Two senior federal law enforcement regulators indicated that seeking personal accountability will be emphasized in upcoming criminal and civil actions involving alleged corporate wrongdoing. Meanwhile, the Securities and Exchange Commission issued proposed new rules aimed to enhance transparency and its oversight of alternative trading systems, including so-called “dark pools,” that include stocks listed on national securities exchanges, while the Commodity Futures Trading Commission readies for release tomorrow proposed new rules dealing with automated trading systems, and possibly the registration of certain proprietary traders who directly access exchanges through ATSs. Moreover, it appears similar SEC rules for proprietary traders may be forthcoming too – as well as rules on disruptive trading. As a result, the following matters are covered in this week’s edition of Bridging the Week:

• Deputy US Attorney General and SEC Enforcement Head Warn Corporate Individual Wrongdoers to Beware;

• Court to House Subcommittee and Staff Member: Comply With SEC Investigative Subpoenas – No Exemptions for You!;

• Enhanced Transparency Is Objective of Proposed SEC Rules for Alternative Trading Systems;

• SEC Chair Tells Congressional Committee Disruptive Trading Rule and Proposals Mandating Third-Party Compliance Reviews of Investment Advisers Coming Soon; CFTC Reg AT Proposal Coming Sooner;

• CCO Fined and Suspended by SEC for Recidivist Violation by Investment Adviser; Sanctions Against IA and Principals Too (includes Compliance Weeds and My View);

• Broker-Dealer Fined $2.6 Million by FINRA for Failure to Retain Key Records in WORM Format (includes Compliance Weeds);

• Bank Settles NYS Charges Related to FX Trading System That Allegedly Rejected Some Client Orders Where Bank Could Not Profit (includes Culture and Ethics); and more.

(There will be no Bridging the Week on November 30, 2015 because of the upcoming Thanksgiving weekend holiday.)

Deputy US Attorney General and SEC Enforcement Head Warn Corporate Individual Wrongdoers to Beware

Deputy US Attorney General Sally Quillian Yates provided further insight into the Department of Justice’s new emphasis on personal liability in connection with corporate criminal and civil law violations, at the same time that the Office of the United States Attorneys rolled out revisions to its written guidelines to its staff regarding the prosecution of corporate criminal and civil cases.

In a speech before the American Banking Association and American Bar Association Money Laundering Enforcement Conference on November 16, Ms. Quillian Yates noted that the US Attorneys’ revised guidelines “now emphasize the primacy in any corporate case of holding individual wrongdoers accountable and list a variety of steps that prosecutors are expected to take to maximize the opportunity to achieve that goal.”

Among other things, if a corporation desires credit for cooperation, “it must provide all non-privileged information about individual wrongdoing” (emphasis added). Whereas, previously, corporations may have received at least some credit for cooperation even where they did not disclose all information regarding individuals, “providing complete information about individuals’ involvement in wrongdoing is a threshold hurdle that must be crossed before we’ll consider any cooperation credit,” said Ms. Quillian Yates.

In connection with notes and memos covered by attorney-client privilege, Ms. Quillian Yates indicated that prosecutors will continue not to request such documents. However, Ms. Quillian Yates indicated that “to earn cooperation credit, the corporation [needs] to produce all relevant facts – including the facts learned through those interviews – unless identical information has already been provided.”

The revised written guidelines are included in the US Attorneys’ Manual. According to the Manual,

[p]rosecution of a corporation is not a substitute for the prosecution of criminally culpable individuals within or without the corporation… Provable individual culpability should be pursued, particularly if it relates to high-level corporate officers, even in the face of an offer of a corporate guilty plea or some other disposition of the charges against the corporation…

Separately, Andrew Ceresney, Director of the Division of Enforcement of the Securities and Exchange Commission, said that holding individuals liable is a priority of the SEC in cases against corporations where there are violations of the Foreign Corrupt Practices Act. In a speech before the American Conference Institutes FCPA Conference on November 17, 2015, Mr. Ceresney said that, although FCPA cases “often present formidable challenges to establish individual liability … [h]olding individuals liable for their wrongdoing is critical to effective deterrence.”

