Securities Mosaic® Blogwatch
September 29, 2016
Antitrust-Related Recent Developments: Second Circuit Confirms Limited Nature of General Personal Jurisdiction
by C. Fairley Spillman, George L. Wolfe & Kenneth R. Simon Jr.

Following the Supreme Court’s 2014 decision in Daimler AG v. Bauman, several opinions from the United States Court of Appeals for the Second Circuit confirm the limited circumstances in which courts may exercise general personal jurisdiction over a defendant.  The Second Circuit’s decisions in Waldman v. Palestine Liberation Organization, Brown v. Lockheed Martin Corp. and Gucci America, Inc. v. Weixing Li demonstrate that branch offices, employees and business registration in the forum state, standing alone, are insufficient.

In Waldman v. Palestine Liberation Organization, — F.3d — (2d Cir. 2016), the court overturned a district court’s determination that personal jurisdiction was present in an action against the Palestinian Liberation Organization (PLO) and the Palestinian Authority (PA) based on attacks that occurred in Israel.  The panel held that the PLO’s maintenance of an office in Washington, D.C., to promote the Palestinian cause in speeches and media appearances, and retention of a lobbying firm were insufficient to provide the court with jurisdiction over the PLO and PA.

In Brown v. Lockheed Martin, 814 F.3d 619 (2d Cir. 2016), the court declined to adopt a rule that would subject an international corporation to general personal jurisdiction based on a state’s registration statute.  The plaintiff argued that, by registering to do business in Connecticut under Connecticut’s registration statute, Lockheed Martin effectively consented to general personal jurisdiction in that state. Rejecting that contention, the Second Circuit noted that all states appeared to have registration statutes and held that adopting such a rule would subject a corporation to the general jurisdiction of courts in every state in which it registered.  The court found it significant that, although Lockheed leased a building in Connecticut and had used three other leased locations in the jurisdiction from 2008 through 2012, it did not own property in the state. The panel further noted that raw numbers of employees or revenues in a jurisdiction are less salient than those numbers in context of a corporation’s overall operations.  To that point, the panel explained that Lockheed’s 30 to 70 workers in Connecticut represented less than 0.05% of Lockheed's full workforce and the $160 million in revenue for its Connecticut-based work never exceeded 0.107% of the company’s total annual revenue.

In Gucci America, Inc. v. Weixing Li, 768 F.3d 122 (2d Cir. 2014), the court held that, although the district court could impose an injunction freezing the assets of individual defendants having clear contacts with New York, the district court’s later order compelling the Bank of China to comply with the injunction ran afoul of personal jurisdiction principles.  The panel concluded that the Bank of China’s four branch offices in and conduct of a small portion of its worldwide business in New York did not provide a basis for the exercise of general personal jurisdiction.

September 29, 2016
Is Chinese Investment in the U.S. Film and Entertainment Industry the Next Area of CFIUS Scrutiny?
by P. John Burke, Christian C. Davis, Thomas J. McCarthy, Jonathan C. Poling, Tatman R. Savio, Wynn H. Segall & Hal S. Shapiro

U.S. lawmakers recently submitted a letter to the Government Accountability Office (GAO) raising concerns about increased Chinese investments in the U.S. film and entertainment industry and questioning whether the Committee on Foreign Investment in the United States (CFIUS or “the Committee”) is applying, and has authority to apply, sufficient scrutiny to these and other inbound investments. This development could be an indication that CFIUS will increase its examination of such investments, which would be consistent with the Committee’s application of evolving criteria for assessing national security concerns to deals that may not present obvious CFIUS issues. Consequently, non-U.S. investors would be prudent to consider CFIUS risks in making investments in the U.S. film and entertainment industry, as would U.S. companies seeking to divest such assets.

As background, CFIUS is an interagency committee with the authority to review certain investments in the United States for national security considerations. The Committee has authority to review “covered transactions” that could result in a foreign person having the ability to control a U.S. business. If it identifies national security concerns related to a covered transaction, CFIUS can require mitigation measures for the transaction to be cleared or can recommend that the President block an ongoing transaction. If the transaction has closed, the President can order that the non-U.S. buyer divest its stake in the U.S. business. To address these risks, companies can submit a voluntary notice to obtain “safe harbor” for a transaction to close without fear of CFIUS intervention.

CFIUS’s national security review centers on whether the non-U.S. buyer poses a threat to U.S. national security and whether the U.S. business exposes a U.S. national security vulnerability. In recent years, Chinese investment, particularly by state-owned or -sponsored entities, has been a focus of scrutiny from the threat perspective. Still, CFIUS concerns can and do arise with investors from various nationalities.

As noted above, the types of U.S. businesses that have been a focus of CFIUS reviews has evolved. Certain U.S. industries have been a fairly consistent focus of the Committee such as the defense, high-technology and energy industries. However, CFIUS has also recently taken interest in investments in other areas, including those in the food, agriculture, insurance and information-related sectors.

With that context in mind, 16 members of the U.S. Congress submitted a letter to the GAO on September 15, 2016, requesting that this investigative arm of the U.S. government review CFIUS to ensure that it is effectively assessing “the growing scope of foreign acquisition in strategically important sectors” and determine whether it has sufficient statutory authority to address these risks. As an example, the letter identified Dalian Wanda’s completed and proposed investments acquisitions of U.S. movie studios Legendary Entertainment and Paramount Studios, and the AMC and Carmike theatre chains. They cited growing concerns about China’s efforts to censor topics and exert propaganda controls on American media, and they implied that these investments could be used to further such efforts.

Consequently, non-U.S. parties seeking to invest in the U.S. film and entertainment industry and their counterparties should not assume that CFIUS does not apply to the transaction due to the nature of the U.S. investment. Instead, these parties would be wise to consider CFIUS risks throughout the deal process. This includes assessing the feasibility of the transaction from a CFIUS perspective, conducting diligence, negotiating appropriate terms and conditions, and submitting a notice to CFIUS, as necessary. These measures will reduce the uncertainty regarding CFIUS risks in a pending transaction and facilitate the accomplishments of each party’s goals.

*This blog post was originally on AG Trade Law.

September 30, 2016
The Ethics of Representing Founders
by Paul R. Tremblay

Lawyers for startups typically serve as counsel to the new organization, with all of the complications that accompany representing an entity. But consider those lawyers as they perform legal work for the enterprise before any organization exists. Who are their clients?

Startup founders tend to be individuals. Sometimes, the startup founders create an entity—an LLC, a subchapter S corporation, a subchapter C corporation, or some other structure—on their own, without seeing a lawyer. In those instances, the eventual lawyer works with the "duly authorized representatives" of the established company, with the entity as the client. But just as often, the founders retain lawyers to help select and establish the appropriate organization and to assure that the business begins on the right footing. Those lawyers, who can end up doing a lot of work before an organization exists, must have someone as the client. One would expect that the clients are the founders themselves, individually through a joint representation agreement. That would be mostly right, but in a paper to be published next winter and available here, I explore the complexities of that assumption. Surprisingly, not a lot has been written in the legal ethics world about this pretty common phenomenon.

There are three complicating factors to which lawyers working with founders must attend. The first is this: Those individual founders, whether they know it or not, often will qualify as partners within a partnership that arises by default. But not always. An inchoate business enterprise, without any real economic activity or ownership of assets, should not be deemed a partnership, and the lawyer will then represent some or all of the founders as individuals. But a business that does have some identity, property, and commercial activity before its entity formation will qualify as a partnership under the Revised Uniform Partnership Act (RUPA), which represents the substantive law in just about all jurisdictions. The lawyer who assists those founders in setting up the business needs to be clear with the founders, and in her retainer agreement, whether she will represent the partnership—an organization, separate from its constituents—or the individual partners.

That lawyer, of course, must discern which setting she and the founders are in. Where the startup enterprise does appear to satisfy the RUPA standards and qualifies as a partnership, it would be unusual, and strategically puzzling, for the lawyer to opt to represent the individuals, and not the enterprise.

The second complication relates to the practical uncertainty about which persons qualify as founders, or as partners in the active business setting. That challenge arises when the founders first approach the law firm, but it also reappears when founders move around. And founders, as we know, do move around, and come and go.

Consider first the non-partnership enterprise, where the lawyer’s clients will be the individual founders. It is easy to state that the lawyer will represent all of the founders collectively, which the Model Rules of Professional Conduct (like RUPA, but with more variation, the basis of the ethics rules in almost all United States jurisdictions) will generally permit with appropriate informed consent. (The lawyer might choose to represent just one of the founders, and expressly not represent the others, but I conclude that such a choice is likely to be awkward and ineffective.) But to suggest "all of the founders" begs the critical question of who qualifies as a founder. Startups frequently emerge from the work of several collaborators who contribute to the enterprise in different, and often uneven, ways. Some members of the team will easily be understood to be genuine founders; others, though, will be helpers whose participation is useful but not essential. When crafting a retainer agreement with multiple individual clients, the law firm must make judgments about which of the team members will be on or off that representational bus.

If the enterprise qualifies as a partnership, the same difficulty arises, just with different labels, as the law firm aims to discern who among the team is a partner. RUPA requires an ownership stake and, usually, responsibility for losses, along with some rights of control, to satisfy the partnership definition. It will matter, and not only for purposes of the attorney-client privilege, which constituents possess partnership rights and which do not.

This uncertainty, in both settings, is only accentuated by the not-uncommon phenomenon I call "founder drift." Once the law firm has identified the individuals who will be clients (in the inchoate setting) or partners (in the active business setting), it will often have to respond to the happenstance that startup founders walk away from the enterprise. This seems to be especially true in early-stage high tech startups, where the participants’ financial investments are less steep and the competing demand for savvy tech talent is high.

