The United States Supreme Court has ruled that Dodd-Frank’s anti-retaliation provisions apply only to whistleblowers who report the misconduct to the SEC. In the case, the employee brought a claim under Dodd-Frank’s whistleblower anti-retaliation provisions, even though he had not reported to the SEC, because he claimed that he was fired as a result of reporting to management suspected securities law violations. The Supreme Court reversed the decision of the Ninth Circuit based on the plain reading of the statute which defines “whistleblower” as any individual who provides information relating to a violation of the securities laws to the SEC. The Court rejected the SEC rule that expanded anti-retaliation protection to those who only report internally. Looking at legislative history, the Court reasoned that “Dodd-Frank’s award program and anti-retaliation provision thus work synchronously to motivate individuals with knowledge of illegal activity” to report to the SEC.
OUR TAKE: We re-state our opinion that the Court is correct on the law even though Congress probably did want to protect those who only reported internally. Regardless, companies should still avoid retaliating against internal whistleblowers because (i) good companies should want to ferret out wrongdoing by encouraging employees to come forward and (ii) other laws and rules (e.g. state employment laws, Sarbanes-Oxley) could serve as the basis for a lawsuit.
The President of a broker-dealer was fined and barred for failing to supervise an inexperienced and ineffective Chief Compliance Officer. The CCO failed to properly monitor and halt excessive mutual fund trading by a registered rep. The CCO had difficulty analyzing the firm’s trade blotter and mutual fund reports even after a compliance consulting firm was hired to assist. FINRA faults the President for failing to recognize the CCO’s failures and take the necessary action to implement an adequate supervisory system. FINRA blames the President because he “was ultimately responsible for supervision.”
OUR TAKE: Do you know if your CCO is competent? Firm leaders do not satisfy their obligations to implement a compliance and supervisory system by merely calling somebody the Chief Compliance Officer. A CCO must be competent, have the necessary resources, effectively implement policies and procedures and test them. Then, firm management must monitor the CCO to ensure that the CCO adequately performs the role.
The Massachusetts Securities Division has commenced administrative proceedings against a large broker-dealer because it ran sales contests that violated its own policies adopted to comply with the Department of Labor’s fiduciary rule. The DoL rule, which became effective in June 2017, requires firms to follow an “impartial conduct standard” including acting in the best interest of customers, charging reasonable compensation, and ensuring full disclosure. In response to the rule, the BD adopted compliance policies prohibiting conflicts of interest when dealing with retirement accounts. Following adoption of the new policies, the firm launched sales contests, which the MSD alleges involved misrepresentations and conflicts of interest. The MSD alleges that the firm violated Massachusetts ethical conduct standards by failing to abide by its own policies and the DoL rule.
OUR TAKE: Even though he DoL won’t enforce the fiduciary rule, the impartial conduct standard applies to firms that recommend products to retirement accounts. Nevada has already passed its own fiduciary legislation. Now, Massachusetts uses its enforcement powers to compel fiduciary compliance. Expect other states to follow.
A large broker-dealer agreed to pay over $5.3 Million in remediation, disgorgement, fines, and interest to settle charges that it failed to properly supervise the traders and salespeople working on its non-agency CMBS desk. Additionally, the head of the CMBS desk was fired, fined, and suspended from the industry for failing to supervise. The SEC alleges that the CMBS desk regularly misrepresented terms and parties on the other side of secondary market CMBS transactions. Although the firm had policies and procedures and conducted training, the SEC faults the firm for not conducting “specialized training regarding the opaque CMBS secondary market” and for weak surveillance that “used generic price deviation thresholds in its trade surveillance to flag potentially suspicious trades instead of ones tailored to specific types of securities.”
OUR TAKE: This case is an example of what we call “compliance voodoo” i.e. the appearance of a compliance program that does not actually discover or stop wrongdoing. Sure, the firm had policies and procedure prohibiting making misrepresentations. Sure, the firm provided compliance training. Yet, the compliance and surveillance team completely missed the ongoing scheme of misrepresentations on the CMBS desk.
