The Impact of the New Commission Cooperation Initiatives – Part II

The SEC’s new cooperation tools have impacted a number of actions. In four cases, as discussed in Part I of this article, the Commission entered into agreements under which it either chose to prosecute or deferred prosecution with a view toward dismissal. In most instances where the agency has acknowledged the cooperation of a party however, an action was brought but the resolution of the case was altered in some fashion.

Reduced sanction

In some cases the Commission acknowledged cooperation while imposing a reduced sanction as in the proceeding against BNY Mellon Securities LLC, In the Matter of BNY Mellon Securities LLC, Adm. Proc. File No. 3-14191 (January 14, 2011). There the Order alleged that the registered broker dealer failed to reasonably supervise the manager on its institutional order desk and the traders under his supervision over a seven year period. During the period the order desk manager failed to meet his duty of best execution to certain customers. Orders were executed at stale or inferior prices which were frequently outside the National Best Bid and Offer at the time of execution. In some instances the orders were executed in cross-trades with a favored handful of accounts held by hedge funds and certain individuals. While the firm did have written procedures, there were none to follow-up on red flags. The Order thus alleged that the firm failed to reasonably supervise within the meaning of Exchange Act Section 15(b)(4)(E) with a view to preventing and detecting violations of Section 17(a).

The broker dealer settled the proceeding, consenting to the entry of a censure. BNY Mellon Securities also agreed to pay disgorgement of $19,297,016, prejudgment interest and a $1 million penalty and to implement certain procedures. The Commission settled on these terms in view of the cooperation and remedial efforts of the broker-dealer which included: 1) Suspending cross-trading and beginning an internal investigation three days after one of the hedge funds involved was charged on an unrelated matter; 2) Terminating the order desk manager for cause; and 3) Self-reporting about two and one half months after commencing its investigation. See also: In the Matter of AXA Advisors, LLC, Adm. Proc. File No. 3-14708 (Jan. 20 2012)(failure to supervise action where employee induced clients to redeem accounts so he could misappropriate funds resolved with censure, adoption of procedures and payment of $100,000 penalty based on cooperation, adoption of procedures and retention of independent consultant);

No penalty

In other instances the SEC has elected not to impose a financial penalty based on the cooperation of the company. A good example of this small group of cases is the proceeding against Arthrocare Corporation, a medical device manufacturer. In the Matter of Arthrocare Corporation, Adm. Proc. File No. 3-14249 (Feb. 9, 2011). There the Order Instituting Proceedings alleged that over a three year period the company inflated its income by overstating and prematurely recognizing revenue primarily in connection with quarter end sales to one customer. The purpose was to meet quarterly goals and street expectations. Eventually Arthrocare was required to restate its financial statements.

The proceeding was settled with a consent to the entry of a cease and desist order which prohibits future violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). No fine was imposed based on the cooperation and remedial efforts of the company which included: 1) Replacing the senior management team; 2) expanding its legal department; 3) creating a position for and hiring a new Compliance Officer position; 4) hiring a new corporate controller and international controller; 5) expanding its internal audit function; 6) instituting quarterly ethics communications from senior management to employees; 7) implementing a sub-certification process as part of its quarterly and annual financial reporting; 8) adopting standard customer contracts with rigorous approval requirements; 9) hiring a contract administrator; and 10) providing regular training on proper revenue recognition and accounting for handling contracts.

During the investigation the company regularly updated the staff on its internal investigation; provided critical documents without waiting for a request; promptly responded to staff requests; routinely granted the staff access to the company’s consulting expert; voluntarily produced witness for testimony who were outside the U.S; and provided the staff with a detailed analysis of its restatement.

Similarly in In the Matter of Fifth Third Bancorp, Adm. Proc. File No. 3-14639 (Nov. 22, 2011) the proceeding was settled with a consent to the entry of a cease and desist order, in this instance based on Exchange Act section 13(a) and Reg FD but no penalty based on the Respondent’s cooperation. The underlying proceeding was based on allegations that the bank selectively disclosed to certain investors that it planned to redeem a class of its trust preferred securities for about $25 per share.

The Order acknowledge “the remedial acts promptly and voluntarily undertaken by Fifth Third – including its compensation of CAP VII TruPS investors harmed by the timing of the disclosure and its adoption and implementation of additional policies and procedures . . .” and the cooperation afforded the staff. In other cases the Commission has made similar statements. See, e.g., In the Matter of GSCP (NJ), Adm. Proc. File No. 3-15514 (Aug. 25, 2011)(no fine imposed on investment adviser that served as portfolio manager for sale of synthetic CDO where the marketing materials failed to disclose the participation of a hedge fund in selecting collateral that had a short position); SEC v. Cinderey, Civil Case No. CV 12-1519 (N.D. Cal. Filed March 27, 2012)(settled action in which bank officer who participated in scheme to circumvent controls to delay recognition of loan losses settled by consenting to an injunction but was not required to pay a civil penalty based on cooperation and fact that he paid a $40,000 fine in an FDIC administrative proceeding).

