had been deliberately withholding information. With respect to any documents HM may possess in the Mainland, the Court concluded that EY, subject to any legal restrictions on cross-border transmission, has a currently enforceable legal right under PRC laws to demand production of the audit working papers from HM. Thus, EY could not argue that it did not have possession – including custody or control – of the documents the SFC sought, whether in the Mainland or not.

As to whether there was any legal restriction on the cross-border transmission of documents in the Mainland, the Court was reluctant to comment on PRC laws, suggesting they were a “complete red herring” since any legal effect was hypothetical until any analysis of the actual contents of the audit working papers could be made:

The burden is on EY to show an applicable restriction on the transmission of the audit working papers and other relevant documents from the PRC to Hong Kong. If it cannot do that by showing the papers or other documents do contain State secrets or commercial secrets, that is the end of the matter, as far as EY’s case is concerned.

This begs the question as to how EY could possibly submit such evidence if its submission is that such transmission would be illegal. However, the Court accepted that if its finding on the absence of legal impediments under PRC laws is wrong, then it was EY’s (and not the SFC’s) burden to make an application to the China Securities Regulatory Commission for approval.

So far, no hearing date has been set for EY’s appeal. 

*  Incidentally, the Hong Kong Court made reference to these American cases, and have noted that the SFO does not purport to have any extraterritorial effect in the same way that section 106 of the U.S. Sarbanes-Oxley Act of 2002 does.

Supreme Court Reaffirms Basic v. Levinson Presumption of Reliance

This post was written by Amy J. Greer, Sarah R. Wolff, and C. Neil Gray.

On June 23, 2014, the Supreme Court of the United States issued its much-anticipated decision in Halliburton Co., et al. v. Erica P. John Fund, Inc., No. 13-317 (2014). The Court vacated and remanded the decision of the United States Court of Appeals for the Fifth Circuit refusing to allow Halliburton to rebut the Basic Inc. v. Levinson, 485 U.S. 224 (1988), presumption of reliance at the class certification stage with evidence of a lack of price impact. In doing so, the Court rejected Halliburton’s invitation either to overturn the Basic presumption of reliance for securities fraud claims, or to require securities class action plaintiffs to prove price impact at the class certification stage. But the Court agreed with Halliburton that defendants should be permitted to provide evidence of the lack of price impact at the class certification stage, rather than putting off such proof to the merits stage.

The decision falls far short of the hopes of frequent targets of securities class actions of drastically changing the securities litigation landscape. The decision takes the least disruptive approach in eliminating the wholly inconsistent construct that allowed, in connection with class certification proceedings, plaintiffs to submit evidence that price impact exists; and defendants to submit evidence of price impact solely as evidence that the market is not efficient; but prevented defendants from submitting that same evidence of price impact to rebut the Basic presumption. And while the decision represents little change in the Second and Third Circuits—those courts already allowed defendants to rebut the presumption of reliance at the class certification stage by demonstrating that the alleged misrepresentation did not distort the market price—the decision will come as welcome relief in the Fifth and Seventh Circuits, which have until now held that price impact may not be considered at the class certification stage.

Click here to read the issued Client Alert.

Breaking News - Supreme Court Vacates and Remands in Halliburton

This post was written by Amy J. Greer, Sarah R. Wolff, and C. Neil Gray.

Supreme Court vacates and remands in Halliburton.  United States Supreme Court declines to overturn Basic, but decides that defendants can rebut the presumption of reliance – before class certification – by showing a lack of price impact.  Watch this space for a full analysis.

Message From FINRA Enforcement Chief: "Talk to Me"

This post was written by Amy. J. Greer and C. Neil Gray.

Earlier this week, J. Bradley Bennett, Executive Vice-President, Enforcement for FINRA, spoke at a gathering hosted by SIFMA’s Compliance & Legal Society.  Bennett’s remarks purported to bust common myths about the FINRA Enforcement program he leads—myths like FINRA picks on larger firms and complexes, or parties will do better if they litigate with FINRA, or FINRA somehow targets chief compliance officers.  Bennett endeavored to bust these particular “myths” and some others, pointing out, for example, that most of FINRA’s 1,400 case enforcement docket is focused on small firms or single-broker matters.  He also noted that in 90 percent of its litigated matters, FINRA proves liability and is awarded sanctions consistent with what they would have obtained in settlement.  (Of course, everyone who litigates expects to be in that lucky 10 percent.) 

Of particular interest, however, was Bennett’s repeated entreaties throughout his remarks to “ask for a meeting” with him and his senior staff.   Indeed, he indicated his surprise at the paucity of such requests.  Think that an 8210 (request for documents and information) is overbroad or outside the scope of a regulated business?  At the outset, consider whether it’s worthwhile to provide it anyway—Bennett believes the honest citizen welcomes the constable’s knock on the door.  But, if on reflection you decide it’s out of bounds, ask for a meeting!  Think that FINRA is just piling on in a multiple-regulator enforcement action, where it has no independent jurisdiction or particular expertise?  Ask for a meeting!  Bennett indicated FINRA has no interest in pursuing actions solely for a place at the table.  And, according to Bennett, FINRA Enforcement wants to be judicious in its use of OTRs (on the record testimonies), and the staff should consider telephonic interviews and background questionnaires to make better use of everyone’s time.  If that is not happening in your matter, ask for a meeting! 

Bennett advised that it is never too early to ask for a meeting.  If your concerns are factual, you may want to wait until a record is developed to enhance the discussion.  On the other hand, if the issue is purely one of legal interpretation, there’s no need to wait.  And strongly consider bringing your businesspeople to a meeting to discuss substance—Bennett suggested that having them available makes a meeting more productive, and he promised not to turn the meeting into an OTR.  Bennett also said that he has had meetings for which lawyers traveled across the country just to tell him that he or his staff are being unreasonable.  These, he counseled, are not productive meetings. 

So, the apparent takeaway here is that FINRA’s Enforcement Chief wants to hear from you.  There was a time when such meetings were a productive tool in managing enforcement investigations to get to the right result.  If Brad Bennett wants to lead a rehabilitation of that process, we’re all for that.

CFTC Awards Its First Whistleblower Award

This post was written by Sarah R. Wolff, James A. Rolfes, Patricia Dondanville, and Michael A. Yuffee.

On May 20, 2014, the Commodities Futures Trading Commission (CFTC) announced an award of $240,000 to an anonymous whistleblower who provided “valuable information” concerning unexplained Commodity Exchange Act violations by an unidentified entity or person.  The award was the first issued under the CFTC Whistleblower Program created under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. 

The CFTC press release claimed that the award illustrates the value of the Whistleblower Program in “protect[ing] market participants and the public through successful enforcement actions.” Senior CFTC officials commented that the increasing number of “high quality tips, complaints and referrals” the CFTC receives has led to the Commission bringing important enforcement actions.  According to Christopher Ehrman, Director of the CFTC Whistleblower Office, “this award will send the strong message that the CFTC will pay for information that helps us do our jobs.”

That CFTC statement, however, is unclear as to its meaning or import for market participants.  The CFTC provides no guidance as to: the nature of the violations or the commodity markets involved; the role of the whistleblower in aiding the CFTC’s efforts to investigate and bring an enforcement action (whether formal or informal, although presumably settled successfully); whether the whistleblower reported through internal compliance programs before, or concurrent with, his or her report to the CFTC; or even the amount of the sanctions the CFTC collected as a result of the “original information” concerning Commodity Exchange Act violations that the whistleblower voluntarily provided to the CFTC. Instead, the CFTC’s statement emphasizes its intent to protect the whistleblower’s anonymity, without providing market participants any insight as to the rationale for its award or disclosure regarding the type of behavior that resulted in finding a violation.

This emphasis on whistleblower confidentiality, and the six-figure award, no doubt will spur others to come forward with whistleblower tips for the CFTC. Whether those tips will be the “high-quality” referrals the CFTC seeks remains to be seen.  Instead, by sending a signal that the Whistleblower Program may just be like buying a lottery ticket – you can’t win if you don’t play – the CFTC may find itself inundated with tips. This will be a challenge for an underfunded agency seeking to distinguish valuable original information from simply opportunistic and anonymous tips. 

China Auditor Update: SEC To Hear Appeal of Decision Barring Chinese Auditors

This post was written by Jennifer L. Achilles, Terence Healy, and John Tan.

The Securities and Exchange Commission recently indicated that it would review, de novo, the January 2014 decision barring the Chinese affiliates of the “Big Four” accounting firms from appearing before the SEC.  The Commission’s Order, found here, also granted both parties’ motions to submit additional evidence for consideration – most significantly, the auditors’ evidence that they have given the Chinese regulators the audit work papers of the Chinese companies being investigated by the SEC.

As we wrote earlier here and here, the SEC instituted administrative proceedings in December 2012 against the Chinese affiliates of the accounting firms for willfully refusing to provide audit work papers to U.S. regulators as required under Sarbanes-Oxley.  The accounting firms had argued that complying with this requirement would violate China’s state secrets and archives laws, and subject the firms to civil and criminal penalties.  In January 2014, an Administrative Law Judge at the SEC found the accounting firms’ “good faith” arguments irrelevant to the issue of whether the firms willfully refused to comply with the SEC’s requests, and barred the firms from appearing before the SEC for six months.  Following the ALJ’s decision, both the audit firms and the SEC’s Division of Enforcement petitioned the Commission to review the ALJ decision and allow additional evidence to be submitted.

The Commission’s Order reveals that the audit firms have turned over the audit work papers they had been refusing to produce for years.  Although the firms did not produce the requested documents directly to the U.S. regulators, they gave them to the Chinese regulators who can, if they so choose, turn them over to their U.S. counterparts pursuant to the MOU the countries entered into last summer. 

The audit firms are no doubt hoping that their “better late than never” productions will be seen as evidence that they were acting in good faith when they refused to comply with the SEC’s requests for the documents.  But it will be up to the Commission to decide whether the firms’ motives ultimately matter. 

SEC's Corp Fin Double-Takes on WKSI Waivers

This post was written by Amy J. Greer and Lisa G. Blackburn.

For the second time in as many months, the U.S. Securities and Exchange Commission’s Division of Corporation Finance (“Corp Fin”) has issued a Revised Statement on Well-Known Seasoned Issuer Waivers (“WKSIs”). As we mentioned last month, WKSIs are issuers of securities that can get the benefit of registering their securities offerings on shelf registrations that become automatically effective upon filing, as opposed to having to wait for a Corp Fin review and a declaration that its registration statement has become effective.  Issuers can lose their WKSI status if they become “ineligible issuers” by engaging in certain prohibited conduct, such as being criminally convicted or violating the anti-fraud provisions of the federal securities laws. 

In its March 12, 2014 Revised Statement on Well-Known Seasoned Issuer Waivers, Corp Fin set out factors it would consider in determining whether to grant a waiver where an issuer had engaged in prohibited conduct that could cause it to lose its WKSI status.  Corp Fin expressly put the burden on the issuer to show Corp Fin why a waiver would be in the public interest and for the protection of investors.  In so deciding, Corp Fin said it would particularly consider the nature of the issuer’s violation or conviction.  Specifically, Corp Fin said that it will look at whether the violation was a criminal conviction or scienter-based violation, or a civil or administrative non-scienter-based violation. 

On April 24, 2014, Corp Fin clarified the impact of the type of violation on its decision-making process.  Now, under that clarification, when an issuer seeks a waiver for conduct that falls into the more serious category – a criminal conviction or scienter-based violation – “the issuer's burden to show good cause that a waiver is justified would be significantly greater.” 

While the revision appears small, the import is large.  Corp Fin’s message is that issuers cannot expect to commit intentional violations or crimes on one hand and retain their WKSI benefits on the other.  This guidance is consistent with the many recent strong SEC statements regarding aggressive enforcement and the Commission view that there should be meaningful consequences for securities violations. 


Corp Fin Takes Another Look at WKSI Waivers

This post was written by Amy J. Greer and Lisa G. Blackburn.

The U.S. Securities and Exchange Commission’s Division of Corporation Finance (“Corp Fin”) recently updated its guidance concerning how it will evaluate requests for waivers by Well Known Seasoned Issuers (“WKSI”) who would otherwise become ineligible to be WKSIs under Rule 405 of the Securities Act..  According to Corp Fin, this update is more of a refinement than it is a change to the existing policy.

WKSIs have benefits such as the ability to sell their securities through shelf registration statements that become effective upon filing rather than after Corp Fin review and declaration of effectiveness.  WKSIs cannot be “ineligible issuers” under Rule 405.  A WKSI could lose its status by becoming an “ineligible issuer” under Rule 405 as the result of certain activities, such as violating the anti-fraud provisions of the federal securities laws or a criminal conviction.  A WKSI can request that the Commission waive the ineligible issuer status.  The Commission has delegated that authority to Corp Fin.   An issuer in need of a WKSI waiver must send a request letter to Corp Fin addressing the considerations described below. The issuer bears the burden of establishing that a waiver is justified.  Corp Fin may grant such a waiver if it concludes that the waiver is consistent with the public interest and protection of investors. 

In July 2011, Corp Fin issued guidance on what it considered “good cause” to issue such waivers.  On March 12, 2014, Corp Fin issued a revised statement regarding its evaluation of these waiver requests.  The revised statement refines how the inquiry is articulated and focuses more sharply on who within the organization knew of the offending conduct, the level within the organization of those personnel, and whether red flags were missed or ignored.  In addition, the new guidance considers subsidiaries’ disclosures for the first time.

According to the recent guidance, Corp Fin will consider whether the violation involved a criminal conviction or scienter-based violation; and the nature of the violation or conviction and whether it involved disclosure for which the issuer or its subsidiaries was responsible, or otherwise calls into question the ability of the issuer to produce reliable disclosures.  The following factors also will be considered by Corp Fin, with no single factor being determinative:  (1) who was responsible for the conduct and the duration of the conduct; (2) what remedial steps have been taken; and (3) what would be the impact of a denial of the waiver request.  As to the responsibility factor, Corp Fin will look at the level of personnel involved, whether “red flags” existed, whether such warning signs were ignored, and whether the conduct was recurring or isolated.  Corp Fin will be looking at the “tone at the top” and how that affected the conduct.   Corp Fin will also look at the remedial steps, if any, that have been taken and how they relate specifically to the issuer’s ability to produce reliable disclosures.  Finally, Corp Fin will consider whether the issuer’s loss of WKSI status would be disproportionate to the conduct and how such loss would affect the markets as a whole.

Supreme Court Probes "Midway" Position in Halliburton

This post was written by Sarah WolffAmy Greer and Neil Gray.

The United States Supreme Court yesterday heard oral argument in Halliburton Co. v. Erica P. John Fund, Inc. In that much-watched case, Halliburton asks the Court to overrule the fraud-on-the-market theory of reliance in securities fraud cases established by the Court’s decision in Basic v. Levinson, or, at least, to adopt a modification that would permit defendants in securities class actions to rebut the presumption at the class certification stage. Halliburton contends, among other arguments, that the efficient market hypothesis, which forms the core of the fraud-on-the-market theory, has been widely discredited by academics in the years since Basic, and that the fraud-on-the-market theory is itself inconsistent with the Court’s more recent pronouncements concerning the proofs necessary to obtain class certification. For its part, the Fund argues that the economic principles underpinning the reliance presumption remain valid; defendants are already given the opportunity to rebut the presumption; and, other evidentiary hurdles in place are entirely consistent with the Court’s more recent class action decisions. The case has garnered much interest, as evidenced by the nearly two dozen amicus briefs submitted to the Court, including submissions from current and former members of Congress, former SEC commissioners, industry and advocacy groups, legal scholars, law processors, and the Solicitor General.

It is always a perilous undertaking to “read the tea leaves” of oral argument. That said, a common theme throughout the argument seemed to be the “midway” position (as coined by Justice Kennedy, referring to the position advocated by law professors as amici) — essentially, accepting the continuing validity of the fraud-on-the-market presumption, but requiring plaintiffs to present evidence, at the class certification stage, to demonstrate whether the misrepresentation distorted the market price. Chief Justice Roberts and Justice Kennedy explored the burden of such a requirement on plaintiffs — a concern echoed by the Fund — while Justice Scalia probed the frequency of settlements after class certification as opposed to proceeding to verdict — a seeming nod to the massive pressures placed on defendants as a result of certification. And Justice Ginsburg prodded the Fund on the practical effects of rebutting the presumption at the certification stage versus putting it off to the merits stage. Finally, both Justices Scalia and Kagan expressed interest in congressional action since the Court decided Basic, with Justice Scalia expressing skepticism that Congress’ enactment of the PSLRA and SLUSA was a ratification of the fraud-on-the-market theory, as opposed to an assumption that the courts would continue to adhere to the theory.

Although several Justices — Scalia, Kennedy, Thomas, and Alito — have each previously signaled a willingness to reexamine Basic, whether the Court will adhere to, modify, or altogether overturn Basic remains to be seen. Based on the argument yesterday, as the commentators predicted, it may all come down to Justice Roberts. A decision is expected by early summer. Watch this space . . .

China Auditor Update: After Round One - SEC 1, Auditors 0

This post was written by Terence Healy, Jennifer Achilles, and John Tan

In the first blow to land in the long running dispute between U.S. regulators and the accounting firms that certify the financial statements of China-based companies listed on U.S. exchanges, yesterday an Administrative Law Judge at the Securities and Exchange Commission (“SEC”) issued a decision barring the Chinese affiliates of the “Big Four” accounting firms from appearing before the SEC for a period of six months and censuring the Chinese affiliate of BDO.  This means, quite simply, that the “Big Four’s” Chinese affiliates cannot provide audit services for any U.S.-listed companies during this period, and the affected companies will have to scramble to find new outside auditors.

The ALJ’s decision can be appealed to the full Commission for de novo review.  From there, the respondents can appeal to the D.C. Circuit.  The firms indicated they will appeal.

As we wrote earlier here, the SEC instituted administrative proceedings in December 2012 against these accounting firms for their “willful refusal” to provide audit work papers and other materials to U.S. regulators on demand, as required under Sarbanes-Oxley.  The accounting firms had argued that complying with this requirement would violate China’s state secrets and archives laws, and subject the firms to civil and/or criminal penalties.  These arguments were found to be insufficient to excuse a refusal to comply with U.S. law.

We will continue to follow the developments in this area.  The ultimate outcome of this dispute may be wide scale delisting of China-based companies from U.S. exchanges.

Friends (SEC Edition): The One With No Evidence

This post was written by Amy Greer.

