SEC

The SEC’s Authority to Enforce the Bank Secrecy Act is Challenged

In the past few years, the SEC has become increasingly active in bringing enforcement actions based on broker-dealers’ alleged failures to comply with requirements of the Bank Secrecy Act (BSA), in particular that requirement that they file “Suspicious Activity Reports,” or “SARs.” The SEC’s authority to bring such actions, however, has never been established by statute or appellate authority, and is being challenged in a petition for a writ of mandamus currently pending in the Second Circuit.  Though the procedural posture of that case makes it an unlikely vehicle for resolving the question, the issue it raises is likely to recur so long as the SEC continues to bring such enforcement actions despite its lack of any clear authority to do so.  Practitioners should be aware of this open issue so that it can be properly raised and preserved in BSA enforcement actions brought by the SEC.

The SEC’s Lack of Civil Penalty Authority under the BSA

The Bank Secrecy Act, enacted in 1970 to combat money-laundering, gives general examination and enforcement authority to the Secretary of the Treasury.  The Treasury Secretary is also authorized to “delegate duties and powers … to an appropriate supervising agency.”  31 U.S.C. § 5318.  By regulation, Treasury has delegated “[a]uthority to examine institutions to determine compliance with the requirements of” the BSA to various other agencies. 31 C.F.R. § 1010.810(b).  With respect to securities broker-dealers, such “authority to examine” has been delegated to the SEC. 31 C.F.R. § 1010.810(b)(6).  However, Treasury has kept “[a]uthority for the imposition of civil penalties” with the Financial Crimes Enforcement Network, or FinCEN, which is a bureau of Treasury.  31 C.F.R. § 1010.810(d).

Despite its lack of delegated authority, for more than a decade the SEC has initiated civil enforcement actions based on alleged failure of securities broker-dealers to comply with BSA requirements. In recent years, these enforcement actions have become more frequent, and have also changed in nature. Earlier enforcement actions typically focused on the requirement that broker-dealers establish and comply with a written Customer Identification Program. And in those cases where the SEC based its enforcement action on the requirement that broker-dealers file SARs, it was generally in circumstances where the broker-dealer in question failed to file any SARs at all for a protracted period. More recent enforcement actions, however, have challenged the adequacy of SARs that broker-dealers actually did file.

In these proceedings, the SEC has based its asserted enforcement authority under the BSA on Exchange Act Section 17(a), which allows the SEC to require that broker-dealers “make and keep for prescribed periods such records” that the Commission requires. Under that provision, the SEC promulgated Exchange Act Rule 17a-8—17 C.F.R. § 240.17a-8—which cross-references the regulations promulgated by the Treasury Department under the BSA and requires that securities broker-dealers comply with them.  In effect, then, the SEC has invoked its books-and-records authority as a means to assert for itself authority to enforce the requirements of the BSA.

The Pending SEC v. Alpine Securities Corp. Litigation

Although the SEC has been bringing enforcement actions based on securities broker-dealers’ alleged failures to comply with BSA requirements for more than a decade, its authority to do so was not challenged until recently.  The SEC brought a BSA enforcement action against Alpine Securities Corp. in the summer of 2017 in the Southern District of New York. That suit is representative of the SEC’s more recent BSA enforcement actions. According to the SEC’s allegations, Alpine did have a BSA compliance program, and did file thousands of SARs. The SEC, however, alleges that the SARs that Alpine filed were inadequate in various ways. And as in other BSA enforcement actions brought by the SEC, the agency alleged that these inadequate SARs violated Section 17(a) of the Exchange Act and Rule 17a-8.

In early 2018, Alpine moved for summary judgment, arguing that the SEC lacks authority to bring enforcement actions seeking civil penalties for alleged violations of the Bank Secrecy Act.  Alpine argued that the BSA expressly delegates authority to bring civil enforcement actions to the Treasury Secretary, and that the Treasury Secretary—while delegating authority to examine various institutions for BSA compliance to various other agencies—retained enforcement authority for itself.  Alpine contended that the SEC’s interpretation of the “books and record” provision as giving it the power to bring its own BSA enforcement actions was contrary to Congressional command, and that the SEC was improperly attempting to “bootstrap” itself into an area where it lacked jurisdiction.

