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Insight & Commentary on SEC Enforcement Actions and Related Issues

Wrapping up Securities Enforcement Forum 2014

Posted in Non-scienter-based Violations, SEC Litigation, SEC Structure

I was lucky enough to spend Tuesday at Bruce Carton’s Securities Enforcement Forum 2014.  In three years, it has gone from zero to the preeminent securities enforcement law conference anywhere.  I blogged it hurriedly throughout the day, but here are what I think are the most salient points or comments after some reflection:

“Broken Windows”

Commissioner Michael Piwowar thinks that a “broken windows” approach to securities enforcement does not necessarily work when applied to all regulations and entities the SEC is charged with overseeing.  This point generated discussion later in the day, when Enforcement Director Andrew Ceresney defended his and Chair Mary Jo White’s approach.   He noted that for his Division, the broken windows theory is not about making every regulatory violation into an enforcement action.  OCIE is still out there issuing deficiency letters without enforcement actions.  Still, Section 16(a) of the Exchange Act is an important protective rule, and is designed to prevent larger trading violations.  Ceresney insisted that the SEC was not moving away from important areas such as financial reporting and market structure cases to do trivial work.

Corporate Penalties

Commissioner Piwowar also raised the spectre of the 2006 Statement of the SEC Concerning Financial Penalties.  The statement raises a number of factors for the Commission to consider in deciding corporate penalties.  Piwowar and others, including Commissioner Gallagher, think that large corporate penalties can sometimes hurt, not help, shareholders.  Piwowar also thinks that the 2006 statement is receiving short shrift from some staff.  Ceresney was somewhat dismissive of the statement when the Directors Panel came around.  As he said, the 2006 statement was never binding and is merely a guide.  It provides factors for the staff to consider, and the staff considers them.  But they are not bound by something that never became a rule.

FCPA Monitors

Chuck Duross at Morrison & Foerster noted that companies coming out of FCPA enforcement actions are not being forced to endure compliance monitors for the lengths of times that they used to.  Instead of three year terms, companies are sometimes able to forego monitors entirely or have them for 18 months with the possibility of extension.  The SEC’s FCPA Unit Chief Kara Brockmeyer sees this as a result of companies preparing their compliance systems on the front end, and not requiring the same level of oversight as before.  Still, she doesn’t see monitors disappearing entirely.  In response to a reporter’s question asking what the downsides of having monitors are, Simpson Thacher’s Jeffrey Knox pointed out that corporate monitors are not mere passive observers but corporate policy makers.  If the compliance function is working without them, their presence may not be good for the company or the public.

Administrative Proceedings

The day saw a lot of discussion of the SEC’s post-Dodd-Frank increased use of administrative proceedings in its enforcement matters.  Several senior staff members, including Ceresney, Brockmeyer, and Associate Director Scott Friestad assured the audience that more were coming.  Recently departed Co-Director George Canellos opined that in deciding between filing cases in federal court or as an AP, it wasn’t appropriate for the staff to consider which gave the SEC a better chance to win.  Ceresney didn’t seem to be as sure about that, and Friestad definitely didn’t buy it.  “Should I be filing where I’m most likely to lose?”  For Russ Ryan, at King & Spalding, administrative proceedings after Dodd-Frank have a core, potentially Constitutional problem.  That is, they provide an extremely accelerated process that is well suited for technical, regulatory violations, but is now being applied to enforce punitive sanctions against non-registered entities.  Now, the SEC is acting as both the prosecutor and the judge in a punitive context and in a way that Ryan thinks triggers Separation of Powers concerns.  He also thinks some of the recent challenges to SEC administrative cases are not quite ripe, and have allowed district courts easy outs by saying the respondents have not exhausted their administrative remedies.  This topic will have a way to go before it’s played out.

Practice Suggestions

Steptoe’s Phil Khinda had a few.  For Wells submissions, he said to remember you’re not writing for the Enforcement staff.  You’re writing for the GC’s office and the worriers in the other divisions and offices to create doubt and weakness in the SEC’s case.  The Wells doesn’t need to be written like an attacking opposition brief.  Instead, it should read like an amicus brief, and speak to the staff like they would talk to each other.  Ryan also said he’d seen a recent trend wherein the staff has been more open to frank discussions very early in a case about what they’re looking for and how a subpoena might be kept relatively narrow.  Friestad said that Ryan may have just been lucky, but that he encouraged staff in his group to be similarly forthcoming.  Khinda also said that he tries very hard to build credibility with the staff early in an investigation.  When he gets challenged for a lack of “independence” when he’s acting as defense counsel, “[w]hat I say to the staff is independence is a proxy for intellectual integrity.  If I seem tired it’s because I’ve been running around trying to get at what the issues are.  The staff wants to know that you are thinking about the issues and trying to learn them the way they would.”

Securities Enforcement Forum 2014 — Current Developments in Trials, Testimony, Wells, APs and Settlements

Posted in Uncategorized

Today I’m blogging from Securities Enforcement Forum 2014, Bruce Carton’s excellent one-day conference, this year being held at the Four Seasons hotel in Washington, D.C.  The posts will be fairly raw, and certainly not verbatim accounts of what is being said.

This post covers what is essentially the SEC process panel.

Phil Khinda at Steptoe & Johnson moderating.

Brad Karp at Paul Weiss:  We represented Citi in its case with the SEC.  The model had worked just fine for JPMorgan, but our case landed on Judge Rakoff’s desk.  We couldn’t provide the court with findings of fact with exposing Citi to huge private liability.  Rakoff decided to pose nine questions to the parties, which turned out to be mostly rhetorical.  He issued a ruling rejecting the settlement as unfair, unreasonable, inadequate, and not in the public interest.  Second Circuit stayed the trial in a per curiam opinion wrote a blistering opinion attacking Rakoff’s opinion.  Emphatic rejection of the district court.  Then merits briefing.  Oral argument in February 2013.  Then we waited and waited.  Finally in June 2014, the Second Circuit vacated Rakoff’s denial of the settlement and announced a new standard for reviewing federal consent judgments.  Fair and reasonable are appropriate criteria.  Adequacy doesn’t have a role in this context, and had seeped in from class actions.  It’s a procedural review only, not a substantive one.  SEC has showed some flexibility in seeking admissions.  It is a harrowing take with a relatively happy ending.