I guess we will see whether SEC Chairman Mary Jo White revisits her decision to try more cases, given the unattractive string of losses that is piling up.  Most recently, a Federal District Judge in the Northern District of Georgia, after a bench trial, found in favor of defendant Ladislav “Larry” Schvacho, who faced insider trading charges. Mr. Schvacho traded in the shares of Comsys, where his very close friend happened to be the Chief Executive Officer. Problem was, the SEC had no evidence to offer except the trading itself and the fact (but not the substance) of a series of telephone calls and contacts between the friends, such contacts being completely in keeping with the men’s usual conduct. Seems these guys routinely kept in close contact by telephone and visited with one another often. Their frequency of communications were not at all unusual and did not change one bit around the time of the trading at issue. In fact, Mr. Schvacho had been trading in his friend’s company for many years, but he had never told him for fear of risking their friendship. According to Mr. Schvacho, he traded because he had confidence in his pal’s skills and because he believed that Comsys, a specialized staffing company, would benefit from the post-recession upswing. Not surprisingly, the court found the evidence completely lacking.

Notwithstanding what we’re seeing these days from U.S. Attorneys’ Offices, aided by wiretaps and cooperating witnesses facing jail time, insider trading allegations are always hard to prove. When I was at the SEC, we knew that bringing some of these cases to trial would be difficult, so we worked hard to get them settled. But you can’t settle them all, and when they don’t settle, judgment about which cases to fight is crucial. You need to have real evidence: documents, emails or text messages, or a tipper or tippee who is willing to testify. Absent that, these cases can’t successfully be tried. Frankly, given the evidence in Schvacho, or the complete lack thereof, it’s hard to believe this case made it through what usually is a pretty rigorous internal Enforcement Division process, much less was authorized by the Commission. If the chairman is looking for more cases to try, the Commission will need to look critically at the quality of the cases it brings, without so much emphasis on quantity.

The Numbers Game

This post was written by Terence Healy and Jeffrey Orenstein.

Yesterday, the Securities and Exchange Commission (“SEC”) released its enforcement statistics for fiscal year 2013, showing the agency filed 686 enforcement actions in the year ending September 30 and collected an impressive $3.4 billion in disgorgement and penalties. Now begins the annual numbers game where commentators – and, ultimately, Congress – take measure of how these statistics reflect on the SEC’s use of its resources over the prior year. These statistics tend to be viewed (wrongly) as a kind of annual report card for the efficacy of the Commission’s enforcement program.

While there will be some clatter as to how the number of actions filed in 2013 was slightly below that of FY 2012, the penalties assessed and the combined penalties and disgorgement were both record numbers. Looking ahead, it will be interesting to see what kind of tempo the SEC’s enforcement program will be able to maintain given some of the Commission’s new stated policies. Mary Jo White has promised to follow both a “broken windows” policy of pursuing even small or technical violations (necessarily requiring additional resources to be devoted to these areas) and a policy of requiring admissions of wrongdoing in certain types of cases – leading to more cases being litigated through trial. The SEC Chairman has also pledged to bring more cases against “gatekeepers” such as accountants and to pursue increased financial fraud cases through a new task force . Financial fraud and “gatekeeper” cases tend to be complex by their very nature and consume large resources to investigate and develop in litigation.

Thus, short of the SEC’s appropriation from Congress increasing markedly, Mary Jo White has pledged to achieve more in her enforcement program, on a dollar-for-dollar basis, than her predecessors. Can this be done? Next year’s “report card” of enforcement statistics may give us some early indication.

The Lawman Cometh: The SEC Adds Deferred Prosecution Agreements to Its Bag of Remedies

This post was written by Terence Healy.

Last week the Securities and Exchange Commission (“SEC”) announced it had entered into its first deferred prosecution agreement (“DPA”) with an individual.  The announcement is interesting for two reasons.  It reflects the increasing tone of law enforcement the Commission is taking in its enforcement proceedings, and it raises the question (as with so many SEC settlements) as to what the defendant is really gaining by falling on his sword rather than challenging the allegations on the merits.

The case arose from a fraud at the Connecticut hedge fund Heppelwhite Fund, LP (the founder of which, Berton Hochfeld, was criminally convicted earlier this year).  The SEC entered into a DPA with Scott Herckis, the former administrator of the fund and the person who first reported the wrongful conduct to the government.  Herckis, a CPA, had no experience as a fund administrator prior to working with Heppelwhite.  At Hochfeld’s direction, he transferred monies from a capital account to personal accounts under Hochfeld’s control.  Over time, these transfers led to Hochfeld’s capital account having a negative balance.  When Herckis raised this issue, Hochfeld reassured him he would pay the funds back.  Herckis also discovered a discrepancy between the net asset value ("NAV") of the fund between its internal reporting and that of its prime broker.  To resolve this discrepancy, Herckis hired an outside consultant to examine the issue.  Herckis eventually resigned as administrator and then contacted government authorities. In other circles, he might rightfully be called a whistleblower.

By entering into a DPA, the Commission is striking the posture of a law enforcement agency – the tough “cop on the beat” that Mary Jo White promised Congress.  Deferred prosecution agreements are a common tool in criminal law, but generally have not been used in civil proceedings (the SEC’s first DPA with an entity was only entered in 2011).  The fact that these agreements went seemingly undiscovered for nearly 80 years by every former Commission and Enforcement Director suggests they may be out of place in a civil enforcement agency.  (Even the use of the word “prosecution” is somewhat strained in a civil context.)

The DPA is also striking for the nature of the underlying settlement.  Herckis agreed to pay a significant figure of “disgorgement,” even though none of the monies he received as fund administrator could rightly be called ill-gotten.  He also agreed to a five-year bar from the securities industry, and to the significant limitations and reporting requirements of the DPA itself.  In short, even though no penalty was assessed, he consented to relief that was every bit as onerous, if not more so, than if he litigated his case and lost.  He also gave up the chance to defend his conduct, which seemed at most negligent, and claim the mantle of whistleblower. 

As with the SEC’s new penchant for requiring admissions in settlements, we will have to wait and see the extent to which DPAs become a common fixture in the civil enforcement landscape. 

Bold and Unrelenting: Six Months In

This post was written by Terence Healy and Amy J. Greer.

Mary Jo White promised Congress she would pursue a “bold and unrelenting” enforcement program as chairman of the Securities and Exchange Commission (“SEC”). Six months into her tenure, we should take her at her word. In public remarks this week, White reiterated her desire for the Enforcement Division “to be everywhere” and to be “felt and feared” in areas beyond where its resources can reach.

Perhaps the best example of this more-is-better approach to enforcement is the move away from the Commission’s traditional “neither admit nor deny” settlement policy. This practice – born out of a 1972 rulemaking – had been consistently followed by the Commission (and other federal agencies) for decades. But in 2012, responding to criticism from at least one federal judge, the Commission changed this policy as it applied to parties that had admitted or been found guilty in related criminal proceedings. In September, White announced she would seek admissions of wrongdoing in certain cases even where there had been no findings of guilt in related proceedings.

Recent settlements with financial institutions such as Harbinger Capital Partners, in which the parties made limited admission of wrongdoing, demonstrate the Commission means what it says in seeking admissions in certain cases. But the standard for when the Commission may seek such admissions remains unclear. In recent public statements, White indicated she would seek admissions where the conduct was “egregious” or where it posed “significant risk” to investors, or where necessary to send “an important message.” These stated reasons, though sound, hardly provide a clear standard to apply to future matters.

Only time will tell whether this new policy – with all its impractical consequences – can be applied in any but the most rare of cases. Then we will know more about the true meaning of “bold and unrelenting” from the new SEC.

CFTC Enforcement Division Drops 'Absent Objection' Investigatory Orders

This post was written by Sarah R. Wolff, Patricia Dondanville, and James A. Rolfes.

In a reversal of course, the Commodities Futures Trading Commission’s Division of Enforcement has confirmed that it will no longer pursue omnibus orders of investigation by means of an “absent objection” procedure, and instead will seek Commission approval before extending such orders.

Last month, CFTC Commissioner Scott O’Malia issued a sharply worded objection to the Division’s use of the procedure. Commissioner O’Malia warned that, by using the “absent objection” process, the Enforcement Division could initiate and extend a broadly scoped examination indefinitely, and avoid a full Commission discussion and review of the legal and factual basis for the investigation. (See RS Client Alert: “CFTC Takes an Aggressive Enforcement Tack”) “It is imperative for the Commission to issue formal orders of investigation that are consistent with Congressional intent and that reflect the Commission’s collective opinion, based upon each Commissioner’s independent review of the merits of each request to authorize or extend investigations,” O’Malia said.  

Seeking the omnibus order of investigation via such an absent objection procedure was one indication of the more aggressive enforcement stance the CFTC has taken since the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010. Its retreat from this practice signals that the CFTC will follow a more deliberative investigatory approach, where the Commissioners take an active role in assessing the legal and factual basis for bringing an investigation, controlling the scope of the investigation, and considering the potentially significant ramifications of exercising the Commission’s new enforcement authority. That said, when responding to the Enforcement Division’s announcement, Commissioner O’Malia reiterated his support of the Division’s efforts to “promptly and effectively investigate potential violations of the Commodity Exchange Act,” and promised to act swiftly when considering Enforcement Division investigatory requests.

The SEC Brings Charges Against 'Gatekeeper' Accountants

This post was written by James A. Rolfes.

In a “crackdown” on the “gatekeepers” who put investors at risk when they fail to uncover financial statement fraud and misstatements, the Securities and Exchange Commission this week highlighted the work of “Operation Broken Gate” when it announced the filing of several proceedings against certified public accountants and their firms. Just three months ago, the SEC made headlines with the formation of its Financial Reporting and Audit Task Force, a move many categorized as nothing more than a reformatted articulation of Enforcement Division’s various historical initiatives to address financial statement-based securities violations. The filing of these proceedings, however, serves as the initial manifestation of the SEC’s refocused efforts to target accounting matters, and is perhaps a harbinger of the aggressive enforcement proceedings to come.

While no doubt the proceedings announced September 30, 2013, have been the subject of SEC investigations for some time, the SEC’s revelation of “Operation Broken Gate” follows shortly upon the July 2, 2013 SEC announcement of the Financial Reporting and Audit Task Force and the Commission’s intent to dedicate resources to detecting fraudulent or improper financial reporting. According to the SEC, this task force will “concentrate on expanding and strengthening the Division of Enforcement’s efforts to identify securities law violations relating to the preparation of financial statements, issuer reporting and disclosure, and audit failures.” Further, the SEC plans to use technology-based tools, such as the Accounting Quality Model, to identify potential investigatory targets, conduct street sweeps in particular industries and accounting areas, and rely on the increased number of accounting-related whistleblower reports the SEC has received in the past couple of years. All of this suggests increased regulatory scrutiny of accountants and auditors, and inevitably, increased enforcement activity directed at accountants, an objective reiterated by Andrew Ceresney, the co-director of the SEC’s Enforcement Division, in mid-September.

The proceedings filed Monday are in this vein. Three of the matters arose from the work of an SEC task force internally dubbed “Operation Broken Gate” – i.e., matters the SEC stated arose from “the agency’s ongoing efforts to hold gatekeepers accountable for the important roles they play in the securities industry.” This “gatekeeper” reference recognizes that the federal securities laws explicitly require public companies to obtain independent audits conducted in accordance with professional standards, and the public’s reliance on such auditors to assure that public companies disclose accurate financial information.

As alleged by the SEC, the work of Malcolm Pollard, John Kinross-Kennedy and Wilfred Hanson, and the accounting firms through which they conducted their audits, deviated markedly from the professional standards. The SEC claimed that each of these individuals on numerous engagements failed to conduct their audits in accordance with the audit standards set by the Public Company Accounting Oversight Board (PCAOB). The “repeated instances of unreasonable conduct” underlying the charged violations included failures to obtain management representations; maintain adequate work papers; consider and document fraud evidence; or obtain engagement quality reviews, or have the experience necessary to conduct such reviews. The SEC also cited these auditors for not investigating evidence of illegal activity, not reporting that evidence to the appropriate level of management, failing to employ appropriate and timely audit checklists and guides, and lacking recent and relevant audit or accounting experience. Two of these accountants, without either admitting or denying the charges, settled with the SEC and agreed to five-year bans from practicing before the Commission and, in one instance, a $30,000 fine. For the third, the SEC is seeking similar relief in a proceeding before an SEC administrative law judge.

On September 30, 2013, the SEC also announced that it had charged a New Jersey-based accounting firm, and one of its founding members, in connection with the “botched audits of a China-based company that failed to disclose related party transactions.” According to the SEC allegations, the firm of Patrizio & Zhao LLC and John Zhao failed to consider the client’s limited operating history and the lack of employees knowledgeable about U.S. accounting when planning and conducting their audits. The auditor also ignored “red flags” that suggested the client had failed to report related party transactions – i.e., the auditors’ discovery of numerous related parties and related party transactions the client neither identified nor disclosed. The SEC further cited the audit team for placing improper reliance on management representations, failing to obtain competent evidential matter, and failing to prepare adequate audit documentation. Such “repeated instances of unreasonable conduct indicating a lack of competence” justified censure under Commission Rule of Practice 102(e)(1)(ii), as well as a finding that the accounting firm and its founding member caused the client’s primary violation of the securities laws. Both the accounting firm and Zhao agreed to settle with the SEC (without admitting or denying the charges), and received three-year bans from practicing before the Commission. The SEC further assessed the accounting firm with a $30,000 fine.

Granted, the SEC brought these actions based on apparent egregious auditing deficiencies against small accounting firms that lacked personnel with appropriate experience, and thus perhaps have less predictive value as to whether the SEC will bring similar claims against larger accounting firms or the accountants at more established public companies. But the language used to describe the cases, the reference to the dedicate task force and SEC-reiterated intent to target those “gatekeepers” who permit the issuance of misstated financial statements, all suggest that accountants and auditors associated with public companies will face even greater scrutiny in the near future.

CFTC Finds Violation of Dodd-Frank's Spoofing Prohibitions

This post was written by James A. Rolfes.

As part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress amended the Commodities Exchange Act (CME) to add a new section of Prohibited Transactions entitled “Disruptive Practices.” Those prohibited practices include any trading “commonly known as ‘spoofing,’” i.e., to conduct bid or offer activity for any product traded on a Designated Contract Market (DCM) or Swap Exchange Facility (SEF) with the intent to cancel the bid or offer before execution. According to CFTC, bids or offers designed to overload a quotation system, delay another person’s trade execution, give the appearance of false market depth, or create artificial price movements, unlawfully disrupt fair and equitable trading and are, therefore, unlawful.

On July 22, 2013, the CFTC entered its first order finding a violation of the anti-spoofing provision. In that order, the CFTC found that Panther Energy Trading LLC and its owner, Michael J. Coscia, placed algorithmic bids and offers in 18 futures contracts on the CME Group’s electronic trading platform that they intended to cancel prior to execution. As the CFTC further stated, by placing large buy-and-sell orders they had no intention of executing, Panther Energy and Coscia sought to give the market the impression that there was significant market interest in the futures contracts. The subsequent market price movement in reaction to these orders allowed Panther Energy to profit on the relatively small counter bids and offers it simultaneously executed at the time it placed, and then canceled, its large orders, amassing a $1.4 million net profit in a little more than two months. As a result of this violation, the CFTC assessed a $1.4 million civil money penalty, ordered disgorgement of the $1.4 million profit, and issued a one-year trading ban against Panther Energy and Coscia. In a press release, the CFTC further noted that the United Kingdom’s Financial Conduct Authority – with whom the CFTC cooperated in investigating the spoofing activity – imposed a penalty of approximately $900,000 against Coscia, relating to similar market-abuse activities on the ICE Futures Europe exchange.

The order in the Panther Energy Trading matter comes amidst several other high-profile CFTC enforcement actions. Consistent with CFTC Enforcement Director David Meister's expressed desire to “bring high-impact cases that [can] influence market behavior,” the CFTC recently has undertaken significant enforcement actions against marquee respondents such as, for example, the multi-billion-dollar enforcement action against several multi-national banks for an alleged manipulation of LIBOR, as well as the June 2013 action against former New Jersey Governor Jon Corzine for the alleged misuse of nearly 1 billion dollars in customer funds. As Enforcement Director Meister has further commented, the additional powers the Dodd-Frank legislation gave the CFTC have "changed the game" by broadening the CFTC’s jurisdiction, expanding reporting requirements, prohibiting additional trading practices, and easing intent requirements for proving certain CEA violations. As the recent CFTC actions demonstrate, the agency is intent on using these powers.

U.S. District Court Vacates SEC's Rule Requiring Public Disclosure of Energy Companies' Payments to Foreign Governments

This post was written by Jennifer L. Achilles and Brandon D. Cunningham.

On July 2, 2013, the U.S. District Court for the District of Columbia vacated a rule promulgated by the Securities and Exchange Commission (“SEC”) that would have required energy companies to publicly disclose payments to U.S. and foreign governments in connection with the commercial development of oil, natural gas, or minerals. The American Petroleum Institute (the “API”), the national trade association representing the oil and gas industry, challenged the rule under the First Amendment and the Administrative Procedure Act (“APA”). In a 30-page Memorandum Opinion, found here, Judge John D. Bates decided the issue in favor of the API, holding that the SEC had “misread the statute to mandate public disclosure of the reports.”

The statute in question is the Dodd-Frank Act’s section 13(q), which directs the SEC to promulgate a rule requiring companies listed on a U.S. stock exchange and engaged in commercial resource extraction to “include in an annual report … any payment made … to a foreign government or the [U.S.] Government for the purpose of the commercial development of oil, natural gas, or minerals.” In September 2012, largely ignoring the comments from the companies affected by section 13(q), the SEC promulgated a final rule requiring public disclosure of payments to foreign and U.S. governments, even where the foreign country’s laws prohibit such disclosure. Without reaching the constitutional issue, the court rejected the SEC’s interpretation of the statute, and found fault with the fact that the SEC declined to adopt an exemption for foreign law prohibitions. Clearly siding with the API, the court noted that, “given the proportion of the burdens on competition and investors associated with this single decision, a fuller analysis [is] warranted.”

The ball is now back in the SEC’s court to promulgate a different rule pursuant to section 13(q), and it remains to be seen whether the new rule will be any less onerous for energy companies. The Commission previously acknowledged that public disclosure of payments to government entities would burden competition and harm investors. If the SEC had viewed itself as powerless to address that harm because of its interpretation of Congress’s mandate, this recent decision may clear the way for a new rule requiring only confidential disclosure to the SEC. If, however, the SEC continues to take an aggressive stance, it could re-promulgate an identical rule pursuant to its own discretionary authority and supported by a better explanation for its refusal to allow exemptions. Alternatively, it could decide to redraft the rule to provide exemptions for the foreign countries with conflicting laws.

