This is the fifth in a series of articles examining future trends in securities enforcement.

The regulation of market professionals is a key area of responsibility for the Commission. Actions brought in this area are a critical part of the Enforcement Division’s responsibilities. Last year, the Division brought a number of important cases in this area focused on investor protection and the integrity of the markets.

In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Admin. Proc. File No. 3-13407 (March 11, 2009) and In the Matter of Commonwealth Equity Services, LLP, Adm. Proc. File No. 3-13631 (Sept. 29, 2009) focus on the integrity of customer information. Merrill Lynch, the so-called “squawk box” case, discussed here, is a settled proceeding based on the failure of the brokerage firm to adequately protect the confidentiality of customer order flow information. Specifically, the Order for Proceedings claims that the firm did not have adequate procedures to prevent day traders from overhearing and using material non-public information regarding unexecuted institutional orders being transmitted through the firm’s squawk box. This failure permitted those who overheard the information to trade ahead of the customer orders and, in many instances, profit from the price movement following the execution of customer orders. The case was resolved with the institution by Merrill of a series of procedures designed to ensure the integrity of customer information in the future, the payment of a $7 million penalty and the entry of a cease and desist order.

Commonwealth Equity focused on the integrity of customer account information. There, the Order for Proceedings alleges that the company failed to require that its representatives maintain antivirus software on its computers. As a result, an intruder was able to obtain login credentials and access to customer accounts to make unauthorized purchases. This action was settled with the entry of a cease and desist order and the payment of a $100,000 penalty.

A third case, In the Matter of INTECH Investment Management, LLC, Adm. Proc. File No. 3-13463 (Filed May 7, 2009) concerned investor voting rights. This settled action against the firm and its former chief operating officer centers on Advisers Act Rule 2006(4)-6, which requires registered investment advisers to adopt proxy voting policies and describe them to clients. The Order alleges that the procedures adopted by the firm were inadequate because they lacked provisions to deal with conflicts and they were not adequately discussed with clients. The matter was resolved with a cease and desist order and the agreement of the firm to pay a $300,000 penalty and its former COO to pay a $50,000 penalty.

Other cases against regulated entities are based on claims regarding the adequacy of disclosure about fees. In the Matter of New York Life Investment Management, LLC, Adm. Proc. File No. 3-013487 (Filed May 27, 2009) focused on the fees charged by investment advisers. A settled action against the investment adviser to the Equity Index Fund, a series of The MainStay Funds, alleges a violation of Section 206(2) of the Advisers Act based on the fact that, during the process for renewing three investment advisory contracts between Respondent and the Equity Index Fund, the board of trustees received information showing that the management fees charged were among the highest of the Fund’s peer group. Although the Adviser urged the board to consider a guarantee feature in evaluating the fees, no information was furnished so it could be evaluated. At the same time prospectuses, annual reports and registration statements claimed that there was “no charge” to the Fund or its shareholders for the guarantee. This representation was false. The action was settled with the entry of a cease and desist order, the payment of disgorgement of about $3.9 million and a penalty of $800,000. See also Jones v. Harris Associates LP. S.Ct. No. 08-586 (issue regarding the standard which investors must meet under Section 36(b) of Investment Company Act to challenge adviser fees; the case is pending decision as discussed here).

In the matter of Ameriprise Financial Services, Inc., Adm. Proc. File No. 3-13544 (July 10, 2009) also focused on fees. In this settled proceeding, the Order claimed that, over a four-year period, Ameriprise received undisclosed cash payments from certain REITS to sell shares in the funds. The payments were mislabeled as invoices to make it appear that they were legitimate reimbursements for service. In fact, they were not. The proceeding was settled with the entry of a cease and desist order and the payment of disgorgement in the amount of $8.65 million and a penalty equal to the amount of the disgorgement. See also In the Matter of Value Line, Inc., Adm. Proc. File No. 3-13675 (Filed Nov. 4, 2009) (settled action against a registered investment adviser based on inflated fees); In the Matter of J.P. Morgan Securities, Inc., Adm. Proc. File No. 3-13673 (Filed Nov. 4, 2009) (settled action based on a pay to play scheme); SEC v. Brantley Capital Management, LLC, Case No. 1:09-CV-01906 (N.D. Ohio Filed Aug. 13, 2009) (settled case against investment adviser, firm and individuals for incorrectly valuing assets).

Other cases which may suggest trends for 2010 and beyond focused on conduct in the marketplace and specifically short selling, an area in which the Commission has recently issued new regulations. These include the first actions based on naked short selling: In the Matter of Hazan Capital Management, LLC, Adm. File No. 3-1570 (Filed Aug. 5, 2009) and In the Matter of TJM Proprietary Trading, LLC, Adm. File No. 3-13569 (Aug. 5, 2009), both discussed here. Others include violations of, respectively, based on Regulation SHO and Regulation M: In the Matter of Rhino Trading, LLC, Adm. Proc. File No. 3-013677 (Filed Nov. 4, 2009)(Reg. SHO), discussed here, In the Matter of First New York Securities, LLC, Adm. Proc. File No. 3-13656 (Filed Oct. 20, 2009) (Reg. M), discussed here and In the Matter of Perceptive Advisors LLC, Adm. Proc. File No. 3-13657 (Filed Oct. 20, 2009) (Reg. M), discussed here.

