Three CCS professionals – Jocelyn Dalkin, Jason Ewasko and Bridget Garcia – recently attended the IA Watch’s 21st Annual IA Compliance: The Full 360° View East conference in Washington. If you were unable to attend, you should review their summary of the most significant sessions including Dan Kahl’s summary of Enforcement Priorities, a top panel’s views on SEC rulemaking, and more specialized sessions on cybersecurity and custody. If you want more information, feel free to contact Jo, Jason or Bridget
The Department of Justice has revised its corporate prosecution policy to allow credit to corporations that identify senior officials without identifying every individual involved. In criminal cases, the defendant corporation must identify “every individual who was substantially involved in or responsible” for the misconduct. In civil cases, the corporation must identify every person “who was substantially involved” to earn maximum cooperation credit. The new policy offers prosecutors discretion over the prior policy, which according to Deputy Attorney General Rod Rosenstein, made prosecutions more difficult, time-consuming, and inefficient. Mr. Rosenstein made clear that “pursuing individuals responsible for wrongdoing will be a top priority in every corporate investigation.”
Many defense lawyers had hoped that the Rosenstein-led Justice Department would completely rescind the Yates memo, which requires the prosecution of individuals and only allows cooperation credit if companies identified the wrongdoers. The revised policy that focuses on senior officials and those substantially involved makes practical enforcement sense but probably offers little comfort to senior executives facing off against the Department of Justice.
The Commodity Futures Trading Commission, the primary commodities and derivatives regulator, imposed nearly $1 Billion in civil monetary penalties, restitution and disgorgement during the fiscal year that ended on September 30. The CFTC Division of Enforcement imposed $947 Million in penalties, disgorgement and restitution, including $897 Million in civil penalties, a nearly threefold increase over last year’s total. The CFTC filed 83 enforcement actions, the most since 2012, and imposed $10 Million judgments in 10 cases, a CFTC high water mark. More than 2/3 of cases charged an individual executive, reflecting the CFTC’s priority to hold individuals accountable in part because it deters others who become “fearful of facing individual punishment.” The CFTC has also prioritized parallel criminal proceedings, setting enforcement records for the number of cases filed in parallel with criminal prosecutors.
The CFTC’s regulatory sphere has greatly expanded with the emergence of swaps, derivatives, cryptocurrencies, and alternative hedge funds. The CFTC, like the SEC, has ramped up its enforcement activities to historic levels.
The SEC Enforcement Division filed 32% more standalone enforcement cases against investment advisers and investment companies in fiscal 2018 (through September 30), as compared to 2017. Cases against investment advisers and investment companies (the second largest category) and broker-dealers (fourth largest) represented 35% of all standalone actions filed. Overall, the SEC Enforcement Division brought 490 standalone cases in fiscal 2018, a 10% increase over 2017. Excluding the municipal disclosure initiative, the Enforcement Division filed more cases than it did in 2016 and 2015, the last two years under the prior administration. The Enforcement Division obtained $3.9 Billion in penalties and disgorgement, which is consistent with amounts obtained during the prior several years. The Enforcement Division outlined five core principles, including a focus on individual accountability because “holding culpable individuals responsible for wrongdoing is essential to achieving our goals of general and specific deterrence and protecting investors by removing bad actors from our markets.”
The Enforcement Division continues to pursue its active litigation agenda, especially against the investment industry. Apparently, the Jay Clayton SEC is not much different from the Mary Jo White SEC when it comes to enforcement cases against adviser, funds, and broker-dealers.
The North American Securities Administrators Association (NASAA) reports that in 2017 the 51 state securities regulators brought cases resulting in 1,985 years of prison time and probation, a 47% increase over the prior year. The state regulators also commenced 4,790 investigations in 2017, a 10% increase over the prior year, and initiated 2,105 enforcement actions, a nearly 6% increase. State securities regulators continued their increased focus on registered investment advisers, taking 377 enforcement actions against RIAs as compared to 270 against BDs. NASAA reports that cases against unregistered firms and individuals exceeded those against registered firms and individuals. “Securities fraud is a constant, ongoing, ever-evolving threat to investors. But as this year’s enforcement survey demonstrates, NASAA members are well-prepared, well-organized, and uniquely qualified to continue to aggressively protect investors,” said NASAA’s Enforcement Chair.