Court to House Subcommittee and Staff Member: Comply With SEC Investigative Subpoenas – No Exemptions for You!

A federal district court in New York rejected arguments from the Committee on Ways and Means of the US House of Representatives and Brian Sutter, the former staff director of the Committee’s Health Subcommittee, that they did not have to comply with investigative subpoenas of the Securities and Exchange Commission for documents and testimony.

The SEC had served subpoenas on respondents in connection with an investigation related to the possible leak of non-public information regarding unexpected Medicare payment rates determined by the US Department of Health and Human Services announced on April 1, 2013. Just prior to the time of HHS’ official announcement, a research firm advised 200 clients of expectations that appeared to presage this unexpected outcome. According to the court, the SEC claimed it possessed information and emails that Mr. Sutter may have been the source of information used by the research firm as the basis for its advice. However, the respondents claimed they were excused from compliance with the SEC’s subpoenas because of principles of “sovereign immunity” and the Speech or Debate Clause of the US Constitution, among other reasons.

Respondents said they could not be compelled to comply with the SEC’s investigative subpoenas under the doctrine of sovereign immunity because the federal government and its agencies cannot be sued unless they voluntarily consent.

The court rejected this argument, saying this doctrine has traditionally barred only private suits against the federal government and not suits by one branch of government against another. In any case, said the court, Congress waived any sovereign immunity defense against the SEC in an insider trading investigation when it enacted into law in 2012 a provision stating that members of Congress and Congressional employees are not exempt from securities laws’ insider trading prohibitions.

The court also rejected respondents’ claim that the SEC’s investigative subpoena was prohibited under the US Constitution’s Speech or Debate clause. This clause states that “for any Speech or Debate in either House, [Senators or Representatives] ... shall not be questioned in any other Place.”

The court acknowledged that the Speech or Debate clause was implicated by the SEC’s subpoena. However, the court said the clause only precluded inquiry that fell within the “sphere of legitimate legislative activity” and a large portion of the SEC’s subpoena addressed matters outside such activity, including personal communications. Accordingly, the court ordered respondents to comply with the SEC subpoenas but endeavored to somewhat limit their scope.

Briefly:

• Enhanced Transparency Is Objective of Proposed SEC Rules for Alternative Trading Systems: The Securities and Exchange Commission published proposed new rules to enhance the transparency of alternative trading systems, including so-called “dark pools,” as well as to augment its oversight of such entities. These rules would apply to all ATSs that trade stocks that are listed on a national securities exchange. Among other things, each applicable ATS would be required to prepare and file with the SEC certain information about its broker-dealer operator and affiliates, as well as the nature of its operations, on a new form ATS-N, as well as all subsequent amendments. This form and amendments would be included on the SEC’s website, and each ATS would be obligated to provide on its own website a direct URL hyperlink to the SEC location of its Form ATS-N. Among other things, ATSs would be obligated to disclose differences in the availability of services and processes available to subscribers as opposed to the broker-dealer operator, as well as types of orders; segmentation of order flow; procedures governing trading during a suspension; and opening, reopening and closing processes. The SEC would review all Form ATS-Ns and amendments, and declare them effective or ineffective. Under the SEC’s proposals, applicable ATSs would also have to maintain written safeguards and procedures to protect subscribers’ confidential trading information. Comments will be due by 60 days after publication of the proposed rules in the Federal Register.

• SEC Chair Tells Congressional Committee Disruptive Trading Rule and Proposals Mandating Third-Party Compliance Reviews of Investment Advisers Coming Soon; CFTC Reg AT Proposal Coming Sooner: In a speech before the US House of Representatives Committee on Financial Services on November 18, 2015, Mary Jo White, chair of the Securities and Exchange Commission, said staff of the SEC is currently working on proposals for an anti-disruptive trading rule and to require registration “of certain active proprietary traders and improvements of firms’ risk management of trading algorithms.” Ms. White also indicated that staff is considering new requirements related to the use of derivatives by registered investment funds, and for investment advisers to be subject to third-party compliance reviews. Ms. White said the proposal related to funds using derivatives would include measures to limit the leverage such instruments might create and to enhance risk management programs for such investments. Ms. White also indicated that staff is considering proposals to enhance the disclosure obligations of brokers regarding their order routing practices. Ms. White provided no time frames regarding these proposals. Separately, the Commodity Futures Trading Commission is expected to propose on November 24, 2015, rules mandating safeguards to automated trading systems – known as Regulation AT – and possibly requiring proprietary traders to register with the CFTC if they access CFTC-regulated markets directly and use ATSs. According to a speech given by CFTC Chairman Timothy Massad on November 18 before the Exchequer Club in Washington, DC, the CFTC-proposed rules related to ATS safeguards “will be largely consistent with the best practices followed by many firms already.”