Khinda:  I want to ask about APs.  The SEC has been keeping more of the work in-house as judge, jury, and executioner.

Russ Ryan at King & Spalding:  I see three main issues.  APs have at most a 300-day clock before a decision must be issues.  Hearing within four months.  Some extensions, but few.  Back in the day with one-broker cases that was no big deal.  Now more complex cases, multiple defendants.  Very hard to get adequately prepared in time.  Enforcement has to turn over the files in seven days, but it can be millions of pages dumped on defense counsel that are not organized in any way.  Even if they could get through the material, many defendants can’t afford the document review.  Basically no Fifth Amendment right because silence can be used against you.  But the main problem is these APs are being used as penal law enforcement when it used to be for technical regulatory violations.  Separation of powers issue because the SEC is acting as both prosecutor and judge.  Most of the litigation so far has been respondents going to the court so far before exhausting their administrative remedies.  Interesting case filed a couple weeks ago filed by Joseph Stilwell raising an interesting issue.  Appointments Clause argument.  Drawing an analogy to a PCAOB case. ALJs are technically appointed by the Commission and can’t be removed except for good cause.  Commissioners are appointed by the President and can’t be removed except for good cause.  Constitutional argument is that you can’t have that much discretion vested in ALJs with that much insulation.

Khinda: What thought has the staff given to pushback on Constitutional grounds?

Scott Friestad, Associate Director at SEC:  We’re not really considering that.  My starting presumption is either federal court or an AP is appropriate.  Question is what is best for the Commission?  We have high winning percentages in federal court and in APs.  The lack of discovery affects us, too.  We have to investigate cases differently knowing that discovery might not be available after we file.  We might have to have experts lined up as well.  We might benefit from that discovery in some cases.  My decision is based in what’s better for us, not what’s better for you.

Ryan: You’re being honest about saying the query is what makes it better for us to win the case.  Canellos was up here saying it’s not appropriate to think about it that way.

Friestad:  Should I be filing where I’m most likely to lose?   I still have to convince an ALJ that our theory is a good theory.  And we’ve had a lot of success in federal courts as well. The playing field has been leveled to a certain degree by Dodd-Frank.  There are good reasons to go to federal court.  I don’t think internal review by GC or the Secretary’s office has ever affected my decision not to do an AP.

Khinda:  What about the pre-Wells calls?  Are those more prevalent?

Tom Sporkin at Buckley Sandler:  There are six month deadlines for Wells notices, but they can be extended up to a year.  You have to set the expectations with the client and try to cabin the staff’s scope, too.  You’re trying to hit certain hot button issues.  The first factual recitation is very important.  When you meet with the staff.  If your client can afford a formidable team with consultants and experts and you know the case well, you have a better chance of getting a better resolution.

Khinda:  Exploit the procedural opportunities.  We’ve been thinking about trial issues from the first day.  You’re not writing for Enforcement.  You’re writing for the GC’s office and the other worriers.  The vibe is that they’re going to litigate.  It doesn’t need to be written like an opposition brief.  It needs to read like an amicus brief, and talk to the staff like they would talk to each other.

Karp: You have to pick your battles.  Hyperbole and hysteria don’t work.  Keep the endgame in mind and think about the entities that will be charged.  Focus on the powerful individuals in the organization.  Signal that if there isn’t an appropriate resolution, you will respectfully fight if necessary.  Acknowledge where you’ve crossed the line.

Sporkin:  Have to think about what meetings to ask for above the frontline staff level.  I recently was in a meeting with Andrew Ceresney and I’ve never seen an Enforcement Director get into the weeds the way he did.

Khinda: Have to ask yourself, why did someone in the Division stop what they were doing and come looking at you?  What I say to the staff is independence is a proxy for intellectual integrity.  If I seem tired it’s because I’ve been running around trying to get at what the issues are.  The staff wants to know that you are thinking about the issues and trying to learn them the way they would.  Pick your spots and understand from the beginning why the staff is looking around.  Some people say that more and more, the staff’s approach depends on who you get.

Friestad:  You should care most about consistency in enforcement decisions at the end of the process.  Our process is about fairness within a case and across cases.  The outcomes ought to be substantially similar.  Each case has nuanced facts and circumstances and the staff has to use their own best judgments.

Karp: Profound sense in the defense community that many different regulators and law enforcement authorities have been overly politicized and that the fines, suspensions, bars, etc. are only going up and up and up.  Something of a foodfight among different agencies to show they are the cop on the beat.

Friestad:  I’m proud of our track record on that and think we’ve done a good job on bringing cases only when they’re warranted.  I think we’ve withstood that pressure to bring cases just for headlines.

Khinda: What we miss is a time when the SEC was the chief regulator and was first in line before the NY AG’s office and DOJ and others.

Friestad:  There clearly is pressure because we’ve taken our fair share of criticism for not being first.  From my perspective, we want not to be first, but right.  When Harvey Pitt was the chairman, realtime enforcement was the mantra.  Nobody since then has said let’s slow things down and have things take longer.  APs fit with that approach, and can add to the deterrence value of cases.

Ryan: Welcome trend I’ve seen anecdotally.  When you do get the first subpoena, I’m finding more and more that the staff sometimes will lay out chapter and verse, we think these three employees did these three things.  If you can help us get to the bottom of that, we’ll limit the subpoena to that.  Tremendously welcome development.  If you just ask the staff, what is it you’re looking for, you might get somewhere.

Friestad:   In many cases, it’s perfectly appropriate for the staff to lay its cards on the table early and can speed the investigation along.  More efficient from our perspective sometimes. It doesn’t foreclose us from coming back later.

