by T. GormanPosted on Posted in SECActions

The SEC lost another case in the D.C. Circuit Court of Appeals. This time, however, it did not involve rule making. Rather, the action focused on the imposition of a life time bar from the securities business by FINRA which was affirmed by the Commission on appeal. Saad v. Securities and Exchange Commission, No. 10-1195 (D.C. Cir. Decided June 11, 2013).

The case is based on the largely undisputed fact that John Saad submitted several false expense claims to his employer and later tried to conceal the wrongful conduct. Mr. Saad had been employed by Penn Mutual and registered with its broker-dealer affiliate, HTK, a FINRA member. He was registered as an investment company products and variable contracts limited representative, a general securities representative and a general securities principal.

In July 2006 Mr. Saad was scheduled to make a business trip. It was canceled. Mr. Saad then checked into a hotel for two days. Later he submitted expresses for air travel not taken and a two-day hotel stay in Memphis, the city to which he had been scheduled to travel. The submission contained a forged airline travel receipt and other documents he claimed supported the expenses. Later the firm discovered the falsification and terminated him.

FINRA investigated. During the inquiry Mr. Saad attempted to cover-up the falsification. He repeatedly mislead FINRA investigators.

In September 2007 FINRA brought a disciplinary proceeding against Mr. Saad alleging “conversion of funds in violation of NASD Conduct Rule 2110. A hearing panel found against Mr. Saad and imposed a permanent bar against association with a member firm in any capacity. That conclusion was affirmed by the NAC.

The Commission affirmed. In reaching its conclusion the SEC rejected Mr. Saad’s claim that there were mitigating circumstances which should have been considered in assessing the penalty.

The propriety of the life time bar was a critical issue before the Circuit Court. In reviewing a ruling regarding a sanction the Court began “[w]e do not limit the discretion of the Commission to choose an appropriate sanction so long as its choice meets the statutory requirements that a sanction be remedial and not ‘excessive or oppressive.” At the same time the Court stressed, the “Commission must be particularly careful to address potentially mitigating factors before it affirms an order . . . barring an individual . . . ”

The Commission is also required to explain the reasons a sanction is remedial in affirming a bar. Under the applicable statute, the SEC can affirm the bar not as a penalty but as a means of protecting investors. Stated differently, the sanction must be remedial, not penal. “If the Commission upholds a sanction as remedial, it must explain its reasoning in so doing; as the circumstances in a case suggesting that a sanction is excessive and inappropriately punitive become more evident, the Commission must provide a more detailed explanation linking the sanction imposed to those circumstances” the Court held. At the same time the SEC need not explain the reasons a lesser sanction is in appropriate.

In this case the decision of the Commission, as well as that of the FINRA Hearing Panel and the NAC, ignores potential mitigating factors asserted by Mr. Saad and supported by the record. This is contrary to established precedent in the D.C. Circuit. Here Mr. Saad established that he had been terminated by his employer prior to any action by FINRA, a point that was not considered. Yet under FINRA Sanction Guidelines this factor must be considered.

Similarly, the SEC’s decision referenced, but did not address Mr. Saad’s contention that he was under severe stress at the time of the incident. While this factor is not specifically mentioned in the FINRA Sanction Guidelines, those are only illustrative and not exhaustive. This factor should have been considered.

The Commission claims that it “implicitly” considered and denied these points. That is not sufficient. “Because the SEC failed to address potentially mitigating factors with support in the record, it abused its discretion . . . “ Accordingly, the Court remanded the case for further proceedings.

ABA Seminar: Fifth Annual FCPA Update: Protecting Your Business in the Future: Lessons from the New DOJ-SEC FCPA Guide, June 19, 2013 from 1:00 -2:30 p.m. EST. The discussion will focus on building effective compliance systems and conducting M&A due diligence. Co-moderators: Thomas Gorman and Frank Razzano. Panel: John Buretta, Principal Deputy to the Assistant AG, DOJ; Charles Cain, Assistant Director, FCPA Unit, SEC Division of Enforcement; Catherine Razzano, Assistant General Counsel, General Dynamics Corporation; Steve Siegal, Senior Counsel, Northrop Grumman Corporation; Ryan Ong, President, U.S. China Business Counsel. Live in Washington, D.C at 600 14th St. N.W., Penthouse (no charge for ASECA members attending live in Washington who pre-register by sending an e-mail to cvitko.diane@dorsey.com). Webcast nationally by the ABA and available in select Dorsey & Whitney offices. For further information please click here.

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by T. GormanPosted on Posted in SECActions

The Chicago Board of Options Exchange became the first Self-Regulatory Organization to pay a civil penalty relating to its regulatory oversight functions. In the Matter of Chicago Board Options Exchange, Inc., Adm. Proc. File No. 3-15353 (June 11, 2013). Other exchanges have been sanctioned for business side misconduct rather than regulatory failures.