The district court judge—Judge Denise Cote—denied Alpine’s motion. First, the court concluded that Alpine was wrong to characterize the SEC’s suit as seeking to enforce the BSA, because the SEC in fact brought the suit under Section 17(a) and Rule 17a-8. Second, the court rejected Alpine’s challenge to the SEC’s interpretation of Section 17(a) of the Exchange Act.  Applying the two-step framework from Chevron v. Natural Resources Defense Council, 467 U.S. 837 (1984), the court concluded that Rule 17a-8, which requires compliance with certain BSA regulations, is a reasonable interpretation of Exchange Act Section 17(a).  The court further observed that “neither the Exchange Act nor the BSA expressly precludes joint regulatory authority by FinCEN and the SEC over the reporting of potentially suspicious transactions.”

Alpine moved for reconsideration of the court’s order or, in the alternative, for certification of an interlocutory appeal. The court denied both motions.  On June 22, 2018, Alpine filed a petition for a writ of mandamus in the Second Circuit, again arguing that the BSA expressly delegates enforcement authority to Treasury, and such authority cannot be usurped by the SEC. On July 9, the SEC filed an opposition to the mandamus petition.

Implications for White-Collar and Securities Practitioners

In light of the high bar for obtaining a writ of mandamus, the chances that the Second Circuit will grant the relief Alpine requests are likely low.  The reasoning and conclusion of the district court’s decision, however, are vulnerable to attack.  The district court focused its analysis almost exclusively on Exchange Act Section 17(a) and Rule 17a-8, and rejected Alpine’s challenge based on its determination that the SEC clearly has authority to impose record-keeping and production requirements on broker-dealers.  In FDA v. Brown & Williamson, however, the Supreme Court emphasized that, “[i]n determining whether Congress has specifically addressed the question at issue, a reviewing court should not confine itself to examining a particular statutory provision in isolation.”  529 U.S. 120, 132 (2000).  Rather, courts must “interpret the statute as a symmetrical and coherent regulatory scheme,” and must also take into account how one statute “may be affected by other Acts.”  Id. at 133 (internal citations omitted).  Similarly, the Second Circuit has held that where an Act of Congress “specifically and unambiguously targets” a particular issue and “unambiguously” gives enforcement authority to a particular agency, another agency’s “assertion of concurrent jurisdiction rings a discordant tone with the regulatory structure created by Congress.”  Nutritional Health All. v. FDA, 318 F.3d 92, 104 (2d Cir. 2003).

As long as the SEC continues to bring BSA enforcement actions, it appears inevitable that at some point a court of appeals will be called upon to determine whether the SEC does, in fact, have such enforcement authority. White-collar and securities practitioners defending broker-dealers in SEC enforcement actions based on the alleged failure to file SARs or comply with other requirements of the BSA should raise the issue during the investigation process and again during court proceedings to ensure that it is preserved, and ask the court to certify the question for interlocutory appeal under 28 U.S.C. 1292(b) if the court determines that the SEC does have such authority.  Although the district judge in the Alpine Securities case refused to certify an interlocutory appeal, in light of the dearth of appellate case law on the issue and the fundamental nature of the challenge, other district judges may be willing to certify.

SEC Proposes a “Best Interest” Standard for Broker-Dealers

On April 18, 2018, the Securities and Exchange Commission proposed a set of rules and interpretations regarding the standard of conduct that broker-dealers owe to their investing customers, and reaffirming and clarifying the standard of conduct owed to customers by investment advisers.