• CCO Fined and Suspended by SEC for Recidivist Violation by Investment Adviser; Sanctions Against IA and Principals Too: Christopher Kelly, the chief compliance office of Sands Brothers Asset Management LLC – a registered investment adviser – agreed to pay a fine of US $60,000 and be suspended from acting as a CCO for one year to resolve charges brought by the Securities and Exchange Commission related to the firm’s alleged recidivist failure to comply with the SEC’s so-called “custody rule.” This rule requires advisers who have custody of client funds to implement certain procedural safeguards. Under certain circumstances – applicable to SBAM – advisers must distribute audited financial statements to all limited partners within 120 days of the end of each fiscal year (click here to access the relevant rule – Rule 206(4)-2 under the Investment Advisers Act). According to the SEC, in 2010, in connection with a prior SEC enforcement action, SBAM, as well as its two co-chairmen, Steve Sands and Martin Sands, consented to the entry of an order by the agency to cease and desist from violating the custody rule. However, despite this Cease and Desist Order, in each year from 2010 through 2012, SBAM distributed the required financial statements to its limited partners later than required by the relevant rule. Although SBAM’s compliance manual required Mr. Kelly to ensure SBAM’s compliance “with the restrictions and requirements” of the custody rule, the SEC claimed “[h]e knew that the audited financial statements were not being distributed on time.” Moreover, said the SEC, Mr. Kelly “implemented no policies and procedures to ensure compliance with the custody rule… At most, he simply reminded people of the [rule] deadline without taking any more substantial action.” Separately, SBAM, and both Mr. Sands agreed to pay a fine of US $1 million and not to raise new funds from investors for one year to resolve charges by the SEC related to SBAM’s alleged violation of the custody rule.

Compliance Weeds and My View: As previously pointed out in prior versions of Bridging the Week, Securities and Exchange Commission rules require investment advisers to adopt and implement written policies and procedures “reasonably designed” to ensure the adviser’s compliance with applicable law. The chief compliance officer solely is responsible to “administer” policies that are adopted by the adviser (click here to access Rule 206(4)-7 under the Investment Advisers Act). At Sands Brothers Asset Management, however, the compliance manual tasked the CCO with ensuring the firm’s compliance with the custody rule – thus placing a higher obligation on the CCO than required by rule, and transferring the legal responsibility of the adviser to Mr. Kelly. CCOs should be mindful of any language in their firms’ compliance manual that places any obligation on them to ensure compliance with any applicable law. CCOs can help firms comply with applicable law, but they cannot guarantee compliance as they typically have no supervisory authority. Here the SEC acknowledged that Christopher Kelly, SBAM’s CCO, reminded personnel of relevant deadlines, but by not doing more, he was held accountable for SBAM’s failures. At a minimum, said the SEC, Mr. Kelly should have notified “…staff of the Commission of any difficulties the Adviser was encountering in meeting the custody rule deadlines.” Once again, this seems an outcome that unfairly punishes a compliance officer for actions of an adviser and its senior officer he or she can influence but not control!

