In a speech at the SIFMA AML Conference last week, FINRA Head of Enforcement Susan Schroeder openly explained the “straightforward framework” that Enforcement uses when making decisions about enforcement actions. The context for Schroeder’s speech was FINRA’s merger of two separate enforcement departments, resulting from FINRA head Robert Cook’s “listening tour” and FINRA’s recent self-evaluation, but Schroeder’s explanation appeared to be more of a response to broader industry complaints about FINRA Enforcement’s lack of consistency and transparency in its charging and sanctions decisions.
If that was Schroeder’s mission, she was successful. She identified the goals of enforcement actions, and justified FINRA’s use of its enforcement tool based upon harms to investors and perceived market risks. Overarching Schroeder’s speech was the principle that firms should know “what to expect from their regulator” so they know “how to shape their behavior in order to comply with the rules.” In this spirit of transparency, Schroeder identified the various principles or factors that FINRA Enforcement considers when evaluating enforcement actions and sanctions. Those principles should provide a vocabulary for firms and their counsel to assess and question FINRA’s enforcement activities.
Here are the principles in Schroeder’s own words:
Is this enforcement action appropriate? According to Schroeder, enforcement actions should be brought to “fix something that is broken or to prevent future misconduct, either by the same respondent or by another individual or firm.” Enforcement is not the only means FINRA has to fix something, and it is not always the “right tool” to use. To determine whether enforcement action is the appropriate regulatory response, FINRA will ask: READ MORE
2016 was a high-water mark for SEC enforcement activity; however, with the uncertainties associated with the new administration’s enforcement regime, we could be seeing a downturn going forward. According to a recent report issued by the NYU Pollack Center for Law & Business and Cornerstone Research, the SEC’s 2016 fiscal year (spanning October 1, 2015 – September 30, 2016) saw the highest number of enforcement actions brought against public companies and their subsidiaries since 2009, the year the Pollack Center and Cornerstone Research first began tracking information on such actions. The 92 actions brought against public companies and their subsidiaries last year is more than double the level of enforcement activity from just three years ago and represents the latest in a continuing upward trend of enforcement actions. Also consistent with recent trends, the vast majority of these actions have been brought as administrative enforcement proceedings before SEC ALJs, rather than civil actions in federal court.
The SEC continues to focus most heavily on issuers’ reporting and disclosure obligations, which comprised more than a quarter of the enforcement actions initiated last year. The SEC has consistently emphasized issuer disclosures as an area of enforcement priority and its pattern of activity has, to date, backed that up. Last year also brought enhanced focus on investment advisors and investment companies, with the SEC initiating more actions against those defendants in 2016 than in the previous three years combined. Allegations of foreign corrupt practices and actions against companies making initial or secondary securities offerings also resulted in an increased rate of enforcement activity over prior periods.
The SEC last week announced that it has sanctioned several market participants in the penny stock industry, including attorneys who wrote offering documents as well as stock transfer agents, for their roles in various sham IPOs of microcap stocks. These are the latest in a string of penny stock enforcement actions since outgoing SEC Chair Mary Jo White announced the implementation of the Commission’s “broken windows” policy in 2013. That policy targeted both large and small issuers and market participants. The strategy has resulted in the SEC racking up its largest-ever volume of enforcement cases in fiscal year 2016.
In the first enforcement actions, the SEC alleged that a California-based securities lawyer wrote false and misleading registration statements in connection with five microcap IPOs, which were part of a scheme to transfer unrestricted shares to offshore market participants. The SEC also alleged that the CFO of American Energy Development Corp. (AEDC), one of the issuers in question, and the attorney who wrote opinion letters for the offerings made false and misleading statements. The market participants were barred from any further penny stock activity, and the attorneys were permanently suspended from appearing and practicing before the SEC. The SEC also suspended trading in shares of ADEC.
On January 11, 2016, the SEC announced its Office of Compliance Inspections and Examinations (OCIE) priorities for the year . The announcement included several new areas of focus, including liquidity controls, public pension advisers, exchange-traded funds (ETFs), product promotion, and variable annuities. Hedge fund and mutual fund managers, private equity firms, and broker-dealers – in particular those that deal with retirement investments – would be wise to take note of these new areas of interest. As in past years, enforcement actions in these areas are likely to follow.
Last week the SEC announced an award of between $1.4 to $1.6 million to a whistleblower who provided information that assisted the SEC in an enforcement action. The enforcement action against the whistleblower’s company resulting in monetary sanctions exceeding $1 million. This marks the second award to a whistleblower with an internal audit or compliance function at a company. The first was back in August 2014, when the SEC awarded a whistleblower in internal auditing/compliance with over $300,000. Here, as with the prior award, the officer had a reasonable basis for believing that disclosure to the SEC was necessary to prevent imminent misconduct from causing substantial financial harm to the company or investors. In both cases, responsible management was made aware of the potential harm that could occur, yet failed to take steps to prevent it.