The SEC’s proposal is the newest development in an ongoing effort to clearly define and determine the standards to which financial professionals are held. In 2010, the Dodd-Frank Act delegated authority to the SEC to propose a uniform fiduciary standard across all retail investment professionals. Rather than wait for the SEC to do so, however, in 2016 the Department of Labor (DOL) promulgated its own fiduciary rule. As previously discussed here, the U.S. Court of Appeals for the Fifth Circuit recently struck down the DOL rule.

According to SEC Chairman Jay Clayton, the Commission’s recent proposal is the outcome of extensive consideration and is intended to enhance investor protection by applying consistent standards of conduct to investment advisers and broker-dealers. The SEC’s proposal, spanning over 1,000 pages, has three main components:

Regulation Best Interest: First and foremost, the SEC proposal includes a new standard of conduct for broker-dealers that would be enacted through a set of regulations entitled, “Regulation Best Interest.” Although the term “Best Interest” is not defined in the proposal, the regulations would require a broker-dealer to act in the best interest of its retail customers when making investment recommendations, and prohibit it from putting its own financial interests first. To discharge this duty, a broker-dealer must comply with three specific obligations:

(1) Disclosure obligation – a broker-dealer must disclose key facts about its relationship with its customers, including material conflicts of interest.

(2) Care obligation – a broker-dealer must exercise reasonable diligence, care, skill and prudence to understand any recommended product, and have a reasonable basis to believe that a product and series of transactions are in the customer’s best interest.

(3) Conflict of interest obligation – a broker-dealer must establish, maintain and enforce policies and procedures to identify, disclose and mitigate or eliminate conflicts of interest.

Guidance for Investment Advisers: In addition to enhancing the standard of conduct for broker-dealers, the SEC reaffirmed its view that investment advisers owe their clients fiduciary duties. The SEC’s proposal seeks to gather, summarize and reaffirm existing guidance in one place.

Form CRS: The Commission also proposed a new disclosure document, Form CRS (Client or Customer Relationship Summary), which would provide retail investors with information regarding the nature of their relationship with their investment professional. The proposed Form CRS would be a standardized, short-form disclosure highlighting services offered, legal standards of conduct, possible customer fees, and certain conflicts of interest. In addition, the proposal limits a broker-dealer’s ability to identify itself as an “adviser” unless it is registered with the SEC as an investment adviser, so as not to cause confusion among investors.

Takeaways

In the wake of the controversy launched by Dodd-Frank and the DOL rule, and on the heels of the Fifth Circuit’s rejection of that rule, the SEC has taken a bold step in the direction of increased regulation of broker-dealers. The SEC’s proposal will undoubtedly impact the way broker-dealers make recommendations to their customers, although to what extent may depend on whether broker-dealers were already adapting to the DOL rule before it was overturned by the Fifth Circuit. The SEC will seek public comment on its proposal over the next 90 days, giving interested parties time to dig into the extensive materials. Indeed, several Commissioners acknowledged that questions about the applicable standards remain, suggesting that changes to the proposal will be forthcoming.

D.C. Circuit Holds PCAOB Improperly Denied Target of Investigation Access to Expert Assistance

A D.C. Circuit panel unanimously ruled that the Public Company Accounting Oversight Board (“PCAOB”) acted unlawfully by denying former Ernst & Young partner Marc Laccetti his right to bring an accounting expert to an investigative interview. The March 23rd decision in Laccetti v. Securities & Exchange Commission potentially throws the validity of many pending PCAOB investigations into question and provides important procedural rights to the subjects of those investigations.

Laccetti was investigated and sanctioned by the PCAOB in connection with Ernst & Young’s audit of Taro Pharmaceutical Industries, Ltd.’s 2004 financial statements. The PCAOB’s rules provide witnesses interviewed by the PCAOB the right to be represented by counsel. However, the PCAOB had interpreted that rule as limited to lawyers only. Accordingly, when Laccetti was interviewed during the PCAOB’s investigation, the PCAOB permitted Lacetti to be accompanied by an in-house Ernst & Young lawyer but refused his request that an Ernst & Young accounting expert also be present. The PCAOB advised Laccetti that he and his counsel could consult with an expert before or after testifying, but that the presence of any technical expert was “not appropriate” at the interview. Following that interview, in a decision subsequently affirmed by the Securities and Exchange Commission (“SEC”), the PCAOB fined Laccetti $85,000 and suspended him from the accounting profession for two years. READ MORE