In the inchoate setting, a founder who leaves the group is still a former client to whom the lawyer owes some duties. Ordinarily, the law firm can continue to represent the remaining clients, even if the founder who left moves to a similar business elsewhere. The Model Rules, in the comments to Rules 1.7 and 1.9, imply that assistance to a former client’s competitor should not be a disqualifying adverse representation. If the former founder has ownership rights in intellectual property important to the enterprise, though, the lawyer might have to send the remaining partners to a new law firm.

The effect of founder departure in the partnership setting is more complicated, at least conceptually. Even under the more liberal RUPA doctrine (compared with its predecessor Uniform Partnership Act, or UPA), a partner’s exit from the partnership-by-default triggers a dissolution of the partnership. The lawyer’s client disappears. The remaining partners (along with the former founder’s replacement, perhaps) may form a new partnership, and the lawyer will then have a new, distinct client, so the RUPA implications might be more technical than substantive. The former founder is not a former client of the law firm, so that helps, but the partners from the original enterprise most likely owe some fiduciary duties to one another, duties the lawyer must respect. And the departing partner is entitled to an accounting and a buyout of her interests, which the lawyer will most likely oversee.

Sometimes the pre-incorporation departure will result from a shift in interest, or a better offer elsewhere, with little ill will. Sometimes, though, the departure will result from serious disagreement about the enterprise or the participants’ relative shares of power or ownership, in which case the rancor could be greater. The law firm can skate more easily through the former happenstance (with full attention to any mandatory duties, of course), but must be especially wary of the latter. The firm may conclude that prudence warrants a withdrawal from any further representation if it is not sufficiently clear that the departed partner has no objections to the law firm’s continuing with the business it started with.

Finally, the third complication: All of the complexity just described will arise immediately when the lawyer first meets the founders (or, as is not unlikely in practice, meets some founders but not some others who can’t make the meeting). To the extent that the lawyer recognizes potential conflicts of interest, as she would, for instance, if she concludes that her clients will be some individuals and not a partnership entity, she must counsel those persons to understand fully the implications of proceeding with one lawyer notwithstanding the risks of possible conflicts down the road. She also must make clear to the participants in both settings that information she learns from any one of them will be shared with the others. And her work with the founders or partners must be accomplished without favoring the interests of any one of them over the interests of the others.

This post comes to us from Clinical Professor Paul R. Tremblay of Boston College Law School. It is based on his recent article, "The Ethics of Representing Founders," available here.



September 30, 2016
A Unified Theory of Insider Trading Law
by Zachary Gubler
Editor's Note:

Zachary J. Gubler is Professor of Law at the Sandra Day O’Connor College of Law, Arizona State University. This post is based on a forthcoming article by Professor Gubler.

In the United States, insider trading law is premised on an anti-fraud statute—Section 10(b) of the Securities Exchange Act of 1934—and therefore liability turns on theories about why insider trading is fraudulent. For nearly forty years, courts have relied on the “classical theory” to explain the classic case of insider trading, where a corporate insider uses information derived from his corporate position to trade in his own corporation’s stock. Drawing on the common law of fraudulent non-disclosure, the classical theory provides that insider trading is fraudulent when the trader owes fiduciary duties to the party on the other side of the trade. In A Unified Theory of Insider Trading Law, forthcoming in the Georgetown Law Journal, I argue that the classical theory of insider trading has outworn its usefulness because it fails to do what a theory must, which is explain settled law and provide answers to unsettled law that are intuitively appealing. Instead, courts should replace the classical theory with an alternative, the misappropriation theory, which courts currently limit to cases involving insider trading by “outsiders”—non-employees of the corporation whose securities form the basis of the trade. The result would be a single, unified theory of insider trading law that both explains what courts do and yields intuitively compelling results.

The problem with the classical theory is that it only makes sense in the narrowest of cases: where a corporate executive purchases shares in his company’s stock as a result of material non-public information belonging to his corporation. There, the executive has a fiduciary relationship with the stockholder on the other side of the trade, and therefore it is fraudulent for the executive not to disclose the information motivating the trade. However, one can alter almost any aspect of that narrow hypothetical and immediately run into problems under the classical theory. For example, what if the executive is selling his company’s stock to someone who is not yet a stockholder of the corporation? Or what if instead of trading on the information, the executive passes it along to a friend who trades on it? Because the classical theory requires a duty owed to the transactional counterparty, it has a difficult time explaining why there should be insider trading liability for sales of stock or for tips. Now, to be sure, the Supreme Court long ago extended liability to both of these scenarios. However, it is unclear how one reaches that conclusion under the classical theory.

Of course, if the classical theory weren’t expected to continue to drive outcomes in unsettled cases, these types of logical problems might not be that big of a deal. But it is, and they are. Consider for example, the question of insider trading in debt securities. Information affects the value of publicly traded debt in much the same way as equity, and yet executives don’t owe fiduciary duties to debtholders. Consequently, under the classical theory, there is no liability for insider trading in debt, as most courts have held. Or consider the treatment of repurchases under the classical theory. Since the corporate entity itself cannot be said to owe fiduciary duties to shareholders, under the classical theory, the insider trading ban would not extend to a corporation’s repurchases of its own stock. This might seem problematic considering that a repurchase can increase the value of unsold shares, and given that it is the corporation’s management, themselves stockholders, who ultimately make the repurchase decision.

So, what’s the solution? In the article, I argue that we should replace the classical theory with the misappropriation theory of insider trading. The main difference between the two theories has to do with the beneficiary of the fiduciary duty in question—the shareholder-counterparty in the case of the classical theory and the source of the information in the case of the misappropriation theory. So, for example, if a lawyer acquires information from a client about a company with which he has no relationship and then subsequently trades in that company’s stock, there is no liability under the classical theory. However, there is liability under the misappropriation theory because of the lawyer’s relationship of trust and confidence with the source of the information, his own client. The lawyer’s failure to disclose the breach of that trust is deemed fraudulent.

Courts have historically applied the misappropriation theory only to cases of insider trading involving corporate outsiders, but there is no reason why it couldn’t also be applied to the classic case of insider trading. After all, when an insider trades in his own corporation’s stock based on material non-public information, he misappropriates that information in breach of a fiduciary relationship owed to the corporate entity. This unified approach to insider trading law would have two important advantages over the classical theory. First, applying the misappropriation theory to the classic case of insider trading would do a better job explaining what courts actually do in these cases. It would no longer require logical leaps to explain why courts hold insiders liable for insider trading involving sales of securities or for tips. Additionally, with respect to those classic insider trading cases where the law is unsettled, the misappropriation theory would lead to more intuitively appealing results than under the classical theory. Specifically, the misappropriation theory would lead to liability for insider trading in debt securities. In such cases, the insider misappropriates information from his corporation regardless of what type of security he subsequently trades in. Additionally, the misappropriation theory would allow for liability in certain circumstances for corporate repurchases.

Of course, the misappropriation theory isn’t perfect. But I argue that its weaknesses are actually less of a concern in the classic case of insider trading than in outsider trading where it’s already well established. Otherwise, the theory’s weaknesses can be addressed through fairly simple SEC disclosure rules. In short, a unified misappropriation theory of insider trading would go a long way to solve some of the problems at the heart of U.S. insider trading law.

The complete article is available for download here.

September 30, 2016
AML Obligations of Broker-Dealers
by Jon Eisenberg, Joseph Valenti, Stephen Topetzes, Vincente Martinez, K&L Gates
Editor's Note:

Jonathan N. Eisenberg is partner in the Government Enforcement practice at K&L Gates LLP. This post is based on a K&L Gates publication by Mr. Eisenberg, Stephen G. Topetzes, Vincente L. Martinez and Joseph A. Valenti.

Since 2002, as part of their anti-money laundering (“AML”) responsibilities, broker/dealers have had a gatekeeper-like obligation to monitor customers for “suspicious” activities and to report those activities to the Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”). In the words of the Financial Industry Regulatory Authority (“FINRA”), “Just as firms have a primary responsibility to supervise their associated persons and ensure that they are not involved in fraudulent schemes, firms must also be vigilant regarding their customers.”[1]

Despite considerable resources that broker/dealers have devoted to meeting their AML responsibilities, many firms are falling short of FINRA’s expectations. Over the last decade, FINRA brought hundreds of enforcement actions against broker/dealers and AML compliance officers (“AMLCOs”) for AML violations.[2] In 2015 alone, AML was referenced in 33 FINRA Acceptance, Waiver and Consents (“AWC”), 18 Orders Accepting Offers of Settlement, and nine FINRA complaints initiating enforcement actions. In 2016, FINRA imposed its largest AML-related fine ever against two affiliated firms even though the firms had very substantial AML programs.

We review below 12 key ways broker/dealers and AMLCOs can reduce the likelihood of being named in FINRA AML-related enforcement actions. We base this analysis on a review of i) every litigated FINRA AML-related enforcement action, ii) every settlement of a FINRA AML-related enforcement action since January 2015, as well as many of the larger settlements before that time, iii) FINRA’s AML-related rules, and iv) guidance that FINRA has provided in the form of notices to members and yearly regulatory and examinations priorities letters. Many of the areas covered may seem basic, but deficiencies in these areas account for the vast majority of FINRA AML-related enforcement actions. The 12 areas are:

  1. tailoring the firm’s AML procedures to the risks posed by the firm’s business and customer mix rather than relying on out-of-the-box policies and procedures, such as FINRA’s small-firm AML template;
  2. providing resources adequate to address the risks;
  3. implementing a strong customer identification program;
  4. filing suspicious activity reports (“SARs”) when firms have “reason to suspect” unlawful or other “suspicious” activity even if a firm does not know that the activities are unlawful;
  5. rigorously reviewing red flags rather than relying on self-serving or superficial responses, and fully documenting the reviews conducted;
  6. avoiding or carefully addressing the risks posed by penny stock transactions, including both fraud risk and registration risk;
  7. avoiding or carefully addressing “market access” (especially market access provided to high-frequency traders), including a robust, automated surveillance program for manipulative trading;
  8. avoiding or carefully addressing correspondent accounts of foreign financial institutions, including enhanced due diligence;
  9. avoiding or carefully addressing doing business with customers with questionable backgrounds;
  10. analyzing and following up on regulatory inquiries into potentially suspicious activities;
  11. undertaking meaningful and independent annual reviews of AML programs; and
  12. checking the completeness and accuracy of the data sources on which AML surveillance is based.