Déjà Vu All Over Again? SEC Announces More Specialized Initiatives

This post was written by Amy J. Greer and Terence Healy.

After several weeks of anticipation, the SEC's Division of Enforcement announced July 2 three new special initiatives: a Microcap Fraud Task Force, a Financial Reporting and Audit Task Force, and a Center for Risk and Quantitative Analytics. These new groups are in addition to the five Specialized Units announced in 2010, shortly after the last leadership change at the top of the Division. Those units – Market Abuse, Structured and New Products, Asset Management, Municipal Securities, and Foreign Corrupt Practices Act – have been something of a mixed bag, dividing personnel between offices and creating strange reporting lines. The existence of specialty units has also put pressure on the SEC staff to bring a higher volume of cases, and more matters, in those areas (with mixed results).

This time around should be a little easier.

Finding microcap fraud is like shooting fish in a barrel. The question really will be whether the staff will actually start targeting the recidivists who prey on investors in this area. Maybe those "obey-the-law" injunctions will finally get put to some use and we will even see some contempt cases. That would be something really new!

Getting people to work together – between Enforcement, Corp Fin, and the various Chief Accountants' Offices – could very well improve the SEC's monitoring of disclosures and offer Enforcement a look into "the next big thing" in financial reporting, which often happens in the Corp Fin comment process.

Finally, it is not a surprise that the Deputy from Market Intelligence is heading up the Center for Risk and Quantitative Analytics (or CRQA – finally, an unpronounceable acronym – we can look forward to what that becomes). The Market Intelligence and the Market Abuse Unit have been singularly successful at actually using technology, which the agency needs to harness and develop in order to actually identify threats to investors and the markets. The Enforcement Division has been talking about risk-based approaches for years, with varying degrees of commitment. Maybe this time it will stick.

Will the Third Time be the Charm for FINRA's New Supervision Rules?

This post was written by Daniel Z. Herbst.

After two unsuccessful attempts to implement consolidated supervisory rules, the Financial Industry Regulatory Authority, Inc. (FINRA), on June 21, 2013, filed with the Securities and Exchange Commission (SEC) a long-anticipated notice of proposed Rules 3110 (Supervision) and 3120 (Supervisory Control System). The proposed rules would replace and consolidate several pre-existing supervisory rules, and would significantly impact the scope of a supervisor’s duties.

FINRA’s two prior attempts at supervisory rules crashed and burned. In 2008, FINRA first published proposed supervision rules and requested comment. After generally negative comments from the industry, FINRA declined to implement the proposed rules. In 2011, FINRA again proposed consolidated rules that sought to address the comments made in the 2008 filing. Amid a flurry of comments criticizing the proposed expansion of supervisory scope and regulatory authority to include “non-securities activities,” FINRA withdrew the 2011 proposal. FINRA’s third rule proposal attempts to address several of the criticisms levied on the prior two notices, while maintaining the fundamental supervisory structures outlined in the prior notices.

The hot-button scope of the supervision issue remains a moving target in the new proposal. In response to comments from 2011, the proposal removed heavily criticized language about the supervision of “non-securities activities” as well as “all business lines.” On the other hand, the proposal rejected a comment proposing limits to the scope of supervision solely to “securities activities.” Instead, the notice leaves the door open to regulatory interpretation by outlining the scope of supervision by referring to FINRA’s Rule 2010 standard of “just and equitable principles of trade.”

The SEC has yet to open up the rules for comment, but the public likely will soon have an opportunity to weigh in on FINRA’s third supervisory rule proposal.


Research and drafting assistance for this post was provided by Reed Smith Summer Associate Paula A. Salamoun.

Third Time Is the Charm for Auditor Seeking Dismissal of Securities Fraud Case

This post was written by Terence Healy, Jennifer L. Achilles and Jill Ottenberg.

On April 8, 2013, District Judge Shira Scheindlin (S.D.N.Y.) dismissed Deloitte Touche Tohmatsu CPA Ltd. (“Deloitte”) from a securities fraud class action brought by investors in Longtop Financial Technologies, Ltd. (“Longtop”), a Chinese company which was delisted from the NYSE in 2011. The plaintiffs alleged auditing giant Deloitte committed securities fraud by issuing unqualified audit opinions during a time when Longtop was engaged in pervasive accounting fraud. Deloitte approved Longtop’s financials even though it had identified risk factors within the company and was otherwise aware of “red flags” suggesting potential fraud. 

In a 70-page opinion found here, Judge Scheindlin reiterated the high bar for pleading securities fraud against auditors. The court clarified that an auditor’s failure to uncover problems with a company’s internal controls and accounting practices does not constitute recklessness. To plead recklessness under the securities laws, a complaint must allege facts that approximate an actual intent to aid in the fraud perpetrated by the company, or that support an inference that the accounting practices were so deficient that the audit conducted amounted to no audit at all. The court found the theory of liability against Deloitte – that, in effect, it had identified risk factors at a company that was later discovered to have engaged in fraud – was “tainted by hindsight.” The court warned of the harmful policy implications for allowing fraud claims on that basis.

The decision, coming after two earlier attempts to have the case dismissed, is a big win for Deloitte – and will come in handy for other firms seeking to challenge claims of securities fraud related to the audits they conduct. The dismissal will also allow Deloitte to avoid some of the thorny discovery issues that arise when adversaries seek documents and workpapers from China.

The case is In re Longtop Financial Technologies Limited Securities Litigation, Case No. 11-cv-3658 (SAS) (U.S.D.C. S.D.N.Y.).

E&Y "State Secrets" Case Kicks Off in Hong Kong - But a Long Way to Go

This post was written by Joan Hon and Veronica Siwang To.

Evidence kicked off last week in the highly anticipated case brought by Hong Kong's Securities and Futures Commission ("SFC") against Ernst & Young Hong Kong ("E&Y") over its failure to adequately respond to statutory requests for information in relation to an SFC investigation of the failed 2009 IPO of Chinese waste management company, Standard Water Limited ("Standard Water").1 A copy of the SFC’s August 2012 originating summons can be found here.

In 2010, the SFC issued formal notices to E&Y seeking the working papers and underlying accounting documents relating to Standard Water’s pre-IPO audit. With respect to several notices, E&Y claimed that it did not possess the relevant records, as they were held in the Mainland by its PRC joint venture partner, Ernst & Young Hua Ming ("Hua Ming"), whose staff was principally involved in the audit. Furthermore, E&Y claimed that PRC law, including China's state secrets and archives law, prohibited it from producing the requested documents.

This case is obviously being closely watched by the Hong Kong accounting community, which frequently comes up against these restrictive Chinese laws, and the Securities and Exchange Commission (“SEC”) has taken up a similar case in the U.S. Unfortunately, not only is a Hong Kong decision not expected to be issued until some time in 2014, but based on the SFC’s emphasis on possession and control, it is possible that such decision would be unlikely to resolve the fundamental conflict between PRC’s restrictive laws governing production of documents and information to foreign regulators and Hong Kong law and the SFC’s statutory power to require parties to produce information.

For a more detailed analysis, click here to read the issued Client Alert.

1 E&Y withdrew its engagement from Standard Water after finding certain undisclosed inconsistencies.

SEC Order Emphasizes Need to Follow Disclosed Valuation Method when Valuing Private Equity Fund

This post was written by James A. Rolfes.

Expressing its concern that “the current difficult fundraising environment … can incentivize private equity managers to artificially inflate valuations,” the Securities and Exchange Commission emphasized the need for private equity firms to “implement policies and procedures to ensure that investors receive performance data derived from the disclosed valuation methodology.” Failing to follow articulated valuation methodology – and having compliance personnel ensure the use of such disclosed valuation policies and procedures – can subject a private equity fund to substantial disgorgement, civil penalties and multi-year oversight of its valuation policies and procedures, as one private equity firm found out this week.

On March 11, 2013, the SEC issued an order that charged a private equity fund manager with violations of the Securities Act of 1933 and the Investment Advisors Act of 1940 because of its failure to follow disclosed valuation policies when preparing marketing materials and quarterly reports disseminated to prospective and existing investors. According to the order the SEC issued, the managers of a private equity fund that itself invested in other private equity funds, had a disclosed policy of valuing assets “based on the underlying managers’ estimated values.” The managers, however, valued their fund’s largest asset using a methodology that differed from that employed by the underlying manager – a switch that led to an internal rate of return mark-up increase from approximately 3.8 percent to 38.3 percent. But “[n]o one told investors and prospective investors that the reported increase in [the private equity fund’s] performance was a result of the Portfolio Manager’s change in valuation method and that, if [the private equity fund] had used [the underlying manager’s] value, as [the private equity fund] had done in the past and as was stated in the quarterly statements and pitch books, the performance numbers would have been materially lower.”

The SEC further criticized the private equity fund managers for failing to have compliance personnel review the portfolio manager’s valuations to ensure such valuations were determined in a manner consistent with written representations. In particular, the SEC found that the managers’ “failure to adopt and implement written policies and procedures” for such a compliance review allowed the dissemination of misrepresentations and omissions that attributed increased value to performance rather than to a changed valuation method, wrongly sourced the valuation write-up to a third-party valuation firm, and falsely disclosed that an independent auditor had audited the underlying funds. As a result, the SEC ordered the private equity fund managers to disgorge $2.27 million to investors, pay penalties of approximately $750,000, and engage an independent consultant to review its valuation policies and procedures; and insure for a period of two years that the private equity fund managers follow adequate valuation policies and procedures.

"Know Your Customer" No More? The SEC Signals a Uniform Fiduciary Standard May Be Coming for Broker-Dealers and Investment Advisers

 This post was written by Terence Healy and Daniel Herbst.

On March 1, 2013, the Securities and Exchange Commission ("SEC") published a sweeping request for comments that may determine whether a uniform fiduciary standard will be required for all broker-dealers and investment advisers providing services to retail customers. 

Under the present regime, registered investment advisers ("RIAs") are subject to fiduciary duties of care to their customers under the Investment Advisers Act, while broker-dealers are held to lower standards under the Exchange Act and the rules of any self-regulatory organization ("SRO") in which they are registered. The Financial Industry Regulatory Authority ("FINRA") requires brokers only to "know your customers" and make suitable recommendations. 

Dodd-Frank required the SEC to study the effectiveness of the standards of care for broker-dealers and RIAs that provide investment advice to retail customers. The statute authorized, but did not require, the SEC to develop rules that would align the different standards for brokers and RIAs. An SEC internal staff study found the lines between full-service broker-dealers and investment advisers had blurred, and recommended that the two regulatory schemes be harmonized and a uniform fiduciary standard of conduct be adopted.

The SEC’s request for comments suggests a uniform federal fiduciary standard may be coming. If such a standard is implemented, brokers-dealers could expect heightened disclosure obligations and increased scrutiny of their investment recommendations to retail customers. RIAs could similarly see changes in their disclosure obligations as the rules are "harmonized." Those who will be affected by a uniform fiduciary standard should weigh in now. The comment period closes in 120 days.

Supreme Court Hands Plaintiff's Securities Class Action Bar A Win

This post was written by Sarah R. Wolff and Thomas M. Levinson.

In its ruling on February 27, in Amgen, Inc. v. Connecticut Retirement Plans & Trust Funds (No. 11-1085), the first of several highly anticipated class action decisions this term, the Supreme Court, in a 6-3 opinion written by Justice Ruth Bader Ginsburg, held that securities fraud plaintiffs need not prove that allegedly misleading statements are material in order to obtain class certification. Ruling in favor of plaintiff Connecticut Retirement Plans and Trust Funds, the Court affirmed the Ninth Circuit, which had held that materiality is a merits question that should not be considered when a court is deciding whether to certify a class. 660 F.3d 1170 (9th Cir. 2011). The Court’s ruling means that a securities fraud plaintiff is obligated to plausibly allege – but not to prove – materiality in order to certify a class under Federal Rule of Civil Procedure 23(b)(3). As the Court put it, “Amgen . . . would have us put the cart before the horse.” The Court went on to explain, “to gain certification under Rule 23(b)(3), [Amgen argues], Connecticut Retirement must first establish that it will win the fray. But the office of a Rule 23(b)(3) certification ruling is not to adjudicate the case; rather, it is to select the ‘metho[d]’ best suited to adjudication of the controversy ‘fairly and efficiently’.” 568 U.S. ____, _____ (2013) (slip op., at 3). The Court found that Amgen’s position would require mini-trials on the issue of materiality at the class certification stage, a preliminary form of adjudication unanticipated in the Federal Rules.

For a more detailed analysis, please click here to read the issued Client Alert.

The Death of Class Actions? A FINRA Panel Ruling Could Signal the End of Class Claims against Brokers

This post was written by Terence Healy and Daniel Herbst.

A recent ruling by a hearing panel of the Financial Industry Regulatory Authority (“FINRA”) could provide a path to effectively kill customer class actions against brokers. On February 21, a FINRA panel upheld an arbitration clause in a Charles Schwab and Co. customer agreement which requires all disputes be brought in a FINRA-run arbitration forum. FINRA does not allow class-action claims in its arbitration system, so the arbitration clause effectively precludes customers from pursuing class action claims in court.

Schwab was an industry frontrunner when it amended its customer agreements to include a mandatory arbitration clause in 2010. At the time, other firms were not using arbitration clauses like Schwab’s because the clause was in direct contravention to FINRA’s rules and guidance on customer agreements. FINRA brought an enforcement arbitration action against Schwab challenging the waiver and seeking penalties.

In a 48 page ruling, the hearing panel found the Federal Arbitration Act (“FAA”) trumps FINRA's enforcement of its rules. The panel relied on the Supreme Court's decision in AT&T Mobility v. Concepcion, 131 S. Ct. 1740, 563 U.S. ______(2011), which held that state laws that prohibit contracts from disallowing class-wide arbitration were preempted by the FAA. FINRA has already announced its decision to appeal the ruling. The industry will be watching closely to see the outcome. If the ruling stands, it could signal the beginning of the end of customer class actions against brokerages.

Down goes Frazier!... The SEC Takes It on the Chin in Supreme Court Fight to Maintain "Discovery Rule" in Enforcement Actions

This post was written by Terence Healy.

The discovery rule is no more. The Supreme Court today issued its decision in Gabelli v. SEC, 568 U. S. ____ (2013), and held the five-year limitations period under 28 U.S.C. § 2462 runs from the date of the underlying violation, and not from when the government reasonably should have discovered the wrongful act. The Securities and Exchange Commission (“SEC”) had long maintained that, in civil enforcement proceedings, the time within which it could initiate actions seeking penalties did not begin to run until the fraud was discovered. After all, the Commission argued, fraud is deceptive by nature, and the law had long recognized a discovery rule as an exception for suits based on fraud.

Gabelli turned on the reading of 28 U.S.C. § 2462, a catch-all limitations statute tracing its roots in the law back to 1799. The statute provides the government must commence any “proceeding for the enforcement of any civil fine, penalty, or forfeiture” within five years from time “when the claims first accrued.” 28 U.S.C. § 2462. In rejecting a reading of a “discovery rule” into § 2462, the Court held that under “the most natural reading of the statute… the five-year clock begins to tick” when the fraud occurs. “In common parlance a right accrues when it comes into existence.” The Court found limiting the government’s ability to bring claims beyond the five-year window also advanced the basic policies of all limitations periods; namely, elimination of stale claims and certainty as to a party’s right to recovery or potential liability.

The Court distinguished cases where a “discovery rule” was used to protect victims of fraud, who often had no reason to know they had been defrauded. The Court noted that the SEC’s very purpose is to root out fraud, and it has been given significant tools to achieve that goal.

Now, with the limitations issue made clear, the SEC’s Division of Enforcement will be under increased pressure to conclude investigations and make charging decisions in a timely manner. If this leads the Commission to better allocate its limited resources – and better exercise its discretion with respect to the individuals and companies it charges – the decision from the Court today may not be such a bad thing…

SEC Better Fasten Those Seat Belts, Looks Like A Bumpy Ride

This post was written by Amy J. Greer.

As the securities enforcement world awaits the U.S. Court of Appeals for the Second Circuit’s decision in the SEC v. Citigroup matter – where Judge Jed Rakoff balked at the Commission’s “neither admit nor deny” policy and refused to approve a settlement for lack of evidentiary support – it now appears the SEC may face increased scrutiny in its litigation practices, regardless of how the Court of Appeals rules. Just last month, another federal judge, this time in Colorado, refused to accept a settlement until the defendant, essentially, admits that the allegations against him are true.

But that might not be the worst of it – the SEC now may have to justify not just a litigation policy but also its own internal practices. In SEC v. Kovzan, the SEC has charged a CFO for his company’s failure to disclose as income certain perks paid to the then-CEO, among them commuting expenses, from the CEO’s home to the corporate headquarters, to the tune of $1.18 million over six years. Kovzan has argued that there was nothing improper about his conduct. And, as support for his position, he sought, and the Magistrate Judge has now ordered produced, the SEC’s own documents and records concerning its practice of reimbursing its officials for travel and lodging when they live in one location but work at an SEC office elsewhere. Ouch. Appropriate or not, you can just hear the gavel at the Congressional hearing as this stuff gets aired.

This is the second time that Mr. Kovzan has sought and been granted the right to receive non-public SEC documents, which he claims are relevant to his defense. Back in October 2012, the District Judge in the case, overruling the Magistrate Judge’s order, granted the defense the right to internal SEC documents relating to the SEC Staff’s decision-making and guidance on Regulation S-K, Item 402, which relates to executive compensation reporting.

So, it appears that even if the Second Circuit hands the SEC a victory, the agency seems to be facing a changed litigation landscape. Defendants are always willing to take shots at the Commission, but these days, the courts seem less willing to block those shots.

Industry Gives Chilly Response to FINRA's Proposed Recruitment Compensation Disclosure Rule

This post was written by Daniel Z. Herbst.

With just a few weeks remaining until the close of the comment period (ending March 5, 2013), the brokerage industry nearly uniformly has given a chilly reception to FINRA’s proposal to require disclosure of broker recruiting incentives to customers when an individual broker is recruited to a new firm. FINRA’s Regulatory Notice 13-02 proposes mandatory disclosures to customers of the details of “enhanced compensation” packages offered by firms to recruit brokers at the time of first contact following a broker’s departure, and in writing with account transfer documentation. “Enhanced compensation” includes the typical recruitment packages brokerage firms provide to entice brokers to move to new firms, such as signing bonuses, upfront or back-end bonuses, loans, accelerated payouts, transition assistance, and similar arrangements. The proposed rule does not require disclosure of “enhanced compensation” of less than $50,000 and to certain institutional investors.