Securities and Exchange Commission leadership and staff members addressed the public on February 20-21 at the annual “SEC Speaks” conference in Washington, D.C. Common themes among the numerous presentations included the Commission’s increasing use of data analytics, the Commission’s focus on gatekeepers such as accountants and attorneys, and the Commission’s still incomplete rulemakings mandated by both the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Jumpstart Our Business Startups Act.
The leaders of the Securities and Exchange Commission addressed the public on February 21-22 at the annual SEC Speaks conference in Washington, D.C. The presentations covered an array of topics, but common themes included the Commission’s ongoing effort to carry out the rulemaking agenda set forth in the Dodd-Frank Wall Street Reform and Consumer Protection Act, its role as an enforcement body post-financial crisis, its increasing utilization of technology, and its renewed focus on the conduct of gatekeepers. In a surprise appearance, Dallas Mavericks owner and former insider trading defendant Mark Cuban attended the first day of the conference. During his time at the conference, Mr. Cuban shared his thoughts on a number of the presentations via his Twitter account.
From a litigation and enforcement perspective, key takeaways from the conference include the following: READ MORE
The SEC this year has demonstrated its willingness to incentivize whistleblowers and companies to share information about misconduct and assist with the SEC’s investigations. To that end, the SEC issued its first Deferred Prosecution Agreement (DPA) with an individual on November 12, 2013. A DPA is an agreement whereby the SEC refrains from prosecuting cooperators for their own violations if they comply with certain undertakings.
This first DPA is with Scott Herckis, a former Fund Administrator for Connecticut-based hedge fund Happelwhite Fund LP. In September 2012 Herckis resigned and contacted government officials regarding the misappropriation by the fund’s founder and manager, Berton Hochfeld, of $1.5 million in hedge fund proceeds. Herckis further reported that Hochfeld had overstated the fund’s performance to investors. Herckis’s cooperation with the SEC, including producing voluminous documents and helping the SEC staff understand how Hochfeld was able to perpetrate the fraud, led the SEC to file an emergency action and freeze $6 million of Hochfeld’s and the fund’s assets. Those frozen assets will be distributed to the fund’s investors. READ MORE
After first announcing a change on June 18 of this year to demand more admissions in SEC actions, an SEC leader recently made further comments echoing that same sentiment, as well as referencing the SEC’s intended use of stiffer monetary penalties. On October 1, at a Practising Law Institute conference, SEC Enforcement Division Co-Director Andrew Ceresney discussed the new SEC regime’s motto of strict enforcement and provided concrete, practical advice for defense lawyers on how to effectively interact with the SEC’s enforcement personnel.
Given the SEC’s ongoing commitment to deter current and future violations, Mr. Ceresney stated that the SEC will continue to increase penalties in an aggressive bid to deter misconduct. He stated that “[t]here is room for bolder actions” and monetary penalties are a deterrent that everyone understands. Mr. Ceresney also advised defense lawyers on how to handle meetings with SEC enforcement personnel. He stated that defense lawyers should focus on a case’s broad policy or legal arguments, including the circumstances surrounding the case, the client’s settlement position, and any flaws in the legal theory and policy implications of the case. Most importantly, stated Mr. Ceresney, defense lawyers must answer the SEC’s questions, must be trustworthy, and must not attempt to intimidate the SEC. READ MORE
Last week the SEC announced the creation of three new Division of Enforcement initiatives designed to combat fraud in financial reporting and microcap securities and to enhance risk identification and analysis: (1) The Financial Reporting and Audit Task Force; (2) The Microcap Fraud Task Force; and (3) The Center for Risk and Quantitative Analytics.
The Financial Reporting and Audit Task Force will focus on expanding and strengthening the Division’s work in identifying securities violations, particularly in the areas of preparation of financial statements, issuer reporting and disclosure, and audit failures. Using technology-based tools like the Accounting Quality Model, designed to identify red flags in areas particularly susceptible to fraudulent financial reporting, along with ongoing review of financial statement restatements and revisions, and analyzing industry performance trends, the Task Force will aim to detect fraud early and to increase prosecution of alleged securities violations involving false or misleading financial statements and disclosures.
The Microcap Fraud Task Force is a much more specialized unit, focusing exclusively on investigating fraud in the issuance, marketing and trading of microcap securities (typically low-priced securities issued by very small companies with limited assets). The principal goal of this Task Force is to develop and implement long-term strategies for detecting and combating fraud in the microcap market, in particular by targeting who the SEC deems as “gatekeepers” or “significant participants,” namely, attorneys, auditors, broker-dealers, transfer agents, stock promoters and purveyors of shell companies. READ MORE