HRO Securities Defense Blog

New Cooperation Initiative: Potential SEC Enforcement “Game Changer”

In a recent speech, Division of Enforcement Director Robert Khuzami announced a new cooperation initiative that has the potential to dramatically change the way the SEC staff interacts with individuals and companies. Historically, the SEC has insisted on punishing all individuals who engaged in wrongdoing and seeking the full array of harsh sanctions against them, regardless of the extent to which they cooperated with the staff, or whether they "self-reported" the misconduct. Mr. Khuzami’s initiative features cooperation agreements, deferred prosecution agreements, and non-prosecution agreements.

According to Mr. Khuzami, the Division of Enforcement will now use cooperation agreements in which it agrees to recommend to the Commission that a cooperator receive credit for cooperating in its investigations or related enforcement actions. Such credit will only be extended if the cooperator provides substantial assistance in those investigations and enforcement actions. Mr. Khuzami did not state what this "credit" will consist of, but presumably could include foregoing the imposition of civil penalties.

SEC Files First Regulation G Case

On November 12, 2009, the SEC filed an accounting fraud case against SafeNet, Inc.  Notably, the SEC touted the case in its litigation release as its  first case involving violations of Regulation G.  This regulation was mandated by Sarbanes-Oxley and was intended to address the widespread use of “pro-forma,” non-GAAP financial metrics, such as EBITDA by technology companies during the late 1990’s.  This case demonstrates the SEC enforcement program’s continuing efforts to crack down on financial fraud, but for the reasons discussed below, is a poor “message case” regarding Regulation G.

SEC Extends Compliance Deadline for Reg S-AM Implementation

On November 5, 2009, the SEC announced that the "compliance date for Regulation S-AM is extended from January 1, 2010 to June 1, 2010."  (See http://www.sec.gov/rules/final/2009/34-60946.pdf.)  See also our previous discussions of Reg S-AM.

Madoff Investors Sue SEC

   Yesterday, two Madoff investors sued the SEC for failing to detect the scheme that caused them to incur $2.4 million in losses.  In a complaint filed in the U.S. District Court for the Southern District of New York, Phyllis Molchatsky, a disabled retiree and single mother, and Steven Schneider, M.D. accuse the SEC of “serial, gross negligence” during its multiple investigations and examinations of Madoff’s firm, Bernard L. Madoff Investment Securities, LLC. The complaint relies heavily on the recent report by the Office of the Inspector General detailing numerous opportunities to detect Madoff’s huge Ponzi scheme that were missed by the agency. [1]

SEC Fines Broker Dealer $100,000 Under Reg S-P for Failing to Protect Customer Data by Requiring Reps to Have Anti-Virus Software

By Sven Collins, HRO. On September 29, the Securities and Exchange Commission (SEC) issued an administrative cease and desist order, under Sections 15(b) and 21C of the Securities Exchange Act of 1934, and Sections 203(e) and 203(k) of the Investment Advisers Act of 1940, against Commonwealth Equity Services, LLP d/b/a Commonwealth Financial Network. See Release No. 34-60733 at www.sec.gov/litigation/admin.shtml. The SEC’s cease and desist order—to which Commonwealth consented without admitting any wrongdoing—found that Commonwealth Financial violated Regulation S-P by leaving its customer information “vulnerable to unauthorized access.” How did Commonwealth Financial do this? According to the SEC’s order, Commonwealth Financial did this by only recommending—but not requiring—that its registered representatives have anti-virus software on their computers used to access Commonwealth Financial’s intranet trading platform. Equally bad, according to the SEC, Commonwealth Financial also did not audit registered reps’ branch office computers to see if they had anti-virus software and did not put in place procedures to follow up on potential computer security issues uncovered during branch audits or when reps reported issues. The end result was that bad guys could potentially crack into Commonwealth Financial confidential customer information.

FINRA Proposes Permanent Disclosure of Disciplinary Proceedings Against Former Brokers

            For many years, FINRA’s Central Registration Depository (“CRD”), which also is known as “broker check,” has been a valuable source of information for investors wishing to learn about the background of their brokers, including whether they have a disciplinary history.   However, CRD data currently is unavailable for brokers whose FINRA registration expired more than two years ago.  This is a problem because brokers who are barred or fired, or who resign their positions, often take jobs in the insurance, real estate or financial planning industries.   The disciplinary history of these former brokers may be relevant to potential customers’ evaluation of their qualifications.

FINRA Seeks to Eject Firms from Membership for Failure to Supervise

          A little-noticed rule change allows FINRA to institute statutory disqualification proceedings firms found to have failed to supervise brokers or other associated persons.  The FINRA Rule 9520 Series sets forth eligibility proceedings under which FINRA may allow “persons,” including member firms, that are subject to a statutory disqualification under federal law to remain in the securities industry.  Effective June 15, 2009, FINRA adopted a revised definition of disqualification to conform to the SEC’s definition of statutory disqualification. As discussed in NTM 09-19, the FINRA thereby incorporated three additional categories of statutory disqualification applicable to member firms: including: (1) any “willful” violations of the federal securities laws or failure to supervise; (2) grounds for statutory disqualification that were enacted by the Sarbanes-Oxley Act, e.g., any fraud-based order or bar imposed by any state securities commission or banking regulator; and (3) being associated with brokers who are themselves subject to statutory disqualification pursuant to Exchange Act Sections 3(a)(39)(A) through (D) due to, among other things, an industry bar imposed by the SEC, the FINRA or any other self-regulatory organization.

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Inspector General Blasts SEC Over Failure to Detect Madoff Fraud

            Today, the IG’s Office released its long-awaited report on the SEC’s failure to detect the Madoff fraud. [1]  The IG stated that “the SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation of Bernard Madoff and [his firm] for operating a Ponzi scheme, and that despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed.  The IG went on to say that “between June 1992 and December 2008 when Madoff confessed, the SEC received six! substantive complaints that raised significant red flags concerning Madoffs hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading.”

Colorado Securities Commissioner Discusses Enforcement Program

           In an August 26, 2009 speech before a diverse audience at the Denver Foundation, Colorado Securities Commissioner Fred Joseph described the current state of the Colorado Division of Securities’ enforcement program. The following is a summary of Mr. Joseph's speech.  He stated that the Division of Securities often “flies under the radar” compared with the better-known SEC, but nonetheless is a powerful and vigorous regulatory presence.

Specialized Enforcement Units

            Robert Khuzami’s recent New York Bar speech indicated that he intends to organize the Enforcement staff into specialized units dedicated to particular highly “specialized and complex areas of securities law.”   These units will focus on asset management (investment advisors, investment companies, hedge funds, and private equity funds), market abuse (market manipulation), structured and new products (complex derivatives and financial products, including CDs, CDOs and other securitized products), the Foreign Corrupt Practices Act (FCPA) and municipal securities and public pensions (offering and disclosure issues, tax and arbitrage-driven activity, unfunded or underfunded liabilities, and "pay-to-play").