The SEC’s Enforcement Division is offering amnesty from civil penalties for firms that self-report failures to fully disclose conflicts of interest when recommending mutual fund share classes that pay 12b-1 fees. Under this new “Share Class Selection Disclosure Initiative,” self-reporting firms would disgorge the 12b-1 fees and reimburse clients as well as implement other compliance procedures to prevent future wrongdoing. The Share Class Initiative would apply to a registered adviser that failed to fully disclose the conflict of interest where it recommended mutual fund share classes that paid back 12b-1 fees to the firm or affiliates when lower fee share classes were available. The amnesty program would not apply to firms already involved in enforcement actions related to share classes but would be available if a firm is undergoing a pending OCIE examination. This amnesty program will not protect individuals associated with self-reported firms as the Enforcement Division will do a “case-by-case assessment of specific facts and circumstances, including evidence regarding the level of intent and other factors such as cooperation by the individual.”
OUR TAKE: Advisers should consult counsel to conduct a cost/benefit analysis of self-reporting, including the potential impact on senior executives.
The United States District Court for the District of Colorado entered a default judgment against a state-registered fund manager for misrepresenting his experience and credentials, among other false statements. As part of his fund-raising efforts, the fund manager claimed to have extensive portfolio management experience including successful management of several large private funds. The SEC alleges that, although the defendant worked for the organizations referenced, he never served as a portfolio manager and generally acted in minor consulting roles unrelated to portfolio management. Additionally, the SEC charges that the defendant made unsubstantiated performance claims.
OUR TAKE: When you engage in resume inflation to raise money, you have engaged in securities fraud. You also run the risk of a criminal prosecution under 10b-5.
The SEC’s Office of Compliance Inspections and Examinations released its 2018 examination priorities, focusing on retail investors, market infrastructure, FINRA, cybersecurity, and anti-money laundering. As part of its mission to protect retail investors, OCIE will focus on (i) disclosure and receipt of compensation that could suggest a conflict of interest, (ii) robo-advisers, (iii) wrap fee programs, (iv) poor-performing mutual funds and ETFs, and (v) cryptocurrency offerings. OCIE also plans to supervise FINRA’s “operations and regulatory programs” including the quality of its examinations. OCIE also intends to scrutinize cybersecurity and anti-money laundering practices including risk assessment and customer due diligence. OCIE makes clear that its priorities list is “not exhaustive” and could be expanded as a result of regulatory developments, examination information, complaints and tips, and other regulators.
OUR TAKE: OCIE is fairly transparent. Now that the staff has identified these issues, compli-pros should expect a heavy focus during examinations. Compliance departments should review policies and procedures and testing to get ready.
The SEC barred from the industry a purported lawyer that failed to investigate red flags arising in municipal bond offerings for which he served as underwriter’s counsel. The sponsor of the offerings previously settled an SEC enforcement action pursuant to which he agreed to repay over $86 Million to investors because of misleading disclosures about compliance with municipal disclosure requirements. The SEC faults the lawyer for engaging in a weak due diligence that failed to investigate disclosure red flags that were raised by several parties involved in the transaction. Additionally, the respondent claimed to be a lawyer even though he was not actively admitted to the bar in any jurisdiction. The SEC charges the respondent with fraud in the offer and sale of securities as well as causing the issuer’s legal violations.
OUR TAKE: The SEC will hold gatekeepers such as lawyers accountable for the bad acts of their clients. This case expands gatekeeper liability by charging securities fraud even though the lawyer is not a registrant.
A large clearing broker-dealer agreed to pay over $1.3 Million in disgorgement, interest, and fines to settle charges that it underfunded its reserve account. Due to a coding error, the firm miscalculated its reserve formula pursuant to the customer protection rule (15c3-3) resulting from repos with its parent company. After discovery by a FINRA examination team, the broker-dealer deposited $133 Million into its reserve account, thereby triggering a liquidity crisis for the firm as it worked to raise the necessary capital. The SEC criticized the BD, which has had other compliance issues, for a “lack of personnel for a regulated entity of its size and import.”
OUR TAKE: Under-resourcing compliance is a red flag for regulators and often leads to enforcement actions. Firms should spend no less than 5% of revenue on compliance infrastructure and should spend more where their activities involve several complex processes.
The SEC barred a broker from the industry for recommending an unsuitable in-and-out trading strategy that generated significant commissions. The SEC asserts that, given the costs, returns, and customers, the defendant had no reasonable basis to determine that a high volume trading strategy was suitable. According to the SEC, the broker should have known better because he attended firm-wide compliance training that addressed the importance of reasonable basis suitability.
OUR TAKE: Compli-pros should take comfort that the compliance training helped insulate the firm from liability against the rogue actions of this employee. Also, firm leaders should note that the SEC will prosecute individuals that violate the securities laws as part of its effort to root out bad actors.