by T. GormanPosted on Posted in SECActions

This is the fourth part of an occasional series. The first is available here, the second here and the third here. The entire paper will be published by Securities Regulation Law Journal early next year.

The volunteer program

The corporate payments issue and the SEC investigations and actions garnered significant publicity, spurring controversy that continues today. Congress initiated hearings that went on for the next two years. In corporate and business circles in the U.S. and abroad there were discussions on topics which ranged from the propriety of the payments to the authority of the SEC to bring the actions. Remarks of SEC Chairman Roderick Hills, Yale Law School (May 1, 1976) (“Hills at Yale”).

As the contours of the problem emerged it became apparent that a new approach was required. SEC Commissioner Philip Loomis, testifying before the Subcommittee on International Economic Policy, the House of Representative Committee on International Relations, suggested that corporations potentially facing a difficulty could have discussions with the SEC staff about the issue. See generally SEC Report at 6-7; Herlihy & Levine at 585. Commissioner Loomis’ suggestion grew into a program crafted by the Directors of the SEC’s Divisions of Enforcement, Stanley Sporkin, and Corporation Finance, Alan Levenson. It was called the Volunteer Program.

The program called for corporations that had made questionable payments to self-report to the SEC. Modeled on the early enforcement cases and settlements, it required that the company take a series of steps to resolve the situation voluntarily rather than be subjected to an SEC investigation. Those included:

· Investigation: A careful, in-depth investigation into the facts surrounding the questionable or illegal payments had to be conducted. A committee of the board of directors would supervise the investigation. Members of the committee could not be officers or involved in the activity. The committee should seek the assistance of the outside auditors and retain outside counsel.

· Scope of the inquiry: The investigation should cover the prior five years since that is the period reflected in the financial statements. Periods prior to that time should also be reviewed if the activities appear to be part of continuing actions or related to those within the period.

· Report: A report should be prepared by the committee at the conclusion of the inquiry and submitted to the full board of directors. That report should contain detailed information about each payment, its purpose and amount, the recipient and the country where it was made along with the surrounding circumstances.

· SEC Staff access: The SEC staff was required to have access to the report and its underlying documentation. The materials would be subject to the Freedom of Information Act. In practice certain accommodations were made. Some issuers expressed concern regarding the publication of sensitive information. In those instances the company initially declined to produce or file the requested materials. The Commission then initiated a subpoena enforcement action. In that action the Commission would obtain an order directing the production of the materials. At the same time the Court would typically enter a protective order regarding certain sensitive materials. See, e.g. SEC v. Lockheed Aircraft Corp., 404 F. Supp. 651, 652 (D.D.C. 1975) (subpoena enforcement action in which the documents were ordered produced and a protective order was entered).

· Adoption of policies: The board of directors should issue an appropriate policy statement regarding questionable or illegal payments. It should typically include a statement that the activities have ceased. The adoption of such a policy should be communicated to appropriate corporate personnel and implemented by adequate internal controls and safe guards.

· Filing: At the conclusion of the investigation a final report of material facts had to be filed with the Commission, generally on Form 8-K. That filing should include a discussion of the inquiry and a commitment to complete it if necessary; an undertaking by the company regarding the termination of the payments; and a detailed discussion of the transactions. SEC Report at 8-10.

The program did not offer issuers or those involved immunity from prosecution, or even promise “cooperation credit.” It did not require the company to consult with the SEC staff. It was an effort to spur corporate self-governance since the illicit or questionable payment cases graphically illuminated serious corporate self-governance issues. As then Chairman Roderick Hills stated at the time:

“It is apparent that our system of corporate self-regulation policed by independent auditors, directors and counsel and ultimately enforced by the SEC has broken down. Hundreds of millions of dollars have been siphoned out of corporate cash flow and spent out of slush funds with the knowledge of some members of top corporate management but without the knowledge of the outside directors, outside auditors and stockholders. No matter that it is only a score or so out of thousands, some are among the biggest and the most audited corporations in the world. If they can do it, who can’t?’ ” Hills at Yale at 7.

The Volunteer Program was a step toward repairing and strengthening corporate self-governance under the supervision of the board of directors and its independent directors and outside auditors and counsel. It also had certain pragmatic aspects: “The voluntary program offers advantages to both the company and the Commission. It enables the company to conduct its own investigation without the involvement of the staff of the Commission, which would tend to tie up the company’s personnel and disrupt its business. From the Commission’s point of view, the program permits a substantial number of companies to be examined without cutting into the availability of the Commission’s limited staff for other enforcement work. Herlihy & Levine at 586.