Ryan: I think the courts will eventually limit these APs to some degree.








Securities Enforcement Forum 2014 — SEC/FINRA Investigations & Cybersecurity Priorities

Posted in Cybersecurity, FINRA

Today I’m blogging from Securities Enforcement Forum 2014, Bruce Carton’s excellent one-day conference, this year being held at the Four Seasons hotel in Washington, D.C.  The posts will be fairly raw, and certainly not verbatim accounts of what is being said.

This post covers the SEC/FINRA and cybersecurity panel.

Jacob Frenkel at Shulman Rogers moderating:

Stephanie Avakian, SEC’s Deputy Director of Enforcement: An array of cases against IAs.  Misrepresentations, undisclosed conflicts and fees. Adequacy of compliance programs.  IAs not disclosing fees.  Custody rule.  Best execution.  Allocation of expenses.  B-D side: 15(g) case against Wells Fargo.  E*Trade case on unregistered sales of penny stocks.  Gatekeeper responsibilities. Developing expertise by centralizing information on B-D cases.  Churning initiative, building on OCIE work.  AML initiative.  Focusing on IRA rollovers.  Complex products being sold to retail customers.  ATSs.  Market access rule.  High frequency trading.

Brad Bennett at FINRA: Single-broker cases are FINRA’s bread and butter.  Those are up 10% year over year.  Lots of cases involving microcap securities and liquidations. Real harm to real people. B-Ds are gateways to those schemes.  Nuts and bolts type cases.  Reg. SHO, e.g.  Compliance is not a place to save money.  We’ll have a strong sanctions year.  A non-compliant firm shouldn’t have a competitive advantage over a compliant firm.

Karl Groskaufmanis at Fried Frank: In addition to people who missed Madoff in the government, sophisticated investors missed it, too.  Investors want to know about principles and strategies.

John Stark at Stroz Friedberg:  Lots of challenges with ESI.  Back in the day as a staff attorney, we didn’t want to ask for too much.  Now the secret information is available and has turned full circle.  You can ask for all data and they can mine it.  Staff says let’s make the subpoenas as broad as possible.  Data exists in so many different places.  Lots of “deleted” data on your systems.  Witnesses often testify that they think they’ve deleted an email or whatever.  It can be found.  Now you have to find it and review it before producing it to the government.  Home devices have to be considered as well.

Bennett: Our enforcement program is only as good as its examination program.  But you should not be receiving overbroad document requests from FINRA.  We start focused and then expand if necessary.

Stark: Regulated entities have recordkeeping obligations.  But then public companies could have more and looser data without those same obligations.  Too many places where your data may reside.

Groskaufmanis: With any buy-side investor, when you come into possession of material, nonpublic information, talk to your compliance staff.  You can’t be omnipresent, but if you do that, you’re doing a lot to protect yourself.  Legal and compliance is challenging in this environment.  Also, don’t suspend your common sense.  A statute won’t, say, tell you specifically not to manipulate LIBOR, but probably don’t do that.

Bennett: As a compliance officer, your job comes with responsibility.  If you have a duty and don’t do it, you’ll be charged.

Avakian: I would echo Brad.  We view compliance people as the front line and our partners in this.  We’ll bring cases where warranted.

Frenkel: How should a compliance officer act to preserve the attorney-client privilege?

Groskaufmanis: First, segregate clearly privileged communications.   In all of these entities, management looks to you to be someone who makes judgments as they go along.  There’s a technical definition for an advice of counsel defense.  If you can meet those factors, that will count more than anything else.  Real challenge for the inside counsel is how to maximize the effectiveness of your judgments in a way that sticks four years later.  Some documentation of what you’re doing is much better than none.  Don’t let the perfect be the enemy of the good in terms of getting some record of your advice down in black and white.

Bennett:  SEC v. Howard on advice of counsel defense.  Sometimes it comes up very late and very few respondents can actually show reliance.

Avakian:  We see the range.  Some people come in with all the boxes properly checked.  In the middle, there was a lawyer in the room or on the emails.  On other end, sort of a reliance on process defense.  We’re going to ask for all of the facts surrounding the advice, so we’ll ask for a waiver and will have to dig into those.

Stark: When it comes to giant document productions, sometimes just the collection of data is a huge process.  We sometimes have to set up data collection centers abroad because data privacy laws donp’t allow the production of documents to the U.S.  Defendants should push back on SEC subpoenas for hard drives.  Those subpoenas are more like search warrants, which the staff aren’t authorized to get.  The more transparent you can be, the better.

Avakian: We expect staff to be reasonable and seek what they need.  We rely on people to exercise their judgment.

Bennett: People who have gotten overbroad requests should negotiate them with the staff.  We can go in and take hard drives from recalcitrant firms.  When you sign up to be a member firm, you sign on for that.  Those seizures haven’t been litigated as far as he knows.  We have to be aggressive because real harm can be done to real investors. The SEC has done good work against stock liquidators.  We have quarantines to avoid getting privileged material.  For some people, only criminal prosecutions workr

Stark: Interesting times for cybersecurity.  Historically it was the data of customers.  Then market manipulations.  That paradigm has shifted.  OCIE cybersecurity module released in April 2014.  Has anyone seen it?  It is very sophisticated and requires a lot from IAs.  The SEC is showing its cards in a way it doesn’t normally do.  You read about these data breaches.  If you’re hacked, you’re the victim of a crime and then treated like a criminal.  The only one who’s your friend is the FBI because they want to figure out who did it.  State regulators are calling.  Customers are calling.  Board is irate.  Boards are hiring independent investigators.  Hacking investigations are sort of like FCPA investigations in that there are multiple workstreams.  Remediation efforts are massive.  Most IAs are almost unable to comply with OCIE’s module.

Bennett: What is the standard on which one should be judged?

Stark: We have extremely sophisticated clients who are suffering breaches.

Bennett: Still, individuals are falling down on the job and signing security certifications that they shouldn’t.