After we provide a very brief overview of AML obligations in the Background section below, we turn to deficiencies that led to FINRA enforcement actions in the 12 areas. The discussion of the enforcement actions is designed to give the reader a practical feel for the types of AML-related shortcomings that have led to enforcement actions in the past. Deficiencies in these areas are also most likely to lead to enforcement actions in the future.


In April 2002, in response to Congress’s enactment of the 2001 USA Patriot Act, the NASD adopted Rule 3011 (now FINRA Rule 3310). The rule requires broker/dealers to develop and implement written anti-money laundering programs.[3] At a minimum, the programs must:

  • be approved in writing by a member of senior management;
  • establish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of “suspicious transactions” relevant to a possible violation of law or regulation,
  • establish and implement policies, procedures, and internal controls reasonably designed to achieve compliance with the Bank Secrecy Act and its implementing regulations;
  • provide independent testing of the AML program;
  • designate and identify to FINRA an individual or individuals responsible for implementing and monitoring the AML program; and
  • provide ongoing training for appropriate personnel.

Rule 3310 is similar to Department of Treasury Rule 31 CFR 1023.210, “Anti-Money Laundering Program Requirements for Brokers or Dealers in Securities,” except that the latter adds:

  • appropriate risk-based procedures for conducting ongoing customer due diligence, to include, but not be limited to:
    • understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile; and
    • conducting ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information.
12 Critical Obligations 1. Tailoring AML Programs to the Most Significant Risks

AML policies and procedures are required to be risk-based. In a number of cases, FINRA has sanctioned firms in part because they used out-of-the-box AML policies and procedures rather than policies and procedures tailored to the risks posed by their businesses. Similarly, the SEC National Associate Director for the Broker-Dealer Examination Program stated, “In our examiners’ experience, the ‘reasonably designed’ standard is not met where firms rely on boilerplate language or templates or ‘off-the-shelf’ programs that are not tailored to their customers, products, services, geographic locations, or methods of customer interface.”[4]

For example, in a decision by FINRA’s National Adjudicatory Council, FINRA stated that a market maker’s policies and procedures with respect to suspicious activities enumerated 25 examples of AML issues identified in Special NASD Notice to Members 02-21 and the template provided by FINRA to small firms to assist these firms in establishing AML programs, and that the procedures should, instead, have focused on the risks that might arise in connection with its market-making activities, such as market manipulation, noncompetitive trading, or fictitious trading. While the firm also had a “Capital Markets Manual” that covered trading abuses, FINRA stated that these were not addressed in the context of AML concerns. FINRA deemed the AML procedures “not reasonably designed” because they included red flags that were largely irrelevant to its business and omitted red flags that were central to its business. Other cases have also found AML procedures deficient when firms used FINRA’s small-firm AML template or other out-of-the-box procedures without tailoring those procedures to the risks of their businesses.

In a more recent case, involving the largest fines FINRA has ever imposed for AML-related violations, the AWC stated that two affiliated firms failed to establish AML programs tailored to each firm’s business and instead relied on a patchwork of written procedures and systems across different departments to detect suspicious activities. FINRA stated that the firms lacked adequate written procedures to monitor certain high-risk activities, including:

  • transfers of funds to unrelated accounts without any apparent business purpose;
  • journaling securities and cash between unrelated accounts for no apparent business purpose, particularly internal transfers of cash from customer accounts to employee or employee-related accounts; and
  • movements of funds, by wire transfer or otherwise, from multiple accounts to the same third party.

They also lacked adequate procedures to monitor for high-risk incoming wire activity, such as third-party wires and wires received from known money laundering or high-risk jurisdictions.

As we discuss below, firms whose customers engage in penny stock transactions, firms that provide “market access” to customers, firms that do business with correspondent accounts of foreign financial institutions, and firms whose customers have a history of regulatory problems are at particular risk if they fail to tailor their AML procedures to the risks posed by these businesses and customers.

2. Providing Resources Adequate to Address the Risks

AML programs must not only be reasonably designed, they must be adequately resourced as well. The larger the business and the greater the risk posed by the business, the larger the commitment of resources FINRA expects. Similarly, the head of the SEC’s broker-dealer examination program, has emphasized, “Examiners assess the capacity of designated compliance officers, including their background and experience and whether they have the resources to perform their jobs adequately.”[5]

For example, in a FINRA hearing panel decision accepting an offer of settlement, FINRA stated that a firm that had a large market access business “assigned an inadequate number of employees to establish, implement and enforce regulatory risk management controls and supervisory systems for its market access business,” and that the employees “lacked a fundamental understanding of multiple forms of manipulative trading.” It stated that the supervisor charged with developing and overseeing post-trade manipulation reviews was inadequately trained and “grossly understaffed” to handle the required compliance tasks delegated to her supervision.

In an AWC, FINRA found that a firm that cleared hundreds of thousands of trades a day for over 200 correspondent firms failed to allocate sufficient resources to the Firm’s AML compliance program and that the failure resulted in, at times, inadequate and untimely reviews. FINRA stated, “Given the limited resources allocated to conduct these reviews, at times these exception reports were not consistently reviewed or, in some instances, reviewed at all.” In another AWC, FINRA found that two affiliated firms that grew from 2400 registered reps to 5300 registered reps over an eight-year period failed to dedicate sufficient AML resources to match the firms’ growth. It found that the six-employee AML Department was inadequate in light of “the extensive responsibilities assigned to the few individuals, including the labor-intensive manual reviews....”

FINRA has also found AML procedures inadequate when firms relied on manual rather than automated reviews of high-volume trading to identify suspicious transactions.

3. Implementing a Strong Customer Identification Program

Broker/dealers are required to have risk-based Customer Identification Programs (“CIPs”) that enable a firm to form “a reasonable belief that it knows the true identity of each customer.”[6] The CIP must contain procedures for verifying the identity of each customer within a reasonable time after the customer’s account is opened, and must describe when a broker/dealer will use documents, non-documentary methods, or a combination of both methods for verification. The CIP must also include procedures for responding to circumstances in which the broker/dealer cannot form a reasonable belief that it knows the true identity of a customer—including when the broker/dealer should not open an account, when it may conduct transactions while it attempts to verify the customer’s identity, when the broker/dealer should close an account, and when the broker/dealer should file a SAR.

In the only litigated AML-related case we found largely rejecting the staff’s allegations, a FINRA hearing panel accepted that the following CIP was adequate with one exception discussed below:

  • the AML Manual set forth the customer identification program;
  • the program required the firm to collect a variety of identifying information for each customer when opening new accounts;
  • the New Account Department examined the new account documents to look for obvious fraud and forgery, and to look for signs of suspicious activity in new account items;
  • the firm checked the Specifically Designated Nationals and Blocks Persons List maintained by Treasury’s Office of Foreign Asset Control;
  • if a customer’s name was found on the list, the AML Manual required the AML compliance officer to follow whatever government directives were applicable;
  • the firm also consulted the Financial Action Take Force’s list of non-cooperative countries and territories to verify that the customer was not doing business with any of them;
  • the firm used the Equifax service to verify basic customer information—for example, Equifax checked a customer’s social security number to see if the number had been issued to someone who was deceased, or if it was issued before the customer’s date of birth;
  • the firm also checked with the Compliance Data Center (“CDC”), an Equifax affiliate, that monitors newspapers and other public information sources, and maintains a database of people with negative information (including whether they had been fined by FINRA);
  • the firm forwarded the CDC reports to its introducing firms;
  • for foreign customers, the firm required the introducing firm to obtain a copy of a government-issued picture identification document.

While the hearing panel found most of the firm’s procedures adequate, it found that the CIP was deficient with respect to obtaining customer identification information for delivery versus payment (“DVP”) accounts, i.e., accounts in which delivery of securities occurs simultaneously with payment at a custodian institution. The panel stated that although the firm believed there was a very low risk to the firm of money laundering through DVP accounts, the absence of customer identification procedures for such accounts violated AML requirements because “[t]here is no exclusion from the customer identification requirements for DVP accounts.”