The proposal elicited strong and decidedly negative reaction from the industry. Some comments raised concerns about adding to the avalanche of regulation and disclosure requirements. Others noted that disclosures of these packages may be too complex or immaterial to the majority of customers. Another suggested that the proposal is anti-competitive and will harm brokers’ ability to freely switch firms. A comment from The Securities Industry Professional Association raised the specter that unscrupulous customers could take advantage of disclosures by seeking a cut of the broker’s enhanced compensation. See SIPA Comment here.

The proposal continues FINRA’s trend toward expansive implementation of fiduciary-based disclosure requirements for brokers. It is unclear the extent to which implementation of the rule will affect competition for talent, or if it will have the effect of "evening the playing field” between the largest wirehouses, which typically offer the largest recruiting packages, and their smaller competitors. If fully implemented – as appears likely – the Rule could have a profound effect on the way firms offer recruiting incentives, and on the free movement of brokers between firms. Certainly, it will make for some very interesting and delicate calls between departing brokers and their customers.

Member firms that utilize enhanced compensation for their recruiting efforts should consider the FINRA’s proposed rule and its potential implications.


The Clock Is Ticking for the SEC... (Or Is It?)

This post was written by Terence Healy.

The Supreme Court heard oral argument this morning in a case addressing the time within which the Securities and Exchange Commission (“SEC”) can initiate an action seeking civil penalties for violations of the federal securities laws. In Gabelli v. SEC, the Court considered whether the “catch all” five-year limitations period under 28 U.S.C. § 2462 runs from the date of the underlying violation or from when the government reasonably should have discovered the wrongful act. The statute – which traces its roots in the law back to 1799 – provides that the government must commence any “proceeding for the enforcement of any civil fine, penalty, or forfeiture” within five years from the time “when the claims first accrued.” 28 U.S.C. § 2462. The SEC argued – and the Second Circuit agreed below – that in cases of fraud, which involve deception by nature, a claim does not accrue until the government reasonably should have discovered the fraudulent conduct. The SEC maintained the law has long recognized the discovery rule as a "historical exception for suits based on fraud." See TRW Inc. v. Andrews, 534 U.S. 19, 37 (2001) (Scalia, J., concurring).

At the argument today, Assistant Solicitor General Jeffrey Wall encountered a hot bench in arguing  that a broad “discovery rule” should be read into a 200-year-old statute. The justices characterized penalties as “quasi-criminal” and distinguished cases finding that a “discovery rule” applied to actions seeking recovery of lost money or property. The government conceded in argument that, for criminal penalties, limitations periods run from the date of violation.

The Court challenged the government to cite any prior cases where a discovery rule was found to apply to an action seeking penalties. On two occasions, Mr. Wall responded that there were not really any cases “on either side of the ledger.” Given the age of the statute at issue, the justices were not satisfied. Justice Kagan asked, “Why is it that you don't have any cases? … This is an old statute.” Justice Breyer pressed the issue, at one point stating, “I will give you 30 seconds to cite me one case. Otherwise, I am going to assume there are none.” Justice Scalia added, “Fraud is nothing new. This has been around for 200 years for Pete’s sake.”

If the Court finds against the SEC and reverses the Second Circuit, the SEC will be under increased pressure to conclude its investigations in a timely manner (something for which the Enforcement Division has not always shown great skill). This is particularly true given that some federal courts have found “penalties” to include such non-monetary relief as professional bars and injunctions against future violations of the law. See SEC v. Johnson, 87 F.3d 484 (D.C. Cir. 1996).

The case is Gabelli v. SEC, Supreme Court Case No. 11-1274. A decision is expected in June.

Sorry Bill W., But Nothing's Secret Any More . . .

This post was written by Amy J. Greer, Terence Healy, and Lisa G. Blackburn.

A recent insider trading prosecution has shown once again that, when you are an officer of a public company with material nonpublic information, you can never be too careful about what you say, even in what should be a secure environment. On November 15, 2012, a Pennsylvania jury convicted Timothy McGee of criminal insider trading and perjury, in connection with his trading in the stock of Philadelphia Consolidated Holding Company, Inc. (ticker: PHLY). McGee had purchased more than 10,000 shares of PHLY in advance of the public announcement that the company was being acquired. McGee learned of the impending acquisition from a friend at an Alcoholics Anonymous ("AA") meeting.

The sheer audacity of trying to profit from information learned in such a confidential environment shocked the jurors – and McGee may spend some time in federal custody as a result (sentencing is set for February 13; United States v. McGee, Criminal No. 12-236 (E.D. Pa.)). He also faces pending SEC charges. Among other things, the McGee case shows that, in the American legal system, facts control outcomes in the courtroom. In the eyes of a jury, trying to profit from private information at an AA meeting just ain’t right …

The law of insider trading is quite nuanced, and requires proof of some deception. A violation of section 10(b) of the Securities Exchange Act, and Rule 10b-5, occurs when one trades (a) based upon material nonpublic information, (b) when that information is obtained through a breach of a duty of trust and confidence owed to the issuer of the securities or to the source of the information, and (c) where the trader is aware of the breach.

Most people are familiar with what is known as the Classical Theory of insider trading, under which a company insider is liable if he trades based upon material nonpublic information learned through his position with the company. Such trading is seen as a breach of the duty the insider owes to his employer and its shareholders, and acts as a deception upon market participants trading without the inside knowledge. McGee is a misappropriator. Under the Misappropriation Theory, the trader does not need to be a company insider. Instead, the trader comes into possession of nonpublic information through a relationship of trust and confidence, and then violates the duty owed to the source by trading based on that information. The trader uses the information for a purpose other than for which it was conveyed, misappropriating the information from its source.

The McGee case falls squarely within the Misappropriation Theory. The executive who discussed the acquisition at AA meetings was simply describing a source of stress in his life, in an environment where he thought the information would remain confidential. He did not breach any duty. Although McGee argued that no relationship of trust or confidence existed between himself and the executive, the court, in deciding pre-trial motions, and the jury, in convicting McGee, plainly disagreed.

In a related pending SEC case, McGee is also facing charges that he "tipped" a friend about the inside information, who then proceeded to share that tip with his friends and family members, leading to further illicit trading. McGee’s criminal conviction is likely to commence a domino effect of settlements with the SEC.

Securities and Exchange Commission ("SEC") Charges Chinese Affiliates of Five Large Accounting Firms for Failing to Produce Work Papers

This post was written by Jennifer Achilles, Terence Healy, John Tan, and  Joan Hon.

Yesterday, the SEC instituted administrative proceedings against the Chinese affiliates of the “Big Four” accounting firms and BDO related to audits they conducted at nine Chinese companies. At issue is the accounting firms’ “willful refusal” to provide audit work papers and other materials the Commission seeks in its investigations into potential accounting irregularities at several China-based companies whose securities are publicly traded in the United States. The administrative order can be found here.

This administrative action is the latest step in an ongoing standoff between U.S. and Chinese regulators regarding the obligations of Chinese accounting firms that certify the financial statements of China-based companies listed on U.S. exchanges. While auditing firms are normally required to produce their work papers to the SEC and Public Company Accounting Oversight Board (“PCAOB”) on demand, China’s “State Secrets” and archives laws could carry severe civil or criminal penalties for sending these materials outside the country. This inability to obtain work papers has frustrated the efforts of U.S. regulators to ensure the integrity of the capital markets. Earlier this week, Commissioner Luis Aguilar said the SEC’s investigations into accounting irregularities at dozens of China-based companies "have been hampered by the lack of access to relevant documents."

The accounting firms in China have been willing to produce their work papers to the Chinese Securities Regulatory Commission (“CSRC”) and Ministry of Finance (“MOF”) with the understanding that U.S. regulators could then seek those materials from their foreign counterparts. But while the SEC and CSRC signed a memorandum in 2006 to improve “the exchange of information in cross-border securities enforcement matters,” U.S. regulators have had difficulty obtaining materials through the CSRC, resulting in the current standoff.

Without a diplomatic solution, the impasse between U.S. and Chinese regulators could lead to the delisting from American markets of some Chinese companies, and even to some major Chinese accounting firms from being barred from appearing before the SEC – an outcome that could complicate the efforts of many multinational companies operating in China. 

Lost in Translation: Chinese Spring Ducks Beware the SFC!

This post was written by Joan Hon.

Defining “insider trading” is already difficult enough, especially across different jurisdictions where elements and defenses can vary ever so slightly, and yet can result in very big differences. But try translating the term to your Chinese-speaking client.

The most commonly used translation for insider trading is “內幕交易” (nèimùjiāoyì) – which literally means “trading behind the curtain.” However, Hong Kong’s financial analysts, journalists and bloggers have taken to calling insiders “春江鴨”(chūn jiāng yā), or “spring river ducks”!

What is the connection? This term actually refers to the Song dynasty poem Huì Chóng Chūn Jiāng Wǎn Jǐng (惠崇春江晚景), which recalls the scene of a beautiful evening on the river, just as the spring season is about to arrive. The poet, Sū Shì (蘇軾), describes the sight of two to three branches of peach blossoms emerging from a thicket of bamboo and how the ducks on the river know that spring is coming, as they can feel the river water warming up underneath them.

Thus, “spring river ducks” are those who are first in the know – and therefore potentially at risk of insider trading.

The entire poem, with translation, is printed below.


Special thanks to Angela Lu, an associate in our Hong Kong Corporate & Securities Department, for inspiring this post. Reed Smith’s strong global presence means having a team of multilingual lawyers.



Beyond the bamboo are 2-3 branches of peach blossoms, the ducks are first to know with the warm Spring river water.

Beach wormwood has grown all over and budding reeds are short, now is the time for fugu to be in the market.

SEC Whistleblower Program Makes its First Award

This post was written by James L. Sanders.

An unnamed individual who provided information to the SEC about a securities fraud has been awarded $50,000 under the SEC’s Whistleblower Program. The award represents 30 percent of the monetary sanctions collected by the SEC in the case in which the whistleblower provided information. The whistleblower has also been awarded 30 percent of any additional monetary sanctions that the SEC collects in that matter.

This is the first monetary award by the SEC to a whistleblower under the Whistleblower Program that was established in August 2011 in order to provide financial incentives to individuals who supply information to the SEC. According to the head of the SEC’s Whistleblower Office, the award shows that the SEC’s program is “open for business and ready to pay people who bring us good, timely information.” The SEC program currently receives approximately eight tips per day. In order to be eligible for an award, a whistleblower must provide timely information that aids the SEC in bringing an enforcement action.

Delaware Test For "Direct" vs. "Derivative" Claims Adopted by NY Appellate Court

This post was written by Herbert F. Kozlov and Lawrence J. Reina.

In a case of first impression in New York, the Appellate Division, First Department, has adopted the test the Supreme Court of Delaware developed in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1039 (Del 2004) for determining the difference between a “derivative” claim and a “direct” claim in shareholder derivative lawsuits.

Please click here to read the issued Client Alert.

Second Circuit Reins In Expansive Application of Dura

 This post was written by Sarah R. Wolff and Jennifer L. Achilles.

In a strongly worded decision that will make it easier for private plaintiffs to withstand dismissal of securities fraud claims in certain cases, the Second Circuit vacated and remanded a federal district court’s dismissal of a putative securities fraud class action. In Acticon v. China Ne. Petroleum Holdings Ltd., --- F. 3d ---, 2012 WL 3104589 (2d Cir. Aug. 1, 2012), (found here), the Second Circuit squarely rejected what it described as the district court’s reliance on a “more expansive view” of the Supreme Court’s decision in Dura Pharmaceuticals v. Broudo, 544 U.S. 336 (2005). Acticon, 2012 WL 3104589, at *6. In Dura, the Supreme Court held that a private plaintiff in a securities fraud action must plead that the plaintiff’s claimed loss was proximately caused by the defendant’s alleged misrepresentation. This is typically accomplished through an allegation that the price of the security dropped following public disclosure of the alleged fraud, an allegation made by the Acticon plaintiffs in their complaint.

According to the Second Circuit, some district courts, including the court below, incorrectly “extrapolated” from Dura, granting dismissal motions based on a showing that the stock price rebounded after its initial drop following corrective disclosure to a level at or above the price at which the plaintiff purchased the security. Acticon, 2012 WL 3104589, at *5. The Second Circuit found this view contrary to both the “out of pocket” measure of damages and the “bounce back” provision contained in the Private Securities Litigation Reform Act that caps the amount of damages available in a securities fraud action. Id. at *6. The Court also reasoned that it would be improper to assume, at the pleading stage, that the stock rebounded from its initial price drop because of the market’s reaction to the disclosure of the alleged fraud, instead of “unrelated gains.” Id. at *6-7. Accordingly, the Second Circuit held that stock price rebound does not negate an inference of economic loss at the pleading stage. Id. at 7.

The Second Circuit’s decision should prove significant in those securities fraud cases in which the share price of the defendant increased after an initial decline following a corrective disclosure. Notably, the decision came in the first case in which a district court granted a motion to dismiss in a securities fraud action against a U.S. listed Chinese company in the so-called “reverse Chinese merger” cases. It remains to be seen whether the ruling will impact the numerous cases pending against other Chinese companies that entered the market through reverse mergers.

Please click here to read the issued Client Alert.

11th Circuit Takes Direct Aim at SEC 'Obey-the-Law' Injunctions and Reminds Us All That Even the Very Broad Anti-Fraud Provisions Have Their Limits

This post was written by Amy J. Greer.

In a recent appeal before the United States Court of Appeals for the 11th Circuit, there is little doubt that the SEC thought its case was something of an easy win. The story is not pretty. Richard L. Goble, the remaining defendant in the matter – everyone else had settled out – founder of the trading firm North American Clearing, in serious financial distress, had directed the firm’s CFO and FINOP to enter a phony $5 million book entry to make the firm’s reserve account appear flush, when, in fact, the account was below the amounts required under the Customer Protection Rule, section 15(c)(3) of the Exchange Act of 1934 and Rule 15c3-3, thereunder. Since the FINRA staff happened to be examining North American at the time (!), the sham transaction was caught, and when it was reversed, instead of being $3.4 million in the black, the reserve account needed $1.8 million in order to stay in business.

The SEC promptly sued North American, Goble, the CEO and CFO, charging the company with violations of the Customer Protection Rule, as noted above, as well as books and records violations under Exchange Act Section 17(a) and Rule 17a-3, charging the individuals with aiding and abetting those violations, and charging all of the defendants with securities fraud under section 10(b) of the Exchange Act and Rule 10b-5. Given the facts, I suppose it’s not terribly surprising that the company, the CEO and CFO all settled. Goble went to a non-jury trial and was found liable on all counts, getting himself permanently enjoined from future violations of all of the noted statutes and rules. The court also, on its own volition, barred Goble from seeking any securities license or engaging in the securities industry.

Goble appealed, asserting, among other issues, that making a false book entry cannot be securities fraud; that the court abused its discretion by barring him from seeking a securities license or working in the securities industry; and that the SEC’s standard injunction is an unenforceable “obey-the-law” command. On these issues, Goble won. And I’m guessing that was pretty unexpected. But should it have been?

The 11th Circuit’s opinion held that absent a material misrepresentation or omission in connection with the purchase or sale of a security, one cannot have a securities fraud, and reversed. I cannot help but wonder how it is that this sham transaction could ever have been found, by the SEC in making its charging decision or by the district court, to have been “in connection with” the purchase or sale of a security? There was no purchase or sale; it was a book entry and it was a fake. The SEC has conditioned itself to presume that every fraud must fall within the broad contours of section 10(b), but the section and its companion rules do have limits. Something about when you only have a hammer, everything looks like a nail?

Because the district court based the securities bar on the reversed securities fraud counts, the sua sponte bar was tossed, as well as the related injunction. I suppose the good news here for the SEC is that the 11th Circuit panel did not find anything amiss in the court adding a sanction not actually sought by the SEC staff.

However, the opinion takes a shot squarely at the centerpiece of all civil actions filed by the SEC, that is, the injunctive relief sought against future conduct. The court vacated the injunction against Goble on the securities fraud counts for substantive reasons, but it also vacated the injunction against him on the other counts. The 11th Circuit panel agreed that such injunctions violate Rule 65(d) of the Federal Rules of Civil Procedure as “obey-the-law” commands, since they merely track the statutory language, thus failing to afford a defendant any real guidance as to how to avoid violating the injunction, and remanded to the district court for a re-drafting session, to see whether an injunction could be written that complied with Rule 65(d). I suppose we’ll see. This is a pretty big blow to the SEC’s usual form injunction language. And leaves one to wonder whether that form language isn’t the real reason why you never see a contempt proceeding for violations of those injunctions. Perhaps there is more of an understanding within the SEC of the lack of enforceability of those many, many injunctions than the agency might be willing to admit.

To take your own look at the 11th Circuit’s opinion in SEC v. Goble, click here.

Restitution for Corporate Victims of Insider Trading: The Skowron Case

This post was written by Pablo Quiñones and Jennifer Achilles.

On March 20, 2012, a New York federal judge ordered Chip Skowron to pay $10 million in restitution to Morgan Stanley as a corporate victim of his insider trading and obstruction of justice schemes. The Skowron decision is a significant victory for corporate victims of insider trading, and provides a roadmap for seeking restitution under the Mandatory Victim Restitution Act. Click here for the full article by Pablo Quiñones and Jennifer Achilles in Bloomberg BNA on the Skowron decision.

Results of the FSA's Thematic Review into Investment Banks

This post was written by Robert Falkner and Tom Webley.

In March 2012, The Financial Services Authority (“FSA”) published the results of its thematic review into the policies and procedures that investment banks have in place to prevent their employees from paying or receiving bribes. Click here for more information on the background to this review.

The FSA’s report revealed that the provisions that many firms have in place for financial crime and anti-money laundering fall short of what is necessary to address the requirements of anti-bribery and corruption compliance.

In summary, the FSA found that:

  • The majority of the firms reviewed had not fully considered the FSA’s anti-bribery and corruption rules
  • Nearly half of the firms reviewed did not have adequate procedures for risk assessment
  • Generally, senior management was not provided with sufficient information on anti-bribery and corruption, and could not provide sufficient oversight
  • Only two firms had started internal anti-bribery and corruption audits
  • There were significant concerns over the way that the firms dealt with third parties to retain or win business
  • Few firms had procedures in place to ensure that the corporate hospitality and entertainment offered to certain clients was not excessive when judged cumulatively

Click here for a copy of the full FSA report.