Avakian: Putting aside the giant breaches, B-Ds and IAs need to have policies and procedures in place.

Bennett: If you are devoting inadequate resources to customer protection, then you might have an enforcement action.  We won’t file cases indiscriminately.

Karl:  For some of companies, these may be material developments.

Bennett: Your enforcement liability may pale compared to your private civil liability.


Securities Enforcement Forum 2014 — Directors Panel

Posted in Uncategorized

Today I’m blogging from Securities Enforcement Forum 2014, Bruce Carton’s excellent one-day conference, this year being held at the Four Seasons hotel in Washington, D.C.  The posts will be fairly raw, and certainly not verbatim accounts of what is being said.

This post covers the panel of current and former SEC Enforcement Directors.

Brad Bondi at Cadwalader, moderating:

Andrew Ceresney:  Happy to be here with other former directors.  Talking about this past year.  Quite a banner year.  Many different kinds of cases.  First ever cases: market access rule.  15c3-5 Wedbush Capital,  WB anti-retaliation.  Halting a muni bond offering.  Twice as many trials this year as prior year.  Did well in those trials.  Wyly case.  Used big data in new ways to detect and investigate misconduct.  Admissions.  MCDC initiative.  Attribute to the Enforcement staff.  Looking forward: insider trading is still a focus.  More than 580 cases in last five years.  Big time for insider trading.  Working closely with DOJ, but many are SEC-only cases.  Investment adviser cases.  15(c) initiative under Investment Co. Act.  Market structure realm, too.  Market access rule cases against B-Ds.  Cases against exchanges, ATSs.  Cases re: manipulative trading. Financial reporting and audit cases.  Microcap and pyramid schemes.  Gatekeepers and others in that area.  Focus on low and middle income investors there.

Bondi: Big data. What’s new?  How do you plan to use it?

Ceresney: Using bluesheet data better.   Billions of lines of that data that we can manipulate now.  Aberrational performance, too.  Team in Salt Lake City gets clearing data showing unsuitable trades.  We can see on a platform basis rather than trader by trader.  Microcap database, too.  Also some technology to make connections among wrongdoers.  Institutional knowledge to build cases.

Bondi: Emphasis on admissions recently.  Please expand on that.  Rob, is the admissions program where you thought it would be?

Khuzami: This program is a little different.  We did it for parallel criminal cases.  Those cases were a little ridiculous.  We didn’t require it on a stand-alone basis.  It does serve a role in accountability.  Question is how is the program playing out in practice.  The criteria are elastic.  Maybe not transparent in how they are being applied.  Does it give extra leverage to the SEC for other settlement points?  If more trials, that’s just a resource allocation issue.  Judicious use of admissions has probably prevented worst possible abuses.

Ceresney: It shouldn’t be used as leverage.  Staff shouldn’t be asking for admissions without clearance from the front office.  Predic, tions of more trials.  Hard to tell, but I don’t think it’s had that result.  We’ve been true to the factors we announced.

Thomsen: I agree the staff aren’t using it as leverage explicitly, but they are using it implicitly.

Ceresney: Staff shouldn’t be saying admissions could still be around the corner.

Bondi: Broken windows approach for small infractions.  How do you square that policy with Seaboard, etc.?

Thomsen: Not sure we know failing to file some form will lead to a larger violation.  But you do want to get to smaller violations before they lead to larger ones.  Are the rules we’re enforcing making sense?  It used to be that a missed filing led to a filing and a remedial program in place.  Now that could lead to enforcement action.  The reaction can be disproportionate.

Ceresney:  It’s not about taking every violation into an enforcement action.  OCIE is still out there issuing deficiency letters without enforcement actions.  But Form 4s are important to file.  We have increased resources on financial reporting and auditing and market structure.  We’re not moving away from those to do dinky stuff.  It’s not every violation.  It’s areas where we have important rules to enforce on the front end.

Bill McLucas:  I think the perception is that in this environment, here’s zero tolerance.  No room to have somebody who broke the rules without fraud and not get charged. Down in the ranks, if there’s any violation you’re in the soup.

Stanley Sporkin:  You have to enforce all the rules.  You have to comply.  I had a commissioner one time who tried to tell me not to bring all these cases.  Once we referred a 16(a) case as a criminal case.

McLucas: Whose side are you on here?  He doesn’t need any encouragement! (pointing to Ceresney)

Bondi: Is the broken windows approach trumping Section 21(a) reports?

Ceresney: No.  We don’t do rulemaking by enforcement.

Sporkin: Your whole insider trading program was by enforcement!

George Canellos:  So, case law, right?

Ceresney: I’m talking about extending prohibitions where the rules don’t provide for it.

Canellos: None of those cases are legally controversial.  The Enforcement Division has done a good job in coming up with settlement templates.  It can some cases it’s hard to properly calibrate remedies in the current environment.

Bondi: Is the penalty statement from 2006 dead?

Ceresney: It was never binding.  Nine factors, non-exclusive.  We analyze them, but it was never binding.

Bondi: But given the increase in penalties, when you’re advising clients, should you tell them to treat cooperation credit the same as ten years ago?

McLucas: Self-reporting is one issue.  You cooperate to the full extent you can.  But if you discover a problem on your own, do you walk it in?  You’re weighing the risk of an investigation against the likelihood that you can deal with it, self-remediate, and move on.  If you do that and the government finds out, you could be penalized more. Among rational people, some of them might want to fix it without reporting.

Thomsen: Especially hard question for old FCPA issues.  Will the government find it or not?  Companies do find isolated, historical issues.  Do I put myself through the wringer?

Bondi: Record $30 million whistleblower award.  What are you trying to signal?  Everyone should step forward?

Ceresney: Yes.  It seems like a huge gamble not to disclose criminal conduct.

McLucas: These are not all criminal.

Ceresney: Even on the border.  But we try to incentivize cooperation.  It’s hard to advertise that, but we do.  Includes providing information on individuals at your company.