In other recent settlements, FINRA stated that CIPs were deficient because:

  • in multiple instances, the firm failed to obtain photo identification from new customers or otherwise verify their identifies in connection with the opening of an account;
  • a clearing firm for 86 correspondent firms relied on introducing firms to populate customer identification information, but some introducing firms failed to provide the information and the clearing firm nevertheless executed transactions for those accounts;
  • the firm failed to uncover a customer’s prior regulatory history because it failed to use the customer’s full name in its search, and, as a result, failed to include the accounts of the customer and the customer’s children on its heightened customer account monitoring list;
  • the firm failed to obtain and verify business or other documents for correspondent accounts, such as certified articles of incorporation, a government-issued business license, a partnership agreement, or a trust instrument, which led to customers being permitted to participate in suspicious activities without appropriate documents in the files;
  • the firm relied on foreign finders to collect and submit customers’ documentary verification data and was unable to verify the information provided;
  • the firm failed to collect and verify identifying information for most of its institutional accounts;
  • the firm failed to retain evidence of its use of documentary methods to verify identifying information for most of the individual and joint accounts and failed to provide notice to its customers that it was collecting identifying information;
  • when clients closed accounts, the firm’s system recycled previously assigned account identifiers, in which case the CIP system treated the new accounts as if they had already gone through the CIP system and did not verify the identities of the new customers with recycled identifiers;
  • when the firm obtained inconsistent identifying information, the firm failed to employ reasonable procedures to address those inconsistencies to form a reasonable belief that it knew the true identity of the customer; and
  • the clearing firm did not have a formal agreement with its affiliated introducing firm detailing the scope and parameters of the CIP procedures.
4. Filing SARs When Firms Have “Reason to Suspect” Unlawful or Other Suspicious Activity Even if Firms Do Not Know the Activities Are Unlawful

A broker/dealer’s obligation to file a SAR may arise well before the broker/dealer knows of unlawful activity. The obligation arises when a broker-dealer “knows,” “suspects,” or even has “reason to suspect” that a transaction of at least $5,000 i) involves funds derived from illegal activity or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity as part of a plan to violate or evade any federal law or regulation, ii) is designed to evade any requirement of the Bank Secrecy Act, iii) has no apparent business or lawful purpose or is not the sort of activity in which the particular customer would normally be expected to engage, or iv) involves the use of the firm to facilitate criminal activity.[7]

The SEC and FINRA are highly focused on whether firms file SARs that they should have filed and whether the SARs adequately describe the facts giving rise to the suspicion of unlawful activity. Last year, the Director of the SEC’s Division of Enforcement expressed concern about both the number and quality of SARs that broker/dealers file.[8] With regard to the number, he stated that the average broker/dealer (of the roughly 4,800 broker/dealers in the United States) files about five SARs per year, and added:

This is disconcerting and hard to understand. Think about your businesses—is it possible that only five transactions a year were suspicious enough to justify a SAR filing? The nature of your industry and the sheer volume of transactions executed each year suggest to me that this number is far too low.

He stated that the SEC was reviewing the number of SARs filed by particular firms compared to the number of registered reps associated with the firms, the number of customer accounts, whether the firm retailed microcap securities, the number of regulatory, civil and criminal disclosures related to the firms, and the number of times the firm was involved in transactions that the Division has investigated in the past. Earlier this year, the SEC fined a firm $300,000 for not filing SARs when it “knew, suspected, or had reason to suspect” that its penny-stock customers were using their accounts to facilitate unlawful activity.

With regard to the content of the SARs, he stated that some firms provided narratives that were far too skeletal and revealed a “check-the-box” mentality—for example, they might say that there was a deposit and sale of shares, but provide no explanation of the basis of suspicious. He stated that such narratives suggest that the firm does not take its AML responsibilities seriously.

FINRA’s principal focus with respect to the filing of SARs has been not on whether a firm should have filed a SAR, but whether a firm gave adequate consideration to whether to file a SAR. Going forward, we expect that FINRA, like the SEC, may increasingly focus on firms that appear to have filed fewer SARs than would be expected given their size and businesses, especially firms whose customers engage in substantial penny stock transactions, or are given “market access,” or are correspondent accounts of foreign financial institutions, or have questionable regulatory backgrounds or have prompted repeated regulatory inquiries. FINRA can easily make comparisons among firms, and the firms with the fewest filings within their peer groups may attract more regulatory scrutiny.

5. Rigorously Reviewing Red Flags and Documenting the Reviews

Many AML enforcement actions involve the failure to adequately follow up on red flags. In some cases, FINRA found that the firms’ policies and procedures failed to provide sufficient guidance on properly investigating red flags. For example, in one case, FINRA acknowledged that the firm’s AML procedures contained a section that identified red flags, but stated, “[E]ven as to those red flags that were identified, the Firm’s AML procedures provided inadequate guidance regarding what steps should be taken to detect and investigate them.”

In other cases, FINRA has not focused on whether the procedures set forth adequate guidance but has concluded that the investigations into red flags were inadequate. For example, in one case FINRA faulted a firm for relying too much on an explanation provided by a registered rep and, instead, should have conducted its own independent investigation. It stated that the firm should have used some combination of the following in responding to red flags involving trading in microcap securities:

  • a more comprehensive review of electronic communications than the email sampling typically performed for routine supervisory surveillance;
  • obtaining detailed explanations of account activity and communications from the customers in question;
  • ascertaining which accounts were transacting or coordinating with one another and towards what end;
  • evaluating the size of the deposits of securities in relation to the issuer share float and the size of sales in relation to average volume or to look for signs of red flags of violative activity; and
  • searching for evidence of touting to identify potentially misleading communications indicative of pump and dump activities.

FINRA has also faulted firms for failing to document their reviews, investigations, and determinations with respect to suspicious trading.

6. Avoiding or Carefully Addressing the Risks Posed by Penny Stock Transactions

Perhaps the largest number of FINRA AML-related enforcement actions involve inadequate procedures with respect to preventing and detecting violations involving the liquidation of large volumes of low-priced securities, including both fraud and registration violations.

FINRA has specifically addressed members’ obligations with respect to registration issues in a 2009 notice to members.[9] In enforcement actions, FINRA found that firms:

  • failed to classify certain penny stock trades as suspicious activities even though the customers deposited large blocks of unregistered and newly issued penny stocks in their accounts and then immediately liquidated their positions and often wired out all of the proceeds from the sales;
  • in concluding that securities were exempt from registration and freely-tradeable, relied too much on the absence of restrictive legends and representations by third parties (such as transfer agents or attorneys) or the acceptance of the stock by a clearing firm;
  • failed to inquire into how the relevant customers received their shares of unregistered penny stocks, the customers’ relationships with the issuers, or other facts that could have revealed whether the shares were, in fact, exempt from registration;
  • even though it placed the registered rep under heightened supervision, failed to exercise sufficient supervision over a new registered rep who brought in penny stock business, which was not an area in which the firm had prior experience;
  • did not adequately respond to red flags regarding penny stocks, including:
    • the relevant customers maintained multiple accounts under the names of multiple newly incorporated entities with no business purpose;
    • the relevant customers deposited into their accounts millions of shares of unregistered penny stocks involving issuers with questionable or unknowable operating histories;
    • the relevant customers immediately sold the unregistered stock and wired the proceeds from their accounts;
    • the relevant customers repeatedly received new issuances as they sold down the stock received in prior issuances;
    • certain of the relevant customers formed corporate entities with no known business purpose shortly before opening accounts;
    • certain of the relevant customers incorporated entities in states that provide for exemptions from the state’s registration requirements, allowing the entities to purchase unrestricted and unregistered stock pursuant to SEC Rule 504;
    • the relevant customers appeared to have opened accounts for the sole purpose of depositing large amounts of unregistered shares;
    • the relevant customers sold their unregistered shares as soon as the newly issued stock certificates were deposited in the accounts, and promptly wired out the funds received from the sales; and
    • the relevant customers agreed to pay the firm exceptionally large commissions (e.g., commissions of 20-26%).
7. Avoiding or Carefully Addressing the Risks Posed by Providing “Market Access” to Customers

SEC Rule 15c3-5, adopted on November 3, 2010, provides that a broker/dealer that provides customers or other persons with access to an exchange or alternative trading system through the use of the broker/dealer’s market participant identifier must establish risk management controls and supervisory procedures designed to limit the financial exposure of the broker/dealer and ensure compliance with all regulatory requirements applicable to market access. It also requires broker/dealers to review annually the effectiveness of their risk management controls and supervisory procedures relating to market access and to certify annually that the controls and procedures satisfy the requirements of the rule. A large number of FINRA AML-related cases are based on the failure to adequately surveil for suspicious activities involving direct market access. In one case that covers the waterfront of what can go wrong when a firm provides market access, FINRA found that the firm:

  • failed to provide adequate staff to ensure appropriate regulatory risk management controls and supervisory systems and procedures;
  • provided inadequate training to persons responsible for monitoring and filing SARs with respect to its market-access business;
  • relied on a compensation system in which employees charged with monitoring trading by market access customers were paid in substantial part based on trading revenue generated by such customers;
  • enabled market access customers to flood the Exchanges with potentially manipulative trades;
  • largely relied on market access customers to self-monitor and self-report their own suspicious trades without sufficient oversight by the broker/dealer;
  • failed to adequately respond to alerts from regulators and Exchanges about suspicious and potentially manipulative customer transactions;
  • failed to track the activity identified in regulatory inquiries or attempt to identify whether any accounts or types of activity were the focus of multiple inquiries;
  • did not attempt to determine whether trading that resulted in regulatory inquiries violated FINRA rules or the securities laws;
  • failed to adequately monitor, detect, and report suspicious and potentially manipulative transactions by its direct market access customers;
  • lacked an adequate process for investigating suspicious activity and filing appropriate SARs with respect to its market access business;
  • exercised insufficient oversight over three market access customers who provided heightened risk: i) an unregistered foreign-based customer; ii) a former FINRA broker- dealer that was expelled by FINRA in connection with its failure to monitor manipulative trading activity by overseas day traders; and iii) a former FINRA broker-dealer that was fined and then expelled in connection with manipulative trading activity;
  • lacked systems or written supervisory procedures designed to detect and prevent various forms of market manipulation, such as layering, spoofing, and the entry of orders with no intention of execution;
  • failed to monitor for patterns of order cancellations by high-frequency traders;
  • failed to effectively monitor for potentially violative wash trades (trades with no change in beneficial ownership);
  • failed to specify how to review the wash sale reports to determine whether transactions may have been executed with the intent to manipulate the market;
  • conducted reviews that were “superficial” and “merely administrative” and “lacked any meaningful substantive scrutiny for potential manipulation”;
  • accepted at face value its customers’ explanations for suspicious trading without conducting its own investigation of the potential problematic trades;
  • failed to conduct any cross-market reviews for wash trades that arose from orders entered on one market center but executed on another;
  • failed to place certain customers under heightened supervision;
  • conducted no reviews of apparent pre-arranged trades for its market access customers in numerous different securities across multiple market centers;
  • made no effort to ensure that each authorized trader was only issued one trader ID or to terminate inactive trader IDs;
  • failed to establish and implement effective controls relating to the deactivation and sharing of trade IDs, the assignment of multiple trader IDs to a single trader, and trading suspensions of disciplined traders;
  • failed to ensure that it had restricted trading to only those persons who had been approved and authorized by the broker/dealer.
  • with respect to a high-risk customer, failed to inquire into the customer’s trading strategy, how it selected its traders, or whether the customer performed any due diligence on them; and
  • for much of the period at issue, failed to monitor market access customers for marking- the-close.

