by T. GormanPosted on Posted in SECActions

Entering into new, international markets may be good for developing business, but it also carries certain risks. This is particularly true in many countries where doing business may include making gifts, paying gratuities and even bribes. The difficulties can be compounded if adequate preparations are not undertaken, including bolstering internal controls and ensuring that adequate FCPA compliance procedures. Firearms manufacturer Smith & Wesson Holdings Company, learned this lesson the hard way. In the Matter of Smith & Wesson Holdings Corporation, Adm. Proc. File No. 3-15906 (July 28, 2014).

Smith & Wesson sought to break into international markets beginning in 2007. The goal was to increase sales. At the time the company did not have any international subsidiaries. It sought to conduct its international business directly through brokering agents.

In seeking business in international markets, the company focused on selling firearms to foreign law enforcement and military departments. In 2008, for example, the firm retained a third party agent in Pakistan to assist in dealing with sales to a local police department. The agent told the company it would have to provide guns worth over $11,000 to the police department to obtain a deal. Additional cash payment would also be required. The Vice President of International Sales and the Regional Director of International Sales authorized the gifts and payment. Ultimately Smith & Wesson sold 548 pistols to the Pakistani police for $210,980, yielding profits of $107,852.

The next year the company sought to secure a contract to sell firearms to a police department in Indonesia. A third party agent told the company that payments would have to be made under the guise of legitimate firearms lab testing costs. The inflated payments were authorized. No deal was consummated. The company also authorized improper payments through a third party agent in Nepal and Bangladesh. No contracts were obtained. Indeed, by the time the improper conduct surfaced, the company had only secured one contract.

Throughout the period Smith & Wesson had inadequate policies and procedures. Specifically, its internal controls were inadequate. The company did not perform any anti-corruption risk assessment and did virtually no due diligence on third party agents. The firm’s FCPA compliance procedures were also inadequate.

The Order alleges violations of Exchange Act Sections 30A, 13(b)(2)(A) and 12(b)(2)(B). The Commission acknowledged the cooperation of the firm which included conducting an internal investigation, terminating its entire international sales staff, terminating pending international transactions and re-evaluating the markets in which it was seeking business. The company also agreed to a series of undertakings which include reporting to the staff at six to twelve month intervals over two years on its remediation and compliance efforts. The firm will also submit a complete report of its remediation efforts to the staff and conduct follow-up reviews which incorporate the comments provided by the staff.

Smith & Wesson consented to the entry of a cease and desist order based on the Sections cited in the Order. It will pay disgorgement of $107,852, prejudgment interest and a civil penalty of $1,906,000.

The Department of Justice declined prosecution according to a recent company filing.

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by T. GormanPosted on Posted in SECActions

Fragmented markets, alternative trading systems and dark pools are increasingly a focus of discussion in the wake of repeated market outages. Interest in these venues has been intensified by the publication of Flash Boys and Dark Pools. To date only a few cases have been brought. See, e.g. In the Matter of Liquidnet, Inc., Adm. Proc. File No. 3-15912 (June 6, 2014)(ATS dark pool where confidential customer data used for marketing); In the Matter of eBX, LLC, Adm. Proc. File No. 3-15058 (Oct. 3, 2012)(informational edge given to another); In the Matter of Pipeline Trading Systems, LLC., Adm. Proc. File No. 3-1460 (Oct. 24, 2011)(concealed conflict re order filling process).

On Friday the Commission added to its increasing number of cases in this area, filing an action against a unit of Citigroup, In the Matter of LavaFlow, Inc. Adm. Proc. File No. 3-15985 (July 25, 2014). Respondent LavaFlow, Inc. is a registered broker-dealer which is an indirect subsidiary of Citigroup Global Markets, Inc. It operates LavaFlow ECN, an electronic communications network which is a particular type of ATS. Generally, it functions as a marketplace for buyers and sellers of securities. LavaFlow ECN displays the top of its order book which is the best bid and best buy in the national market system. Other orders are not displayed.

In 2006 Lava Trading, a subsidiary of Citigroup, acquired the ECN which became known as LavaFlow ECN. Prior to that time Lava Trading had functioned as a technology services company. Its flagship product was ColorBook, software that provided smart order routing services for over 100 registered broker-dealers that used it to route their customer orders to execution venues. As a smart order router, ColorBook applied preprogrammed analytics that carried out an execution strategy. This distinguished ColorBook from an order router which generally allows an end user to submit an order to an execution venue.

When LavaFlow ECN was acquired, Lava Trading personnel believed they could use ColorBook to improve important functions of the ECN. Nevertheless, the services that ColorBook provided to customers remained distinct from those provided by LavaFlow ECN.

Initially, LavaFlow did not permit ColorBook to access and use information from the ECN direct subscriber non-display order flow when determining how to smart route orders. Beginning in March 2008, and continuing for the next three years, LavaFlow did permit ColorBook to access that information and use it for smart order routing decisions for customers who also were subscribers of the ECN. Thus if an ECN customer placed an order that would match a non-displayed order in the venue, ColorBook would route the customer order to the LavaFlow ECN with the expectation that the two orders would match.

LavaFlow did not obtain meaningful consent from its ECN subscribers to allow ColorBook to have access to direct subscriber non-displayed order flow information or to use it. While marketing materials indicated that ColorBook would be “exposed” to non-displayed order flow data, there was no procedure in place to ensure that subscribers reviewed this material. There is no indication that non-displayed orders were communicated to customers of the smart order routing business.

In June 2008 Lava Trading, which had been a registered broker-dealer since 2005, withdrew its registration. The next year Lava Trading entered into an agreement with LavaFlow under which the latter would receive all income associated with contractual arrangements that previously existed between Lava Trading and its customers. From August 2008 through February 2009 Lava Trading received transaction-based compensation for broker-dealer services, including about $1.8 million for orders handled by the smart order router.

The Order alleges willful violations of Rules 301(b)(2) and (10) of Regulation ATS and Exchange Act Section 15(a). Rule 301(b)(10) requires an ATS to establish adequate safeguards and procedures to protect subscribers’ confidential trading information and to have adequate oversight. This rule was violated by permitting ColorBook to have access to the direct subscriber non-displayed order flow information and use it to make routing decisions. Rule 301(b)(2) requires an ATS to amend its Form ATS before implementing a material change to its operation. That form was not amended here regarding the access of ColorBook.

To resolve the proceeding LavaFlow consented to the entry of a cease and desist order based on the Rules and Section cited in the Order and to a censure. It also agreed to pay disgorgement of $1.8 million, prejudgment interest and a civil penalty of $2,850,000.

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