OUR TAKE: Unlike the SEC, the state securities regulators have the power to pursue criminal penalties including prison time. Regardless of what happens at the federal level, the states appear ready to flex their enforcement muscles.
In this podcast, Todd Cipperman questions whether the SEC has really abandoned its broken windows enforcement policy.
The New York State Court of Appeals has ruled that the NYS Attorney General must institute cases under the Martin Act within a three-year statute of limitations period. The court reasoned that the Martin Act, a broad securities fraud statute, expands liability beyond common law fraud and does not permit private rights of action. Consequently, the shorter 3-year statute of limitations applies, rather than the default 6-year period requested by the Attorney General. The case involved Martin Act fraud allegations against the sponsor of residential mortgage-backed securities.
OUR TAKE: This decision follows recent Supreme Court cases limiting statutes of limitations in government enforcement proceedings. The case also materially constrains the use of the (over) broad Martin Act.
The SEC fined a deregistered investment adviser and barred its former principal for multiple compliance failures involving double dipping, Form ADV disclosures, fee rebates, and misrepresentations. The respondents recommended that clients invest in private funds in which the principal held ownership and managerial interests. Although the SEC acknowledges that clients knew about the conflict, the firm failed to list and describe the conflicts on Form ADV. The SEC also charges the firm with multiple compliance program failures including inadequate policies and procedures and failing to conduct annual testing of the compliance program.
OUR TAKE: There is no such thing as declaring regulatory bankruptcy: the SEC’s long arm won’t let a firm engage in wrongdoing and then simply de-register to avoid consequences. Compli-pros should also note that disclosure alone will not always cure significant conflicts of interest, such as fee double dipping for advisory services along with underlying products.
In its 2017 fiscal report, the SEC’s Enforcement Division cites individual accountability as one of its core enforcement principles. The report expresses the Enforcement Division’s view that “individual accountability more effectively deters wrongdoing.” Since Chairman Clayton took office, the SEC has charged an individual in more than 80% of standalone enforcement actions. The report notes that it can be more expensive to pursue individuals, but “that price is worth paying.” The report notes a modest decrease in filed enforcement actions and recoveries since 2016: 754 vs. 784 cases (excluding municipal cases) and $3.8 Billion vs. $4 Billion in total money ordered.
OUR TAKE: “Just because you’re paranoid doesn’t mean they aren’t after you.” (Joseph Heller) The data and the explanation imply that the SEC will prioritize prosecuting individuals, even if the money ordered is smaller than in institutional actions, because of the fear and deterrent effect. If financial executives need another reason to engage a best-in-class compliance program, how about protecting yourselves from a career-ending enforcement action?
An unregistered investment adviser/fund manager and its principals agreed to pay over $1 Million in disgorgement, fines and interest for engaging in conflicted transactions that were not properly disclosed. The SEC accuses the respondents of using fund assets to invest in a company that the principals controlled and then buying out the ownership interest at a loss, all without consent of the limited partners or any relevant disclosure. The SEC also asserts that the respondents engaged in undocumented personal loans and payment of overhead expenses in contravention of the fund’s disclosure documents and limited partnership agreement. Although the firm (which had less than $25 Million in AUM) was not registered, the SEC argues that it engaged in investment advisory activities, owed the fund and its investors a fiduciary duty, and, therefore, violated the Advisers Act’s anti-fraud rules.
OUR TAKE: Just because you are not eligible (or fail) to register as an investment adviser, does not mean that the Advisers Act does not apply. In fact, most of the antifraud provisions apply to unregistered and state-registered advisers, thereby allowing the SEC to assert its enforcement jurisdiction.