In other market access cases, FINRA found that firms:

  • relied on an ad hoc, undocumented, manual system of surveillance for potential manipulative activities even though hundreds of trades a minute were coming across the trading desk;
  • relied on an exception report for potential wash sales but failed to specify the procedures for investigating such suspicious trading and determining whether a SAR should be filed;
  • failed to document the actual review, investigation, and determination of any particular potential suspicious trading;
  • although the firm restricted or disabled traders who engaged in potentially manipulative activity, the firm did not keep a record of all of the disciplined traders and did not assess whether the activity warranted the filing of a SAR;
  • monitored the activities on a trader-by-trader basis rather than at the customer level to gauge whether groups of traders at the customer were potentially working together;
  • failed to monitor trading activity to detect recurring types or patterns of activity by various traders within a customer’s account; and
  • confronted traders with respect to problematic trades, but, when they provided non- credible explanations, failed to investigate sufficiently to determine whether the firm should file a SAR.
8. Avoiding or Carefully Addressing the Risks Posed by Correspondent Accounts of Foreign Financial Institutions

Treasury Regulation 31 C.F.R. 1010.610 requires that broker/dealers establish a risk-based due-diligence program for “correspondent accounts” maintained by foreign financial institutions. A correspondent account is an account established for a foreign financial institution to receive deposits from, or to make payments on behalf of, the foreign financial institution, or to handle other financial transactions related to the foreign financial institution. As part of the due-diligence program, broker/dealers are required to have procedures that identify foreign correspondent accounts and conduct due diligence taking into account: i) the nature of the foreign financial institution’s business; ii) the type, purpose and anticipated activity of the account; iii) the nature and duration of the broker/dealer’s relationship with the foreign financial institution; iv) the AML and supervisory regime of the jurisdiction in which the foreign financial institution is located; and v) information known or reasonably available to the broker/dealer about the foreign financial institution’s AML record.

The rule also requires broker/dealers to conduct a periodic review of the correspondent account activity to determine i) whether the activity in the account is consistent with the information initially obtained, and ii) whether, given the volume and/or type of activity in the account, the broker/dealer can adequately identify suspicious transactions.

Many of FINRA’s AML enforcement actions involve deficiencies with respect to accounts of foreign financial institutions. For example, FINRA found that a firm failed to maintain documentation evidencing that:

  • it had determine whether each correspondent account was subject to enhanced due diligence;
  • it had assessed the money laundering risk presented by each correspondent account;


  • it had applied risk-based procedures and controls to each correspondent account reasonably designed to detect and report known or suspected money laundering activity, including a periodic review of the correspondent account activity sufficient to determine the consistent with information obtained about the type, purpose, and anticipated activity of the account.

In one case, FINRA found that the firm:

  • failed to identify the money laundering risk associated with two large correspondent accounts of Venezuelan financial institutions, and failed to address this risk in its AML policies even though it accounted for a majority of its revenues;
  • did not have AML policies and procedures:
    • addressing the money laundering risks presented by foreign correspondent accounts and foreign financial institutions, particularly those located in higher-risk jurisdictions;
    • for applying risk-based procedures and controls to each correspondent account reasonably designed to detect and report known or suspected money laundering;
    • for conducting ongoing review of activity in foreign financial institution accounts;
  • did not sufficiently consider the risks of corruption, politically exposed persons, sanctioned individuals/entities, and narco-trafficking with regard to the foreign financial institution and its correspondent accounts even though Venezuela is a high-risk country for AML purposes;
  • did not obtain sufficient information to confirm the accuracy of the representations made by the foreign financial institutions; and
  • did not adequately address facts inconsistent with the representations made by the foreign financial institutions.

In another case involving a wide range of AML compliance issues, FINRA found that a firm:

  • sometimes failed to enforce an internal requirement that the firm obtain information through a Foreign Financial Institution Questionnaire designed to obtain information regarding a correspondent account holder’s business, markets served, client base, types of activity, and nature of the account; and
  • had no reliable periodic review process in place to ensure that the activities in the foreign financial institution’s accounts were consistent with representations made by the foreign financial institutions at the time of the account opening.

In another case, the foreign financial institutions used a master/subaccount and omnibus- account structures, which FINRA stated “present significant regulatory risks due to their potential to mask beneficial ownership and to be used as vehicles to engage in illegal activity, such as money laundering, insider trading, and market manipulation.” FINRA found that the firm failed to conduct periodic reviews of the activities of each foreign financial institution correspondent account, as required by its AML policies. In another case, the firm’s AML Procedures incorrectly stated that the firm had no correspondent relationships with foreign financial institutions, and the firm failed to inquire further.

9. Avoiding or Carefully Addressing the Risks Posed by Customers with Prior Regulatory Problems

Not surprisingly, firms are at heightened risk of enforcement actions when the customers who engage in suspicious activities are customers who have a prior history of securities fraud or similar violations. Indeed, a questionable background may itself be a red flag requiring investigation, and FINRA has criticized AML procedures that:

  • did not state when and how often the firm should undertake a background check (e.g., at account inception or from time to time thereafter or if triggered by concerns or certain types of account activity);
  • how and by what means the firm would conduct a search; or
  • what further investigation or action should be taken upon discovery of matters that constituted a questionable background as described in the red flag.
10. Analyzing and Following Up on Regulatory Inquiries into Potentially Suspicious Activities

Many of FINRA’s AML enforcement programs involve firms that received numerous inquiries from FINRA Market Regulation or other regulators about potential illegal activity by customers and did not adequately follow up on the customers whose activities generated the inquiries. It is often not enough simply to respond to FINRA’s requests for information. The failure to conduct one’s own investigation may lead to findings that the firm failed to adequately follow up on red flags and thus violated its AML responsibilities.

For example, in one case, the firm received dozens of regulatory inquiries regarding potentially manipulative trades, but FINRA found that “[t]he firm did not attempt to determine whether the trading activity that resulted in regulatory inquiries had violated FINRA rules or the securities laws.”

In another case, the firm received 36 separate inquiries from FINRA’s Market Regulation Department and the Market Surveillance section of NYSE Arca related to trading in approximately 30 separate master accounts, but “did not attempt to determine whether the trading activity that resulted in regulatory inquiries violated FINRA rules or the securities laws” and “took no steps to understand the trading activity of the subaccount traders who provided written statements in response to FINRA’s inquiries—even when the traders’ written statements to [the firm] suggested that they were engaged in market manipulation.” In addition, the firm “did not review trading outside of responding to FINRA’s inquiries, even when an account appeared on multiple FINRA inquiries, or when multiple responses provided the same explanation for the trading at issue.” Despite the number of inquiries, it did not place any of the accounts under heightened supervision and “did not track the activity identified in regulatory inquiries to determine if any accounts or types of activity were the focus of multiple reviews.”

In another case, FINRA stated that a firm received multiple inquiries from FINRA Market Regulation in connection with thousands of instances of potential manipulative trading, but “took no meaningful steps to improve its ability to detect possible manipulative activity” and “continued to rely on its manual-based real-time monitoring of order/trade activity.”

11. Implementing a Meaningful, Independent Annual Review of AML- Compliance Programs

FINRA Rule 3310(c) (formerly NASD Rule 3011(c)) requires that the AML program must “provide for annual (on a calendar-year basis) independent testing” to be conducted by member personnel or by a qualified outside party.”[10] FINRA has stated that the test must review and assess the adequacy of and level of compliance with the firm’s AML program.[11]

FINRA has frequently found that the testing of AML programs was inadequate, either because it was too cursory or because it was not independent. For example, in one case, FINRA found:

  • the testing was not independent because the AMLCO participated with a third party in the testing and chose the documents that would be reviewed;
  • the third party conducting the tests never reviewed new account applications, customer files, or visited the firm’s office to conduct the AML test;
  • the test failed to determine whether AML training was provided to firm personnel and failed to examine the adequacy of any such training;
  • the test did not ascertain whether the firm had been responding to information requests issued by FinCEN; and
  • the test did not provide for a reasonable review of the firm’s customer identification program.

