by T. GormanPosted on Posted in SECActions

The insider trading trial of former SAC Capital official Matthew Martoma opened this week in Manhattan with jury selection. The SEC announced the resignation of George Canellos, Co-director of the Division of Enforcement.

FCPA was a central focus this week as the Department of Justice and the Commission filed settled charges involving aluminum giant Alcoa, Inc. The resolution of those actions put the company in the number five slot on the list of top ten FCPA settlements. The DOJ also announced three criminal FCPA actions against individuals.

In court the Commission prevailed on a motion for summary judgment in a Ponzi scheme case which Judge Rakoff terms an almost “endless” fraud. SEC enforcement also filed an insider trading action as an administrative proceeding rather than a civil injunctive action, and two new Rule 105 short selling actions.

Finally, JPMorgan resolved yet another investigation, agreeing to pay $1.7 billion for its role as the banker to the Madoff Ponzi scheme. The settlement contains a detailed recitation of facts regarding the information and red flags available to the bank over the years about the massive fraud which were largely ignored.

SEC

National exam program: The Commission announced the examination priorities for 2014 which cover a wide range of issues and institutions (here).

Announcement: George S Canellos, Co-director, Division of Enforcement, announced his resignation, effective later in January.

CFTC

MOU: The CFTC entered into a memorandum of understanding with the Federal Energy Regulatory Commission or FERC regarding areas of overlapping jurisdiction. Under the accord the two agencies will notify each other of activities that may involve overlapping jurisdiction and “coordinate to address the agencies’ regulatory concerns.”

JPMorgan settlement

Madoff: U.S. v. JPMorgan (S.D.N.Y. Filed Jan. 7, 2014). The bank entered into a deferred prosecution agreement and will pay $1.7 billion to resolve charges arising from its role at the primary bank for Bernard Madoff, his securities firm and the massive Ponzi scheme he operated. The underlying information alleges two counts of violating the Bank Secrecy Act. The $1.7 billion payment, which will largely go to victims of the world’s largest Ponzi scheme, is being paid under a parallel forfeiture claim. The deferred prosecution agreement has a term of two years.

The agreement is based on a length and detailed statement of facts agreed to by the bank and the U.S. Attorney’s Office. That statement of facts details the relationship between the bank and Madoff beginning in 1986. Throughout the term of the relationship there were numerous instances in which bank officials ignored evidence indicating that Madoff was conducting a massive fraud. For example, in the early 1990s the bank learned that Madoff “and a prominent client of JPMorgan’s Private Bank were engaged in what looked like round-tripping, check-kiting transactions.” Another bank involved recognized the transactions as suspicious and without any legitimate business purpose. In 1996 the second bank filed a suspicious activity report or SAR with the government and closed all its Madoff accounts which then moved to JPMorgan. Repeatedly over the course of the relationship Madoff refused to permit the bank to conduct standard due diligence on transactions. Warnings from the bank’s anti-money laundering software were not appropriately followed-up. In 2008 the U.K. branch of the bank filed a report with regulators in that country raising concerns related to Madoff stemming from dealings with the feeder funds. Although bank compliance officials in this country were aware of the UK report, none was filed with U.S. regulators. In 2008, just months before Madoff’s arrest, the bank watched as Madoff largely drained his account, reducing a $5.6 billion balance that existed in August of that year to about $234 million. The bank did, however, act to minimize its exposure to what it viewed as high risk transactions.

SEC Enforcement – litigated actions

Investment fund fraud: SEC v. Aronson, Civil Action No. 11 Civ. 7033 (S.D.N.Y.) is an action against Eric Aronson, Vincent Buonauo, Jr., Fredrick Aaron, PermaPave Industries, LLC and others alleging fraud in connection with the sale of interests in PermaPave Industries, reputed to be a seller of paving stones. Over a four year period beginning in 2006 the defendants raised over $26 million from about 140 investors. Investors were told that there was a large demand for permeable paving stones and that they would be repaid from profits generated by guaranteed sales. In fact investor funds were recycled to pay other investors and misappropriated. In addition, after an affiliate of PermaPave acquired a majority stake in Interlink-US Network, Ltd., Eric Aronson, Frederic Aaron and others issued a press release stating that Interlink intended to invest $6 million in the firm, although it was unfamiliar with the company. The Court granted in part the Commission’s motion for summary judgment, noting that the agency had established an “almost endless fraud.” The Court thus concluded that defendant Eric Aronson violated Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). Subsequently, the Court granted another Commission motion, finding that Eric Aronson violated Section 20(e) of the Exchange Act. Relief will be determined at a later date. In addition, the Court granted summary judgment on the disgorgement claim against relief defendant Caroline Aronson.

