by T. GormanPosted on Posted in SECActions

The SEC, the DOJ and other regulators frequently encourage self-reporting and cooperation with law enforcement. Taking those steps will result in “cooperation” credit that will be reflected in the charging process or when sanctions are imposed. While there are cases where the value of that cooperation is evident, in many it is not. That is the case with the recent action in which Bank of America Corporation was sanctioned for violations in connection with its regulatory capital stemming from its acquisition of Merrill Lynch during the financial crisis. In the Matter of Bank of America Corporation, Adm. Proc. File No. 3-16177 (September 29, 2014).

In the proceeding Bank of America was charged with violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). Those violations are the result of not properly calculating its regulatory capital since 2009.

In the acquisition of Merrill in 2009 the Bank acquired Notes with a par value of $52.5 billion. The notes had a fair value at the time which was below par stemming from a decline in Merrill’s creditworthiness. Thus, in accord with GAAP, Bank of America booked the notes at fair value which was a $5.9 billion discount to par. At the same time the Bank assumed the liability at par.

In calculating regulatory capital Bank of America was required to include the realized losses that were recognized in GAAP equity. Yet in calculating regulatory capital from the time of the acquisition until 2013, the Bank failed to include the losses. As more notes matured, or were repurchased by Bank of America, additional losses resulted. Failing to book those losses resulted in overstatements of its regulatory capital. During the period 15 Form 10-Qs contained an overstatement of regulatory capital. In addition, 5 Form 10-K Filings contained overstatements.

The overstatements trace to the time of the acquisition and a list crafted by the transition team that worked on the deal. That team created a schedule that tracked cumulative gains and losses on certain liabilities. In creating the list the Bank correctly recognized that pre-acquisition declines in fair value of the Notes relating to Merrill’s creditworthiness should not be included as an adjustment to its regulatory capital. What the schedule did not take into account was the fact that the notes would mature or otherwise be redeemed.

The Bank used the schedule each quarter and correctly excluded the difference in value of the Notes at par and their fair value at acquisition. The flaw is that it continued to make the adjustment to regulatory capital even after some Notes had matured or were otherwise redeemed. This resulted in a continuing overstatement of regulatory capital.

In April 2014 the Bank discovered the flaw in its process and issued a press release announcing a downward revision to its disclosed regulatory capital amounts and rations. A Form 8-K was also filed. The firm self-reported, instituted remedial steps and developed improved documentation and spreadsheet controls and enhanced internal controls.

Bank of America resolved the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay a civil penalty of $7,650,000.

The Order states that the Bank “provided substantial cooperation to the Commission staff . . . [and] has voluntarily undertaken steps to remediate and address, among other things, the inadequate books and records and internal accounting control deficiencies that are the subject of this proceeding.” The Commission’s press release states that the Bank self-reported and cooperated. This permitted the staff to efficiently and effectively conduct its investigation. The cooperation credit is reflected in the penalty, according to the Commission.

There is no indication of the value of that credit. Yet when considering the question of cooperation, an important consideration is the value of the potential credit. The SEC does not give any indication of the value. In contrast others do. For example, in criminal cases the amount of the credit can frequently be seen in the sentencing guideline calculations and/or from the percentage by which the fine is under the bottom of the range. In the UK the FSA specifies the percentage discount in the fine that reflects cooperation credit. More certainty about the value of cooperation can encourage it. If the SEC wants to encourage cooperation, the agency should consider providing more disclosure of its value.

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by T. GormanPosted on Posted in SECActions

Traditionally, the SEC has brought insider trading cases as civil injunctive actions. The recent emphasis on administrative proceedings, however, appears to be changing that. Earlier this week the agency brought an insider trading cases as an administrative proceeding against a Wells Fargo Analyst and Trader, In the Matter of George T. Bolan, Jr., Adm. Proc. File No. 3-16178 (September 29, 2014). Last week the SEC brought an insider trading case against an associate of an unregistered investment adviser, In the Matter of Richard O’Leary, Adm. Proc. File No. 3-16166 (September 25, 2014). Yesterday, the Commission added to the growing list, filing two related proceedings against a friend of a hedge fund Analyst and his tippee. In the Matter of Filip Szymik, Adm. Proc. File No. 3-16183 (September 30, 2014); In the Matter of Jordan Peixoto, Adm. Proc. File No. 3-16184 (September 30, 2014).

Filip Szymik is employed as a consultant in New York City. His roommate and friend is an Analyst at Pershing Square Management, L.P, a hedge fund lead by well-known activist investor William Ackman. The analyst began working at Pershing Square as an intern. Later he became a full time employee. In that capacity he acknowledged in writing the compliance procedures of the firm which directed that he not disclose inside information.

Beginning in September 2012 he was part of an investment team assigned to research Herbalife. Though that position he learned that Pershing had concluded the company was an illegal pyramid scheme. He also knew that the firm intended to disclose its conclusion at a conference on December 20, 2012.

While the Analyst worked on the Herbalife team, and before, he was roommates with his childhood friend, Filip Szymik. Both grew up in Poland. The Analyst has instructed his roommate that the work at Pershing is highly confidential and could not be disclosed or used to trade securities.

Prior to December 19, 2012 the Analyst disclosed to his friend and roommate that he was working on Herbalife. He also told Mr. Szymik that the firm had a negative view which would be disclosed on December 20.

One of Mr. Szymik’s close friends is Jordan Peixoto, a research analyst at Deloitte. Although he lives in Toronto, during December 2012 he was working in New York City. The two men spent nearly every weekend together.

Prior to December 19, 2012 Mr. Szymik told his friend about Herbalife, the position of Pershing Square and the pending presentation. Mr. Peixoto knew that his friend’s roommate was an analyst at Pershing Square and that the work was confidential. Nevertheless, just before 2:00 p.m. on December 19, 2012 he purchased Herbalife options. Shortly after those purchases, CNBC reported that Pershing had acquire a significant short position in Herbalife and was making a presentation the next day.

Following the CNBC report, and the Pershing presentation on December 20, 2012, Herbalife stock declined by 39%. By the close of the market on December 21 Mr. Peixoto’s options had increased in value to about $339,421. He asked his brokers to let them expire worthless. One refused, giving him a profit of $47,100.

Each Order alleges violations of Exchange Act Section 10(b). Mr. Szymik settled with the Commission, consenting to the entry of a cease and desist order based on the Section cited in the Order. He also agreed to pay a civil penalty of $47,100. Mr. Peizoto did not resolve his action. It will be set for hearing.

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