As a result of its findings, the FSA is holding a consultation on proposed amendments to its "Financial Crime: a guide for firms." Click here for more information on the FSA’s consultation.

The FSA also made it clear that it intends to take enforcement action in relation to shortcomings in firms’ anti-bribery and corruption policies and procedures.

SEC Expands Its Cooperation With Global Regulators: Hedge Funds and Investment Advisors Take Note

This post was written by Pablo Quinones, Sarah Wolff and Joseph Prater.

On March 23, 2012, the United States Securities and Exchange Commission (“SEC”) announced that it had entered into cooperation arrangements with the Cayman Islands Monetary Authority (“CIMA”) and the European Securities and Markets Authority (“ESMA”) in its continuing effort to improve global regulation of transnational business entities. The cooperation between the SEC and CIMA is particularly significant because a large number of hedge funds, investment advisers, and investment managers operate in the Cayman Islands and frequently access capital and investors in the United States. ESMA is an independent European Union Authority that regulates credit rating agencies and coordinates with other EU securities regulators. The SEC’s press release announcing the new arrangements is available here.

The new cooperation arrangements between these regulators will allow them to share information about hedge funds, investment advisers, investment fund managers, broker-dealers, and credit rating agencies. The arrangements establish “supervisory cooperation agreements” with the SEC’s foreign counterparts aimed at “establish[ing] mechanisms for continuous and ongoing consultation, cooperation and the exchange of supervisory information related to the oversight of globally active firms and markets.” According to the SEC’s Director of International Affairs, these types of arrangements are intended to build relationships that may help prevent fraud in the long term or lessen the chances of a future financial crisis. Currently, the SEC has cooperative arrangements of various types with approximately 80 jurisdictions around the world.

International securities fraud cases require cooperation among foreign regulators. While regulators are willing to informally share some information, the existence of a formal cooperation arrangement facilitates a full exchange of information. The growing cooperation between the SEC and foreign regulators will no doubt lead to an increasing number of securities enforcement actions as more eyes focus on a single business entity. Hedge funds have been subjected to increased regulatory scrutiny in recent years. The SEC's latest expression of interest in the Cayman Islands underscores that hedge funds continue to be high on the SEC’s agenda.


Don't Drink and Deal: Former Hong Kong Civil Aviation Chief Gets Jail Sentence Despite Intoxication Defense

This post was written by Joan Hon.

The Eastern Magistracy of Hong Kong recently found former Hong Kong civil aviation chief, Albert Lam Kwong-yu, guilty of insider dealing.

On June 4, 2010, Lam, who at the time was an independent non-executive director (“INED”) of Hong Kong Aircraft Engineering Company (“HAECO”), received a call at 3:13 p.m. from HAECO’s Chief Executive Officer about a coming deal in which Cathay Pacific Airways Limited, a substantial shareholder, would sell all its HAECO shares to Swire Pacific Limited (“Swire”), which would then, in accordance with Hong Kong listing rules, trigger a general offer by Swire for all shares in HAECO.

Shortly thereafter, Lam, who was lunching at the Hong Kong Club, Hong Kong’s oldest exclusive members’ only social club, walked to a friend’s office nearby, logged into an internet account, and purchased 4,000 shares of HAECO. Lam did not have enough cash in his securities account and paid for the shares by electronically drawing down and transferring HK$340,000 (about US$44,000) from an overdraft account. These actions were completed within the 47 minutes of his call with the CEO, ensuring that Lam’s trade was completed before Hong Kong market close at 4:00 p.m.

Upon announcement of the deal on June 7, 2010, HAECO shares were valued at about 25% higher than the then market price. Lam sold the shares shortly after, netting a profit of around US$10,000.

At trial, Lam pleaded not guilty, claiming that he had “forgotten” he was an INED of HAECO at the time due to intoxication. In his defense, Lam brought fact witnesses to testify exactly what he drank at this luncheon – specifically, a gin and tonic, two glasses of white wine, and two glasses of red wine. The director of the Hong Kong Poison Information Centre also appeared to provide expert testimony on the impact of alcohol on Lam’s judgment.

Additionally, Lam claimed that he did not intend to make a profit on his trade, a statutory defense in Hong Kong. Lam testified that he self-reported the act to the CEO the next day, and pledged to donate his profit to charity. He also resigned as INED on June 6, 2010, before the deal was announced.

Lam was sentenced to five months’ imprisonment (suspended for two years), fined HK$50,000 (~US$6,450), and ordered to pay the Securities and Futures Commission’s costs – a pretty hefty fine for a few drinks too many.

SEC Warning: Phony Email Hoax

This post was written by Amy J. Greer.

The SEC sent out a warning yesterday that a phony message referencing the Agency's Whistleblower Office is being used in connection with a potential computer hack or dissemination of malicious software. According to the SEC Alert, sent through the Agency's push technology, it has received numerous calls in the past 24 hours concerning an email that reads as follows:

 "Dear customer, Securities and Exchange Commission Whistleblower office has received an anonymous tip on alleged misconduct at your company, including Material misstatement or omission in a company's public filings or financial statements, or a failure to file Municipal securities transactions or public pension plans, involving such financial products as private equity funds. Failure to provide a response to this complaint within a 14 day period will result in Securities and Exchange Commission investigation against your company. You can access the complaint details in U.S. Securities and Exchange Commission Tips, Complaints, and Referrals portal under the following link: "

According to the SEC, the email is a hoax. Since the message appears to be directed at companies, it may be prudent to warn your personnel about this hoax.

Account Intruder Intrigue Obscures Real Market Threat

This post was written by Amy J. Greer.

The latest account intrusion case brought by the SEC had all of the usual hallmarks: a foreign national; hacking into accounts; and trading long distance. But this newest case revealed a potentially more dangerous threat: unfettered and direct access to the markets by those out to commit fraud, whose identifies are hidden through omnibus trading accounts or sponsored market access arrangements. For the first time, the SEC has taken action to try to limit that threat.

Account intrusion cases are not new, unfortunately. The SEC brought the first of these cases when I was still at the agency, back in December 2006. And I was a part of the team that brought the case, against a Belize corporation, located in Estonia, run by a Russian national, which tells you everything you need to know about how difficult it was to effect service - but we did, eventually. In that case, known as Grand Logistic, S.A., which was the name of the company (seemed pretty apt), the SEC also froze some of the assets, since they remained in a US brokerage account, as well as working with foreign regulators to attempt repatriate some of the assets that had been moved out of those accounts. Much about this sounds too familiar to the case brought by the SEC last week against a Latvian national, Igor Nagaicevs, who appears to have gotten away with this conduct for over a year and to have absconded with the cash - $850,000.

For those unfamiliar with the account intrusion scheme, it's really just the latest incarnation of a pump-and-dump: a trader with a knack for hacking will buy or sell short, in his own account (preferably a rather secretive account where the trader's identity will not be obvious to snoopy regulators and SROs), a security that is generally relatively thinly traded; then our hacker will hack into a legitimate brokerage account (like yours or mine) and, using the assets in that account, either cash or cash created by selling holdings, will create movement in the security he already has purchased (the "pump") by buying or selling a lot more. Then, the fraudster dumps his own holdings, making a little killing, all artificially generated by his own actions.

Now, there are at least two other parties to this scheme that do not involve our trader/hacker guy: the trading firm that is giving him market access and the victim brokerage, where the accounts are getting hacked. Up until last week, neither of these had ever been charged by the SEC. In regard to the victim brokerage firms, they have been making their account holders whole, at rather significant cost. For that reason, and presumably because they are also taking whatever steps are humanly possible to prevent such activity, and also because, perhaps appropriately, the SEC rarely takes action against those viewed as victims, the SEC has never acted against these victim brokerage firms. But with this most recent Nagaicevs case, the SEC has decided that it is had enough with these omnibus trading accounts and sponsored market access arrangements that mask the identity of the actual traders, especially when those traders turn out to be committing frauds. Accordingly, the SEC has charged these various unregistered trading firms and their principals, and several of them have settled the charges, including Alchemy, KM, Zanshin, and Mercury, Richard V. Rizzo, and Mercury and Hyatt.  Veiled, unfettered access by traders to the markets is potentially dangerous. The frailty of the markets was well demonstrated in the "flash crash" and many market participants are less than confident that the reasons for that were fully identified (and some think the reasons have yet to be identified at all). "Hidden" traders are also free to trade on material nonpublic information. The degree of potential mischief making is somewhat self-evident. Beginning to close off an avenue for such trouble-making seems like a really necessary first step.


Judge Rakoff Rejects the SEC-Citi Settlement, But Is "Truth" Really the Purpose of Any Settlement and Does the SEC Need the Courts to Settle its Cases?

This post was written by Amy J. Greer.

Once again, Judge Jed Rakoff has proven to be a thorn in the side of the SEC, rejecting the agency’s $285 million settlement with Citigroup Global Markets. While Judge Rakoff’s opinions are always a good read: sharp, well written, and to the point - and this one is posted at the SDNY website and also available here - one can’t help but wonder whether his effort to bring sunshine to the process so as to further his view of the public’s interest in these proceedings won’t have precisely the opposite result.

Using the hook of the injunctive relief incorporated into the settlement as the touchstone for his analysis of whether the public interest is served by the settlement proffered, Judge Rakoff concludes that the settlement “is neither fair, nor reasonable, nor adequate, nor in the public interest. Most fundamentally, this is because it does not provide the Court with a sufficient evidentiary basis to know whether the requested relief is justified under any of these standards.” Opinion at p. 8. This really gets to the meat of Judge Rakoff’s concern: that a party can settle an SEC enforcement action without admitting or denying the underlying allegations. Apparently, in Judge Rakoff’s view, these missing admissions would provide the Court with the facts needed to decide the propriety of the settlement.

While I concede that in certain circumstances this long-standing SEC policy is silly: when I was at the agency, I recall inquiring why the policy applied to convicted felons, for example, who were willing to consent to the entry of SEC judgments after their criminal convictions, a question I still have today. In most circumstances, however, the analysis is no different than in the settlement of any civil matter. Defendants settle cases – including SEC cases – for a multitude of reasons, many of which have nothing to do with whether or not they actually engaged in the conduct alleged. The SEC settles cases for a similar wide range of reasons, including the fact that they simply cannot try every case, and losing cases is decidedly not good policy, makes for bad precedent, and does not serve to deter future conduct.

Just as the settlements of private civil litigation would stall if admissions were required for settlement, significantly fewer SEC enforcement cases would settle if defendants had to admit to any of the alleged conduct. Just like in private civil actions, many defendants do not agree with the SEC’s conclusions, as alleged in the Complaint, and settling parties tend not appreciate the ability of non-parties to seize upon such admissions to further their own causes.

Notwithstanding Judge Rakoff’s suggestion that “knowing the truth” is the overriding public interest to be served by SEC settlements (Opinion at p. 15), in fact, that is the interest served by confidential SEC enforcement investigations, where neither the public nor the Court has any participation. Once that truth is known, the agency then takes the information and undertakes a necessary calculation to serve its true mission, which is to protect investors; sometimes settling cases, sometimes taking defendants to trial. One wonders whether a forced trial can ever be the right outcome, as Judge Rakoff has accomplished here.

But, of course, to achieve its mission of protecting investors, the SEC does not really need Judge Rakoff and I suspect that what we will see is less use of the courts and, so, less public participation in the process. The SEC can just as easily resolve any enforcement matter it chooses to bring in an SEC administrative proceeding, without any of the drama and uncertainty.

Regulatory Round Up 10 .20. 11

This post was written by Michael A. Grant.


UK Bribery Act - first conviction - a damp squib?

This post was written by Rosanne Kay and Emma Osborne.

MoneyThe first person to be charged under the new UK Bribery Act, a magistrates court clerk, was convicted by Southwark Crown Court on Friday, 14 October 2011.

The court clerk, 22 year old Mr Munir Yakub Patel, was convicted under Section 2 of the Bribery Act for requesting and receiving a bribe intending to improperly perform his functions. The court heard that Mr Patel agreed to use his position at Redbridge magistrates court to prevent a traffic penalty from being entered onto a court database in exchange for £500.

Mr Patel was bailed until 11 November 2011, when he will be sentenced.

The case was brought by the Crown Prosecution Service (‘CPS’) which, like the Serious Fraud Office (‘SFO’), can bring prosecutions under the Bribery Act. It is anticipated that the CPS will focus on more domestic prosecutions whilst the SFO will focus on the more complex overseas corruption cases.

Although this is a minor conviction, it marks the start of the jurisprudence under the new Act. However, it will have little bearing on how complex overseas bribery cases will be dealt with or on how contentious parts of the Act relating to jurisdiction and “associated person” will be interpreted. The Act is not retrospective and will only apply to offences committed since it came into force on 1 July 2011. It may therefore take some time before we see the first SFO prosecution under the Act.

Raj Rajaratnam Sentenced: Finally A Small Victory?

This post was written by Amy J. Greer.

After his conviction on 14 counts of securities fraud and conspiracy in what has been described as the biggest insider trading case ever - and, by his defense counsel, John Dowd as a “victory,” since he didn’t get convicted on all counts - today Galleon founder Raj Rajaratnam was sentenced to 132 months, or 11 years in prison, for his massive insider trading scheme.

This sentence represents the longest of the string of sentences handed down this year in connection with this trading ring. Former hedge fund trader Zvi Goffer, another link in the conspiracy’s chain, was sentenced on September 21, 2011 to 10 years, so it was widely expected that Raj would get a longer term.

Prior to sentencing, in an effort to reduce the sentencing guideline range, a complex calculation that takes many factors into consideration - but probably most important here, the amount at issue as a result of the unlawful trading - Raj’s lawyers made pitches to the court in an effort to reduce the ill gotten gains or losses avoided. The prosecution’s numbers were in excess of $70 million; the defense was at under $8 million. There was also much discussion about Rajaratnam’s health issues, also a potential consideration for a sentencing court.

Given that Raj was looking at a sentence in excess of 20 years, perhaps this is where his defense team can finally claim some actual victory. While the crimes for which they were convicted differ, the treatment of white collar criminal defendants in the financial fraud/securities area are often compared and, after all, Dennis Kozlowski is doing 8 to 25 in New York State prison, Jeffrey Skilling, who won at the United States Supreme Court, is doing more than 24 years in a federal penitentiary; more recently, Lee Farkas got 30 years for a mortgage fraud scheme, and then, of course, there’s Madoff’s 150 year sentence.

UK Bribery Act: identifying bribes from tax calculations

This post was written by Fionnuala Lynch and Rosanne M. Kay.

Earlier this month, Richard Alderman, Director of the SFO, was speaking at an international symposium on economic crime in Cambridge and made an interesting point which has been picked up by many UK newspapers.

He referred to the fact that 20 years ago, it was possible for UK companies to get deductions for tax purposes in respect of bribes. Clearly this is no longer the case and, now that the new Bribery Act is in force, may lead to potential prosecutions.

Mr. Alderman was however suggesting that companies should have information to ensure that they are not claiming tax deductions in respect of bribes and the SFO has therefore started to require companies to disclose relevant parts of their tax calculations in the hope that these might provide evidence of bribes and the fact that companies are identifying them.

The SFO is seeking to persuade companies to self-report their own breaches of the Act.

There are several potential situations where companies’ tax calculations may reveal unlawful practices under the Bribery Act:

  • Where companies offer or hold offshore accounts – Various tax authorities worldwide are trying to unravel the secrecy surrounding offshore banking. This process involves the exchange of information between worldwide tax authorities on the tax affairs of multinational companies and offshore account holders. This could result in previously undetected bribes coming to light.
  • The Act’s impact upon existing disclosure requirements – Section 6 of the Bribery Act (the foreign public official offence), in contrast with Sections 1 and 2, does not require any intention to procure “improper” conduct from the official. The briber need only intend to “influence” the official to act to the briber’s business advantage. The British Bankers’ Association (BBA) has, in the past, expressed concerns that what would normally be considered legitimate promotional expenditure, could now be caught by the Act. This uncertainty over what constitutes an offence under Section 6, may result in banks and financial institutions making more frequent Suspicious Activity Reports (SARs) to the Serious Organised Crime Agency (SOCA). The institutions’ tax calculations are likely to be disclosed and inspected as part of this process, which may expose bribes.
  • More stringent monitoring roles for companies relating to bribes – Companies should use internal monitoring to look into all policies and procedures that may shed light on potential bribes. In particular, financial monitoring may well include ensuring that books and records relating to tax are properly kept and will pick up irregularities which indicate that bribes are being paid.

Despite the hype, the likelihood that companies’ tax calculations will reveal bribes seems remote. In particular, it seems unlikely that those preparing tax calculations will be made aware that bribes have been paid. For example, payment of a bribe is usually supported by an invoice for consulting services.

Mr. Alderman was previously the Director of National Teams and Special Civil Investigations in HMRC, where he conducted specialised tax investigations. In his speech, Mr. Alderman explained that, if a tax deduction was sought in the context of a bribe where the expense had not been identified properly, this would create another ‘books and records’ offence and a separate line of prosecution for HMRC, rather than the SFO.

UK Bribery Act - first prosecution

This post was written by Rosanne M. Kay.

The first person to be charged under the new Bribery Act will be a magistrates court clerk who allegedly accepted £500 for fixing a motoring offence.

The Crown Prosecution Service (“CPS”) has decided to prosecute Munir Yakub Patel who faces a charge under Section 2 of the Bribery Act for allegedly requesting and receiving a bribe intending to improperly perform his functions. Mr Patel is due to appear before Southwark Crown Court on 14 October 2011. According to press reports, he is currently being held in custody.

Proceedings for offences under the Bribery Act require the consent of either the Director of Public Prosecutions or the Director of the Serious Fraud Office (“SFO”). The SFO is the lead agency in England and Wales for investigating and prosecuting cases of overseas corruptions whereas the CPS prosecutes bribery offences investigated by the police committed either overseas or in England and Wales (although it is anticipated that the CPS will focus more on domestic cases).

Whilst this may only be a small case which will not touch on key concerns relating to jurisdiction and hospitality, it marks the start of jurisprudence on the Bribery Act. It will also put the SFO under increased pressure to start its own action under the Bribery Act.