Defendants Vincent Buonauro and Fredric Aaron agreed to settle. The Court entered an order by consent as to Mr. Buonauro, enjoining him from future violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). The Court also entered an order by consent as to Mr. Aaron, enjoining him from future violations of Exchange Act Sections 10(b) and 13(a). The order imposes a five year officer and director and penny stock bar as to Mr. Aaron. The Commission’s monetary claims against each man will be determined at a later date. See Lit. Rel. No. 22901 (January 6, 2014).

SEC Enforcement – filed and settled actions

Weekly statistics: This week the Commission filed, or announced the filing of, 2 civil injunctive district court actions, DPA or NPA and 5 administrative proceedings (excluding follow-on actions and 12(j) proceedings).

Financial statement fraud: SEC v. Diamond Foods, Inc., Civil Action No. 3:14-cv-0022 (N.D. Cal. Filed January 9, 2014), SEC v. Neil, Civil Action No. 3:14-cv-00123 (N.D. Cal. Filed January 9, 2014) and In the Matter of Michael Mendes, Adm. Proc. File No. 3-15674 (January 9, 2014) are actions against, respectively, the company, its former CFO, Stephen Neil, and its former CEO, Michael Mendes. The actions center on a financial fraud. It resulted in a restatement of the company’s financial statements in November 2011 for 2010 and 2011. One of the significant lines of business for the company is the sale of walnuts. As prices increased the company was forced to pay more to produces for the walnuts to maintain its long standing relationships. At the same time there was significant pressure to meet the expectations of analysts. To resolve the conflict CFO Neil had his staff defer the cost of the walnuts into later periods. This permitted the company to pay the higher prices and meet street expectations. Mr. Neil also misled the auditors as part of the scheme and personally benefited from it.

The complaint as to the company alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) and each subsection of Securities Act Section 17(a). The company, whose cooperation and remedial efforts were considered by the Commission, settled the action by consenting to the entry of a permanent injunction based on the Sections cited in the complaint and paying a fine of $5 million. The complaint against Mr. Neil alleges violations of the same Sections and, in addition, Exchange Act Section 13(b)(5). That action is pending. The Order as to Mr. Mendes alleges violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). Mr. Mendes resolved the proceeding by consenting to the entry of a cease and desist order based on those Sections and agreeing to pay a civil penalty of $125,000. Mr. Mendes previously returned or forfeited more than $4 million in bonuses and other benefits he received during the time of the company’s fraudulent financial reporting. See Lit. Rel. No. 22902 (January 9, 2014).

Insider trading: In the Matter of Marcus S. Spillson, Adm. Proc. File No. 3-15675 (January 9, 2014) is an action against Mr. Spillson alleging insider trading. Specifically, the Order alleges that Mr. Spillson purchased options of Petrohawk Energy Corporation in advance of the July 14, 2011 announcement that the company had executed a merger agreement with BHP Billiton Limited. The options were purchased in an account Mr. Spillson opened on June 30, 2011. He had never before purchased options. Subsequent to opening of the account, and prior to the deal announcement, Mr. Spillson was in regular contact with a person identified as Individual A who was a friend from college employed by Petrohawk. Individual A participated in due diligence for the transaction. Mr. Spillson sold his securities for a profit of $154,821.91. The Order alleges violations of Exchange Act Sections 10(b) and 14(e). To resolve the proceeding the Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay disgorgement in the amount of his trading profits, prejudgment interest and a penalty equal to the amount of the disgorgement.