Bondi: How do you deal with dissents by commissioners?  Aguilar issued a forceful dissent this summer, calling a case a slap on the wrist.  First since your days, Bill.

McLucas: It wasn’t that long ago!  The challenge today is different.  There was a lot of debate about enforcement actions.  You can’t stop a commissioner from speaking.  The difference today was the effort to have the Commission speak with one voice 20 years ago was different from today.  Some of the individual identities dissipated once they were sworn in.  The better message was to have the agency speak with one voice.  We had spirited debates.  The meetings in the closed Commission room could be heated, but collegial.  Difference is the Commissioners worked harder then to speak as one.  But it’s not the end of the world.  My personal view is these dissents erode the SEC’s credibility with the markets and the bar.

Bondi: Will these dissents chill enforcement staff from bringing a particular charge?

McLucas: I don’t think so, but the individual views of Commissioners hold great sway with recommendations of the staff and where they think they can navigate a case to completion.

Thomsen: The Commission has become the Commissioners.  I’m not sure that fracturing is a good thing.  It used to be that there was more dovetailing actions with past actions, as courts do.  That happens less now.

Canellos: There have always been dissenting voices.  It’s hard to navigate the shoals of the SEC process.  It can be like there’s threading a needle but there’s no hole. Pleasing one Commissioner will displease another.  In some cases, you want to bring cases to send a message to someone who’s fallen down in their duties but hasn’t committed fraud.  Aguilar’s dissent in Blodgett/Kaiser was very acrimonious.

Ceresney: We’ll make decisions based on the evidence.

Khuzami: Jesse Eisinger said admissions were only the first vertebra needed in the SEC’s spine.  Politicization of the agency since the financial crisis.

Sporkin: The SEC can no longer regulate from behind.  The genie’s out of the bottle.  The SEC needs good intelligence and to get out in front of things when they can.  Make little cases now so you don’t have to make big cases later.

Bondi: Any advice to the bar to get better cooperation credit?

Ceresney: You need credibility.  Having robust dialogue with defense counsel is critical.  We’ve been doing reverse proffers, laying out what our case would look like.  It breeds transparency.  We know what our litigation risk is, but that probably won’t persuade us not to bring a case.  If we’re not using a few, we’re not being aggressive enough.  Helps  to hear that this is not the kind of case where you want to expend your resources.

Bondi: Cites Russ Ryan’s WSJ piece on APs. Where do you make the call on APs vs. federal court?

Ceresney: We look at a number of things.  ALJs are sophisticated fact finders.  Sometimes we need more discovery in court.  I disagree with Russ.  We’ve lost APs and will probably lose some more.  There are extensive procedural protections.  We turn over the entire file seven days after filing.  No depositions in criminal proceedings either.

Khuzami: Also guilt beyond a reasonable doubt.

Ceresney: Supreme Court has upheld APs as appropriate under the Due Process Clause.

Bondi: Will there ever be any published guidance on the SEC’s decisions here?

Ceresney: Probably not.  Facts and circumstances.

Thomsen: You’ll see some challenges.  Gupta case was unique.  Rakoff said the SEC was evidently forum shopping.  Joseph Stilwell sued the SEC this month.  Those challenges may not prevail, but if the forum choice seems to be unfair to the defendant, I could see a court treating those circumstances as profoundly unfair.

Canellos: 80% of the administrative docket is extremely technical and appropriate for an AP.  Reg. SHO cases.  Rule 105, etc.  Significant differences between the two forums.  Higher penalties in insider trading matters in federal court, e.g.  You shouldn’t be picking the forum where you’re most likely to win, but the one that is most appropriate for the case.

Bondi:  Closing cases.  What have you done to streamline case closings post-Madoff?

Ceresney:  We’ve placed a premium on doing cases quickly. Quarterly reviews with every senior officer.  For old cases, let’s bring or close.  Sometimes a parallel DOJ case could keep it open.   Trying to move them along.

Sporkin: Chairman Casey gave Sporkin the authority to close cases.

Securities Enforcement Forum 2014 — Financial Reporting and Accounting Fraud

Posted in Financial Fraud

Today I’m blogging from Securities Enforcement Forum 2014, Bruce Carton’s excellent one-day conference, this year being held at the Four Seasons hotel in Washington, D.C.  The posts will be fairly raw, and certainly not verbatim accounts of what is being said.

This post covers the accounting fraud panel.

Marty Wilczynski at FTI Consulting moderating.

Steve Cohen at the SEC:  Under new Chief Accountant Mike Maloney, we’re redistributing staff accountants to enforcement groups to build knowledge and familiarity.

Wilczynski: How are accountants working with the staff under the Financial Fraud Task Force?

Cohen: The task force is a hybrid group.  It generates leads and then farms them out to investigative groups.  The Task Force is about a year old and trying to integrate more staff.  We can consolidate best practices in how we look for cases and investigate them.

Bill Baker at Latham & Watkins:  Are regional offices part of this?

Cohen:  Yes.

Baker: Can you be talked out of proceeding?

Cohen: Yes, but in the early stages of an investigation probably not.

Jonathan Tuttle at Debevoise: What is the handoff point from Task Force to an investigative group?

Cohen:  It depends on how complex the matter is.  The harder it is, the longer the Task Force will keep it and develop it.

Wilczynski: Bill, do you see differences in your interactions with the staff?

Baker: To me the biggest change is inquiries from CorpFin or comment letters can now turn into Enforcement investigations easily.  You have to educate lawyers dealing with CorpFin staff that rewordings can lead to Enforcement involvement.   David Woodcock and Margaret McGuire, the Task Force chairs, are not bashful about showing up early.

Tuttle: You can end up in an enforcement investigation much sooner than corporate lawyers realize.

Baker: The issuers can think enforcement defense lawyers are the problem by holding off indiscriminate document productions to CorpFin.

