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Month: April 2014

SEC Charges Corporate Insider with Insider Trading for Passing Information

The SEC brought insider trading charges against a technology firm’s accounting manager for relaying material nonpublic earnings information to his hedge fund trader friend.  The defendant agreed to settle charges by agreeing to a $30,000 fine and an industry bar from serving as an officer of public company.  The SEC charges that the defendant passed inside earnings information to a hedge fund trader with whom he played poker.  The SEC alleges that the friend passed the information to several hedge funds that traded on the information.  The SEC asserts that the defendant is liable for the trading profits earned by the downstream hedge funds and that he violated the antifraud rules. Sanjay Wadhwa of the SEC’s New York Regional Office stated that: “Insiders at public companies who are entrusted with confidential information are duty bound to protect it” and that the defendant “violated that sacred duty.”
OUR TAKE: This case expands tipper liability because the SEC never charges that the defendant actually received any financial benefit from passing the information.  If the defendant never benefitted financially, how can he be charged with violating the antifraud rules in connection with the purchase/sale of a security?  Is a tipper liable for downstream profits or just his own?


FINRA Approves Registered Rep Background Checks

FINRA has approved new rules that will require firms to verify the accuracy of information provided on Form U4, the form required for new applicants or transfers and includes information on employment background, disciplinary information, and litigation history.  The new rules would require firms to adopt written procedures to verify information through due diligence of publicly available criminal, bankruptcy, and litigation records.   FINRA also indicated that it plans its own search of public financial records for all reps that have not been fingerprinted during the last 5 years.  FINRA will also “conduct periodic reviews of public records to ascertain the accuracy and completeness of the information available to investors, regulators and firms.”
OUR TAKE: The new rules will require a new review process at many firms.  Perhaps, the easiest way for firms to implement background checks would be to retain a third party firm that specializes in background checks.  Firms should expect that FINRA will hold them accountable if registered reps have issues that could have been uncovered.  

Top 5 Regulatory Alerts – March 2014

Here are our Top 5 Regulatory Alerts for March 2014, ranked by
significance.  We have also included the Top 5 most read Alerts (other
than Best of the Web and Top 5).


Top 5 Regulatory Alerts – March 2014

  1. SEC
    Official Targets Dual Registrants
  2. Cost
    of Compliance Increasing with Regulatory Focus on Culture
  3. Large
    Firm to Pay $25 Million for Insufficient Electronic Communication Surveillance

  4. Supreme
    Court Extends Whistleblower Protection to Mutual Fund Service Providers

  5. FINRA
    Adopts New Supervisory Rules; Guidance on Email Reviews


Most Read – March 2014

  1. Investment
    Management Division Lists 2014 Priorities
  2. Cost
    of Compliance Increasing with Regulatory Focus on Culture
  3. FINRA
    Adopts New Supervisory Rules; Guidance on Email Reviews
  4. Large
    Firm to Pay $25 Million for Insufficient Electronic Communication Surveillance

  5. SEC
    Official Targets Dual Registrants

SEC Will Conduct Cybersecurity Sweeps

The SEC’s Office of Compliance Inspections and Examinations has announced that it will conduct cybersecurity examinations of more than 50 broker-dealers and investment advisers.  The sweep exams will focus on identification and assessment of cybersecurity risks, protection of networks and information, remote access to funds, vendor risks, detection of unauthorized activity, experience with cybersecurity threats, and firm governance.  OCIE also released a 7-page sample request list to “empower compliance professionals … regardless of whether they are included in OCIE’s examinations.”   OCIE has also said that it would assess cybersecurity during routine examinations.
OUR TAKE: The request list (and its required activities) will challenge compliance officers because it demands technical knowledge outside the regulatory expertise of compliance and regulatory staff.  Ultimately, Compliance may need to deputize somebody in IT to help.  The required activities may also prove very costly to smaller firms.

SEC Charges Fund Manager for Failing to Fully Disclose Revenue Sharing Payments

The SEC has commenced enforcement proceedings against a fund-of-funds manager and its principals for failing to adequately disclose revenue sharing payments received from underlying fund investments.  The firm’s ADV and the funds’ PPMs included disclosure stating that the adviser “may” receive revenue sharing from underlying fund investments.  However, the SEC asserts that the disclosure was misleading because (i) the firm was already receiving revenue sharing payments, (ii) the disclosure was not specific enough about the sources, recipients, amounts, and duration of the fees, (iii) the firm did not inform investors that the revenue sharing payments would be distributed directly to the firm’s principals, and (iv) the PPM disclosure was “buried” on page 60 of the PPM.  The SEC also alleges that the firm fired a compliance consultant that recommended enhanced disclosure and terminated an administrator that asked for substantiating documents.  The SEC charges violations of various antifraud statutes and rules.
OUR TAKE: The SEC has indicated that it will heavily scrutinize any revenue sharing payments received from investments recommended by an investment adviser.  Although revenue sharing is not per se illegal, it may not be possible to include enough disclosure to satisfy the staff that a firm has cured the inherent conflict of interest.  Also, firing a compliance consultant is a red flag that something may be amiss.