Rule 105: In the Matter of Axius Holdings, LLC, Adm. Proc. File No. 3-15668 (January 6, 2014) is a proceeding which names as Respondents the firm and its owner and sole employee, Henry Robertelli. The Order alleges that between June 2008 and March 2010 the firm, at the direction of Mr. Robertelli, violated Rule 105 in thirteen instances by selling issuer shares short during the prohibited period prior to an offering. As a result, Respondents realized profits and obtained related benefits totaling about $31,103.74. To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on Rule 105, Regulation M. In addition, they agreed to jointly and severally disgorge all trading profits, pay prejudgment interest and a fine of $26,000.

Rule 105: In the Matter of John Durrett, Adm. Proc. File No. 3-15667 (Jan. 6, 2013) is a proceeding which names as a Respondent, Mr. Durrett, the owner and sole proprietor of Pembrook Partners, LLC, an unregistered investment adviser. The adviser had discretionary authority over its accounts, each of which used the same long strategy. In connection with 15 covered offerings between May 2008 and September 2010 Mr. Durrett violated Rule 105 by shorting issuer’s shares in one or more of the managed accounts during the restricted period prior to the offering. Overall trading profits of $44,729.02 were obtained. To resolve the proceeding Mr. Durrett consented to the entry of a cease and desist order based on Rule 105, Regulation M and a censure. He also agreed to disgorge the trading profits, pay prejudgment interest and a penalty of $26,000.

Criminal cases

LIBOR: U.S. v. RBS Securities Japan Ltd. (D. Conn.). RBS Securities Japan Limited, a subsidiary of The Royal Bank of Scotland plc, was sentenced following its guilty plea to one count of fraud in connection with the manipulation of LIBOR. The plea was part of a resolution of charges in which the subsidiary will pay a fine of $50 million. In addition, the parent corporation entered into a deferred prosecution agreement under which it will pay an additional $100 million penalty. The parent also accepted responsibility for the misconduct as detailed in an extensive statement of facts. The DPA recognizes the significant remedial procedures of the firm. In addition, the firm also agreed to pay $325 million to resolve a parallel action by the CFTC and $137 million to resolve an inquiry by the UK FCA.

LIBOR is an average interest rated calculated based on submissions from leading banks around the world. It is published by the British Bankers’ Association for 10 currencies at 15 borrowing periods or maturities. At various points beginning in 2006, and continuing through 2010, RBS Securities Japan Yen derivative traders took steps to move LIBOR in a direction favorable to their trading position, thereby defrauding their counterparties. The scheme involved efforts to manipulate over 100 Yen LIBOR submissions.

Financial fraud: ArthroCare Corporation, a medical device manufacturer, agreed to pay a $30 million penalty and entered into a deferred prosecution agreement to resolve charges that the company and its executives engaged in financial fraud in violation of the federal securities laws. Specifically, over about a three year period beginning in late 2005 company executives materially inflated the revenues of the firm by parking product with distributors sufficient to permit the firm to make periodic projections. On July 11, 2008 the firm announced a restatement as a result. Following the announcement, the share price of the firm’s NASDAQ listed securities dropped from $40.03 to $23.21. U.S. v. ArthroCare Corporation (W.D. Tx.). Two former executives have pleaded guilty to conspiracy to commit securities and wire fraud in connection with the scheme. The former CEO and CFO of the company are scheduled to stand trial later this year. See also In the Matter of ArthroCare Corporation, Adm. Proc. File No. 3-14249 (February 9, 2011).

FCPA

U.S. v. Alcoa World Alumina LLC (W.D. Pa. January 9, 2014) and In the Matter of Alcoa Inc., Adm. Proc. File No. 3-15673 (January 9, 2014) are actions, respectively, against a majority-owned and controlled global alumina sales company of Alcoa Inc. and Alcoa, which is a public company based in Pittsburgh, Pennsylvania. Alcoa of Australia, a subsidiary of Alcoa, secured a long term alumina supply agreement with Aluminium Bahrain B.S.C. or Alba, an aluminum smelter controlled by the government of Bahrain. Subsequently, members of the Royal Family that controlled the tender process had Alcoa of Australia insert a London based middleman into the arrangement. As the relationship between Alcoa of Australia expanded with the middleman, invoices with increasingly large volumes of alumina were submitted through shell companies. This permitted the consultant to pay bribes to certain government officials.