• Broker-Dealer Fined $2.6 Million by FINRA for Failure to Retain Key Records in WORM Format: Scottrade, Inc. agreed to pay $2.6 million to the Financial Industry Regulatory Authority to resolve charges brought by FINRA that, from January 30, 2011, through January 29, 2014, the firm did not retain certain records in a non-rewritable and non-reversible format – known as Write-One, Read-Many or WORM – required by a rule of the Securities and Exchange Commission. The records included suspicious activity reports, written supervisory procedures, tax forms and certain customer account statements, among other documents. According to FINRA, during the relevant time, Scottrade personnel saved relevant documents in a restricted shared drive that was not WORM-compliant. The firm did not have a centralized department to ensure that all departments “followed a consistent document retention process, fully compliant with record retention rules,” said FINRA. FINRA also alleged that, from September 1, 2011, through September 1, 2014, Scottrade did not keep over 160 million mass marketing emails transmitted by third parties on its behalf; did not have an adequate supervisory system to ensure its compliance with the SEC’s record-keeping requirements; and, between May 30 and August 17, 2012, did not report nine customer complaints for damages in excess of US $25,000, as required. In accepting Scottrade’s offer of settlement, FINRA acknowledged the firm’s cooperation in self-reporting its document retention and preservation issues and undertaking a review of its relevant supervisory procedures.

Compliance Weeds: Both the Securities and Exchange Commission and the Commodity Futures Trading Commission have strict rules regarding the electronic storage of mandatory records, including retention periods. These rules – which generally apply to all SEC brokers, dealers and exchange members, and all CFTC registrants – specify the format in which such documents must be kept (WORM format); back-up requirements; written operational procedures and control requirements; how information in such documents may have to be produced; and how compliance with SEC and CFTC requirements must be back-stopped through use of mandatory technical consultants. Certain required records must always be retained in native format even if also maintained electronically. Registrants periodically should double-check to ensure there are no gaps in their document retention process prompted by new, amended or discontinued businesses or processes. (Click here for access to the relevant CFTC rule – Rule 1.31 – and here for the relevant SEC rule – Rule 17a-4.)

• Bank Settles NYS Charges Related to FX Trading System That Allegedly Rejected Some Client Orders Where Bank Could Not Profit: Barclays Bank PLC and its New York branch agreed to pay US $150 million to the New York State Department of Financial Services to resolve charges related to a “Last Look” feature on its automated electronic foreign exchange platform — BARX. This feature – which imposed a slight delay between customer orders and their acceptance and execution by the firm – was intended to prevent Barclays from being taken advantage of by electronic traders who might react faster to market developments in foreign exchange than Barclays’ platform, said NYSDFS. However, claimed NYSDFS, from 2009 to 2014, this feature was also used by Barclays to reject orders from customers that would be profitable to customers and unprofitable to the firm. According to NYSDFS, “Barclays did not seek to distinguish toxic order flow from instances in which prices merely happened to move in favor of the customer and against Barclays after the customer’s order was entered on Barclay’s system.” Moreover, alleged NYSDFS, on occasion, when customers questioned the reason for the rejection of their trades by BARX, Barclays “failed to disclose the reason that trades were rejected, instead citing technical issues or providing vague responses.” In addition to agreeing to pay a fine, Barclays also agreed to fire the Managing Director and Global Head of Electronic Fixed Income, Currencies and Commodities (eFICC) Automated Flow Trading that oversaw BARX; the Global Head of eFICC previously was terminated. Barclays previously paid US $503 million to NYSDFS to resolve allegations related to the manipulation of spot foreign exchange. (Click here for further information.)

Culture and Ethics: As I wrote back in May 2015, “It can only be hoped that [recent] settlements of alleged acts of Forex manipulation provide the last revelations of major inappropriate conduct by financial service industry companies and their employees. Unfortunately, this may not be the case, as there appear to be continuing investigations into electronic trading of Forex and Forex-related products as well as the price-setting process for gold, silver, platinum and palladium. Hopefully, though, financial service firms have minimized the likelihood of future incidents of such illicit behavior by not only implementing better internal controls to prevent and detect such potential issues earlier, but by enhancing overall compliance cultures. This can be encouraged through enacting compensation schemes that better reward and penalize good and bad behavior (not only by line employees, but by their direct and indirect supervisors as well), and by repeatedly educating employees not only about their legal requirements, but also about their ethical obligations too. (Keep in mind the ‘grandma test:’ don’t engage in conduct you would not be proud for your grandmother to read about in her morning tabloid.) It’s not just about avoiding the line between black and white, but about staying out of the zone surrounding such lines altogether. For sure, implementation of better internal controls is critical to prevent and detect potential violations. However, such controls cannot solely be reliant on quantitative analysis and metrics. Such controls must include the intuitive analysis of trained and seasoned professionals who can piece together different metrics and detect issues through application of the ‘smell test’ as well as through application of complex formulas!” This was good advice in May 2015, it is good advice in November 2015 – and it will be good advice in the future too and regularly worth repeating!

