by T. GormanPosted on Posted in SECActions

One key debate regarding current SEC enforcement policy centers on the application of the so-called “bad actor” provisions. Previously the Commissioners split over the nature, use and application of those provisions. Central to the debate is whether the application of those provisions is an additional enforcement sanction or a remedial provision and how the decision on a waiver or its application is made.

Chair White’s views

SEC Chair Mary Jo White detailed her views on the application of these provisions in recent remarks at the Corporate Counsel Institute, Georgetown University, titled “Understanding Disqualifications, Exemptions and Waivers Under the Federal Securities Laws (March 12, 2015)(here).

Chair White began by drawing a distinction between enforcement remedies and disqualifications resulting from them. As to the former, the SEC has “broad authority to bring enforcement actions for violations of the securities laws . . . The Commission is authorized by statute to seek a variety of enforcement sanctions and other remedies . . .” which are tailored to the misconduct involved in the particular case, she noted.

A separate question involves “disqualifications from engaging in specific, regulated activities for individuals and entities that are the subject of certain kinds of enforcement actions or prosecutions. For example, if, on account of the unlawful actions of one or more employees, an entity is subject to certain enforcement actions and remedies or convicted of certain crimes, Section 9(a) of the Investment Company Act provides for the disqualification of the entire firm from serving as an investment adviser for a registered investment company. Rule 405 of the Securities Act provides that a well-known seasoned issuer (WKSI) can be disqualified from accessing the public capital markets on an accelerated and streamlined basis if it become an ‘ineligible issuer.” Rule 506 of Regulation D of the Securities Act, the new ‘bad actor’ provision under the Dodd-Frank Act, provides for disqualification from relying on the rule’s private placement exemption in connection with a securities offering.” There are other provisions similar provisions in the federal securities laws.

These provisions differ from the sanctions applied in enforcement actions. Each is designed to “safeguard investors and our capital markets from those whom we do not think should be able to fully function in them because of their past conduct,” Chair White noted. To illustrate this point she cited the legislative history of Investment Company Act Section 9(a) which provides in part that the drafters intended to “’get rid of persons with criminal records, persons who were under injunctions from courts of competent jurisdiction for improper practices in connection with securities . . . Our purpose was simply to try to get that type of person out of this business – where such persons ought to be out of it.’”

These provisions are triggered automatically. Each is broad to cover a range of situations. “To temper the potential over-breath of the disqualification provisions, the securities laws also provide explicit grants of authority and discretion to the Commission . . .” to provide for waivers under specific circumstances.

The Commission and its staff have established a rigorous process for considering the application of these provisions, Chair White stated. The staff considers a number of factors which include the nature of the violation, the duration of the wrongdoing, the specific employees involved and their level of seniority and responsibility and their state of mind. In addition, the staff “considers whether the conduct touched at all upon the activity at issue in the disqualification . . . the extent of the remediation implemented by the institution in the wake of the enforcement action . . . and if that is bona fide and effective . . . A repeated string of serious violations, on the other hand, can call into question whether a firm’s compliance culture and ‘tone at the top’ are so deficient that there is cause for concern even in unrelated areas of the firm” Chair White stated.

Finally, to improve the transparency of the process the staff last year reviewed its guidance on WKSI waivers and is developing similar guidance for others. This guidance is “intended to provide a clear explanation of factors the staff considers in evaluating waiver requests.” Accordingly, the process is “through, rigorous, and principled . . .” Chair White concluded.

Comments

Controversy has swirled around the application of the disqualification provisions. Chair White’s discussion focused on one key issue – are they enforcement remedies or remedial provisions designed to protect the markets and investors.

In her view those provisions are not enforcement remedies. Others disagree. For example, in recent remarks Commissioner Gallagher made it clear that the provisions are being used to enhance enforcement penalties (here).

Regardless of the intent behind the provisions, one point is clear. The disqualifications flow from the resolution of an enforcement action by the SEC or in some instances other enforcement officials. Arguing about whether they are additional sanctions or “remedial” is in large measure a pointless debate which depends on whose view is adopted. The SEC may view them as remedial since they protect the market from a “bad actor” in the future just as a prison term protects the public from the bad person incarcerated. From the point of view of the person on whom they are imposed however, they are additional punishment – no doubt the person in prison does not see the sentence as “remedial” but as punishment.

What Chair White did not address is the approach to waivers. While the staff may have a rigorous and fair process, as Commissioner Gallagher noted the imposition of those provisions comes after the enforcement action is settled. That means a person resolving an enforcement action has no way to determine at the time of settlement if additional, non-negotiated provisions will be added to the sanctions imposed regardless of whether they are labeled “remedial” or “punitive.” This presents a basic question of fairness regardless of what label is applied to the disqualification provisions or the transparency of the process used by the staff.

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by T. GormanPosted on Posted in SECActions

The SEC filed one new action this week – an administrative proceeding involving the principal of an investment adviser and undisclosed conflicts of interest. The Commission also amended a complaint in an insider trading action, adding an additional defendant in a manner which raises issues under Newman (here) and negotiated a preliminary injunction in another insider trading case which effectively extended a previously entered freeze order (here).

