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Chief Compliance Officer, Protégé of CEO, Failed to Stop Client Overbilling

 

The Chief Compliance Officer of a registered investment adviser was barred from the industry and faces criminal sentencing for wire fraud for his role in overbilling clients over $11 Million over a 10-year period.  The CCO, a 5% owner of the firm and a protégé of the firm’s CEO/principal, implemented several of the billing practices directed by the firm’s principal and 90% owner.  Overbilling practices included double billing clients, charging the wrong fee, charging a management fee instead of a performance fee, failing to prorate fees, and billing for services not performed.  The CCO admitted that he knew there was a high probability that the CEO was defrauding clients, but the CCO deliberately avoided learning the truth.

There is no “just following orders” defense for employees of registered investment advisers.  We can appreciate the conundrum when your boss and mentor engages in wrongdoing; but, failing to resign and call out the wrongdoing can lead to significant civil and criminal penalties. 

Charged CFO/GC Agrees to Cooperate to Avoid Big Penalty

The former Chief Financial Officer/General Counsel of a technology company settled an enforcement action which included requiring him to pay over $400,000 in disgorgement and interest. The CFO/GC avoided a civil penalty by agreeing to cooperate in a related enforcement action.  The SEC charges the CFO/GC with turning a blind eye to inflated financial statements prepared by the CEO to help sell insider shares in secondary market transactions.  The CEO recently settled charges by agreeing to pay more than $17 Million.  Although the respondent did not have a financial background, the SEC asserts that he knew or should have known that the financial statements were misleading based on internal communications with the CEO and internal accounting professionals.

Corporate executives cannot avoid accountability by claiming that they were just following orders.  The SEC has maintained that senior executives have a duty to investors and the markets to stop financial wrongdoing at the companies they steward.  Once charged, the SEC will often use its leverage to encourage cooperation in cases against others in the C-Suite.

Department of Justice Allows Credit for Identifying Only Senior Execs

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. 

CCO Blamed for Signing Certifications that Facilitated Unlawful Securities Lending

 

The SEC censured and fined the Chief Compliance Officer of a broker-dealer for signing certifications that she knew, or should have known, were inaccurate, thereby enabling her firm to engage in unlawful securities lending transactions.  The CCO signed certifications to third party depositaries that confirmed her firm complied with certain ADR pre-release agreements that required that her firm hold ordinary shares that evidenced ADRs.  The SEC maintains, however, that the CCO knew the firm did not comply with those agreements because she participated in drafting the firm’s procedures for acquiring pre-release ADRs and knew that the firm did not comply with the pre-release agreements.  The SEC charges the CCO with causing her firm’s violations of the Exchange Act’s antifraud provisions.

OUR TAKE: Compliance officers should avoid signing certifications that facilitate securities transactions.  If the situation requires a certification, a CCO must conduct adequate due diligence to ensure the accuracy of all statements made.  Also, we would recommend that a CCO obtains back-up certifications from others in the organization.

 

Broker and His Client Charged in IPO Kickback Scheme

The SEC has charged a broker and his customer for conspiring to conceal alleged kickbacks in exchange for preferred IPO and secondary offering allocations.  According to the SEC, the defendants agreed that the customer would kick back 24% of his trading profits.  The defendants attempted to conceal the scheme by laundering the payments through multiple bank withdrawals of less than $10,000.  The SEC maintains that the broker and the client repeatedly lied on compliance certifications about conflicts of interest and payments, which were required by the firms’ policies and procedures that specifically prohibited any type of conflict, allocation or payment scheme.

OUR TAKE: The SEC properly targets the persons that benefited from the scheme, rather than the firms that had adopted relevant policies and procedures and required specific certifications.  It is also noteworthy that the SEC charged the enriched client and not just the broker.  We believe this case shows the SEC’s continued focus on holding individuals, and not just organizations, accountable for bad behavior.

https://www.sec.gov/litigation/complaints/2017/comp-pr2017-234.pdf

SEC Fines and Bars CCO for Ignoring Compliance Problems

The SEC fined and barred an adviser’s Chief Compliance Officer from acting in a compliance or supervisory capacity because of his failures to remedy compliance deficiencies.  The adviser hired an outside compliance consultant which recommended 59 compliance action items.  The SEC alleges that the CCO failed to address many of the issues raised including failures to (i) ensure a surprise audit pursuant to the custody rule, (ii) retain emails and other electronic records, and (iii) implement policies to protect customer information.  The SEC also charges the CCO with compliance program deficiencies including failures to update the compliance manual or conduct any meaningful annual review of the compliance program.  The firm’s president/principal was also censured and fined.

OUR TAKE: The SEC doesn’t often prosecute standalone (i.e. not dual hat) CCOs without an underlying client loss, but it will if the CCO ignores obvious compliance deficiencies of which he has notice.  This is what we call “compliance voodoo” i.e. an appearance of compliance infrastructure without an effective program.  This CCO had a compliance manual, did some quarterly testing, and hired a third party consultant.  But, neither the CCO nor the firm took any action to actually implement relevant procedures to address cited compliance deficiencies.

 

Chief Accounting Officer Barred and Fined for Approving CEO Expenses

The SEC barred and fined a public company Chief Accounting Officer for approving undisclosed expense reimbursements for the company’s CEO.  The CEO ultimately repaid the $11.285 worth of perquisites incurred over a 5-year period for personal items such as private aircraft usage, cosmetic surgery, cash for tips, medical expenses, charitable donations, and personal travel expenses.  The SEC asserts that the CAO approved the expenses in violation of company policy and without appropriate backup documentation and then failed to disclose the reimbursements in the company proxy statements.  The SEC charges the CAO with causing the company to file false reports.

OUR TAKE: We wrote on Friday that the SEC is looking to hold financial executives accountable.  In this case, the SEC doesn’t even allege that the CAO derived any personal benefit by approving his boss’s expenses.  Regardless, the SEC holds him accountable for allowing wrongdoing to occur.

 

SEC Takes Action against Head of Regulatory Reporting

The SEC issued a cease and desist order against the Head of Regulatory Reporting of a large investment bank for causing violations of the firm’s customer protection rule.  As previously reported, the firm agreed to pay $415 Million to settle the charges.  The SEC faults the respondent, who also served as the Financial and Operational Principal, with misleading regulators about the true purpose of certain synthetic transactions intended to reduce the amount held in the firm’s reserve account.  The SEC cites FINRA’s handbook which prohibits any window dressing designed to reduce the reserve formula.

OUR TAKE: It is noteworthy that the Head of Regulatory Reporting was the only individual specifically charged by the SEC in this action even though the firm paid a staggering settlement.  Regulatory officers, including CCOs and FINOPs, continue to be targeted by the regulators.

 

CMBS Trader Lied to Clients about Pricing

 

The SEC fined and barred an investment bank’s head CMBS trader for lying to customers about pricing, spreads, and compensation over a 2-year period.  According to the SEC, the defendant oftentimes used elaborate stories and doctored documents to support his untrue statements.  The SEC asserts that clients relied on the incorrect information when making purchase/sale decisions.  The SEC maintains that the respondent knowingly ignored compliance policies requiring truthfulness in dealings with customers.   The defendant benefited through higher discretionary bonuses resulting from his illicit activities, thereby making him directly liable for securities fraud.

OUR TAKE: It is noteworthy that the SEC took action against the trader himself rather than his firm, which presumably avoided liability because it had implemented adequate policies and procedures.  SEC Commissioner Piwowar has previously indicated that the SEC should pursue individuals rather than firms.