In 2004 Alcoa World Alumina secured a long term alumina supply agreement with Alba. It called for the sale of over 1.5 million metric tons of alumina to Alba through offshore shell companies owned by the consultant. The consultant added mark ups to the price of the alumina totaling about $188 million over a four year period beginning in 2005. Those mark ups were used to pay bribes, according to the court papers. The payments were concealed through false invoices. While officials at Alcoa reviewed certain matters involved in these transactions, the SEC’s Order states that there is “no findings that an officer, director or employee of Alcoa knowingly engaged in the bribe scheme.”

To resolve the criminal case Alcoa World Alumina agreed to plead guilty to one count of violating the anti-bribery provisions of the FCPA. The firm also agreed to pay a $209 million criminal fine and administratively forfeit $14 million. Alcoa, as part of the arrangement, agreed to maintain and implement an enhanced global anti-corruption compliance program.

The SEC’s Order alleges violations of Exchange Act Section 30A(a), 30A(g), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding the firm consented to the entry of a cease and desist order based on Section 30A as well as the books and records and internal controls sections. It also agreed to pay disgorgement of $175 million, a portion of which is deemed satisfied by the payment of the forfeiture order in the criminal case to the extent that obligation is paid. The total amount paid to resolve the criminal and civil charges places Alcoa at number five on the list of top ten FCPA cases by the amount paid.

U.S. v. Hammaskjoid, No. 13-2086 (D. N.J. Filed No. 8, 2013) and U.S. v. Sigelman, No. 13-2087 (D.N.Y. Filed Nov. 8, 2013) are criminal complaints against, respectively, Knut Hammarskjold and Joseph Sigelman, former co-CEOs of PetroTiger. Each complaint contains one count of conspiracy to commit wire fraud, one count of conspiracy to violate the FCPA, three counts of FCPA violations and one count of money laundering. The charges are based on a scheme executed by the two man, along with the former general counsel of the company, Gregory Weisman. As part of the scheme three payments were made on behalf of the company to an official at Columbia’s state owned and controlled oil company to secure a lucrative oil services contract. Initially, the defendants tried to conceal the payments by depositing them into the account of the official’s wife. When that proved unsuccessful the payments were deposited into the account of the official. The defendants are also alleged to have attempted to secure kickback payments at the expense of PetroTiger’s board members in connection with the negotiation of an acquisition. Mr. Weisman pleaded guilty on November 8, 2013 to a criminal information charging one count of conspiracy to violate the FCPA and to commit fire fraud. U.S. v. Weisman (D. N.J.). The actions were unsealed on January 6, 2014.

FINRA

Supervision: The regulator fined two affiliated firms, Stifel, Nicolaus & Company Inc. and Century Securities Associates, Inc., for not having reasonable supervisory systems in place with regard to the sale of leveraged and inverse ETFs. Those complex products reset each day and can cause significant losses for customers in the short term even if there is a long term gain. When selling these products to 59 customers from January 2009 through June 2013, the firms only had traditional supervisory systems in place which were not adequate. Accordingly, a fine of $550,000 was imposed on the two firms which will also pay restitution of nearly $475,000.

New York

Insider trading 2.0: The New York AG secured an agreement arising out of his inquiry into what he calls Insider trading 2.0, that is, the dissemination of market moving information to preferred customers. In this instance BlackRock, the world’s largest asset manager, agreed to halt its analyst survey. Previously, the firm conducted telephone surveys of analysts and asked specific questions. The AG concluded that the design and structure of the survey permitted the firm “obtain information from analysts that could be used to get ahead of, or, as a BlackRock document put it, “front-run” future analyst revisions.” BlackRock agreed to halt the practice world wide and will continue to cooperate with the investigation.