SEC Censures Firm for Failing to Disclose Control Person

The SEC censured and fined a transfer agent and its principals for failing to disclose the true owner and control person.  According to the SEC, the firm’s president arranged a financing deal with a third party lawyer to purchase the firm.  The registrant did not disclose in required SEC filings that the third party lawyer owned the firm or that he participated in firm decisions such as hiring, business strategy, agreements and procedures, and leasing premises.  The SEC uncovered the control relationship during an examination.
OUR TAKE: One of the first activities that the SEC exam staff undertakes is a fact checking of disclosure documents.  Somebody needs to ensure that forms filed with the SEC actually reflect reality.  


SEC Warns Investors about Social Media

The SEC’s Office of Investor Education and Advocacy has issued an “Investor Alert” warning “investors to be better aware of fraudulent investment schemes that may involve social media.”  The OIEA is concerned about social media fraud because it “offers a number of attributes that criminals may find attractive” including low cost distribution, ease of mass communication, anonymity, and the appearance of legitimacy.  The Investor Alert warns investors to be wary of unsolicited investment offers, promises of outsized returns, pressure sales tactics, and affinity group sales tactics.
OUR TAKE: This Investor Alert shows how the SEC views social media as a tool to commit fraud and avoid regulatory supervision rather than a new venue to educate potential clients.  Investment advisers using social media marketing must make sure its social media compliance policies and procedures can withstand this scrutiny.  

SEC Fines Mid-Level Corporate Officer $75,000 for Accounting Violations

The SEC fined a company’s retail controller $75,000 and barred him from appearing before the Commission for changing accounting policies in violation of GAAP.  The SEC charges that the respondent worked against his company’s outside valuation firm and audit firm by changing treatment of certain acquired assets, thereby increasing third quarter 2009 reported earnings.  The SEC states that the respondent took the position as retail controller after the Controller, his supervisor, terminated his predecessor.  The SEC says that “the Controller was being scrutinized by … senior management as a possible successor to the CFO.”  The SEC charges the respondent with violating Section 17 of the Securities Act (antifraud), Rule 13b2-1 of the Exchange Act (prohibition on falsifying books and records), and aiding and abetting violations of Section 13.
OUR TAKE: This action against the retail controller is very puzzling.  Why did he get singled out but none of his supervisors have (yet) been charged?  What was his motive other than pleasing his boss, who the SEC suggests was jockeying for a promotion?  Why was he fined $75,000 when the SEC did not allege that he received any specific personal benefit?  Can an individual corporate officer be liable for violating the antifraud provisions of the Securities Act, or does Section 17 only apply to registrants themselves?  Perhaps, the SEC is warning corporate officers that they have a higher duty than simply pleasing their employers.  

SEC Chairman Stresses Importance of Criminal Prosecutions

SEC Chairman Mary Jo White, in a recent speech, highlighted the importance of “All-Encompassing Enforcement,” which involves the “vigorous use of criminal, civil, and regulatory tools to enforce the securities laws.”  Chair White stressed the importance of threatening and pursuing criminal actions as the most powerful enforcement tool.  She noted the significant rise in criminal prosecutions arising from the securities markets during the last two decades, including criminal actions against investment advisers for “false valuations, overcharging, and hidden fees.”  She also described the deterrent effect of SEC enforcement actions that “are closely watched by industry participants” so that they have a “multiplier effect by having meaningful impact on market participants who are not involved in the particular misconduct that has been charged.”
OUR TAKE: Under Chair White, a former federal prosecutor, the SEC is stressing enforcement actions and referrals for criminal prosecution as regulatory tools to change industry-wide behaviors. 

BD and Its Clients Will Pay $3 Million for Order Layering and Other Violations

A broker-dealer and its clients will pay nearly $3 Million, and agreed to individual industry bars, for paying/receiving illegal brokerage commissions and manipulating markets by layering orders.  The SEC charges the registered broker-dealer for aiding and abetting securities law violations by ignoring red flags that commissions paid to a registered representative were shared with his third party firm and his partners that were neither licensed nor registered.  The SEC also charged that one of the individuals used a layering strategy – using non bona fide contra-orders to generate counterparty interest – to manipulate the market and earn greater trading profits.  
OUR TAKE: This may be the beginning of the SEC bringing market manipulation cases in the wake of the growing probes into high frequency and flash trading.  Also, it is noteworthy that the SEC is holding the broker-dealer accountable for actions of its clients.