Deborah Conner at U.S. Attorney’s Office in D.C.: My office hasn’t seen much generated from the Task Force.  Expect to see more as it grows.  We do training together but there’s not regular reporting on this issue between SEC and DOJ.  We do have forensic accountants on our staff.

Cohen: We’ve seen a lot of interest from DOJ in our accounting cases.

Wilczynski: Any particular areas or trends that you’re seeing?

Baker: Internal controls, internal controls, internal controls.   Outgrowth of FCPA issues, but much broader today.

Tuttle: More focus on technical accounting issues.

Mike Trager at Arnold & Porter:  We’re seeing the staff be more methodical and so looking into areas that might not be obvious.

Wilczynski: Internal controls.  Extension of broken windows philosophy?

Cohen: No.  We’re seeing an increase in revisions vs. restatements.  Often we see large frauds in places without a lot of visibility to senior management.  You can expect the focus on internal controls to continue, even in stand-alone, non-fraud cases.  Hard in my mind to segregate fraud/scienter from internal controls.  But we’re investigating internal controls from the outset more and more.

Marty: Technology.  New investments in this area by the government?  Effective?

Connor: We have to keep up with big law firms producing all of this data.  We have data management systems to review and analyze information.  I tell our staff to be careful about subpoenas because we have to understand what we collect.  We also use technology from the FBI and IRS.

Trager: Of course you could always narrow your requests for information.

Wilczynski: Accounting Quality Model.   What’s the status?

Cohen: We’re seeing a renaissance in technology, both reacting to data and in seeking out accounting fraud.  Commission created the Center for Risk and Quantitative Analytics last year.  CRQA has been able to centralize these tools.  Also access to a wide range of data and we assemble tools in house to process it.  AQM is really just one small piece of what we’re doing.  It’s been refined over the last year and will get better, especially for earnings management.

Trager:  What about false positives?

Cohen: The AQM, e.g., looks at accruals compared to industry peers.  It’s just a red flag, not the entire case.  We take those leads and then do due diligence from other sources.  We don’t want to waste staff resources either.  Earlier meetings with companies can actually be useful to them.

Baker: Yeah, but we’re always in reactive mode.  The requests we get are very open-ended.

Tuttle: The staff won’t share their specific concerns.  From the defense side, there often are rational explanations for seemingly aberrant accounting.

Cohen: We’re not guided only by technology.  The AQM and other tools are only leads.   These tools (and reasonable corporate explanations) have sometimes led us not to pursue investigations.

Linda Thomsen (Davis Polk) question: How frequently can defense counsel talk the staff out of a case?

Trager: Rarely.  An early presentation can backfire and give the staff more information to pursue.

Cohen: I can’t think of an investigation where we held it against the company for not knowing all the facts very early in an investigation.

Cohen: Gatekeepers and auditors are very important for our investigations.  We’re willing to bring cases against auditors for their failures even if not necessarily fraud by the underlying companies.

Tuttle: Before maybe there were too many restatements.  It’s a pendulum going back and forth on that.

Baker: Last week I spent three hours in testimony where the staff accountant went through SAB 99 line by line.  Unusual to see that level of detail.

Cohen: An admission is not a negotiable part of a settlement.  We’ve raised them early so people aren’t caught off guard.

Connor: If a person chooses to admit or not, we have our own DOJ investigation.

Baker: As a result of a PCAOB exam, an auditing firm can change its position in a way that causes a company to make a restatement.  Then an investigation opens.  It changes how the auditors react to you in real time.

Mark Adler at PCAOB: I’d like to think we’re contributing to the mission.  We do cooperate with the SEC.

Trager:  What about admissions in non-fraud cases?

Cohen: Scienter isn’t necessarily required for admissions.  There are about a dozen of them.  Soon we’ll stop counting but it will continue tolp  be exception rather than the rule.

Trager:  Also may help avoid a fraud charge if you admit to negligence.

Tuttle: When you add admissions, you may remove the last benefit of settlement and force a case to trial.  Individuals have a lot of incentive to litigate.

Cohen: And you can assume that’s fine with us.

Baker: Sharp increase in trials, but those have mostly not involved accounting cases.

Securities Enforcement Forum 2014 — FCPA, SEC/DOJ Joint Actions, and Other Recent Criminalization Trends

Posted in FCPA

Today I’m blogging from Securities Enforcement Forum 2014, Bruce Carton’s excellent one-day conference, this year being held at the Four Seasons hotel in Washington, D.C.  The posts will be fairly raw, and certainly not verbatim accounts of what is being said.

This post covers the FCPA panel.

Chuck Duross at MoFo is the moderator.

Kara Brockmeyer, the SEC’s FCPA chief: Our cases are all over the world and in every industry.  Also, size doesn’t matter.  We’re suing large companies and small companies that are moving into the international space for the first time.  Also, some of our investigations are spinning out of earlier investigations.  Your competitors are probably ratting you out, and problems run across industries.

Jeff Knox,  formerly at DOJ’s Fraud Section and now at Simpson Thacher:   lots of tech companies are having FCPA issues.  Factors: they operate in high-risk markets.  Large government contracts in competitive markets.  IT people in these industries have a lot of discretion in selecting winners.  They rely heavily on third party distributors who are former government officials.  The deals tend to be complex and lend themselves to excess margin to hide corrupt payments.  You can’t police hundreds of sales people effectively, but you have to apply heightened due diligence to the highest risk transactions.  What role is this entity playing with respect to that entity?

Jon Barr at Baker Hostetler:  In the Marubeni case, the DOJ brought the stick out and said if you u’cooperate, here’s what’s going to happen.  Forfeiture in the Alcoa settlement was noteworthy.  Where does the forfeiture go?  Also, monitors.

Duross:  What’s the trend on monitors?  He suspects the government is opportunistic and looks for chances.  It really depends on the case.  The “trend” goes up and down over time.

Brockmeyer:  It matters if a company is getting a handle on their compliance.  If they can demonstrate that, a monitor might not be necessary.  But we’ll see more going forward.