In other cases FINRA found the testing inadequate because:

  • the testing failed to address penny stocks despite the fact that this was a high-risk activity for the firm’s customers;
  • the tests failed to evidence any review of recently established surveillance systems;
  • the tests failed to uncover shortcomings in trade monitoring and asset movement monitoring that FINRA identified;
  • the testing failed to adequately assess the firm’s compliance with its AML procedures because the tester, though aware of red flags associated with penny stock accounts, did not note the red flags or explore whether the firm detected the red flags or whether the firm conducted adequate due diligence in response to such activity;
  • the testing was limited in scope to those areas of “primary responsibility” for detecting money laundering rather than the full AML program;
  • the testing was conducted by the firm’s chief financial officer, who was not independent;
  • the tests were conducted by a person who was not experienced or trained in AML, and the testing consisted of a general review without a specific review period, specific instructions, or provisions for follow-up to ensure that recommendations would be implemented;
  • no testing was conducted to ensure that the identities of the firm’s adviser customers were verified, and the test summaries did not evidence a review to determine whether any firm customers were excluded from the definition of customer for AML purposes;
  • although the firm stated that a sample of customer applications, deposits, and outgoing wires had been reviewed, it was unable to evidence such reviews;
  • the testing reports did not evidence the sampling or review of certain records, including i) records of any risk-based monitoring of the red flags described in the AML procedures to confirm that it was being performed; or ii) records of underlying securities transactions to confirm that any red flags were being effectively detected;
  • the testing reports were inaccurate because the reports represented that the firm engaged in certain monitoring activity but the evidence showed that the firm did not monitor the activity;
  • the testing did not address certain risks associated with the firm’s business and client base, including procedures for detecting suspicious activity related to transfer of low priced stocks via deposit/withdrawals at the custodian, through physical certificates, or journals; and
  • the testing was not conducted on a timely basis.
12. Verifying the Completeness and Accuracy of Data Sources Used for AML Surveillance

FINRA’s 2016 Regulatory and Examination Priorities Letter stated that AML would be one of the four principal areas FINRA would focus on in 2016 (the others being management of conflicts of interest, technology, and outsourcing). For the first time in its annual priorities letters, it stated that it had observed problems with firms’ automated AML surveillance systems not capturing complete and accurate data, and that firms should routinely test systems and verify the accuracy of data sources, particularly with respect to higher-risk accounts and activities. While this has not produced noteworthy AML-related enforcement actions in the past, the priorities letters often foreshadow future enforcement actions. Thus, firms are well-advised to take steps to verify the accuracy of data sources used in connection with their AML-surveillance programs.


The above areas account for the vast majority of FINRA AML-related disciplinary actions brought to date and are likely to show up in future enforcement actions as well. Given the continued focus on AML and on these areas in particular, broker/dealers should give careful attention to each of these areas in their design, implementation and review of their AML compliance programs.


[1] 2011 FINRA Regulatory and Examination Priorities Letter.
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[2] The FINRA enforcement actions are in addition to the AML-related actions brought by the Department of Justice, the Securities and Exchange Commission, and FinCEN against banks and other financial institutions. Some of these have been for very substantial penalties.
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[3] In connection with its adoption of NASD Rule 3011, the NASD issued an 18-page Special Notice to Members, NTM 02- 21, which provides interpretive guidance. FINRA frequently cites that guidance in its AML-related enforcement actions. In August 2002, it issued NTM 02-47, providing additional guidance, and in 2003 it issued NTM 03-34 providing further guidance. FINRA has also issued a 49-page “Small Firm Template” that sets forth AML policies and procedures. At least since 2006, each of FINRA’s annual Regulatory and Examinations Priorities Letters have discussed AML areas in which FINRA is focused. Additional AML guidance can be found at, for example, SEC, “Anti-Money Laundering (AML) Source Tool for Broker-Dealers,” (June 20, 2012),, and on FINRA’s AML home page, For a description of the relevant guidance in this area from the perspective of two senior FINRA enforcement attorneys, see Allen Boyer and Susan Light, “Dirty Money and Bad Luck: Money Laundering in the Brokerage Context,” 3 Virginia Law & Business Review 81 (2008).
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[4] Kevin W. Goodman, “Anti-Money Laundering: An Often-Overlooked Cornerstone of Effective Compliance,” (June 18, 2015).
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[5] Id.
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[6] 31 C.F.R. 1023.220.
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[7] 31 C.F.R. 1023.320.
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[8] Andrew Ceresney, “Remarks at SIFMA’s 2015 Anti-Money Laundering & Financial Crimes Conference,” (Feb. 25, 2015).
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[9] Notice to Members 0-9-05, “Unregistered Resales of Restricted Securities,” (Jan. 2009).
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[10] Firms that do not execute transactions for customers or otherwise hold customer accounts and do not act as introducing brokers may test once every two years rather than on an annual basis.
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[11] NASD Notice to Members 02-21.
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September 30, 2016
This Week In Securities Litigation (Week ending Sept. 30, 2016)
by Tom Gorman

As the government fiscal year draws to an end, the Commission filed a series of enforcement actions. Those included two insider trading cases, an action alleging violations of the whistleblower provisions, another against a community bank tied to allegations about the valuation of its loan reserves, a financial fraud case against Weatherford International tied to its tax avoidance efforts and a market access proceeding against Merrill Lynch.

The SEC also filed two FCPA actions. Once was brought against a hedge fund Och-Ziff tied to is actions in certain African countries. The proceeding stems from the Commission’s investigation of sovereign wealth funds. A second focuses on the Indian subsidiary of beer giant Anheusar Busch.


Proposed rule: The Commission proposed a rule amendment to shorten the settlement process for securities transactions from three days to two (here).

Final rule: The Commission adopted rules to enhance the regulatory framework for securities clearing agencies that are deemed systemically important or that are involved in complex transactions such as security based swaps (here).

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 7 civil injunctive action and 12 administrative proceeding, excluding 12j and tag-along proceedings.

Offering fraud: SEC v. Savva, Civil Action No. 16-cv-5432 (E.D.N.Y. Filed Sept. 29, 2016) is an action against Nicholas Savva. It centers on defrauding 12 investors in connection with his fund, Five Star Capital Fund, LP. The complaint alleges that Mr. Savva made misrepresentations about the firm’s management and its industry experience and historic performance in soliciting investments. A total of about $1.2 million was raised from investors. Defendant Savva misappropriated over $38,000 of the investors’ funds. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Mr. Savva resolved the action, consenting to the entry of a permanent injunction based on the Sections cited in the complaint. He also agreed to pay disgorgement of $58,391.98, prejudgment interest and a penalty of $160,000. See Lit. Rel. No. 23661 (Sept. 29, 2016).

Whistleblowers: In the Matter of International Game Technology, Adm. Proc. File No. 3-17596 (Sept 29, 2016) is a proceeding which names as a Respondent the manufacturer of gaming equipment. An Employee of the firm responsible for evaluating the pricing methodology used at its parts division reported to the company and the Commission that the financial statements may be misstated because of its cost accounting model. An internal investigation was conducted. Investigators determined that the financial statements were correct. A few months later Employee was terminated. The Order alleges violations of Exchange Act Section 21F(h). To resolve the action the firm consented to the entry of a cease and desist order based on the Section cited in the order and agreed to pay a penalty of $500,000.

Insider trading: SEC v. Gadimian, Civil Action No. 1:16-cv-11955 (D. Mass. Filed Sept. 29, 2016). Defendant Robert Gadimian was employed by Puma Biotechnology, Inc. from November 2011 through October 2014. The firm was developing a drug for the treatment of breast cancer. In 2013 and 2014, Mr. Gadimian learned that the drug had reached key mile stones and, in advance of the announcements of trail results in each year, purchased company stock and options. In each instance he made the purchase in violation of firm policy during a blackout period. Overall he had trading profits of about $1.1 million. During an internal investigation at the firm, launched after hearing about some of Mr. Gadimian’s trading through a FINRA inquiry, Mr. Gadimian admitted to the transactions – after altering his brokerage records. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. A parallel action criminal action was brought by the U.S. Attorney’s Office for the district of Massachusetts.

Insider trading: SEC v. Coppero, Civil Action No. 1:16-cv-07591 (S.D.N.Y. Filed Sept 28, 2016) is an action which names as defendants Nino Coppero Del Valle, an employee of HudBay Minerals, Inc. and a lawyer resident in Peru; Julio Antonio Castro, Mr. Coopero’s close friend and also a lawyer in Peru; and Richardo Carrion, Mr. Coopero’s acquaintance and a manager of a brokerage firm in Peru. The action centers on the February 9, 2014 announcement by HudBay that it would make a tender offer to acquire all the shares of Augusta Resource Corporation. After learning about the deal Mr. Coopero first tipped Defendant Castro; later he tipped Mr. Carrion. Subsequently, Messrs. Coopero and Castro traded together through the brokerage account of an off shore shell corporation. Mr. Carrion also traded. Following the deal announcement Messrs. Coopero and Castro had trading profit of over $73,000. The two men later tried to cover up their trading. The case is pending. See Lit. Rel. No. 23660 (Sept. 29, 2016).

Offering fraud: SEC v. Kohli, Civil Action No. 16-cv-5413 (E.D. Pa. Filed Sept. 28, 2016) is an action against Peter Kohli, DMS Advisors, Inc. and Marshad Capital Group, Inc. Mr. Kohli is the CEO of DMS, a registered investment adviser which advises DMS Funds; Marshad, controlled by Mr. Kohli, owns DMS. In 2012 Mr. Kohli launched DMS Funds. In the registration statement he falsely overstated the Funds’ sophistication and ignored key risks, including the fact that neither he nor DMS Advisors would be able to pay the expenses. Investors were told that Marshad had taken steps toward an IPO which was false. Mr. Kohli also misappropriated investor funds, using them to pay fund expenses. In addition, promissory notes were sold to investors despite the fact that there was no reasonable hope they could be honored. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4) and Investment Company Act Section 34(b). The court granted temporary relief. The case is pending. See Lit. Rel. No. 23659 (Sept. 28, 2016).

Supervision: In the Matter of UBS Financial Services Inc., Adm. Proc. File No. 3-17887 (Sept. 28, 2016) is a proceeding which names the registered broker-dealer and investment adviser subsidiary of UBS AG as a Respondent. Beginning in 2011, and continuing for the next three years, the firm sold a product called single stock-linked reverse convertible notes or RCN’s to its customers. The product is a complex structured note tied to single underlying stocks that had sufficient volatility to permit significant upside but limited downside risk and it had an imbedded derivative. Overall about $10.7 billion notional RCNs were sold. About $548 million of notional RCNs were sold to over 8,700 customers, many of whom had little relevant investment experience and modest reported net worth. Most of the sales were solicited. Yet the firm failed to adequately train its sales force regarding the product. Its supervisory policies were thus insufficient within the meaning of Exchange Act Section 15(b)(4)(E). The firm undertook unidentified remedial acts and cooperated with the Commission’s investigation. It consented to the entry of a censure. Respondent will also pay disgorgement of $8,227,566 along with prejudgment interest and a $6 million penalty.