Regulatory Round Up 8.16.11

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SEC Rejects Proposal by its Enforcement Staff to Settle Landmark 'Clawback' Suit

This post was written by James A. Rolfes.

Last week, the Washington Post reported the SEC had rejected a proposed settlement of SEC’s landmark case seeking enforcement of the so-called “clawback” of executive compensation under Sarbanes Oxley Section 304. See Hilzenrath, D., Washington Post July 20, 2011, SEC Rejects Proposal. In SEC v. Jenkins, No. 09-cv-01510 (D. Ariz. filed Jul. 22, 2009), the SEC for the first time sought over $4 million in incentive-based compensation from an admittedly non-culpable CEO of a company that had misstated its financial statements due to employee fraud. The SEC further had obtained an early victory in that case, persuading the federal court that SOX 304 did not require a showing that the defendant CEO aided or even knew about the fraud leading to financial statement restatement. SEC v. Jenkins, 718 F. Supp. 2d 1070 (D. Ariz. 2010). Now the Commissioners have rejected the settlement recommendation of the SEC enforcement staff and accepted the risk that trial of the matter could undo this victory -- signaling perhaps the Commission’s intention to aggressively pursue clawbacks.

Behind the scenes, however, the rejection of the settlement provides a less clear message. According to unnamed sources, some Commissioners balked at a settlement that obtained less than half the sought-after compensation, but others rejected the staff’s recommendation claiming the SEC should never have brought the case in the first place. That tension reflects a wider debate now on going as to whether SOX 304 enforcement against “innocent” CEOs and CFOs represents an intended tough Congressional mandate to punish executives who oversee the filing of later-restated financial statements, or a poor policy choice by the SEC. See e.g., Harvard law School Forum on Corporate Governance and Financial Regulation.

That divergence of Commissioner opinion may also play out as the SEC undertakes to establish rules required under Dodd-Frank 954. That legislation mandated expanded restatement-based clawback requirements, and directed the SEC to craft rules requiring public companies to recover incentive-based compensation calculated using erroneous financial data. See Dodd-Frank Leaves Clawback Uncertainty, Compliance Reporter (August 30, 2010) Rolfes, J.  Right now, the SEC has placed that rulemaking responsibility on hold at least until the Fall 2011.

Following jurisdictional victory for UK citizen, FCPA Africa Sting case ends in mistrial

This post was written by Sarah R. Wolff and Leonard E. Hudson.

The Department of Justice suffered a “stinging” setback to its widely touted FCPA Africa Sting prosecution late last week when the first of four anticipated trials based upon its most aggressive Foreign Corrupt Practices Act investigation to date ended in a mistrial. The jury deadlocked after six weeks of trial and after taking six votes while failing to reach a unanimous verdict in the bribery trial of four arms salesmen alleged to have offered to pay bribes to obtain military contracts.

In January, 2010, DOJ indicted 22 individuals, including citizens of the UK and Israel, claiming violations of the FCPA as a result of the defendants’ alleged payment of bribes to officials of Gabon in order to obtain government contracts to provide that country with armor, weapons and military gear. The indictments were brought following a lengthy FCPA undercover sting operation in which the purported foreign official to whom the defendants allegedly caused bribes to be paid was, in reality, an FBI agent as was a purported middleman to the alleged scheme. This was DOJ’s first large-scale undercover operation in connection with an FCPA investigation. The investigation is another example of the ongoing cooperation between U.S. and UK law enforcement agencies, particularly in the anti-corruption area. In this investigation, the FBI teamed up with the UK’s City of London Police. On January 18, 2010, the two agencies executed a total of 21 search warrants in various locations in the U.S. and in London.

Following the indictments, United States District Court Judge Richard Leon (District of Columbia) rejected DOJ’s request that he try all of the defendants together and broke them up into smaller groups for trial. At the close of the government’s case of four defendants in the first trial, the judge entered judgments of acquittal on some of the counts, with the most significant ruling coming on the motion of defendant Pankesh Patel, a UK citizen and the managing director of a UK company that acts as a sales agent for companies in the law enforcement and military products industries. Patel challenged a substantive FCPA count that rests upon a statutory jurisdictional requirement that a foreign defendant engage in corrupt activities “while in the territory of the United States.” DOJ has become increasingly aggressive in asserting jurisdiction over non-US residents based upon actions taken outside of the US as causing or aiding and abetting a corrupt or improper payment to be made. For example, the government has based FCPA charges against non-US citizens on conduct such as sending wire transfers requests from an account in a foreign country to a financial institution in the United States, and on sending emails and facsimiles from the UK to the US. Here, DOJ claimed jurisdiction over Patel in the count in question based on his sending a DHL courier package containing a purchase agreement in furtherance of the alleged corrupt scheme from the UK to the United States.

Patel moved for acquittal under the relevant count, arguing that he did not engage in any prohibited conduct “while in the territory of the United States” as required by the statute. In granting Patel’s motion, the judge expressed substantial skepticism regarding DOJ’s contention that sending a DHL package from the UK met the jurisdictional requirement, calling the theory a “novel interpretation” of the law. In granting the acquittal motion, Judge Leon said that “the more cautious, conservative interpretation would be that each act has to be while in the territory of the United States.” Judge Leon’s ruling is believed to be the first entered against the government on this jurisdictional ground and should encourage foreign defendants in other FCPA cases to test the limits of DOJ’s aggressive jurisdictional theories.

DOJ has announced that it will refile its case against the four defendants and will proceed with its case against the remaining defendants.

FSA to investigate Bribery in the Banking Sector

This post was written by Rosanne Kay and Tom Webley.

The Financial Services Authority (“FSA”) recently announced its intention to carry out a thematic investigation of the policies and procedures that investment banks have in place to prevent their staff and agents from paying or receiving bribes. Click here for the full speech.

This coincides with the coming into force of the Bribery Act 2010 on 1 July 2011. Click here for more information about the Bribery Act.

Thematic reviews are carried out by the FSA to look into widespread issues affecting a whole industry, market or product and result in the publication of a report of what the FSA discover. Although they may lead to enforcement action against specific firms depending on what the FSA find, the reviews are not enforcement actions in themselves.

A similar review was carried out of the insurance sector which resulted in the publication of a report in June 2010 highlighting a widespread lack of understanding of the risks of corruption and compensation and bonus schemes which increased the risks of bribery.

In their recent announcement, the FSA highlighted the overlap between corruption and money laundering. Indeed, most banks will already have detailed procedures in place to reduce the risk of failing to comply with, for example, anti-money laundering rules as well financial sanctions and FCPA requirements. They may well therefore have most of the relevant procedures in place to deal with bribery risks already

Preparations for the UK Bribery Act 2010

This post was written by Simon D. Hart.

With the coming into force of the UK's Bribery Act 2010 today, companies will be reviewing and revising a wide range of documents, policies and procedures across their organisation. Whilst in-house Counsel will almost certainly have been at the forefront of any internal review to ensure the company's readiness for the Bribery Act, the Human Resources department also has a very significant role to play in that exercise. Reed Smith's Employment group looks at the Act from an employment perspective.  To read more click here.

Regulatory Round Up 6.24.11


UK Bribery Act - The SFO fires a warning shot over jurisdiction

This post was written by Simon Hart and Rosanne Kay.

The Director of the Serious Fraud Office (“SFO”) has recently articulated a robust interpretation of the SFO’s jurisdiction under the UK’s Bribery Act 2010, which comes into force on 1 July 2011. In doing so, the Director has challenged the understanding of many companies and their advisors. Whilst the debate may be seen by many as an academic debate for lawyers, the implications could have a significant impact on whether or not particular operations of a global company fall within the reach of the SFO.

The Director made it very clear that, in his view, if a global company had a UK subsidiary, but there was bribery in another part of the global company, the SFO would have jurisdiction under the Bribery Act. This interpretation is in contrast to statements made in the Guidance issued by the Ministry of Justice in March 2011 which indicated that such foreign companies would not themselves be regarded as “carrying on business in the UK” simply by virtue of having a UK subsidiary or a listing on an exchange. (“Carrying on business” is the test for determining whether an entity can be fixed with criminal liability under the corporate offence in the Act.)

Mr Alderman made it plain that the SFO would be adopting a very wide interpretation of the phrase “carrying on business in the UK”. Mr Alderman has said “What I have said to corporates is that it would be very dangerous for them to use a highly technical interpretation of the law to persuade themselves that they are not within the Bribery Act and that it is permissible for them to carry on using bribery. I have said that they could have a very unpleasant shock…”

Mr Alderman went on to explain “Our view is that if a foreign group has a subsidiary in the UK and in another country and that bribery occurs in that other country then that bribery is within the remit of the SFO.”

Ultimately, the much-debated jurisdictional provisions of the Act will be determined neither by the SFO nor those that the Act purports to cover, but by the English Courts. However, it is clear that the SFO will be looking to promote an anti-corruption agenda by highlighting the risks of engaging in corrupt activities anywhere in the world if the business has any connection with the UK.

To reinforce the message, Mr Alderman has emphasised that surprise arrests of overseas nationals at UK borders could be a possibility if they have engaged in bribery: “You can’t be sure that you won’t be stopped at the airport. We are not going to say, “if you turn up, you will be arrested”. It may or may not happen”.

Mr Alderman has also signalled that the SFO will be interested in prosecuting cases against foreign corporations where there has been bribery that has disadvantaged ethical UK companies. He has suggested that in such a case, there would be a strong UK public interest in bringing that foreign company before the UK courts. Mr Alderman has said that he is keen to test the new law against foreign companies despite the challenges in investigating, prosecuting and punishing a foreign company.

Despite Mr Alderman’s strong words, it remains to be seen whether the SFO will have the resources or the will to investigate and prosecute foreign corporates. Nevertheless, these recent statements highlight the fact that companies can only draw limited comfort from the commentary on jurisdiction in the Ministry of Justice Guidance.

Supreme Court's Bright Line Test Narrowly Limits Primary Securities Fraud Liability

This post was written by Amy J. Greer.

In Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. ___ (2011), the United States Supreme Court reversed a decision of the United States Court of Appeals for the Fourth Circuit, largely resolving a disagreement among the lower federal courts regarding the level of involvement required to expose defendants to primary liability for a securities fraud violation. The Court held that primary liability can attach to a material misstatement or omission only if the defendant had “ultimate authority” over its making or, perhaps, if it was publicly attributed to him. As a result, primary liability is no longer a risk for professionals who only prepare or contribute information to the public statement of another, absent explicit public attribution. Professionals who work on public filings and offering documents are breathing a heavy sigh of relief today.  To read more click here.


UK's Serious Fraud Office survives - but for how long?

This post was written by Simon D. Hart.

After months of speculation, and rumoured turf wars within the UK government, it has today been confirmed that the UK’s Serious Fraud Office (“SFO”) will not be broken up and will remain independent of the new National Crime Agency (“NCA”). The SFO will retain both its investigative and prosecution powers in relation to major economic fraud and corruption. Crucially for the SFO, this means it retains control of investigations and prosecutions under the new Bribery Act 2010 which comes into force on 1 July.

There had been considerable speculation that the SFO would be broken up with its investigative powers being folded into the new NCA and its prosecution powers being passed to the existing Crown Prosecution Service. Richard Alderman, the director of the SFO, had been arguing strongly that the way to tackle serious fraud and advance the anti-corruption agenda was for there to continue to be a single, specialised unit which had both investigative and prosecution powers. He appears to have won that battle – but perhaps not the war. The sting in the tail of today’s announcement is that the government has left open the prospect of the future of the SFO being reviewed one year after the NCA becomes operational in 2013.

The recent uncertainty over the future of the SFO has given rise to the departures of a significant number of senior personnel from the organisation. Whilst today’s announcement means the SFO will survive in its current form for now, the fact that it may only be a stay of execution is unlikely to assist the SFO in recruiting the investigators and prosecutors it now needs to deal with complex and high value fraud and corruption.

Unanimous Supreme Court Appears to Hand Investors Big Wins, But Opinions Offer Defendants More Than Rulings Might First Reveal

This post was written by Amy J. Greer.

The Supreme Court issued two opinions this term that could dramatically alter the landscape of securities fraud litigation. In Matrixx Initiatives, Inc., et al. v. Siracusano, 563 U.S. ____ (2011), the Court unanimously held that a claim for securities fraud against a drug company may be stated if the company intentionally or with deliberate recklessness fails to disclose adverse drug reactions, regardless of whether those reactions are statistically significant. In another unanimous decision, Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. ____ (2011), the Court rejected the Fifth Circuit’s stringent requirement that plaintiffs relying on a fraud-on-the-market theory need also prove loss causation at the class-certification stage. While at first blush these decisions would appear to be clear victories for investor-plaintiffs, analysis reveals the more likely outcome of these new cases will be to make the initial pleading and class certification aspects of securities fraud litigation more critical than ever, encouraging the parties to engage experts and undertake extensive discovery even at those early stages of a lawsuit.  Click here to read more.

At Least One Big Fish Enters the Murky Regulatory Waters of Social Media

This post was written by Amy J. Greer.

While some have suggested that Morgan Stanley's announcement this week that it will permit its financial advisors to take some tentative first steps into the world of social media is nothing but a big yawn, given how fraught the social media world is with potential regulatory land mines, in context, these apparent "baby steps" start to look more like giant leaps.  For more information on Morgan Stanley's splash into Social Media click here.


Doth Congress Protest Too Much?

This post was written by Amy J. Greer.

Just as the SEC and DOJ are basking in the glow of the Rajaratnam guilty verdict, we once again find Congress shaking its finger at the regulators, suggesting that perhaps they’re not doing their job well enough in connection with another insider trading investigation – like somehow the enforcement types at the SEC and DOJ don’t have an interest in catching the bad guys. (As someone who used to be among those ranks, I’ve never quite understood this theory – but I digress.) From a group that is not itself prohibited from insider trading, I consistently find this conduct remarkable.

While there is always plenty of discussion around issues of whether insider trading is inherently “bad,” Congress doesn’t seem troubled by this largely academic inquiry; this latest salvo being Exhibit A. Yet, as I noted in a prior post, the law of insider trading can be excruciatingly complex and technology keeps stretching its limits. Note, for example, the non-fiduciary thief cases, like Dorozhko, which, at first blush, seem like they should be, but are not, insider trading cases, and present substantial and developing issues for regulators and the courts. Still, there seems little interest in Congress – the actual makers of law in this country – to simplify or streamline (or touch) this body of law.

Maybe it’s just me, but among the governed, government’s ability to address, much less solve, problems seems hampered by a real credibility gap. Perhaps if Congress spent a little less time asking regulators who they’re investigating and how, and a little more time addressing their own ethics rules – so that they, too, would be prohibited from insider trading – they could close that gap, just a bit. 

Regulatory Round Up 5.23.11

Jury Finds Company and Executives Guilty in FCPA Trial

This post was written by Sarah R. Wolff.

In a stunning jury verdict following a five-week trial, a California federal jury took just one day to find a privately-held company and two of its senior officers guilty on all counts of violating the Foreign Corrupt Practices Act (“FCPA”). The verdict against Lindsay Manufacturing Company (“Lindsay Manufacturing”), a manufacturer of electrical transmission towers, is the first conviction of a corporation under the FCPA since the law was enacted in 1977. The charges against Lindsay Manufacturing, its President and its CFO, centered on allegations that they engaged in a seven-year scheme to pay bribes to procure contracts with a state-owned Mexican utility, Comisión Federal de Electricidad (CFE), by making payments to employees of the utility through an intermediary that represented companies doing business with CFE.

The trial was preceded by several hotly contested pre-trial rulings in which the court rejected various defense claims of prosecutorial misconduct and an aggressive challenge by Lindsay Manufacturing to a key element in an FCPA prosecution – the meaning of the term “foreign official.” Lindsay Manufacturing argued that the Mexican utility was not an “instrumentality” of the state within the meaning of the FCPA, and therefore, the commission payments made to CFE’s employees were not bribes paid to foreign officials. Although the judge rejected the foreign official challenge, there are several other FCPA cases in other jurisdictions in which that issue is being pursued vigorously by defense counsel and we will continue to monitor those cases.

If the verdicts are upheld, the company faces extensive monetary penalties. As for the individuals, each faces a maximum of five years in prison on each of five FCPA counts and an additional five years on a count of conspiracy to violate the FCPA.

Not surprisingly, the Department of Justice immediately cited the convictions as a harbinger of things to come under its ongoing FCPA enforcement program. Touts and condemnations of the verdict aside – companies both public and private – as well as their officers and employees, should take note of this verdict.

The Raj Guilty Verdict - What Took So Long?

This post was written by Amy J. Greer.

The verdict is in – finally. Guilty on all counts. We’ll have more on that later, as will many people, no doubt.

But for those who wondered what took the Rajaratnam jury so long, I think it’s worth a reminder that, while the evidence in the case might seem somewhat straightforward – at least the juicy tidbits reported in the media, plus all those seemingly useful guilty pleas – insider trading law is definitely not.

Bottom line, there is no US law that says: “thou shalt not trade on material non-public information we all wish we had”; instead, we have Section 10 of the Securities Exchange Act of 1934 and Rule 10b-5 , which proscribe fraud far more broadly.

From these very broad pronouncements have come a patchwork of legal decisions that comprise US insider trading law and which require a fact finder – the Raj jury – to make at least six separate factual findings: that the defendant (1) intentionally (2) purchased or sold a security (3) on the basis of (4) material (5) non-public information (6) in breach of a duty of trust or confidence.

Whew. That’s a lot of work. And it’s worth remembering that most of these elements likely played a role in how the evidence was presented at the trial. Oh yeah - and there’s also that “beyond a reasonable doubt thing” that’s required for a finding of guilt in a criminal trial.

Most of us never have to face the question of whether a jury of our peers will do that hard work. At some level – at every level really – it’s good to know they do. Even in those cases where it seems so straightforward.

Regulatory Roundup 4.29.11

After reading this article, I will no longer complain while my family gets ready to go out. Unlike the DoD, which spends approximately $31 Billion/year, I’m pretty sure I can't fund a constant state of preparedness.

Howard Sklar does some thinking out loud about the risk/reward for implementing a private sector bribery compliance program under the UK Bribery Act.

Line of the Day (ok -- I know the post is a couple weeks old) goes to Clif Burns at Irish-American musicians can’t go to the Cuban festival because there will be Irish people there (emphasis in original). Thanks OFAC.

Electric car buying … batteries no longer included?

Presenting a new segment I'm calling: It's OK to Laugh.


UK Bribery Act - Guidance for Prosecutors published

This post was written by Matthew Stone.