Looking Out for Main Street: SEC Focuses on Retail, Cybersecurity and Cryptocurrency

The Commissioners and senior officials of the Securities and Exchange Commission (“SEC” or “Commission”) addressed the public on February 23-24 at the annual “SEC Speaks” conference in Washington, D.C. Throughout the conference, many speakers referred to the new energy that SEC Chairman Jay Clayton had brought to the Commission since his confirmation in May 2017. The speakers also seemed relieved that the SEC was finally operating with a full set of commissioners since the recent additions of Robert J. Jackson, Jr. and Hester M. Peirce. Clayton’s address introduced the main refrain of the conference: that the SEC under his leadership is focused on the long-term interests of Main Street investors. Other oft-repeated themes included the challenges presented by cybersecurity and the fast-paced developments in cryptocurrency and blockchain. To address these shifts in focus, the Enforcement division plans to add more resources to the retail, cybersecurity and cryptocurrency spaces.

Following are the key litigation and enforcement takeaways.

Main Street Investors

Commissioner Kara Stein picked up on Clayton’s Main Street investors focus when she asked whether increasingly complex and esoteric investments, such as product strategies and structures that utilize derivatives, were appropriate for retail investors. She explained that it was not a question whether the financial industry could develop and sell these products, but whether it should. She said it was not clear that financial professionals fully understood the products they were selling, and that even if brokers and advisers made disclosures regarding the potential outcomes and risks to investors, complete disclosures might not even be possible due to the products’ complexity. Both SEC and FINRA Enforcement have brought actions related to the sales practices of inverse and leveraged ETFs, as well as the purchase and sale of complex products. Stein opined that gatekeepers needed to remember the real people behind every account number when they were advising clients on how to handle these types of products.

Steven Peikin, Co-Director of the Division of Enforcement, described the SEC’s Share Class Selection Disclosure Initiative as one way in which Enforcement was trying to help Main Street investors. The Initiative was created to address the problem of investment advisers putting their clients into higher fee share classes when no fee or lower fee classes were available. The SEC is incentivizing advisers to self-report this issue by promising not to impose any penalties, and only requiring them to disgorge their profits to investors. Peikin encouraged investment advisers to take advantage of this opportunity, indicating that if the Commission learned that an adviser had engaged in this conduct and did not self-report, it would be subject to significant penalties. The Chief of the SEC’s Broker-Dealer Task Force shared that AML programs and SAR-filing obligations are also a priority for the Enforcement division and OCIE exams. READ MORE

SEC’s OCIE Announces 2018 Areas of Focus

On February 7, 2018 the SEC’s Office of Compliance Inspections and Examinations (OCIE) announced its 2018 National Exam Priorities. The priorities, formulated with input from the Chairman, Commissioners, SEC Staff and fellow regulators, are mostly unchanged from years past (New Year, Similar Priorities: SEC Announces 2017 OCIE Areas of Focus, Orrick.com). However, the publication itself is presented in a more formal wrapper that begins with a lengthy message from OCIE’s leadership team describing the Office’s role and guiding principles, including that they are risk-based, data-driven and transparent, and that they embrace innovation and new technology.

2018 Priorities

OCIE’s principal 2018 priority, not surprisingly, appears to be the protection of retail investors, including seniors and those saving for retirement. OCIE specifically stated that it will focus on the disclosure of investment fees and other compensation received by financial professionals; electronic investment advisors – sometimes known as “robo-advisors”; wrap fee programs in which investors are charged a single fee for bundled services; and never-before-examined investment advisors. As to the latter, OCIE indicated that in the most recent fiscal year, it examined approximately 15 percent of all investment advisors, up from 8 percent five years before. It remains to be seen whether that increasing trend will continue.