Australia

Misrepresentations: The Australian Securities and Investments Commission announced that the Administrative Appeals Tribunal affirmed its decision banning Mervyn Ross Tarrant from the financial services business for a period of seven years. The decision was based on repeated violations of the law. Specifically, Mr. Tarrant, the sole director and authorized representative of Tarrantts Financial Consultants Pty Ltd., invested over $23 million of client funds in Astrarra Strategic Fund, a managed investment scheme promoted by Trio Capital Limited and Shawn Richard. In making those investment Mr. Tarrant did not disclose that he and his firm were paid more than $1.1 million as a marketing allowance by Mr. Richard. He also made false and misleading statements about remuneration or benefits in statements to clients and lacked a reasonable basis for recommendations to eight clients.

Hong Kong

The Securities and Futures Commission reprimanded Cheong Lee Securities Limited and fined the firm $2 million in connection with internal control failures related to self-matching transactions. Specifically, beginning in 2008, and continuing for about the next three years, the firm had a client that adopted a master account and sub-account structure. During the period more than 1,500 transactions were made between the sub-accounts, operated by different traders, for the same master account. The firm did not have adequate and effective internal control systems related to detect and prevent self-matching transactions between the sub-accounts. This is not in the best interest of market integrity the regulator concluded.

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by T. GormanPosted on Posted in SECActions

This is the fourth and concluding segment of this series projecting the path of SEC Enforcement. The first three segments were published on Monday, Tuesday and Wednesday of this week.

Parts I and II of this series looked back at select cases brought by the Commission during 2013. Part III considered the projected path of SEC Enforcement based on remarks by members of the Commission and new initiatives. This segment analyzes the projected path of SEC Enforcement based on those items.

Analysis and conclusions

The SEC is crafting a new “get tough/omnipresent” SEC enforcement doctrine and program. Promises have been made that enforcement will be bold, unrelenting and everywhere. New initiatives have been announced. At the same time the number of cases being filed is dwindling. The critical questions are the future direction of the program and its effectiveness.

Part of the answer to those questions lies in the cases brought in the last year. Those actions, an outgrowth of earlier initiatives, focus on areas such as exchanges and SROs, insider trading, municipal issuers, PRC based issuers, funds and the FCPA. Analysis of those actions helps to define probable future avenues for the enforcement program at least in the near term. For example:

Exchanges/SROs: These actions center largely on market structure issues. The action against the NYSE concerned the fairness of how nonpublic market data was disseminated; the action concerning NASDAQ involved questions about how the Facebook IPO was handled; and the case against the CBOE, which resulted in the first fine imposed on such an organization based on its regulatory functions, involved questions about how the organization implemented procedures to monitor the implementation of SEC rules. With an increasing number of exchanges and trading platforms, and additional market disruptions from failures such as the outage late last summer, it seems clear that SEC Enforcement will continue to be involved in these issues.

Insider trading: The Commission can be expected to continue pushing the edge in insider trading cases. While the U.S. Attorney’s Office in Manhattan may bring more criminal actions in the fund industry, those cases are typically built on wire taps and/or cooperating witnesses and involve the use of information which is well within traditional notions of insider trading such as earnings releases and M&A details. While the SEC typically is involved in those actions, the more significant trend for many is reflected in cases such as Bauer which has the potential to expand and extend the boundaries of what constitutes insider trading, building on actions such as Knight and Obus (discussed in Part I of this series).

Municipal issuers: Last year the SEC brought a series of cases in this area and issued a Section 21(a) report of investigation. These cases typically centered on what might be called procedural issues – that is, the lack of procedures for ensuring effective disclosure. In some instances they involve questions about the accuracy of material statements made by officials as discussed in the recent Section 21(a) Report issued by the Commission (discussed in Part I of this series). As these markets continue to evolve it seems clear that SEC enforcement will focus on them.

PRC issuers: Last year, and in prior years, the Division brought a number of cases in this area. Frequently they focused on the quality of the financial reporting as well as self-dealing transactions by corporate officials which were not properly accounted for in the financial statements. The pending industry wide proceeding against the PRC affiliates of five international accounting firms (discussed in Part II of this series) may have a significant impact here if orders are entered precluding those firms from appearing and practicing before the Commission. That could inhibit the ability of PRC based issuers to utilize the U.S. capital markets. Such an order might spur PRC regulators to revise their policies and effectively implement the MOU executed with the PCAOB and agree to inspections as required by SOX. At the same time the number of cases brought in this area, in probability, will decline in the wake of the industry wide proceeding.