And more briefly:

• Former Sentinel CEO Formally Banned From the Futures Industry: Eric Bloom, former president and chief executive officer of Sentinel Management Group, Inc., was formally barred from businesses regulated by the Commodity Futures Trading Commission by a federal judge in Illinois. Previously, Mr. Bloom and Charles Mosley, former head trader, were both sentenced to long terms in prison for their roles in the 2007 collapse of Sentinel and for defrauding customers of more than US $665 million. 

• One More Time: Treasury Official Warns of Need for Cybersecurity Preparedness: Last week, Sarah Bloom Raskin, Deputy Secretary of the US Department of Treasury, reminded financial institutions of their need to implement and maintain vigilant cybersecurity programs. According to Ms. Bloom Raskin, three critical elements of these programs are to ensure that (1) cybersecurity is embedded in firms’ governance, control and risk management systems; (2) firms regularly engage in “cyber hygiene” (e.g., basic practices to enhance the “security and resilience of computer networks and systems” such as multi-factor authentication to gain access to firms’ networks, systems and data); and (3) firms have a robust response and recovery procedure. Ms. Bloom Raskin’s comments were delivered before the Clearing House Annual Conference on November 17, 2015.

• Staff Issues Report on CFTC De Minimis Exception for Swap Dealer Registration But Makes No Recommendations: Staff of the Commodity Futures Trading Commission issued a comprehensive report regarding the so-called “de minimis exception” – namely the maximum quantity of swap dealing a firm may engage in prior to being required to register as a swap dealer. Currently the threshold is US $3 billion aggregate gross notional amount measured over the prior 12-month period. However, an interim threshold of US $8 billion is in effect until December 31, 2017. The report presents an estimation of current swap activity and endeavors to calculate how many additional swap dealers might be required to be registered at different thresholds. However, because of limitations in data quality, staff made assumptions regarding current swap activity and the impact of different thresholds on the number of swap dealer registrants. Staff seeks input on its assumptions; different methodologies to assess how “quantity” might be calculated to assess registration requirements; and whether cleared swaps should be included in the calculation of entities’ gross notional amount of swap dealing, among other topics. Comments are due by January 19, 2016.

• ESMA Determines Not to Permit Use of Non-Collateralized Bank Guarantees to Support Cleared Energy Derivatives After March 15, 2016: The European Securities and Markets Authority issued a statement indicating that, beginning March 15, 2016, non-financial firms could no longer support their European-cleared derivatives transactions related to electricity and natural gas products using non-collateralized bank guarantees. Non-collateralized bank guarantees are currently permitted to be used for such purposes. (Click here for additional information)

• FCA to Study Competition in the Asset Management Industry: The Financial Conduct Authority indicated that it will look into competition in the asset management industry for both retail and institutional investors. The study will address how asset managers deliver value; whether asset managers are sufficiently “motivated” and are able to control costs; and what impact investment consultants have on competition for institutional asset management. In connection with consultants, FCA will specifically look at their role and potential conflicts of interest. Comments may be submitted through December 18, 2015.

• CFTC Extends Certain Inter-Affiliate Swaps Transaction No-Action Relief and Suspends Index Investment Data Report: The Commodity Futures Trading Commission extended previously granted no-action relief exempting (1) certain inter-affiliates’ swaps from the Commission’s trade execution requirement, and (2) affiliated counterparties in certain non-US jurisdictions from complying with certain so-called “outward-facing swap conditions.” These new extensions will expire at the latest on different dates in December 2016. The CFTC also announced it will stop issuing and collecting data related to its monthly Index Investment Data Report. The last report will be issued this week for the month of October 2015.