by T. GormanPosted on Posted in SECActions

The SEC entered into its first deferred prosecution agreement with an individual. The agreement with Scott Herckis, former administrator to hedge fund Heppelwhite Fund LP. The agreement recognizes his timely and significant contributions to the Commission’s efforts to halt an on-going fraud at the hedge fund which once employed Mr. Herckis. At the same time, the five year agreement imposes many of the remedies the agency would have demanded in settlement.

The underlying case

Mr. Herckis, the owner and managing member of accounting firm SJH Financial, LLC, was retained by the Fund in December 2012, according to an admitted statement of facts in the agreement. The Fund had about 25 investors and at least $6 million in assets. Its sole shareholder was Berton Hochfeld, manager of Hochfeld Capital Management, LLC. As fund administrator, Mr. Herckis was responsible for calculating the performance of the investments, preparing monthly account statements for investors and maintaining other pertinent accounting records.

Hochfeld Capital Management or HCM, the general partner, and each of the Fund’s limited partners or investors, had capital accounts at the Fund. Hochfeld Capital was required to maintain a balance in its capital account equal at least 1% of the Fund’s total assets. The Fund was prohibited from making loans to Mr. Hochfeld or the management company.

When Mr. Herckis began the HCM capital account had a positive balance. Repeated withdrawals by Mr. Herckis and transfers to other accounts he controlled changed that fact. Eventually the account had a negative balance.

As the withdrawals mounted, Mr. Herckis realized that there was an increasing discrepancy between the Fund’s net asset value which he calculated using the internal records and the NAV reported to the Fund’s prime broker. In June 2012 Mr. Herckis, in conjunction with a consultant, determined that the discrepancy was $1.5 million.

In September 2012 Mr. Herckis resigned and reported the difficulties to the authorities. He worked closely with the SEC, furnishing them a substantial number of documents and detailing the wrongful conduct. As a result the Commission brought an action against Mr. Hochfeld in which he consented to the entry of an injunction, an asset freeze and other relief. SEC v. Hochfeld, Civil Action No. 12-cv-8202 (S.D.N.Y.). Eventually Mr. Hochfeld pleaded guilty to criminal charges. U.S. v. Hochfeld, No. 13-CR-0021 (S.D.N.Y.).

The agreement

The agreement is for a term of five years. Under its terms Mr. Herckis:

Admissions: Admitted the facts regarding the underlying violations as detailed in the agreement;

No violations: Will not violate Federal or state securities laws;

Securities business: Will not serve in any capacity with an investment company or an investment adviser;

Disgorgement: Paid disgorgement in the amount of $48,000 along with prejudgment interest; and

Cooperation: Continues to cooperate with the Commission.

Previously, the Commission entered into non-prosecution and deferred prosecution agreements only with corporations. For example, the SEC entered into a non-prosecution agreement with Carter’s Inc. which involved a financial fraud. The agency entered into a deferred prosecution agreement with Tenaris S.A., centered on FCPA violations. While the SEC had entered into cooperation agreements with individuals, it had not previously entered into a non-prosecution agreement with an individual.

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by T. GormanPosted on Posted in SECActions

The SEC enforcement program has been the subject of significant commentary in the wake of its new “get tough” policy. The new approach demands admissions to settle, similar to those required in criminal cases creating the image of a harder-edged enforcer that will hold defendants accountable and impose significant sanctions. Yet even as the new “tough guy” approach is being rolled out, there are questions regarding the proper role of SEC Enforcement, a point reflected in recent comments from the new Chair and two Commissioners.

The new SEC Chair, drawing on her experience from the U.S. Attorney’s Office, has articulated the new “get tough” approach. It keys to deterrence built on a cop on the beat approach fortified with criminal style admissions and penalties.

Ms. White outlined her approach to enforcement in two key speeches, one delivered to the Council of Institutional Investors on September 26, 2013 (here) and another at the Securities Enforcement Forum on October 9, 2013 (here). The approach might be called omnipresent / “broken windows.” Omnipresent because the Division would be everywhere to halt all violations using the proverbial “cop on every corner” approach, or at least trying to appear to be everywhere since that is not physically or fiscally possible. “Broken windows” because no violation would be too small to prosecute.

Omnipresence/broken-windows is built on four basic principles: 1) The program will be aggressive and creative, bringing the “tough cases” and the “small ones.” The settlements will have “teeth” and send a strong message of deterrence; 2) Remedial measures will be considered to prevent a reoccurrence in the future; 3) Accountability will result from requiring admissions in some cases; and 4) The program will cover the “whole market.” This program will be fortified by winning at trial – defendants can take what is offered to settle or lose in the courtroom.

Deterrence is also key to the enforcement approach of Commissioner Aguilar. In remarks delivered to the 20th Annual Securities Litigation and Regulatory Seminar, on October 25, 2013 (here) the Commissioner declared: “[I]t is customary for Commission representatives to talk the tough talk about enforcement, I am optimistic that the current Commission will walk the walk.” He went on to note that corporate penalties should not be limited by the notion that they are only cause further harm to the shareholders since their company pays the fine. Rather, the Commission should refocus its corporate penalty policy on the misconduct, the nature of the defendant, self-reporting and equitable concerns.

The new admissions policy will bolster the program, become stronger as it continues to evolve Commissioner Aguilar noted. While it has only been applied in two cases as the Commission “continue[s] to develop experience under the new policy, the admissions that we will require in the future will be stronger. For example, the focus should go beyond having defendants only admit facts, but also accepting fault for the misconduct, and admitting to having violated specific provisions of the law.” Such admissions would be similar to those demanded in criminal cases.

A different tone was stuck by Commissioner Daniel Gallagher in remarks at the FINRA Enforcement Conference (here). The Commissioner carefully traced the evolution of the SEC Enforcement Program concluding that from start: “Punishment was not the Commission’s primary enforcement mission; rather, that mission belonged to the Department of Justice. The Commission’s original enforcement mission was to stop ongoing violations and to prevent further harm to investors and the markets.”

Over time the Commission’s enforcement authority has evolved. With the passage of the Remedies Act in 1990 the agency was given “robust penalty authority against individuals and nuanced penalty authority, to be used judiciously, against corporate issuers,” Commissioner Gallagher noted.

Turing to the question of an “omnipresent” enforcement program, Commissioner Gallagher stated that many have espoused this approach and the “cop on every corner” analogy for a tougher program. It is, however, unworkable, since the agency clearly cannot be everywhere. Perhaps more importantly , the SEC is a “capital markets regulator, and its enforcement function should support its efforts to maintain and improve our capital markets.” While the enforcement program should be robust, it is essential that it focus on the mission of the agency and leave the criminal cases to the Department of Justice, according to Commissioner Gallagher.

While these statements may represent differing views of SEC enforcement, in the end, everyone can agree that the Commission should have a strong and effective enforcement program. Everyone can agree that violations should be rooted out and halted. Nobody would dispute the fact that appropriate sanctions should be imposed, coupled with meaningful remedies that focus on reform and preventing a reoccurrence of the wrongful conduct in the market place. And, when administering that program no one should dispute the fact that, as Commissioner Gallagher stated, the SEC is a capital markets regulator and its enforcement program is intended to facilitate and implement that mission – it is not a prosecutor and should not be turned into one.

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