Alex Bourrelly at Baker Botts:  There can be rational reasons not to cooperate, especially if you’re a non-U.S. issuer.

Duross:  Debarment can be a real issue.  A guilty plea by the parent corporation can be a big negotiating point.

Knox:  Some companies make a calculated risk that the government won’t be able to put a case together.  Parent-level guilty pleas are possible.  DOJ is more skeptical of collateral consequence claims now, and getting more experience in dealing with them.  Not buying the sky-is-falling arguments.

Duross:  Government is letting the spectre of Andersen fade away.  The company may well survive without mass layoffs.

Brockmeyer:  Administrative actions are the new normal because Dodd-Frank allows civil penalties.  We’re exploring using those more frequently.

Bourrelly: If you have a settled case in an AP, it allows you to avoid a meddlesome federal judge.  Can lessen uncertainty.  The sta ff has the authority, but as a practical matter, it can be very bad for a defendant to get a case together on that compressed time schedule.  New administrative law judges, but not sure there will be tons of litigated FCPA cases in administrative court.

Barr: With a litigated case against an individual, discovery is limited and it can be very hard.  No jury.   Very little time.  Not like you have all the documents.  Drinking from a fire hose.  I’d hope the SEC would not use the administrative process for those cases.

Brockmeyer:  You do get the whole record in seven days.

Barr: Terabytes of information!

Brockmeyer: Hopefully not terabytes.

Barr:  It’s very difficult.

Duross: Hybrid monitor of 18 months with an option to go longer can be a reasonable option.  DOJ and SEC are becoming more sophisticated in recommending them.

WSJ question:  What’s the disadvantage from not having a monitor in place?

Brockmeyer:  If they’ve remediated the problem, a monitor might not be useful.

Knox: Monitors are not just passive observers.  They are in the middle and creating policy.  If the compliance function is working, a monitor might not be good for the company or the public.

Duross: A monitor is not supposed to be punitive, au nd it carries costs.  It has to be necessary.

Brockmeyer:  Many companies are doing a much better job now.  Question used to be, how are you going to test that?  The company wants to find the problem long before the government does.  Companies are being much more proactive these days.  Corporate sophistication is helpful here.

Barr: Goal is to make the government comfortable with getting continued self-reports.

Brockmeyer:  Same conduct that can minimize monitors is also the best way to a declination.

Question from Jacob Frenkel at Shulman Rogers: What about tips from foreign whistleblowers, non-issuers?

Brockmeyer:  We have strict confidentiality provisions with respect to whistleblowers.

Question about overlapping jurisdiction.

Brockmeyer: If a company has problems with internal controls, those problems often aren’t going to be confined to a single area.

Knox: Reality is sometimes prosecutors are focused on one particular kind of conduct.  Also, sometimes people aren’t incentivized to report different kinds of conduct.

Bourelly: You want to resolve everything with the government at once if you can.

Duross: International cooperation. Looking at the last year, the government put thought into who gets thanked at the bottom of press releases.

Knox:  Level of international cooperation is much higher these days.  Three tools: traditional ones, corporate cooperators, cooperation from international governments. Lots of times the only window into bribe recipients is going to come from foreign governments.

Brockmeyer: IOSCO lets us get critical bank and brokerage records.

Barr:  Lots of cooperation going on.  If you’re going to walk something in you have to be careful about proffer letters to limit what DOJ can share with foreign regulators.  Also NPAs.  If you’re not careful, you’ll be compelled to cooperate with a foreign government, and you won’t necessarily have any protections as to that government.  DOJ has been sensitive to that.

Bourrelly: To what degree do foreign governments feel cut out of deals like that?

Barr: We’ve had luck negotiating additional terms.  Most you can really get is an agreement to share if the government agrees to X protections.

Duross: DOJ has understood that there can’t be a proffer where the defendant is then immediately turned over to the Serious Fraud Office.

Barr: You have to ask for it.

Securities Enforcement Forum 2014 — Morning Keynote Speech by Commissioner Piwowar

Posted in Uncategorized

Today I’m blogging from Securities Enforcement Forum 2014, Bruce Carton’s excellent one-day conference, this year being held at the Four Seasons hotel in Washington, D.C.  The posts will be fairly raw, and certainly not verbatim accounts of what is being said.

This post covers Commissioner Michael Piwowar’s morning keynote speech.  He started by noting that he’s one of only three economics Ph.Ds to serve as a commissioner at the SEC.  He also pointed out the Takings Clause of the Constitution, which should give you an idea of his perspective on securities regulation. Also, did you know that the Code of Federal Regulations has grown from two volumes to three?  If every rule is a priority, then no rule is a priority.  Commissioner Piwowar thinks that a “broken windows” approach to securities enforcement does not necessarily work when applied to all regulations and entities the SEC is charged with overseeing.

He gets the requirements of the Administrative Procedures Act can be cumbersome and frustrating, but says due process requires their application.  Also, raw numbers for SEC enforcement actions are not good measures for Enforcement Division effectiveness.  You wouldn’t measure a police officer’s effectiveness by counting up the number of speeding tickets he issued.  He notes that because of general diversification practices, a dishonest broker or adviser could be more damaging to a particular investor than a dishonest CFO.

The Commission has not held a summit devoted to elderly investors in a long time, and should focus on that area.  Individuals commit violations and should be charged as such.  Sometimes entities may settle cases just to resolve them.

Commissioner Piwowar also got into the SEC’s treatment of corporate penalties and the notion, also held by Commissioner Gallagher, that investors should not be punished for acts committed by corporate officers and directors.  In particular, many SEC staff are recommending corporate penalties without reference to the factors laid out in the Commission’s 2006 statement on those penalties.  Piwowar thinks those omissions are a failure that could expose the SEC as acting in a misleading way.

Finally, the SEC’s new ombudsman mandated by Dodd-Frank.  Piwowar suspects many issues for the ombudsman will relate to whistleblower tips, but thinks her jurisdiction will grow.  It is not unusual for government agencies and private companies have such a person.  An ombudsman with authority to examine the SEC’s workings below the IG level could be a useful addition.