Reduced penalty

In other instances cooperation resulted in a reduced fine as in In the Matter of Martin Currie, Inc., Adm. Proc. File No. 3-14873 (May 10, 2012). There an investment adviser used assets of one client to rescue another in violation of Advisers Act Sections 206(1) and (2) and Investment Company Sections 17(d) and 34(b). The matter was resolved with a cease and desist order, censure and the payment of an $8.3 million fine. The fine was limited because of cooperation which included: Compensating the fund injured; refunding fees; terminating and/or disciplining those involved; conducting an investigation; and implementing procedures. Similarly in SEC v. Easom, Civil Action No. 2:11-CV-7314 (D.N.J. Filed Dec. 16, 2011) a corporate insider who tipped a cousin – broker who then tipped others entered into cooperation agreement. As a result the insider settled by consenting to a fraud injunction and paying disgorgement of $327 in trading profit and prejudgment interest but only a $10,000 civil penalty. See also SEC v. Wrangell, Case No. 7:12-cv-00274 (E.D.N.C. Filed Sept. 20, 2012)(tippee in insider trading case cooperated and settled by consenting to a fraud injunction, disgorging his trading profits of over $42,000 and paying a reduced penalty of $11,380.99); SEC v. Rooks, Civil Action No. 1:12-cv-02988 (N.D. Ga. Filed Aug. 28, 2012)(same).

Finally, in some instances while the Commission has acknowledged cooperation and apparently mitigated the penalty, but the impact is not readily apparent. SEC v. Pressetek, Inc., Civil Action No. 10-1058 (E.d.N.Y. Filed march 9, 2010) is such a case. There the company was charged with violations of Exchange Act Section 13(a) and Reg FD. The action centered on conversations about the performance of the company by its chairman and CEO with an investment adviser to a fund which owned a substantial block of Pressetek stock.

In an unusual step, the complaint acknowledged the cooperation of the company and its remedial acts which included revising its corporate communications policies and governance principles, replacing its management team, appointing new independent board members and creating a whistleblower hotline. Nevertheless, the company settled with the Commission by consenting to the entry of a permanent injunction prohibiting future violations of the Sections cited in the complaint and paying a $400,000 fine. The impact of the cooperation was not specified.

Similarly, in SEC v. Long-Short term, Inc., Civil Action No. 1:11-cv-1127 (E.D.Va. Filed Oct. 18, 2011), an action based on false statements made during options trading seminars, the Commission acknowledged the cooperation of the defendants and noted that they retained counsel who evaluated the company, instituted new policies and installed procedures to prevent a reoccurrence. Yet both defendants consented to the entry of permanent injunctions prohibiting future violations of Exchange Act Section 10(b). The company paid a penalty of $750,000 while the co-founder paid $150,000. See also In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Admin. Proc. File No. 3-14204 (January 25, 2011)(misuse of customer order flow information, improper mark-ups and downs results in failure to supervise charge settled with cease and desist order and civil penalty of $10 million, although cooperation acknowledged); In the Matter of JSK Associates, Inc., Adm. Proc. File No. 3-14296 (March 14, 2011)(investment adviser and two others charged in action based on failure to disclose compensation; each settle by consent to cease and desist order; adviser paid disgorgement of over $60,000; and individuals each paid civil penalty of $10,000; resolution based on prompt cooperation and remedial efforts).


The Commission’s new cooperation tools have been employed in a series of cases. Few have resulted in either a non-prosecution or deferred prosecution agreement. The circumstances under which either of these types of agreements have been utilized are limited, typically reflecting the type of case on which the 2002 Seaboard Release was based.

Yet there seems to be little reason for restricting the use of these agreements to such limited circumstances. Seaboard represented a decision not to prosecute. There was no formal mechanism to obtain disgorgement, impose a civil penalty or insure the implementation of remedial measures to prevent future violations.

The Commissions new cooperation tools solve this dilemma. With either a non-prosecution or deferred agreement the agency can obtain as part of the arrangement disgorgement, a civil penalty and require the implementation of policies and procedures which can help prevent future repetition. Indeed, a deferred prosecution agreement can serve as a kind of time limited mini-injunction, conditioning dismiss at a future point in time on: 1) The payment of disgorgement and/or a penalty as appropriate; and 2) the continued implementation of policies and procedures which reform the company and its culture to prevent a future reoccurrence of the wrongful conduct. Accordingly, there is no reason not to broaden the application of these tools which would better serve their goal of encouraging self-reporting and cooperation while speeding investigations.

Finally, while in many instances the Commission has detailed the cooperation and remedial efforts involved, that is not true in each case. A better explication of the efforts which earned the company “cooperation credit” and a reduced sanction provides added guidance to the market place encouraging cooperation. Overall, experience to date suggests that these initiatives represent the adoption of new tools which will well serve the enforcement program in the future.

Hurricane Sandy: The President suggested that those who want to aid the victims of this devastating storm contribute to the Red Cross. The link is here.

Seminar: The ABA’s premier Securities Fraud seminar will be held in New Orleans on November 15 and 16, 2012 (here).

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