Valuation: In the Matter of Orrstown Financial Services, Inc., Adm. Proc. File No. 3-17583 (Sept. 27, 2016). Orrstown is the holding company of Orrstown Bank, a Pennsylvania chartered bank. Respondents Thomas Quinn, Bradley Everly, Jeffrey Embly and Douglas Barton were, respectively, the CEO, CFO, Chief Credit/Risk Officer and CAO of the bank. In 2010 the firm had a loan policy which governed its review process. Loan reviews were to be performed by a Loan Review Officer, supervised by Mr. Embly and the firm’s Credit Administration Committee. The bank did not properly follow those policies. The key issue centers on three significant commercial lending relationships which involved the bank’s largest customers. Meetings were held with each customer. Messrs. Quinn, Everly and Embly attended the meetings. One customer had a total outstanding balance of about $28.8 million; a second had a balance of $12.2 million; the third had a balance of about $7.7 million. Each loan was impaired. The bank did not, however, disclose any of the loans as impaired. In addition, Orrstown did not disclose the value of other impaired loans in its quarterly filings for the periods ended June 30, 2010 and September 30, 2010. As a result there were violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the action each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order except, the order as to Mr. Barton which was only based on the cited Exchange Act Sections. In addition, the bank will pay a penalty of $1 million; Messrs. Quin, Everly and Embly, will each pay $100,000 and Mr. Barton $25,000.

Financial fraud: In the Matter of Weatherford International PLC, Adm. Proc. File No. 3-17582 (Sept. 27, 2016). Weatherford is a multinational Irish public limited company based in Switzerland. Respondents James Hudgins and Darryl Kitay were, respectively, the firm’s V.P. of Tax and Tax Director. A key strategy of the firm was tax avoidance. To further that goal the firm did an inversion and Mr. Hudgins created a program of tax avoidance designed to reduce the effective tax rate of the firm. Weatherford reduced its effective tax rate nearly 10% from 2001 through 2006. That rate, however, was higher than its inverted peers. Subsequently, the firm began reporting results that suggested its strategy was outperforming that of others. In 2008 and 2009, for example, the firm reported a pre-tax effective tax rate of 17.1%. In each year from 2007 through 2010 Messrs. Hudgins and Kitay took steps to ensure that the reported effective tax rate was commiserate with their statements to analysts and shareholders touting their tax structure. Typically at year end the two men would calculate the actual rate. If the firm had not met the metric sought, they reversed legitimate financial entries, substituted plugs, and announced the false rate and related numbers as the firm’s actual results. This gave the firm plug tax benefits of over $150 million in 2007 and just over $100 million in 2008, 2009 and 2010. The firm never questioned the drop in the effective tax rate. The first restatement resulted from the discovery of Ernst & Young of certain discrepancies. The restatement reduced net income by $500 million. The remediation effort was led by Mr. Hudgins but was done improperly, yielding the second restatement at the end of September 2011. It resulted in an $84 million reduction from the firm’s previously reported net income to correct for the failure to accrue for certain withholding taxes prior to 2012. Mr. Hudgins resigned in March of the next year. Mr. Kitay was relieved of his duties. The third restatement resulted from a material error that a firm employee identified shortly before the second restatement was filed. The email went unanswered for over a month. As a result Weatherford failed to create a timely reserve for the item. Net income was reduced by $186 million, driven largely by the firm’s efforts to remediate its material weakness over internal controls related to accounting for income taxes. In February 2014 Weatherford announced it has successfully remediated its control weakness for accounting of income taxes. The Order alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The firm cooperated with the Commission’s investigation and agreed to implement a series of undertakings which include filing a report detailing its internal controls, policies and procedures over accounting for income taxes and conducting subsequent reviews. To resolve the action Weatherford consented to the entry of a cease and desist order based on each of the Sections cited in the Order except Exchange Act Section 13(b)(5). Messrs. Hudgins and Kitay also consented to the entry of cease and desist orders but based on each of the Sections cited in the Order. The firm will pay a penalty of $140 million. Mr. Hudgins is prohibited for a period of five years from acting as an officer or director of any issuer. Messrs. Hudgins and Kitay are each denied the privilege of appearing or practicing before the Commission as an accountant with the right to apply for reinstatement as an accountant after five years. Mr. Hudgins will pay disgorgement of $169,728, prejudgment interest and a penalty of $125,000. Mr. Kitay will pay a penalty of $30,000.

Financial fraud: SEC v. Hunter, Civil Action No. 2:16-cv-07246 (C.D. Cal.) is a previously file action against Keith Hunter, a former IT executive at the Commonwealth Bank of Australia. The complaint alleged that Mr. Hunter participated in a scheme to defraud Computer Sciences Corporation of about $98 million by accepting a bribe to have his employer enter into contracts with SCS in 2013 and 2014 so that CSC could receive an earn-out payment. To resolve the action Mr. Hunter consented to the entry of a permanent injunction based on Securities Act Section 17(a) and Exchange Act Section 10(b). In addition, he is barred from serving as an officer or director of any U.S. issuer and will pay disgorgement of $651,990 and prejudgment interest with credit for any amounts paid to the Australian and U.S. criminal authorities in the parallel actions. See Lit. Rel. No. 23657 (Sept. 27, 2016).

Market manipulation: SEC v. Wallace, Civil Action No. 8:16-cv-01788 (C.D. Cal. Filed Sept. 27, 2016) is an action which names as a defendant Jason Wallace. The complaint alleges that Mr. Wallace was retained by James Price, the owner of penny stocks. He was recruited as part of an effort to inflate the share prices of the stocks. Mr. Wallace operated a boiler room. Between September 2010 and January 2012 solicitations were made for four penny stock companies using cold calls to improperly inflate the share prices. About 8.3 million shares were involved generating $2.4 million in gross proceeds. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 9(a)(2), 10(b) and 15(a). The case is pending. See Lit. Rel. No. 23656 (Sept. 27, 2016).

Market access: In the Matter of Merrill Lynch, Pierce, Fenner & Smith Inc., Adm. Proc. File No. 3-17573 (Sept. 26, 2016). To comply with the market access rule — Exchange Act Section 15(c)(3) and Rule 15c3-5 — Merrill Lynch determined that its orders would flow though four order controls known as a hard block. Orders of a certain size were blocked from market access. Many of the thresholds selected by senior managers of the business units were set at such high levels that the controls were ineffective. This resulted in numerous orders which should not have reached the market reaching it. Those orders at times caused the prices of the stock involved to fluctuate dramatically and disrupted the markets. Although Merrill Lynch conducted periodic reviews of its risk management controls under its procedures the firm concluded that they were functioning as expected. The reviews failed to consider if the high thresholds were effective. No adjustments were made. The Order alleges violations of Exchange Act Section 15(c)(3) and rule 15c3-5. To resolve the action the firm undertook remedial steps. Merrill Lynch also consented to the entry of a cease and desist order based on the Section and rule cited in the Order and a censure. The firm agreed to pay a penalty of $12.5 million.

Boiler room: SEC v. Sizer, Civil Action No. 1:16-cv-24106 (S.D. Fla. Filed Sept. 26, 2016) is an action which names as defendants Craig Sizer and Miguel Mesa. Mr. Sizer hired Miguel Mesa to operate a boiler room in South Florida and Southern California to sell shares of Sanomedics, Inc. and Fun Coo Free, Inc. Mr. Sizer provided pitch points for the salesmen and scripts. Mr. Mesa hired and supervised the boiler room agents in cold calls to sell the shares. Over a six year period beginning in 2009 investors were falsely told that the transactions were commission free. In fact commissions ranging from 15% to 20% were paid from investor funds. Investors were also falsely told that the funds raised would be used to conduct research and development and for the acquisition of another firm. In fact Mr. Sizer diverted at least $3 million of the proceeds to his personal benefit. To conceal the operation investors were told the callers worked for the companies. Mr. Mesa was not registered with the Commission as a broker. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). Each of the defendants resolved the action in part, consenting to the entry of permanent injunctions based on the Sections cited in the complaint. Other remedies will be considered at a later date on motion by the Commission.

Conflicts: In the Matter of Jan Gleisner, Adm. Proc. File No. 3-17588 (Sept. 28, 2016) is a proceeding which names as Respondents Mr. Gleisner and Keith Pagan. Mr. Gleisner is the managing director of Belvedere Asset Management LLC and owned 40% of Belvedere Tigers LLC which owned Belvedere. Mr. Pagan was the CEO of Belvedere. He owned 45% of Belvedere Tigers. From January 2013 through April 2014 Mr. Gleisner invested about one third of the assets held by Belvedere’s individual clients in the firm’s new mutual fund, Belvedere Alternative Income Fund. In doing so the firm and the Respondents failed to disclose to clients the material conflicts of interest which arose because of the ownership interests of each individual Respondent in the entities. The Order alleges violations of Advisers Act Sections 206(4) and 204(a). Respondents resolved the matter, consenting to the entry of cease and desist orders based on Advisers Act Section 206(2). The order as to Mr. Pagan is also based on the other Sections cited in the Order. Mr. Gleisner was censured. In addition, Mr. Gleisner will pay a penalty of $40,000. A penalty was not imposed on Mr. Pagan based on financial condition.