Ghost of David Sokol Haunts SEC’s Insider Trading Case against Szymik and Peixoto

Posted in Insider Trading, SEC Litigation

It never actually became a case, but maybe you remember this matter from a few years ago.  In January 2011, former Berkshire Hathaway executive David Sokol bought about 100,000 shares in Lubrizol Corporation shortly before suggesting to Warren Buffett that Berkshire consider acquiring the company.  Berkshire did acquire Lubrizol on March 14th, and the company’s stock soared.  It was a big hoo ha.  Berkshire’s audit committee quickly issued a report accusing Sokol of violating company standards by misleading Berkshire about his personal stake in Lubrizol.  The committee stopped short of concluding that Sokol committed insider trading, but stood ready to cooperate “with any government investigations relating to this matter.”

The question for many observers: had Sokol insider traded?  More specifically, was Sokol’s knowledge about Berkshire’s potential acquisition of Lubrizol material nonpublic information?  Regardless, the SEC never made a case, and ended its investigation into Sokol almost two years later.  But the question was out there.  Could a holding company’s or hedge fund’s investment plan regarding other issuers by itself be material information for insider trading purposes?

The SEC finally got around to answering this question last week, when it filed administrative insider trading cases against Filip Szymik and Jordan Peixoto.  According to the SEC’s orders, Szymik learned from his roommate, then an analyst at Bill Ackman’s Pershing Square Management, that Pershing planned to publicly announce that it had taken a $1 billion short position in Herbalife, Ltd. on December 20, 2012.  The SEC says Szymik tipped Peixoto, who bought Herbalife put options the day before the announcement and made $47,100 in illicit profits.

Similar to the Sokol matter that never materialized, the only material information at issue was another investor’s plans to take a massive position in a separate issuer, just with Pershing and Ackman standing in the places of Berkshire and Buffett.  Material for insider trading purposes?  Apparently, though I don’t think this is a radical position.

Matt Levine, whose thinking about insider trading is as sophisticated as anybody’s these days, notes that Peixoto thought better of it after the trades went through and tried to let his put options expire without exercising them.  His plan didn’t go that well and he was stuck with a $47,100 target that the SEC hit last Tuesday.  Levine points out the logical inconsistency in the SEC’s charging Szymik and Peixoto but not the Pershing analyst who was the source of all of this.  But if the analyst really didn’t intend for Szymik to trade, he wouldn’t have had the necessary intent for an insider trading case.  It may be that the SEC’s staff just made a reasonable judgment not to recommend charging the analyst even if it technically could have.  I suppose that happens from time to time.

Szymik has settled his case, but Peixoto’s continues.  His litigation in administrative court will likely not be a lot of fun.  We’ll see how it goes.

Charged with Interpreting “Officer” in Corporate By-Laws, Third Circuit Decides 12 Random People Are Better Suited for the Job

Posted in Investigations

Here are two things I thought when I was a kid: (1) Quicksand was a real threat, something that could suck me into the Earth if I wasn’t careful when walking around outside.  I don’t know if this was a function of too many episodes of Gilligan’s Island or what, but quicksand seemed both exotic and like something that could get me if I didn’t watch out.  (2) Being a vice president was a real thing, and basically made you Number 2 in a government or business.  Well, that’s true for, say, the United States government.  And at the time Walter Mondale and George H.W. Bush were my frames of reference for this thought.  But for lots of businesses, vice president doesn’t mean all that much.

In fact, at Goldman, Sachs & Co., which employs tens of thousands of employees, about a third of them are vice presidents.  This wasn’t a great fact for Sergey Aleynikov, a vice president in Goldman’s equities division from 2007 to 2009.  On his last day, according to a Third Circuit opinion from earlier this month, he copied some of the company’s source code into computer files and transferred the files to a server in Germany.  A federal grand jury indicted Aleynikov in 2010, and he was eventually convicted of violations of the National Stolen Property Act and the Economic Espionage Act.  He served 51 weeks in prison before a federal appeals court reversed his convictions and ordered him immediately released in February 2012.  In August of that year, a state grand jury in New York indicted Aleynikov on similar charges; that case remains pending.  Michael Lewis wrote a quite compelling Vanity Fair story about Aleynikov’s case casting serious doubt on these efforts to punish Aleynikov.

Anyway, his legal defense has been very expensive, and he is now trying to recover its costs from Goldman under both the indemnification and advancement provisions of the company’s by-laws.  As the court explains, indemnification and advancement are separate but related avenues by which a company pays for an individual’s legal expenses.  For indemnification, the corporation reimburses the individual for her legal expenses once she has been successful in the underlying proceeding on the merits or otherwise.  For advancement, the company pays legal expenses on an ongoing basis, provided that he must repay the amount advanced if it turns out he’s not successful on the merits or otherwise in the underlying lawsuit.

Aleynikov wants both, but his entitlement to them depends on whether he was an “officer” at Goldman, Sachs.  The court determined that an officer is someone who holds a position of trust, authority, or command.  As a vice president, was Aleynikov in such a role?  The court isn’t sure!  The court decided that the evidence introduced by Goldman raised genuine issues of material fact on the meaning of the company’s by-laws.  So that’s where this case will apparently go: a jury trial so some twelve of Aleynikov’s peers can study Goldman’s by-laws and determine whether they encompass an employee like him.

Judge Fuentes dissented and wrote separately to say that under the doctrine of contra proferentem, the by-laws should be construed against their drafter, Goldman Sachs.  In his view, turning the question over to a jury incentivizes Goldman not to make its by-laws clear, but to keep them ambiguous, “thereby giving many persons the reasonable expectations they will receive advancement, while reserving the right to make unpredictable post hoc determinations about which former employees should be advanced attorney’s fees and which shouldn’t.”

Matt Levine hilariously covered this case at Bloomberg two weeks ago.  Check it out here.