The SEC (and the U.S. Attorney) will take action against securities markets gatekeepers such as outside lawyers for aiding and abetting securities violations even though the defendant is not directly registered with the SEC. Serving as outside counsel does not allow a lawyer to further a client’s fraud.
This case should prompt fund financial officers to review the charges imposed by the custody bank. That nickel and diming on everything from wire fees to foreign custody reports may be unlawful. Service providers should also take note that the SEC will initiate enforcement for overcharging registrants even where the service provider itself is not an SEC registered or regulated entity.
The SEC fined a Big 4 audit firm $50 Million for misappropriating information from the PCAOB concerning impending inspections. Several members of firm management were also terminated and charged. The firm obtained the confidential exam information from employees that previously worked at the PCAOB as well as PCAOB employees being recruited by the firm. Information included lists of audit engagements that the PCAOB planned to inspect, specific criteria used for the inspection, and the focus areas. The SEC alleges that the firm also reviewed and revised work papers to avoid deficiencies. Separately, the firm was also charged with sharing answers and adjusting scores so that internal personnel could more readily pass internal continuing education courses. The SEC charges the firm with failing to comply with ethics and integrity standards, AICPA conduct rules, and PCAOB quality control standards. In addition to the fine, the firm agreed to retain an independent consultant.
The SEC relies on the securities markets gatekeepers, such as the large audit firms, to police the industry. When the gatekeepers act without integrity, it undermines the SEC’s ability to protect investors. This case once again raises the issue whether government officials should observe a cooling-off period before going to work for the companies they previously regulated.
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.
OUR TAKE: Although it may be a legal stretch to assert that a fund administrator caused a fraudulent client’s illegal conduct, the SEC will hold securities markets gatekeepers accountable for their client’s behavior. Service providers must conduct due diligence before accepting a client or risk being found guilty by association.
OUR TAKE: Lawyers and other securities markets gatekeepers cannot plead ignorance when red flags indicate that they knew or should have known about their clients’ wrongdoing. Firms must conduct significant due diligence both before accepting a client and during representation. It is also noteworthy that the SEC charged the lawyers with securities fraud and not just aiding/abetting.
OUR TAKE: We have previously predicted that the SEC would target lawyers as a class of gatekeepers responsible for policing securities markets. Counsel cannot ignore wrongdoing by claiming to have relied solely on client representations.
The SEC has instituted enforcement proceedings against an audit firm engagement partner for failing to follow professional standards, thereby allowing a venture fund manager to loot the fund by taking unearned management fees. The SEC alleges that the venture fund manager, in order to meet cash needs for affiliates, advanced unearned management fees in amounts that would never be earned. The SEC charges that the respondent and the audit team knew about the unearned fees but failed to fully investigate the payments and further failed to properly disclose the payments in the financial statements. Instead, the audit firm issued unqualified opinions over a 4-year period. The SEC also asserts that the audit partner removed relevant financial statement disclosure when management objected.
OUR TAKE: As a key securities market gatekeeper, the auditor performs a critical control function upon which investors rely. The SEC will hold audit firms and their senior personnel accountable when clients engage in observable unlawful behavior. The same rationale will apply to other gatekeepers including administrators, lawyers, and consultants.