Funds: The Division continued to focus on procedural issues at funds last year, perhaps as an outgrowth of its enhanced partnership with OCIE. Alderman (discussed in Part II of this series) is a good example of the type of cases brought in the past and which may be in the pipeline for the future. There the action centered on the lack of procedures for the board to fully comply with its obligations. Variations of this theme can be expected to include proceedings where fund policies and procedures are not properly applied and valuation issues concerning illiquid assets which was, in fact, the underlying issue in Alderman.

FCPA: This enforcement staple can be expected to be a continued as an area of focus in the future. Despite dwindling numbers of cases in recent years, the actions last year against Total, Weathford and Diabold should be more than sufficient to dissuade anyone of the notion that the new era of FCPA enforcement is drawing to a close. This is particularly true since two of those cases made the FCPA top ten list. Perhaps more important for the future, however, is the scrutiny on cooperation and remediation evidenced in Weathford and Diabold. In the former, the company was penalized for a lack of cooperation while in the latter enforcement officials were critical of the lack of remedial efforts by the company. Together these cases suggest that issuers considering self-reporting, or those involved in on-going investigations, carefully assess their efforts if earning cooperation credit is an important part of the overall strategy. Indeed, in that context issuers may want to consider the approach to that issue used by companies such as Siemens and Johnson & Johnson who became corporate whistleblowers, developing evidence of wrongful conduct on others, to earn extra cooperation credits. See, e.g., Thomas O. Gorman & William P. McGrath, Jr., “The New Era of FCPA Enforcement: Moving Toward a New Era of Compliance, 40 Sec. Reg. L.J. 341,354-356 (2012)(discussing this trend); see also Remarks of Deputy AG James Cole to The Foreign Corrupt Practices Act Conference (Nov. 19, 2013)(calling for increased cooperation from issuers in FCPA cases).

While the trends reflected in these areas can be expected to continue in 2014, the central question going forward will be the implementation of the new “get tough/omnipresent” approach, implemented through the announced new initiatives. Stated differently, the key question may well be whether this approach will bring back the swagger for the enforcement program.

The “get tough/omnipresent” approach appears to be a composite of proposals and announced initiatives. Read together, the remarks of the new SEC Chair and various Commissioners, along with press releases announcing new initiates, appear to define the contours of the new enforcement program. It has six key facets:

Admissions: Settlements with “teeth” are a critical part of the program to engender deterrence. Accordingly admissions will be required in select cases. The settlements with Mr. Falcone and his entities and JPMorgan are examples (discussed in Part III of this series). Yet as Ms. White noted, the majority of SEC settlements will be based on the traditional “neither admit nor deny” approach.

Operation Broken Gate: Holding gate keepers such as accountants and other professionals responsible is a critical part of the overall strategy. Under this approach if gatekeepers are halted other possible violations are stopped.

Manipulative short selling: Another key aspect of the strategy to police the markets. The announced strategy is to rely on Rule 105.

The custody rule: Another focus will be on the custody rule which governs the manner in which investment advisers care for the assets of investors. This part of the program appears to be an extension of recent efforts to carefully police the implementation of policies and procedures of funds.

Financial statement fraud task force/microcap fraud task force: The former refocuses SEC enforcement into a traditional area. Past efforts such as those following former Chairman Levitt’s “Numbers Game” Speech yielded a series of high profile financial fraud actions. See, e.g., Thomas O. Gorman, The SEC’s New Financial Fraud Task Force, 45 SRLR 2132 (Nov. 18, 2013)(reviewing cases brought in the wake of the speech). This effort will be aided by a computer analytics group. The latter appears to be an extension of existing programs focused on manipulative actions in penny and pink sheet stocks.

Trial: Winning at trial is critical to the credibility of the program, according to Ms. White.