Noting that the cryptocurrency and initial coin offering (ICO) markets “present a number of risks for retail investors,” OCIE included them as a priority for the first time. Examiners will focus on whether financial professionals maintain adequate controls and safeguards over the assets, as well the disclosure of investment risks.

Other 2018 priorities are compliance and risks in critical market infrastructure; cybersecurity protections, which OCIE states are critical to the operation of our markets; and anti-money laundering programs. In addition, OCIE has prioritized its examinations of FINRA and MSRB to ensure that those entities continue to operate effectively as self-regulatory organizations subject to the SEC’s oversight. READ MORE

Financial Derivatives Intermediaries Who Trade Virtual Currencies Face the NFA’s Enhanced Reporting Requirements

Derivatives regulators continue to take actions that pull virtual currencies – also known as digital currency or cryptocurrency, the best known of which is bitcoin – into their regulatory schemes. In December, the National Futures Association (NFA), the futures industry’s self-regulatory organization, issued three Notices to Members that expand the notification and reporting requirements for futures commission merchants (FCMs), introducing brokers (IBs), commodity pool operators (CPOs) and commodity trading advisers (CTAs) trading in virtual currencies and related derivatives. In issuing these directives, the NFA cited the fact that a number of CFTC-regulated trading venues were in the process of offering derivatives on virtual currency products and stated that it was expanding the notification and reporting requirements due to the volatility in the underlying virtual currency markets.

Specifically, the NFA’s notices:

  • direct each FCM for which NFA is the DSRO to immediately notify NFA if the firm decides to offer its customers or non-customers the ability to trade any virtual currency futures product. NFA also requires each FCM to report on its daily segregation reports the number of customers who traded a virtual currency futures contract (including closed out positions), the number of non-customers who traded a virtual currency futures contract (including closed out positions), and the gross open virtual currency futures positions (i.e. total open long positions, total open short positions);
  • direct each IB to immediately notify NFA if it solicits or accepts any orders in virtual currency derivatives. NFA also requires each IB that solicits or accepts orders for one or more virtual currency derivatives to notify NFA by amending its annual questionnaire, by answering this question: Does your firm solicit or accept orders involving a virtual currency derivative (e.g. a bitcoin future, option or swap)? In addition, starting with the current quarter, IBs that solicit or accept orders for virtual currency derivatives will also be required to report the number of accounts they introduced that executed one or more trades in a virtual currency derivative during each calendar quarter;
  • direct each CPO and CTA to immediately notify NFA if it executes a transaction involving any virtual currency (such as bitcoin) or virtual currency derivative (such as a bitcoin future, options or swap) on behalf of a pool or managed account. NFA’s Notice requires that CPOs and CTAs provide such notice by amending their annual questionnaire, to which NFA added questions that inquired, for CPOs, whether the firm operates a pool that has executed a transaction involving a virtual currency or virtual currency derivative and, for CTAs, whether the firm offers a trading program for managed account clients that have transacted in a virtual currency, or managed an account that transacted in a virtual currency derivative. In addition, beginning with the current quarter, the NFA is requiring CPOs and CTAs to report on a quarterly basis the number of their pools or managed accounts that executed at least one transaction involving a virtual currency or virtual currency derivative.

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The SEC Enforcement Division 2017 Annual Report: Continued Focus on Individual Wrongdoers and Enhanced Protections for the “Main Street” Investor

Almost a year into the new administration, the U.S. Securities and Exchange Commission’s Division of Enforcement released its annual report last week, providing a recap of the SEC’s enforcement results over the past 12 months, as well as some insight into its direction for the coming year. Overall, the report suggests that the SEC will increase its focus on addressing harm to “Main Street” investors and that pursuing individuals will continue to be the rule, not the exception.