On 30 March 2011, the Serious Fraud Office (SFO) and the Director of Public Prosecutions published their joint guidance for prosecutors (the Guidance) for offences under the UK's new Bribery Act, which comes into force on 1 July 2011. This coincides with the publication of the final guidance issued by the Department of Justice on the adequate procedures defence to the s. 7 corporate offence of failing to prevent bribery.  Bribery Act 2010 - Adequate Procedures Guidance.

The new Guidance addresses a number of issues:

  • Two-stage test for prosecutors – As with other criminal offences, prosecutions for bribery under the new Act need to pass the two-stage test in the Code for Crown Prosecutors  - i) the evidential stage and ii) the public interest stage.

If a prosecutor does not have sufficient evidence to make a conviction more likely than not, prosecutors should not go on to consider whether a prosecution is in the public interest, no matter how serious or sensitive the case is.

  • Public interest considerations – In determining whether a prosecution is in the public interest, prosecutors should take into account a number of factors set out in the Guidance which tend either in favour or against prosecution. These factors differ depending on the offence in the Act in respect of which prosecution may be brought. They include, among other factors: 

○  whether conviction is likely to result in a substantial sentence
○  whether the suspect was in a position of authority or trust; and
○  whether there was an element of corruption of the victim in the way the offence was committed.

In respect of the Corporate Offence, the SFO's Guidance on Corporate prosecutions will be considered. This Guidance sets out further factors likely to weigh in favour of prosecuting a company which include:

○  whether the company has a history of similar conduct;
○  whether the conduct is part of the established business practices of the company
○  whether the company has already been the subject of warnings or sanctions; and
○  whether the company's reporting was slow or concealed the full extent of the offending conduct.

Prosecutors are also entitled to consider whether conviction of company personnel for a minor offence under the Act would have a disproportionate effect on the company by leading to the company's debarment from public contracts.

  • “Financial or other advantage” – The general "active" and "passive" bribery offences and the offence of bribing a foreign public official all refer to a "financial or other advantage". This term is not defined in the Act. The Guidance states that the term "advantage" should be understood in its ordinary everyday meaning.
  • Strict Liability Corporate Offence of failing to prevent bribery – The Guidance makes clear that the Corporate Offence does not require prior prosecution of the associate person although there needs to be sufficient evidence to prove bribery by the associate person to the normal criminal standard.

For corporates seeking to avail themselves of the adequate procedures defence, they will need to establish the defence on the balance of probabilities. The Guidance makes clear that a single instance of bribery does not necessarily mean that an organisation’s procedures are inadequate. The actions of an employee may be wilfully contrary to very robust corporate contractual requirements, instructions or guidance.

  • Hospitality – The Guidance makes clear that hospitality which is not excessive or disproportionate and which is made in good faith is unlikely to attract the attention of the prosecutors. The more lavish the hospitality or expenditure, the greater the inference that it is intended to encourage or reward improper performance of a function or activity. Lavishness is just one factor that may be taken into account in determining whether an offence has been committed.
  • Facilitation Payments – Unlike the US Foreign Corrupt Practices Act, the UK Bribery Act has no carve-out for facilitation or grease payments and this point is reiterated in the Guidance.

The Guidance stresses that all cases under the new Bribery Act should be considered on their own merits, but given the likely importance of precedents - particularly for prosecutions under the Corporate Offence - lawyers will be watching closely to see how prosecutors and the courts apply the new law in practice after 1 July 2011.

Regulatory Round Up 3.31.11

Now THAT's "Real Time" Enforcement

This post was written by Amy J. Greer.

At the recent SEC Speaks conference, the recounting of a particular SEC Enforcement action caught my attention and I thought it particularly worthy of note, since most of us who practice in this area believe – with pretty good reason and a whole lot of evidence – that the SEC’s Enforcement Division moves like, well, that tortoise. Usually getting to a finish line, of sorts, but it takes a while. Often a really long while . . . with a lot of meandering.

So, needless to say, Daniel M. Hawke, who heads the Division’s Market Abuse Unit and leads the Philadelphia Regional Office, proudly recounted the much more “hare”-like freezing of $1.1 million in assets of two Spain-based traders, accused of insider trading in connection with PotashCorp’s announcement that it had received and rejected an unsolicited offer from BHP Billiton plc, within 72 hours of that announcement. That’s right: on August 17, 2010, PotashCorp publicly announced the spurned offer, and on August 20, 2010, the SEC’s Enforcement Division obtained a signed order freezing the traders’ assets in the Northern District of Illinois.

And, actually, it’s even better than that. Let’s recount the geography here. The traders are both in Madrid, Spain, trading options through US-based Interactive Brokers, LLC accounts, and all of the trading at issue took place on the Chicago Board of Options Exchange. Potash Corp. is based in Saskatchewan, Canada, and its stock is traded on the New York and Toronto stock exchanges and its options are traded on the CBOE. BHP is based in Melbourne, Australia. SEC staff on the case were located in Chicago, New York, and Philadelphia.

Real time enforcement – that is, taking action shortly after the conduct actually occurred – has been a matter of discussion for a long time at the SEC. Of course, in these types of circumstances, when money is at risk of being moved out of the country and out of the SEC’s ready reach, the timing is even more imperative. But given all of the moving parts here, especially the geographic issues, gathering sufficient evidence to get the freeze order in just 72 hours of the announcement, and within about a week of the trading (all of which occurred between August 12 and 16), just goes to show how quickly the agency can move in the right cases. 

At Last, The Bribery Act 2010 Adequate Procedures Guidance is Here

This post was written by Rosanne M. Kay and Tom Webley.

The waiting is over! At last the UK Ministry of Justice has published guidance about procedures which commercial organisations can put into place to prevent persons associated with them from bribing. The Act will now come into force on 1 July 2011.

The guidance offers non-prescriptive procedures and commentary on the scope of the Act. As the Lord Chancellor and Secretary of State for Justice, Kenneth Clarke, said this morning in his statement on the publication of the guidance "These are quite tough rules. But what the guidance I am also publishing today underlines – after helpful consultation with businesses, and NGOs – is that combating bribery is about common sense, not bureaucracy."

At the core of the guidance are proportionality and risk assessment which should give comfort to those small and medium sized enterprises worried at the prospect of having to spend a fortune on putting in place complex, burdensome polices and procedures. Of limited comfort is the Secretary of State's indication that there will not be a large number of prosecutions and certainly not for trivial cases but these decisions are not his to make and will be decided by the Director of Public Prosecutions or the Director of the Serious Fraud Office. 

Click here for more information about the guidance.

UK Bribery Act - Guidance on Adequate Procedures to be published tomorrow and Act to be implemented in June/July 2011

This post was written by Rosanne M. Kay and Suzie A. Savage.

It is understood that the UK Ministry of Justice will publish its guidance on adequate procedures tomorrow, Wednesday 30th March 2011.

The Act was originally scheduled to be implemented in April of this year, three months after guidance was to be published in January about the “adequate procedures” firms should have in place to prevent bribery.  The Act will now apparently come into force in June/July 2011. 

Regulatory Round Up 3.24.11

UK Bribery Act - timing is still unclear

This post was written by Rosanne Kay and Neil Donovan.

The UK Ministry of Justice (“MoJ”) official with responsibility for managing the implementation of the Bribery Act 2010 (“Act”) provided an update on the status and content of the revised adequate procedures guidance during a speech last Thursday. 

The speech covered the following:

  • Timeframe- according to the official, the delayed adequate procedures guidance will be published “as soon as possible” but set no specific date. There is still no information about when the Act will come into force but the MoJ has promised a three month gap between publication of the guidance and the coming into force of the Act.
  • Principles in the Guidance- the six guiding principles contained in the draft of the guidance released last year will remain but the revised guidance will differ “quite substantially” from the previous version.

The timing of the adequate procedures guidance and the Act remain unclear. The content of the guidance is also apparently in a state of flux. Nevertheless, companies who are waiting for the guidance to implement changes to their policies and procedures may wish to reconsider. It will almost certainly take most companies more than three months to plan and make changes and they may run out of time.

Regulatory Round Up 3.11.11

When Ambiguity Can Mean Criminal Indictment: the FCPA and the Case of Establishing the Elements

This post was written by Anne E. Borkovic.

As everyone can cite, the Foreign Corrupt Practices Act (“FCPA”) in part prohibits offering or providing anything of value to a foreign official to obtain or retain business. But what does that mean in practice? Two federal courts are grappling with defining “foreign official” and, in turn, whether the prosecution can establish all the elements of a violation.

In U.S. v. Stuart Carson et al., defendants moved to dismiss and argued that the officers and employees of state-owned companies are not “foreign officials” because the companies are not instrumentalities, departments, or agencies of the foreign government. The FCPA Professor Mike Koehler filed a declaration in support of the motion, detailing the legislative history of the FCPA and the “foreign official” element. A hearing on the motion is set for March 21.

In U.S. v. Enrique Faustino Aguilar, defendants also moved to dismiss under the same argument and have asked the judge to take judicial notice of the Carson declaration.

Of course, we will keep you apprised of developments as the Courts decide this important issue.

Regulatory Roundup 3.4.11


Former company directors receive prison sentences from UK Court for corrupt payments to Saddam's government

This post was written by George Brown and Tom Webley.

Two former directors of engineering firm Mabey & Johnson received custodial sentences today, having been found guilty earlier this month of inflating the prices paid under humanitarian contracts to provide steel bridges to ensure that kickbacks of over Euros 420,000 could be paid to Saddam Hussein’s government.

The directors, Charles Forsyth and David Mabey, who were respectively the Managing Director and Sales Director of the firm, were found guilty of making the illegal payments in 2001 and 2002. Another employee, Richard Gledhill, had pleaded guilty to offences relating to breaching United Nations sanctions and subsequently gave evidence for the prosecution. 

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The Tenth Circuit Rejects the Application of the Investment Advisers Act to Brokers of Life Insurance Products

This post was written by James A. Rolfes.

Last week, the Tenth Circuit Court of Appeals, in a matter of first impression, held that a life insurance company sales agent, who referred to himself as a Financial Services Representative (FSR), did not have to fulfill the fiduciary duties imposed on investment advisers under the Investment Advisers Act. Instead, the incidental nature of the investment advice given and the manner in which the sales agent was compensated, qualified the agent for the broker-dealer exemption to the Act’s definition of an investment advisor.

In Thomas v. Metropolitan Life Ins. Co., --- F.3d ---, 2001 WL 310371 (10th Cir. Feb. 2, 2011), the Met Life sales agent analyzed the plaintiffs’ financial situation, gave advice on how to allocate their 401(k) funds, conducted an investment/insurance product “suitability analysis” and recommended the plaintiffs’ purchase of a variable universal life insurance policy. In doing so, alleged the plaintiffs, the agent and, vicariously, his life insurance company employer, failed to disclose the strong incentives the agent had to sell the Met Life proprietary products -- a purported violation of an investment advisor’s statutory duty to give unbiased advice.

The Tenth Circuit, however, rejected the notion that the Act imposed fiduciary obligations on a life insurance agent’s provision of investment advice in the context of the sale of insurance products. The court instead held that the agent’s actions met the two pronged definition of a broker-dealer whose advice the statute explicitly exempts. In particular, the court found that (i) the agent gave advice “solely incidental to” his sale of the life insurance product; and (ii) his compensation (i.e., a $500 brokerage commission) derived from the sale of the insurance policy, and not from his provision of investment advice. In so holding, the court expressed its belief that the plain language of the statute, the legislative history and SEC interpretations all supported the court’s conclusion that the statute’s reference to advice “solely incidental” to the brokerage services meant advice “solely attendant to,” or “given in connection with,” the brokerage service provided, and not to the amount or import of the advice given. Consequently, even though the agent’s advice purportedly served as the “central component” of the sale transaction, he gave such advice in connection with, and thus incidental to, the sale of the insurance product. He therefore did not owe the plaintiffs a fiduciary duty under the Investment Advisers Act.

Ironically, this decision follows on the heels of the SEC’s release of the January 2011 SEC Staff’s Study on Investment Advisers and Broker-Dealers. Pursuant to the Congressional mandate in Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC Staff evaluated the effectiveness of existing legal and regulatory standards of care for providing personalized investment advice and securities recommendations to retail customers. Contrary to the court’s analysis, the Staff suggests that the amount of advice a broker-dealer provides is relevant in analyzing the applicability of the broker-dealer exemption. But of even greater importance, the Staff strongly recommended consideration of regulatory enacted rules that would do away with the broker-dealer exemption altogether, and instead impose a uniform fiduciary standard on both investment advisers and broker-dealers who provide personalized investment advice about securities to retail customers. In particular, the Staff called for a uniform fiduciary standard that would, among other things, require broker-dealers to disclose conflicts of interest – the issue at the heart of the plaintiffs’ claims in Thomas v. Met Life.

Thus, while the Thomas v. Met Life decision provides comfort to insurance companies and their sales agents, such comfort may be short lived.

UK Bribery Act - practical guidance

The Director of the Serious Fraud Office (SFO), Richard Alderman, gave a speech yesterday about the Bribery Act which touched on many practical issues and further guidance to be issued.

The speech covered:

  • Prosecution guidance – this should be issued by Mr Alderman and the UK Director of Public Prosecutions at the same time as the “adequate procedures” guidance. The guidance will set out the public interest factors that prosecutors should take into account in deciding whether to prosecute under the Act and should shed light on facilitation payments and hospitality.
  • Exclusion from EU public contracts – many have expressed concern about whether the offence of failing to prevent bribery under the Act will result in mandatory exclusion from public works in the EU. Mr Alderman confirmed that this was a point which the UK Government was still considering and he hoped that clarification on this would be given at some point.
  • Foreign corporates carrying on business in the UK – there is also a question mark about the SFO’s jurisdiction over foreign corporates which carry on business in the UK and whether a London Stock Exchange listing or the presence of a subsidiary are sufficient to bring a corporate within the SFO’s jurisdiction. The SFO takes a wide view of the scope of its jurisdiction but Mr Alderman acknowledged that the UK courts would need to consider the question.
  • Joint ventures – the SFO draws a distinction between current and new joint ventures. With current joint ventures, the SFO expects corporates to do what they can to establish that their partners are complying with ethical obligations but recognises the practical and legal limits to this. However, the SFO would expect any new joint ventures to address anti-corruption issues. The SFO has already had a number of discussions with companies about their joint ventures.
  • Hospitality – Mr Alderman was clear that it was not correct that all hospitality or promotional expenditure was illegal under the Act. Sensible, proportionate entertaining or promotional expenditure is lawful.

    By way of practical example, he referred to buying breakfast or lunch for a client or flying a group of prospective clients from another part of the world to see the company’s facilities in the UK. This will usually be sensible business. A month long all expenses paid holiday to the company’s private island in the Caribbean would likely be viewed with suspicion.
  • Sporting events – the SFO is considering giving more guidance on the appropriateness of taking clients to sporting events.
  • Facilitation payments – Mr Alderman was very clear that these were bribes and illegal. He referred to the respect he has for corporates which have adopted a zero tolerance policy towards facilitation payments. According to him, these corporates find their policy good for business as their employees are not bothered by demands for these payments because their policy is well known. He also referred to the SFO’s sympathetic approach to situations when payment is demanded under extreme duress or in medical emergencies. The prosecution guidance should also provide more clarity on the issue.

Without pre-empting the guidance which is anticipated shortly, the SFO is clearly keen to lay to rest some of the wilder speculation which has recently appeared in the press concerning the impact of the Act, particularly with regard to corporate hospitality. Mr Alderman has sought to leave his audience with the impression that the SFO’s enforcement of the Act will be tough, yet underpinned by common sense. The written guidance should reinforce that message. 

Regulatory Round Up 2.3.11

With a title like "Tactical Secrets" I was expecting a insiders look into fly fishing for Steelhead trout . But then I realized I was reading the New York Times. Instead, this piece addresses the government's assertion of the state-secrets privilege in General Dynamics Corp v. US.

Déjà vu all over again. Nick Silver compares the political landscape that President Clinton faced with the current congressional make up now facing President Obama.

When blogs reference other blogs, we here in the Round Up office get excited. Howard Sklar at Open Air Blog explains why he disagrees with the FCPA Professor and Alexandra Wrange (of TRACE) over the impact of the UK Bribery Act.

Sudan Watch: With referendum results showing overwhelming support for secession, Khartoum is calling for an end to the US embargo. In news that should surprise absolutely no one, the US has decided to wait and see.

The National Institute of Standards and Technology has issued new guidelines for cloud computing. If "safeguarding data in the public cloud" is something you are in to, or have no idea what it means, you may want to read this.

UK Bribery Act - still more delays

The implementation of the UK Bribery Act has been delayed, the UK Ministry of Justice has confirmed today.

The Act was due to be implemented in April 2011, three months after guidance was to be published about the “adequate procedures” firms should have in place to prevent bribery.
It was originally thought that the guidance would be published at the end of this month. The guidance has now been delayed although there are rumours circulating that it may be published in the next few weeks.

As previously reported, the Act has been the subject of significant debate about its potential adverse impact on the British economy as well as of criticism about its lack of clarity.

It is thought that the delay will result in changes to the guidance, a draft of which has so far been the subject of consultation, but not to the Act itself.

Regulatory Round Up 1.24.11


Proposed restructuring of UK agencies dealing with economic crime and fraud continues at pace

This post was written by Simon Hart and Tom Webley.

In advance of the much anticipated consultation in the United Kingdom on the creation of the proposed Economic Crime Agency (“ECA”), which is due to take place this spring, the Home Office announced this week that it plans to take a greater role in the fight against economic crime by having the ECA fall within its remit rather than that of the Treasury. On 17 January 2011 it set out plans to merge the Serious Fraud Office (“SFO”) into the soon-to-be-formed, all-powerful National Crime Agency (“NCA”). It also suggested that the ECA could become part of the NCA.

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Strong debate continues over the UK Bribery Act and its implementation

This post was written by Simon Hart and Sarah Wolff.

On January 13, 2010, the London Evening Standard reported that Prime Minister David Cameron’s office has ordered a review of the new UK Bribery Act as a result of strong concerns expressed by UK business leaders and others about the potential adverse impact the Act might have on the British economy. The Act has the effect of potentially criminalising corporate gift-giving, facilitation or "grease payments" and hospitality, regarded by many as vital to doing business abroad. The review will be conducted by a committee chaired by the Chancellor of the Exchequer and the Business Secretary whose charge is to scrutinise a broad range of regulations which are perceived as hindering business growth.