The proceeding centers on three key issues. First, the CBOE failed to adequately enforce the federal securities laws and its own regulations. Second, the exchange interfered with a Commission enforcement investigation. Third, it failed to propose rule changes until after it implemented certain trading functions.

Initially the CBOE failed to adequately enforce Regulation SHO regarding short selling. The applicable rules require that a registered clearing agency deliver equity securities when delivery is due. Settlement is usually T+ 3. If there is a failure, delivery must be made the next morning.

Here the CBOE developed policies and procedures for a surveillance program to identify possible violations of Regulation SHO. It sought to identify suspicious scenarios which would then be followed-up by an appropriate investigation. While the program did in fact generate exceptions, the exchange failed to take any significant action. For example, in January 2010 75 exceptions in several securities were identified for a member firm for the third and fourth quarters of 2009. A response by the self-clearing firm to a CBOE letter demonstrated that for each of the securities the firm had a failure to deliver. That suggested a possible violation of Regulation SHO. The exchange staff failed to adequately review the information and closed the file.

The exchange failed to adequately train its investigative staff regarding short sales and Regulation SHO, according to the Order. Indeed, the investigator primarily responsible for monitoring Regulation SHO surveillance from the third quarter of 2009 to the second quarter of 2010 had not read the rule in its entirety. The investigator had “briefly perused it.”

In February 2009 the exchange received a complaint concerning possible short sale violations. During the inquiry the CBOE staff consulted with the Commission staff. They were told that if there was no failure to deliver associated with the trade, no violation occurred and there was no violation by the customer because a customer cannot violate Regulation SHO. Yet the CBOE staff focused almost exclusively on the customer’s activity and incorrectly concluded there were no failures to deliver. As a result a closing report was prepared which incorrectly analyzed the trading.

Second, during the course of an investigation by the SEC Enforcement staff the CBOE “took misguided and unprecedented steps to assist the member which was under investigation . . . and failed to provide information to Commission staff when requested,” according to the Order. At one point during the investigation members of the CBOE staff actively advocated for the member. Later the exchange staff assisted in the preparation of a Well submission to the Commission which contained inaccurate statements. The Commission staff did not become aware of this until later when the CBOE responded to a document request and drafts of the Wells were produced.

Finally, the exchange failed to adequately enforce its firm quote, priority and registration rules. The CBOE also made unauthorized “customer accommodations,” rebates and other credits to some members in the absence of an applicable rule resulting in unfair discrimination The exchange, and its affiliate C2 Options Exchange, Inc., also a Respondent, failed to file proposed rule changes with the SEC when certain trading functions on their exchanges were implemented. The Order alleges violations of Exchange Act Sections 17(a)(1), 19(b)(1) and 19(g)(1).

After the SEC commenced its investigation the CBOE and C2 undertook a series of remedial efforts and initiatives which the Commission considered in resolving this action. Those included: the reorganization of its Regulatory Service Division; the retention of a chief compliance officer and two deputies; an update of its policies and procedures and an increase in the regulatory budget; the implementation of mandatory training for all staff and management; the retention of a third-party consultant to review its Regulation SHO enforcement program; a “bottom-up review of its regulatory Services Division; and the retention of outside counsel to investigate and self-report instances of financial accommodations to members after the SEC staff expressed concern about such an instance.

The proceeding was resolved with the CBOE consenting to the entry of a cease and desist order based on the Sections cited in the Order. C2 consented to the entry of an order based on Exchange Act Section 19(b)(1). The CBOE also agreed to pay a civil penalty of $6 million and is continuing to implement a series of undertakings.

ABA Seminar: Fifth Annual FCPA Update: Protecting Your Business in the Future: Lessons from the New DOJ-SEC FCPA Guide, June 19, 2013 from 1:00 -2:30 p.m. EST. The discussion will focus on building effective compliance systems and conducting M&A due diligence. Co-moderators: Thomas Gorman and Frank Razzano. Panel: John Buretta, Principal Deputy to the Assistant AG, DOJ; Charles Cain, Assistant Director, FCPA Unit, SEC Division of Enforcement; Catherine Razzano, Assistant General Counsel, General Dynamics Corporation; Steve Siegal, Senior Counsel, Northrop Grumman Corporation; Ryan Ong, President, U.S. China Business Counsel. Live in Washington, D.C at 600 14th St. N.W., Penthouse (no charge for ASECA members attending live in Washington who pre-register by sending an e-mail to cvitko.diane@dorsey.com). Webcast nationally by the ABA and available in other Dorsey & Whitney offices. For further information please click here.

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