While the proposals for the get tough program focus on omnipresence or being everywhere, Ms. White and Commissioner Gallagher appear to agree that SEC enforcement cannot achieve that result. At the same time Chair White insists that by leveraging the Commission’s resources in various ways, such as through computers and relationships with other regulators, this program can be implemented to effectively cover the market.

Closer examination raises critical questions. Initially, the notion of leveraging the Commission’s limited resources is hardly new. From virtually the beginning of the Division, the agency has sought to leverage its resources. While this approach can facilitate some actions, there is nothing to suggest that revisiting this time worn notion now is going to somehow make the enforcement division omnipresent today.

There are similar questions regarding the effectiveness of Operation Broken Gate. Again, this is a time worn notion. Again, from the earliest days of the Enforcement Division the agency has attempted to enlist gatekeepers such as outside auditors as a kind of front edge of enforcement with little success. As the court in SEC v. Arthur Young, 590 F. 2d 785, 788 (9th Cir. 1979)stated over 30 years ago: “We can understand why the SEC wishes to so conscript accountants. Its frequently late arrival on the scene of fraud and violations of securities laws almost always suggests that had it been there earlier with the accountant it would have caught the scent of wrong-doing and, after an unrelenting hunt, bagged the game. What it cannot do, the thought goes, the accountant can and should. The difficulty with this is that Congress has not enacted the conscription bill that the SEC seeks to have us fashion and fix as an interpretive gloss on existing securities laws.” (emphasis original).

Likewise, focusing on “manipulative short selling” and the custody rule is unlikely to achieve the kind of cop on the beat/market presence being sought for the enforcement program. Manipulative short selling as illustrated by the cases cited in the Release is based on Rule 105 whose application is limited to those who trade in a small time window prior to a secondary offering. The custody rule is of concern only when the adviser actually holds the assets of the client, not to the many who do not. Rules such as these with limited application should clearly be enforced. In view of the limited application they are not likely to generate market wide presence even if the actions are viewed in conjunction with others.

In contrast, the financial fraud task force has the potential to significantly impact in the market place. This is a traditional area of emphasis for the Division. As the market crisis unfolded and resources were shifted to investigations on those issues, the number of financial fraud cases dwindled. If the agency is able to rekindle the kind of efforts brought in the past, it may be able to bring a significant number of actions which can impact a large segment of the financial markets. Those actions, in conjunction with others in areas such as insider trading, funds and FCPA may well create the kind of market impact the program seeks.

Critical to that effort, however, will be the charging process and the remedies employed, both of which can impact settlement and trial. In the charging process the Commission has an array of choices and multiple options when assessing the potential liability of an issuer and/or individuals. If, for example it is a financial fraud action the traditional fraud provisions and filing provisions can be used as to the company. In considering the individuals multiple avenues are available including aiding and abetting, causing, control person liability and the SOX claw back provisions. How the case is charged, and whether the allegations in the complaint are factual and match the charges or are overstated and mismatched sends a critical message to the market. See, e.g., SEC v. Citigroup Global Markets, Inc., Civil Action No. 11 Civ. 7388 (S.D.N.Y.)(court noted the allegations were of intentional fraud but the charges were negligence).

Equally important is the selection of remedies, particularly since most cases settle. While the new admissions policy may have its uses, and large fines can in select circumstances be effective, the critical point here is to marshal all of the tools available to the agency. Admissions will, by definition, only be used in very select cases. Fines, as Judge Rakoff has noted, are often viewed as a cost of doing business. Increasing the Commission’s fining authority is not likely to change this fact.

To be effective the Commission needs to move past the headlines garnered from these new policies and employ the other, more effective available tools. Fashioning relief which stops the wrongful conduct with an injunction and does more, such as reforming the policies and procedures of the organization or even the culture which permitted and perhaps fostered the wrongful conduct, can be very effective in preventing future violations. In the past the Commission has utilized these tools effectively. If the enforcement program is going to be an effective part of a regulatory program in the future – not a prosecutor seeking deterrence through punishment – it is critical that the agency utilize these tools to reform the market place, crafting a better future for investors and the markets. The SEC has the tools; it has the talent; now is the time.

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