Two other cases brought last year which center on deceptive market conduct may also indicate trends for the future. In the Matter of ICAP Securities USA LLC, Adm. Proc. File No. 3-13726 (Dec. 18, 2009) is a settled action brought against the subsidiary of the world’s largest inter-dealer broker, ICAP, Inc., discussed here. The action, brought against the firm and several registered representatives, alleged manipulative market conduct based on the use of fictitious flash trades, misrepresentations regarding certain workup protocols and other misrepresentation regarding whether the firm engaged in proprietary trading in certain markets. The case was settled with the entry of a cease and desist order, the payment of $1 million in disgorgement and a $24 million fine.

In the Matter of Perry Corp., Admin. Proc. File No. 3-13561 (Filed July 21, 2009) is an action against a broker which failed to file a Schedule 13D disclosing its nearly 10% stake in Mylan Laboratories, Inc. because it was trying to implement a strategy known as “merger arbitrage.” The stake the firm held in Mylan was put together through a series of swap transactions which were designed to fully hedge its position. The position gave the firm voting rights to about 10% of Mylan’s shares. The case as settled with the entry of a cease and desist order and the payment of a $150,000 civil penalty.

Three other cases brought by the Commission last year may also be a harbinger of things to come in the new decade. One concerns the Sarbanes Oxley clawback section, another, Reg. FD and a third, penalties. SEC v. Jenkins, Case No. CV 09-1510 (D. Ariz. Filed July 23, 2009) is the Commission’s first clawback case under SOX Section 304, discussed here, which seeks the repayment of an executive bonus where the SEC admits that the defendant had not engaged in any wrongful conduct.

Jenkins is a civil injunctive action brought against Maynard Jenkins, the former CEO of CSK Auto Corporation. During a period when the company and other executives engaged in financial fraud which resulted in two restatements, Mr. Jenkins was paid about $2 million in incentive compensation. The complaint seeks the repayment of the incentive compensation on what is essentially a strict liability theory. Mr. Jenkins was not named in the Commission’s enforcement action based on the fraud. SEC v. Fraser, Case No. 2:09-cv-00442 (D. Ariz. Filed March 6, 2009). Briefing has been completed on a motion to dismiss, but no ruling has been entered.

A second case involves Regulation FD, In the Matter of Christopher A. Black, Adm. Proc. File No. 3-13625 (Sept. 24, 2009) and SEC v. Black, Case No. 09-cv-0128 (S.D. Ind. Sept. 24, 2009). These settled actions are based on claims that the former senior vice president and CFO of American Commercial Lines, Inc. furnished a revised earnings forecast to several analysts prior to its issuance by the company. To resolve the action Mr. Black consented to the entry of a cease and desist order and the payment of a $25,000 penalty.

In an usual statement the Commission articulated its reasons for not bringing an action against the company. Those included the fact that: 1) the company cultivated an environment of compliance; 2) Mr. Black acted alone and outside the control systems of the company in distributing the information from home; 3) once the illegal conduct was discovered, the company promptly disclosed the matter to the public and the SEC; 4) the company self-reported and took remedial steps to prevent a reoccurrence. See also Litig. Rel. 21222 (Sept. 24, 2009).

Finally, the resolution of In the Matter of Ernst & Young LLP, File No. 3-13726 (Filed Dec. 17, 2009) may signal a new approach to settlement. The underlying action is based on audit failures regarding fitness giant Bally. The company had, prior to its bankruptcy, engaged in an number of improper accounting practices according to the Commission. The Order in this case charges Ernst & Young, the firm’s outside auditors, and several of its professionals, with improperly issuing unqualified audit opinions during the period 2001 – 2003. To resolve the matter, the audit firm agreed to the entry of a cease and desist order and proposed a series of undertakings it would institute. One of those undertakings was the payment of $8.5 million to the treasury “in the nature of a penalty.” The language makes it clear that it is intend to be similar to a civil penalty of the type which the SEC can impose on regulated entities in administrative proceedings or others in civil injunctive actions.

Next: The concluding segment to the series

Seminar sponsored by the ABA Criminal Justice Section: January 13, 2010, Enforcement Trends in Securities & Commodities Actions 2010, in person in Washington, D.C. at 600 14th St. N.W. 9th Floor and webcast nationally.

Speakers: Adam Safwat, Deputy Chief, Fraud Section, Department of Justice; Steve Obie, Director, Division of Enforcement, CFTC; Laura Josephs, Assistant Director, SEC Division of Enforcement and Cheryl Evans, Special Counsel U.S. Chamber Initiatives For Legal Reform.