That same day, Vivian Robinson, the General Counsel of the Serious Fraud Office (SFO), the agency responsible for enforcing the sweeping anti bribery law, predicted that the review would not result in any “transformational changes” to the Act and may only impact the formal guidance on the Act that is to be published by the UK’s Ministry of Justice. That said, Mr. Robinson also stated that we can expect to see the formal guidance issued by the end of January. [For our posting on the Ministry’s consultation with industry which has taken place in relation to the guidance, see link ].  If that is the case then the effective date of the Act will remain on track for April 2011.

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Regulatory Round Up 1.13.11

Regulatory Round Up 1.7.11

Curtain Drops (For Now) on First Hollywood Couple Charged with FCPA Violations

This post was written by Joelle E.K. Laszlo.

While it’s usually good to be the first to do something in Hollywood, it is decidedly not good when that something is violate the Foreign Corrupt Practices Act (“FCPA”). Former power couple Gerald and Patricia Green are learning that lesson the hard way, as they spend the holidays and beyond in Federal prison. Though the Greens and the Government are appealing the six-month sentences handed down in August, it’s safe to say the Greens’ post-conviction lifestyle won’t come close to matching what it was before.

The Greens were originally indicted in January 2008 for bribing the former governor of the Tourism Authority of Thailand (“TAT”) in exchange for contracts to operate and manage the annual Bangkok International Film Festival (“BIFF”) from 2002 through 2007. In October 2008 the plot thickened as a superseding indictment added bribery charges related to several other TAT tourism programs. In all, and among other things, the Greens were accused of violating the FCPA ten times, ultimately paying out $1.8 million to generate nearly $14 million in revenue. In September 2009 a Los Angeles jury found the Greens guilty of nine FCPA violations and nearly all of the other charges against them.

Sentencing of the Greens was postponed numerous times over several months, as both sides battled to sway the court’s final act. The Justice Department, arguing that FCPA defendants who do not plead guilty or otherwise cooperate with the Government generally receive stricter sentences, asked for ten years in prison for each Green. Defense counsel requested five years’ probation, noting both that Mr. Green suffers from emphysema and that the BIFF generated substantial revenue for Thailand and its people, and thus there were no real victims from the Greens’ actions. After a final lengthy hearing, in August 2010 the Greens were sentenced to six months in prison each, followed by six months of home confinement.

Though the Greens’ prison sentences are some of the lightest ever received by FCPA defendants, there is no Hollywood ending to their story. Under a forfeiture agreement approved along with their sentences, each Green personally owes the Government nearly $1.05 million and any amount of their production company’s pension that can be traced to their offenses. The Justice Department intends to seize and sell a home owned by Mrs. Green to satisfy the judgment. And unable to muster any more funds for his defense, Mr. Green will be represented in his sentencing appeal by a court-appointed attorney. Thus the Greens’ saga is not really fodder for a future blockbuster, or even a movie of the week, though it may make for a good public service announcement on complying with the FCPA.

Regulatory Round Up 12.16.10

Around this time of year many people look forward to the ringing of bells. Bryan Rahija wants your help in ensuring that we have year-round blowing of the whistles.

If the estate tax was called the death tax, would we all try to live a little healthier? (It’s the holidays – I'll make and break my resolutions in a few weeks). Regardless of its title, the tax is on the table. So what should congress do about it?

As a child, my parents coerced my siblings and I to get along through the promise of presents from Santa. Turns out FCPA violators who play nice with the DOJ may be able to secure a present of their own: a Non-Prosecution Agreement.

Holiday takeaways: good = presents; bad = coal; Microsoft engineer who attempts to export ITAR controlled goods to China  = criminal complaint.

Regulatory Round Up 12.02.10

Will the Whistles Start Blowing?

This post was written by Sarah R. Wolff.

In January 2010, the Securities and Exchange Commission ("SEC") announced a new cooperation initiative intended to encourage and incentivize individuals and companies to cooperate with and assist the SEC in its investigations and enforcement actions. That initiative, which was characterized as a “potential game-changer” for the SEC’s Enforcement Division by its new director, Robert Khuzami, gave the SEC a new set of tools for its “enforcement toolbox”, including cooperation agreements, deferred prosecution agreements and non-prosecution agreements. These options, while employed by the Department of Justice, were not previously available in SEC enforcement matters. In addition to outlining those tools in a revision to the SEC’s Enforcement Manual, the Commission provided a policy statement detailing the factors the SEC considers when evaluating cooperation by individuals and by companies.

The SEC evidenced its latest expression of interest in obtaining cooperation with its July 23, 2010 announcement that it had awarded a $1 M bounty to two whistleblowers for their substantial assistance in providing information and documents leading to the imposition and collection of civil penalties in the Commission’s May 2010 insider trading actions brought against Pequot Capital Management, Inc. and various individuals. The award was made pursuant to the Commission’s then-existing authority under the Securities Exchange Act of 1934 to award bounties to whistleblowers in insider trading cases. Significantly, in the twenty years since the SEC received its bounty authority, it had only awarded a total of $160,000 to five claimants. All of that appears to have changed with the adoption of the Dodd-Frank Act.

Among the many provisions of Dodd-Frank are specific provisions designed to significantly expand the SEC’s authority to reward whistleblowers for information beyond insider trading cases. The Act provides for the payment of potentially large awards as well as for the protection of employees who provide information to or assist the SEC relating to any violation of the securities laws. To be sure, in order to qualify for a whistleblower award, the information provided to the SEC by the whistleblower must be “original” information; in other words, the information must not previously have been known to the SEC. But if that information provides substantial assistance and leads to a successful enforcement action resulting in over $1,000,000 of monetary sanctions imposed on the wrongdoer, then the SEC has the discretion to award the whistleblower not less than 10 percent and not more than 30 percent of the monetary sanctions collected.

On November 3, the Commission published its proposed rules for implementing the whistleblower provisions of Dodd-Frank. Comments on the rules, which total over 180 pages, are due by December 17, 2010.

Have these developments changed the landscape for clients and their counsel in considering whether, and when, to self-report a potential FCPA or other securities law violation to the SEC or other regulators? Certainly the past five years have seen an uptick in enforcement activity in FCPA investigations and actions, and many of those investigations began with a self-report. The confluence of increased pressure to cooperate early in order to obtain full cooperation “credit” with Dodd-Frank’s whistleblower protections mandates that companies must even more carefully evaluate how they will conduct internal investigations at the first sign of possible wrongdoing. Does an e-mail or an anonymous tip of suggested wrongdoing automatically trigger a full blown investigation? How early companies must share their concerns, preliminary or otherwise, if not their findings, with the SEC and other regulators in order to get cooperation credit, becomes an even more critical decision under the new regulatory regime.

One obvious risk of holding back is that the SEC will receive information from a company employee who in years past might have gone to an in-house compliance officer to voice her concerns. Instead, she went directly to the SEC. Such conduct raises significant issues for companies that have installed significant compliance programs and which now must deal with risk management where the government’s financial incentives may undermine their efforts. In the end, every decision as to whether and when to self-report, and the nature and extent of an internal investigation, are fact-intensive, and there isn’t a one-size fits all prescription. It remains to be seen how the SEC will parse the “race” to disclose and cooperate, in terms of either rewarding an early disclosure or penalizing a company for failing to timely cooperate by, for example, imposing a more significant penalty and other remedies against a company in a subsequent enforcement action.

At a minimum, the dynamics have changed at the SEC and, when combined with Dodd-Frank, present new challenges in navigating the cooperation waters.

Regulatory Round Up 11.04.10

I bet you think pretty highly of yourself. I know I do … come on, I’m a lawyer! (Please insert stereotypical lawyer joke here – put a good one in the comments if you dare). From time to time, I’m “gently” reminded that not all of my accomplishments are oh-so noteworthy. As my brother used to say after I would regale him with some of my more humdrum endeavors: “what do you want, a cookie?” It looks like I’m not the one in search of a cookie.

As the great state of Wisconsin bids farewell to Russ Feingold, the rest of us begin to say goodbye to the legislation he is most known for.

When I think of auditors, the first thing I think of (after the Grim Reaper) is efficiency. So why then is the Defense Contract Audit Agency amending its procedures in a way that “could expose the government to massive overcharges by prime contractors?”

Interested in potentially saving millions of dollars? Yep, I thought so. Now lets play: Follow the Blogosphere Link Machine. This post is my reference to the FCPA Blog’s reference to an article written by Andrew Weissmann and Alixandra Smith discussing the potential for substantive FCPA revision.

Regulatory Round Up 10.28.10

After the roaring success of the first Round-up (remember when I gave it the cool nickname) we are back for round two. Here is a quick jog around the regulated legal world.

  • Have you ever known a professor who didn't love golf? I didn't think so. Have you ever been able to get a lawyer to stop talking about the law? Don't lie to me, its rude. It was going to happen sooner or later, but I'm hoping this one sticks around -- ladies and gentlemen, for your tee time banter: The FCPA Mulligan Rule.
  • I hope you got all of your "Congress never does anything" jokes out of your system. These Lame Ducks could cost you a fortune.
  • 10 years ago the thought of having two employers would have meant that I had: 1) two small paychecks, 2) a couple of lousy jobs, and 3) at least one terrible middle manager to report to. I'd much rather be a federal contractor in this day and age, where having joint employers means there are more people to sue.
  • If you sit real still, watch closely, and are willing to have less fun than bird watching, you can witness the birth of the proxy advisor industry.

No Indemnification for SOX 304 Clawbacks

This post was written by James A. Rolfes.

The Second Circuit Court of Appeals recently ruled that a corporation could not indemnify its CEO or CFO against liability arising under Sarbanes Oxley Act Section 304. The so-called Section 304 “clawback” provision requires a public company’s CEO and CFO to return bonuses, other equity-based incentive compensation and trading profits when “misconduct” leads to material noncompliance with financial reporting requirements (i.e., a financial statement restatement). This statute further gives the SEC the authority to enforce such clawbacks, and, importantly, to exempt CEOs and CFOs from its application. As a result, allowing a corporation to provide a release and indemnification for the clawback would “frustrate the power of a federal agency to pursue the public’s interests in litigation” and “[fly] in the face of Congress’s efforts to make high ranking corporate officers of public companies directly responsible for their actions that have caused material noncompliance with financial reporting requirements.” Cohen v. Viray.

This decision follows closely upon Congress’s call last summer for the SEC to get serious about the return of executive bonuses when a company restates its financial statements. In particular, in the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress expanded upon the SOX Section 304 compensation clawback provision, explicitly instructing the SEC to establish rules requiring exchange-listed public companies to recover the incentive-based compensation paid to corporate executives as a result of using erroneous financial statement data.

The decision also issues during a period in which the SEC has more aggressively used the SOX 304’s clawback provision in enforcement proceedings. Despite being on the books for over eight years, the SEC sparingly invoked the provision in enforcement actions, and then only when a CEO or CFO had direct involvement in causing a financial statement misstatement. Starting in 2007, however, the SEC more regularly has sought SOX 304 disgorgement, and, as the result of a controversial decision that split the Commissioners along party lines, has demanded the return of pay from CEOs and CFOs that unwittingly – as opposed to intentionally – benefitted from the accounting misconduct. (An interpretation recently endorsed by a federal court in SEC v. Jenkins.)

Many questions remain regarding the interpretation of SOX 304 – questions likely to be repeated as the SEC works its way through the rule making process Congress has demanded under Dodd-Frank Section 954. The issues range from what activity will trigger a disgorgement obligation, to whom the obligation will apply, to what payments or incentives will be covered, to what discretion will remain in the SEC’s enforcement of the executive compensation clawback provisions. See Rolfes, Dodd Frank Leaves Clawback Uncertainty, Compliance Reporter (Aug. 30, 2010). What remains clear, however, is that financial statement errors, even if unintentional, will put the earnings of CEOs and CFOs, as well as those of their C-level colleagues, at risk.

Regulatory Round-up

This post was written by Michael A. Grant.

Hello good-looking regulatory attorneys. Welcome to the first installment of the Regulatory Round-up (catchy, I know). If you are reading this post, odds are someone in an office larger than yours is wondering why you aren't working -- but I'm glad you stopped by. The goal of this weekly installment will be to connect you to stories from around the blogosphere that impact those of us practicing in regulated industries. While the primary focus of the Round-up (look, I already gave it a trendy nickname) will be the 7 topics to the left, I'll be sure to mix in other stories that catch the eye. Here's hoping you see something new, have a laugh, or at least get some legitimate "professional reading" time.


UK Government consults on Bribery Act: "adequate procedures" guidance - but not for long

This post was written by Simon Hart.

Eight weeks and counting. That is the period that the UK’s Ministry of Justice has given for responses to their consultation paper on the guidance which will be published by the Government as to what might constitute “adequate procedures” for companies who might find themselves relying on the statutory defence under the new Bribery Act 2010.  What is significant is that the Government has consciously truncated the usual 12 week consultation period so that the formal guidance can be published in January 2011 with the intention being that the Act will still come into force in April 2011.

The draft guidance is built upon 6 principles:

  • risk assessment
  • top level Board commitment,
  • due diligence
  • clear practical and accessible policies and procedures
  • effective implementation
  • monitoring and review.

Around each of these the Government has identified a number of draft questions that organisations need to ask themselves in order to decide whether their procedures are adequate for their business.  As expected, it appears the guidance will be high level, leaving the onus upon companies to interpret what is required.

Whilst the form of the draft guidance is not a surprise, the timetable for the consultation shows a clear commitment by the Government to bring this Act in to force in spring of next year. In planning terms, that is a very short space of time for corporations to assess their business models and put in place the necessary procedures.  The clock is ticking.

For those wanting to review and respond to the consultation, the relevant papers can be found here.

Market Abuse and the May 6th "Flash Crash": The SEC Expands its Enforcement Focus

This post was written by Amy Greer.

Recently, I had the opportunity to moderate a panel hosted by the Pennsylvania Bar Institute on which Daniel M. Hawke, the Chief of the SEC’s new Market Abuse Unit and Regional Director of the SEC’s office in Philadelphia, participated. Dan and I worked together for several years, while I was at the SEC, where I served as Chief trial counsel for the Philadelphia Regional Office. It was a pleasure (and really quite a coup) that he, and Elaine Greenberg, who heads the Municipal Securities and Public Pensions Unit and is the Associate Regional Director for Enforcement of the Philadelphia Office and also a former colleague, agreed to come and speak about their new national positions and the current focus of the Agency. Dan and Elaine head two of the five new specialized subject matter units created at the Division of Enforcement, focusing a lot of attention on the SEC’s Philadelphia Office.

The Market Abuse Unit focuses on investigations involving large-scale market abuses such as organized insider trading networks as well as other market manipulation and trading violations. One can expect that future cases brought by the unit may be similar to the SEC v. Galleon insider trading case currently under way. During the discussion, Dan described the Market Abuse Unit as conducting trader-based investigations, instead of reviewing trading on a security-by-security basis. Much of the Unit’s initial detective work depends heavily on computers and the development and deployment of automated trading data analysis. Dan explained that focusing only on securities is too limited to effectively capture improper trading. By focusing on traders, the Market Abuse Unit can look for patterns and relationships across securities to proactively uncover market abuse and trading violations.

However, perhaps even a trader-based analysis is too narrow in light of the “flash crash” that occurred in the stock market on May 6, 2010. The Dow Jones Industrial Average fell nearly 1,000 points causing many companies to trade at unreasonably low levels before the market recovered that same day. While the causes of the “flash crash” still elude regulators, the SEC has taken a strong interest in uncovering the origins of the “flash crash” and preventing future anomalies.

During the discussion, Dan acknowledged that when the market crashed on May 6th, he realized the focus of his Unit was still too narrow. He explained that the Market Abuse Unit must focus on market structure as well. As Dan explained, the Market Abuse Unit will need to specialize on such topics as Regulation National Market System (“Reg NMS”), market fragmentation, un-displayed liquidity and dark pools, high frequency and algorithmic trading, direct market access providers, and related issues. Such specialization will allow the unit to analyze, for instance, a fragmented market with over 50 exchanges to uncover where improper conduct may be occurring.

So how will this new initiative at the SEC’s Market Abuse Unit affect traders and trading practices? At the very least, we can expect this new Unit’s proactive approach and desire to expand its focus will cultivate more knowledgeable and savvy attorneys within the SEC’s Enforcement Division. What’s more, the SEC will now be on the lookout for more advanced and harder to detect market abuse schemes, not just across traders but, between fractured and fragmented markets as well. With all of these changes, one thing is certain, Dan Hawke and his Market Abuse Unit intend to be just as creative and knowledgeable as the traders they investigate.

The Bribery Act 2010 - What it means for you

This post was written by George Brown, Matt Stone, Simon Hart, Sarah Wolff, and Jim Sanders.

The Bribery Act 2010 (the "Act") which recently was passed by Parliament has far-reaching implications for any business which is either registered in the UK or which has any part of its operation in the UK. The breadth and importance of this legislation means that corporates and their senior officers would be well advised to familiarize themselves with the effects of this new law.

 Why is this legislation important to you and your business? The Act includes:

  • A new corporate offence of failing to prevent bribery: this is a strict liability offense: a company's guilt can be a result of an attempted or actual bribery on the company's behalf;
  • "Senior officers" (including non-board level managers) can individually be held criminally liable for a company's bribery offenses;
  • Extensive extra-territorial powers of prosecution similar to those found in the U.S. Foreign Corrupt Practices Act ("FCPA");
  • Offenses apply to both public and private sectors (unlike the FCPA);
  • No carve-out for facilitating or "grease" payments (unlike the FCPA)
  • Conviction could mean debarment from all public sector contracts within the European Union.

This legislation comes at a time of increased international co-operation between regulators not only in matters relating to bribery, including enforcement of the FCPA, but in connection with financial fraud, insider dealing and related activities. The extensive powers provided by the Act will be used by UK enforcement agencies such as the Serious Fraud Office ("SFO") to clamp down on corrupt behavior. The Bill received Royal Assent on 8 April 2010 and its various provisions are likely to be bought into force over the next six months.

To view the entire client alert, please click here.

The UK's Bribery Bill

This post was written by George Brown

It is well over a decade since the UK government started a consultation process as to the future form of the law controlling bribery. A Bribery Bill was put to Parliament in 2000 but, as a result of criticism as to its content, the Bill was never enacted. The latest Bribery Bill was introduced to Parliament in November 2009 and is now at the Committee stage. The Government is keen to ensure that the law is enacted before the General Election although there will be some delay before the law is put into force after enactment.

To view the entire alert, please click here.