During fiscal year 2017, the SEC pursued 754 enforcement actions, 446 of which were “stand-alone” actions (as opposed to “follow-on” actions which seek to bar executives from practicing before the Commission or to deregister public companies). This represents a drop from the prior year in which the SEC pursued 784 enforcement actions, 464 of which were stand-alone actions. The bulk of the Division’s 446 stand-alone actions in FY 2017 focused on issuer advisory issues, issuer reporting, auditing and accounting, securities offerings, and insider trading—all areas that saw a relatively similar number of cases in FY 2016. Actions involving public finance abuse represented the only significant decrease in the number of cases versus the prior year. In FY 2016, the SEC brought nearly 100 public finance abuse actions compared to fewer than 20 in FY 2017. READ MORE

FCPA Violators Beware—SEC to Double Down on Enforcement

The SEC has signaled plans to double down on its FCPA enforcement efforts and speed up FCPA investigations. On November 9, 2017, Steven Peikin, Co-Director of the SEC’s Enforcement Division, delivered a speech at New York University School of Law to commemorate the 40th anniversary of the FCPA and the 20th anniversary of the Organisation for Economic Co-Operation and Development Anti-Bribery Convention. In his speech, Peikin stressed the importance of the FCPA to the Commission’s enforcement mission and noted that the Commission will continue its commitment to FCPA enforcement. Pointing out that the Commission has brought 106 FCPA-related actions against individuals and corporations since forming its designated FCPA Unit in 2010, Peikin highlighted the Commission’s success in fostering a more predictable and uniform approach to FCPA enforcement and domestic and international partnerships in fighting corruption.

Peikin stressed the importance of collaborating with international colleagues in the fight to “eradicate[e] corruption and bribery” and pointed to recent global settlements, including the settlement with Telia (reported here), as examples of successful cross-border coordination and cooperation. Citing deterrence and investigation efficiencies as key benefits of global coordination, Peikin noted that he expects “the trend of the Enforcement Division working closely with foreign law enforcement and regulators in anti-bribery actions to continue its upward trajectory in the coming years.” READ MORE

The SEC Wants to Know What’s Next for Blockchain: Are You Keeping Up?

On October 12, 2017, the United States Securities and Exchange Commission’s Investor Advisory Committee met to discuss Blockchain technology and its impact on the securities industry. While Blockchain is best known as the decentralized accounting system that make transactions in Bitcoin and other cryptocurrencies possible, the panel of industry professionals and academics emphasized its potential to transform “mainstream” financial recordkeeping in a way that makes executing and recording all financial transactions more secure and efficient.

SEC Chairman Jay Clayton, who oversaw the proceedings, explained that the Commission seeks to explore the ways in which Blockchain can promote robust and competitive markets, while ensuring that investors are protected and federal securities laws are applied to transactions in cryptocurrencies made possible by the technology.

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Supreme Court Likely to Decide Whether to Hear SEC ALJ Issue This Term

As the U.S. Supreme Court commenced a new term last week, one issue of substantial interest to many readers of this blog is whether the Court will address the constitutionality of the Securities & Exchange Commission’s use of administrative law judges (“ALJs”) to adjudicate enforcement proceedings. The issue, which we have covered extensively in past posts, essentially comes down to whether SEC ALJs are Officers subject to the Constitution’s Appointments Clause, or whether they are merely employees, who do not require appointment by the President or a Presidential appointee. The SEC currently selects ALJs through an internal administrative process, pursuant to 5 USC 3105.

Advocates on both sides of a clear circuit split have already filed petitions for writ of certiorari. Most recently, on September 29, 2017, the U.S. Department of Justice Solicitor General’s office filed a certiorari petition on behalf of the SEC asking the Court to review the Tenth Circuit’s December 2016 holding in Bandimere v. SEC. That holding, which was denied en banc review by the Tenth Circuit in May, found that SEC ALJs were “inferior Officers” and thus are subject to the Appointments Clause. After the Tenth’s Circuit ruling in Bandimere, the SEC stayed all administrative ALJ proceedings that could be appealed to the Tenth Circuit pending resolution of the issue by the Supreme Court or further order of the Commission.

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