The program was a huge success. Overall about 450 corporations stepped forward, conducted comprehensive internal investigations, remediated the issues and provided their findings to the SEC staff and shareholders. Sporkin at 273. Within months of its announcement, nearly 100 companies joined the program. A wide variety of corporate conduct was uncovered. As SEC Chairman Hills stated in analyzing the early returns for the program in May 1976: “The revelations are of a wide variety. Some corporations have disclosed annual payments of millions of dollars. Others indicate that they made far smaller payments. Some payments were clearly designed to cause illegal actions by government or business officials, but some were to persuade persons to do jobs they were supposed to do without ‘tips.’ Some were authorized, or at least known of, by top corporate officials who deliberately permitted corporate books to be distorted in order to deceive outside directors, lawyers, and accountants and shareholders; others were carried out by low-level officials, either in violation of general corporate policy or under corporate procedures that carelessly permitted the practices to continue to grow.” Hills at Yale at 3.

The SEC report to Congress shed additional light on the kinds of conduct uncovered as the program unfolded:

· The two largest identifiable groups of companies that self-reported were drug manufacturers and those in the petroleum refining and related services business;

· The most common transactions were payments to foreign officials;

· A significant number of companies reported that at least some member of corporate management had knowledge of the transactions;

· Most reported the falsification of corporate records or the maintenance of records that appear to be inadequate; and

· Many of the defects in the financial systems represented intentional efforts to conceal the activity. SEC Report at 37-41, Appendix (chart summarizing the initial findings from the program, identifying the company, the nature of the issues, the knowledge of management and the steps taken).

Next: Congressional debates

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by T. GormanPosted on Posted in SECActions

Barclays took a double hit from regulators yesterday. First the Financial Conduct Authority in the UK fined Barclays Bank Plc, about £38 million for putting £16.5 billion of client assets at risk. Then the SEC imposed a $15 million penalty on Barclays Capital Inc. In the Matter of Barclays Capital Inc., Adm. Proc. File No. 3-16154 (September 23, 2014). Both sanctions are based on inadequate procedures.

The FCA’s action follows 16 instances in which the regulator or its predecessor imposed sanction on the firm relating to client assets or client money. This action is predicated on what the FCA called a “significant weakness” in the systems and controls in Barclay’s investment banking division between November 2007 and January 2012. FCA rules require firms to protect client assets if a firm becomes insolvent. Barclays failed to properly apply these rules when opening 95 accounts in 21 countries. As a result the firm did not establish the appropriate legal arrangements with these companies. The failings also resulted in assets being listed at times under Barclay’s name rather than that of the client. The fine imposed reflects the violations and the firm’s regulatory history. It is also the largest imposed by the FCA or its predecessor for client asset breaches.

The SEC’s action centers on the failure of Barclay’s to properly enhance its internal procedures after acquiring Lehman Brothers Inc. advisory business in September 2008. Prior to that time Barclays operations in the United States were comprised largely of broker-dealer functions. After the September 2008 acquisition the firm created what is now called the Barclay’s Wealth and Investment Management, Americas division. Despite the growth of the advisory business, Barclays Wealth failed to build the appropriate infrastructure. That contributed to deficiencies which include:

  • Engaging in principal transactions without making the required written disclosures and obtaining consent in violation of Advisers Act Section 207(3). As a result the firm received compensation of $2,853,119.62 which, along with interest, has been credited to the impacted clients.
  • Commissions and fees were charged and earned revenue that was inconsistent with its disclosures to certain advisory fees. This occurred from September 2008 through December 2011 and violated Advisers Act Section 206(2).
  • The custody rule was violated. Rule 206(b)-2 under the Advisors Act requires that Barclays ensure customer funds and securities are subject to verification by an annual surprise examination by an independent public accountant. The firm had inadequate procedures which caused it not to identify more than 800 advisory accounts to the independent accountant.
  • The firm failed to adopt and implement written policies and procedures designed to prevent violations of the Advisers Act. Although the firm had written compliance policies and procedures they had deficiencies and weaknesses.
  • Barclays also failed to make and keep certain books and records as required by Section 204(a) of the Advisers Act and violated Section 207 of that act by making materially inaccurate disclosures in it Form ADV.

To resolve the proceeding the firm agreed to implement a series of remedial measures. The Barclays reimbursed or credited affected clients about $3.8 million, including interest. It also developed and implemented an action plan in consultation with outside experts. Finally, the firm consented to the entry of a cease and desist order based on Advisers Act Sections 204(a), 206(2), 206(3), 206(4) and 207 and to a censure. Barclays also agreed to pay a penalty of $15 million.

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