SEC

Remarks: Chair Mary Jo White delivered remarks titled Understanding Disqualifications, Exemptions and Waivers Under the Federal Securities Laws at the Corporate Counsel Institute, Georgetown University, Washington, D.C. (March 12, 2015). As the title indicates Chair White discussed disqualifications, waivers, exemptions and argues that disqualifications are not an enforcement remedy (here).

Remarks: Commissioner Daniel M. Gallagher delivered remarks titled A Watched Pot Never Boils: The Need for SEC Supervision of Fixed Income Liquidity, Market Structure, and Pension Accounting, New York, New York (March 10, 2015). His remarks focused on oversight of the bond markets (here).

Remarks: Commissioner Kara Stein delivered at the Stanford Rock Center for Corporate Governance, Stanford Law School (March 5, 2015). Her remarks focused on capital formation (here).

Remarks: Dave Grim, Acting Director, Division of Investment Management delivered remarks at the 2015 IAA Compliance Conference, Arlington, Va. (March 6, 2015). His remarks focused on enhanced data reporting and stress testing (here).

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 0 civil injunctive action and 1 administrative proceeding, excluding 12j and tag-along-actions.

Conflicts: In the Matter of Edgar R. Page, Adm. Proc. File No. 3-1607 (March 10, 2015). There the Order names as Respondents Page One, a registered investment adviser, and its principal, Edgar Page, 95% owner, CEO and COO. The Order centers on a late 2008 arrangement entered into by Mr. Page and a Fund Manager who managed a series of private investment funds. The two men entered into an agreement under which Fund Manager would acquire Page One for about $3 million. The payments would be made in installments over time. The agreement also stipulated that Mr. Page would refer Page One clients to the funds managed by Fund Manager. The acquisition would not close unless, and until, those clients had invested $20 million in the funds managed by Fund Manager. Subsequently, the arrangement was modified. Under the new terms Fund Manager would only acquire 49% of Page One. While the purchase price was reduced, Mr. Page’s obligation to refer $20 million of business to the funds was not. In preparing the Form ADVs for Page One – Mr. Page was the chief compliance officer – the deal to sell Page One was not disclosed. To the contrary, in the 2009 filing the firm told clients that it was not charging management fees because it was compensated by Fund Manager. That filing significantly understated the amount of that compensation. More importantly, it failed to disclose the arrangement under which Fund Manager would acquire the firm. Subsequently, amendments were made to the filings. The deal for Fund Manager to acquire Page One was not disclosed. Eventually the deal collapsed. The Order alleges violations of Advisers Act Sections 206(1), 206(2) and 207. The Respondents partially resolved the proceeding. Each consented to the entry of a cease and desist order based on the Sections cited in the Order. Page One also consented to the entry of a censure. Further proceedings will he held to determine what monetary sanctions, if any, should be imposed.

Australia

Misappropriation: The Australian Securities Investment Commission banned registered representative Lewis Fellows for life based on his conduct relating to six client accounts over a two year period beginning in July 2008. Specifically, he is alleged to have diverted about $480,000 from the client accounts to his personal use. He also diverted $1million from one client’s bank account to his.

Misleading advertising: The ASIC fined Australian Financial Planning Solutions Pty Ltd $10,200 for making false or misleading representations. The statements were made on the firm’s website in an article titled “Benefits of a Self-managed Super Fund” that appeared from July to early November 2014. The article contained misleading and unsubstantiated claims that major retail and industry superannuation funds will experience payout difficulties and made incorrect statements regarding the tax implications.

Hong Kong

Short selling: The Securities and Futures Commission banned Ms. Luo Jiangian, previously a registered representative with J.P. Morgan Broking (Hong Kong), from the securities business for six months. On August 22, 2013 she created a short sell order of 300,000 shares in China Resources land Limited and released part of the order to the market without ensuring a relevant stock borrowing arrangement. Subsequently she tried to conceal the transaction from the compliance department.

Unauthorized transactions: Wong Chun Yin, formerly of Standard Chartered Bank (Hong Kong) Limited, was banned from the securities business for life. The SFC found that Mr. Wong effected fund transactions in clients’ accounts without their authorization to meet his sales targets. He then tried to conceal the transactions.

Breach of duty: The SFC commenced proceedings seeking the disqualification of, and compensation orders against, the chairman of Inno-Tech, Ms. Wong Yuen Yee, and three former directors, Robert Wong Yao Wing, Wong Kwok Sing and Lam Shiu San based on breach of duty claims. Specifically, the suit claims that the directors failed to adequately investigate or conduct due diligence with respect to the acquisition and disposition of certain assets which resulted in the loss by the firm of HK$125 million.

U.K.

Investment fund fraud: Phillip Boakes was sentenced to serve 10 years in prison and directed to pay at least £3.5 million. The sentence is based on the fact that Mr. Boakes ran a Ponzi scheme through his company CurrencyTrader Ltd. which caused substantial losses for 30 investors. This is the longest sentence imposed as a result of any Financial Conduct Authority action.

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