False pricing: In the Matter of Nicholas M. Bonacci, Adm. Proc. File No. 3-17575 (Sept. 26, 2016) is a proceeding naming Mr. Bonacci, formerly a registered representative at Morgan Stanley, as a Respondent. He was a trader on various securitized product desks. When trading mortgage-backed securities or RMBS he at times made misrepresentations to clients regarding the pricing. Specifically, during 2012 he misled clients regarding the price and the amount paid to Morgan Stanley. In some instances he falsely claimed to be arranging trades among parties when in fact he was selling out of inventory. Since the RMBS market is illiquid and opaque clients often rely on traders for accurate pricing information. The Order alleges violations of Exchange Act Section 15(c)(1)(A). To resolve the matter Mr. Bonacci consented to the entry of a cease and desist order based on the Section cited in the Order. He is suspended from the securities business for twelve months and will pay a civil penalty of $100,000.

Microcap fraud: SEC v. Medient Studios, Inc., Civil Action No. 4:16-cv-00253 (S.D. Ga. Filed Sept. 23, 2016) is an action which names as defendants the company, purported to be in the film business and which changed its name to Moon River Studios, Inc.; Fonu2, Inc., supposedly a social commerce company operating under the name Moon River Studios, Manu Kumaran who founded and served as CFO and CEO of Mediente International Films; Joel Shapiro, at one point the CEO and CFO of Medient; and Roger Miguel, ithe CEO of Fonu2. Beginning in late 2012 Medient claimed to be a movie and video game producer. The firm also claimed to be building the largest movie studio in North America. By early 2015 the building plan failed. The firm’s assets were transferred to Fonu2. The CEO of each firm at the time was Joel Shapiro. Fonu2 was doing business at the time as Moon River Studios. During the period billions of shares of Medient and Fonu2 were issued at a discount to third-party financing companies who dumped the shares. The filings of each company during the period contained a series of misrepresentations. The share sales were not registered or reported. Defendants benefited from the scheme, according to the complaint, by having the firms finance their lavish life styles. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b), 13(a) and 14(c). The case is pending. See also In the Matter of Charles A. Koppelman, Adm. Proc. File No. 3-17569 (Sept. 23, 2016) (alleging violations of Exchange Act Section 16(a) by Respondent who was on the board of Medient; resolved with a cease and desist order based on the Section cited and the payment of a $25,000 penalty); In the Matter of Matthew T. Mellon, II, Adm. Proc. File No. 3-17571 (Sept. 23, 2016)(Exchange Act Section 16(a) action against a Medient board member; the action will be set for hearing); In the Matter of David A. Paterson, Adm. Proc. File No. 3-17568 (Sept. 23, 2016)( Exchange Act Section 16(a) action against a Medient board member; resolved with consent to a cease and desist order based on the cited Section and the payment of a $25,000 penalty).

Prime bank fraud: SEC v. North Star Finance LLC, Civil Action No. 15-cv-1339 (Sept. 23, 2016) is a previously filed action alleging a prime bank fraud. Included as defendants are the firm, Thomas Ellis and Yasuo Oda, each of whom settled with the Commission. Each defendant consented to the entry of an injunction prohibiting future violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). Other remedies will be considered at a later date on motion of the Commission. See Lit. Rel. No. 23653 (Sept. 23, 2016).


Och-Ziff Capital: Hedge Fund Och-Ziff Capital Management Group and its subsidiary, OZ Africa Management GP, LLC resolved FCPA charges with the DOJ and the SEC. In the criminal case the firm was charged in a four count criminal information. It alleged two counts of conspiracy to violate the FCPA, one count of falsifying its books and records and one count of failing to implement adequate internal controls. The firm’s subsidiary was charged with conspiring to bribe senior officials in the Democratic Republic of Congo. To resolve the charges Och-Ziff admitted the facts alleged in the complaint as part of entering into a three year deferred prosecution agreement that imposes a monitor. Och-Ziff will pay a criminal fine of $213 million. Subsidiary Oz Africa Management GP, LLC pleaded guilty to one count of conspiracy to violate the FCPA. Sentencing will be held on March 29, 2017.

The scheme centered on paying bribes in Libya, the DRC, Chad and Niger. Beginning in 2005, and continuing through 2012, a business man in the DRC paid over $100 million in bribes to officials for special access to certain investment. The hedge fund entered in several DRC related transactions with the businessman despite the fact that two firm employees knew – and a senior Och-Ziff employee believed – that it was likely the individual gained access to the investment through bribery.

Firm employees funded the ventures involving the businessman on the understanding that portions of the money would be used to pay high ranking DRC officials to secure, and to obtain, preferential treatment as to certain investment opportunities. In fact the businessman did pay bribes to secure the opportunities.

In 2007 a senior Och-Ziff employee engaged a third party arrangement to assist in securing an investment from the Libyan sovereign wealthy fund. When the agent was hired the company official knew corrupt payments would be required. No due diligence was conducted when the employee was retained. Following a meeting between a senior firm employee and a Libyan official empowered to make investment decisions for the sovereign wealth fund, a $300 million investment was made with Och-Ziff hedge funds. The firm subsequently entered into a consulting agreement under which $375 million was paid as a finder’s fee, knowing that a portion of that fee would be paid to Libyan officials.

In resolving the action the Department considered the fact that the firm failed to self-report and the high dollar nature of the transactions and that it cooperated during the investigation. The fine was set at 20% below the lower end of the sentencing guideline calculation.

The SEC brought a parallel action against the hedge fund, Oz Management L.P, a registered investment adviser, Daniel Och, its founder and CEO, and Joel Frank, its CFO. In the Matter of Och-Ziff Capital Management Group, Adm. Proc. File No. 3-17595 (Sept. 29, 2016). The conduct was discovered as part of the Commission’s investigation into dealings with sovereign wealth funds. The Order alleges violations of Exchange Act Sections 30A, 13(b)(2)(A), 13(b)(2)(B) and Advisers Act Sections 206(1), 206(2) and 206(4). To resolve the matter the two entity defendants agreed to implement a series of undertakings which include enhancing the internal controls and designating a CCO. The firm and Respondent Frank consented to the entry of a cease and desist order based on the Exchange Act Sections; Oz Management consented to a cease and desist order based on the Advisers Act Section; and Respondent Och consented to a cease and desist order based on Exchange Act Section 13(b)(2)(A). The two entities were also censured and will pay, jointly and severally, disgorgement of $173,186 and prejudgment interest. Respondent Och will pay disgorgement of $1,900,000 which represents his estimated gain from certain transactions and prejudgment interest.

In the Matter of Anheuser-Busch InBev SA/NV, Adm. Proc. File No. 3-17586 (Sept. 28, 2016) is a proceeding against the Belgian firm, a global brewer formed from the merger of Anheuser-Busch Companies Inc. and InBev SA/NV. Its wholly owned subsidiary, Crown Beers India Private Limited, operates in India. From 2009 through 2012 AB InBev held a 49% interest in an Indian joint venture that did the marketing for the firm. The Marketing firm used third party sales promoters to make improper payments to officials of the Indian government to obtain beer orders and increase brewery hours in 2011. The firm invoiced the subsidiary for reimbursement for certain of those expenses. They were paid. In doing so the Order alleges the firm had inadequate internal controls. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, it agreed to pay disgorgement of $2,712,955, prejudgment interest and a penalty of $3,002,955. The firm also agreed to certain undertakings.

Criminal cases

Manipulation: U.S. v. Galanis, No. 1:15-cr-00643 (S.D.N.Y.). Gary Hirst was found guilty of conspiracy to commit securities and wire fraud relating to Gerova Financial Group, Ltd. He made about $2.6 million from the scheme. Mr. Hirst, along with his co-defendants — Jason, John, Jared and Derek Galanis and Ymer Shahini and Gavin Hamels — participated in a scheme to manipulate the shares of the company. Control was obtained over the shares of Gerova which was concealed. About 5 million shares were issues and a series of controlled accounts opened. Those accounts were then used to engage in manipulative trading and hold the proceeds from the transactions. Overall about $20 million in shares were sold from the accounts. The value of the remaining shares held by the public is now $0. Previously, Derek Galanis, Jason Galanis, John Galanis and Gavin Hamels pleaded guilty.

September 30, 2016
Settling Trades: SEC Proposes T+2!
by Broc Romanek

On Wednesday, the SEC proposed shortening the standard settlement cycle for most market transactions from 3 business days after the trade date to just two – known as "T+2" (here’s the 148-page proposing release). A significant number of European countries already use T+2 – & the SEC’s Investor Advisory Committee is already clamoring for T+1!

Technology keeps enabling further reductions in the settlement cycle. I remember back in the day when moving off of "T+5" was a big deal...

More on "Auditor Independence: SEC Settles 1st Violation Caused By Personal Relationships"

Last week, I blogged about the SEC’s first enforcement action against an auditor – EY – for auditor independence violations due to personal relationships. This blog by Davis Polk’s Ning Chiu raises the question about how this impacts the clients of the auditor (also see this blog). Here’s an excerpt:

EY’s policies require that activities with clients to include a "valid business purpose" with expectations that "meaningful business discussions" will take place and forbade gifts or hospitality that are beyond what is customary. The SEC, however, still faulted the audit firm for ignoring various red flags, such as the fact that two senior EY partners noted back in 2012 that the coordinating partner’s expense spending was double that of the next highest individual but did not investigate, and there was no follow-up responses to the issuer’s questions about the expenses it was billed in 2014.

EY already had policies and procedures assessing their employees’ independence from audit clients, which included training and certification and addressed possible familial, employment and financial relationships that are expressly prohibited under SEC rules. As part of the remedial efforts from both cases, additional procedures have been instituted that will require the audit firm’s engagement team members to ask management of an issuer whether they are aware of any "close relationships" between members of the audit engagement team and any individuals employed by "or associated with" the issuer.

Also note the SEC’s Enforcement Director – Andrew Ceresney – recently gave this speech on auditors & auditing.

Auditor Independence: PwC Settle $5 Billion Lawsuit

Speaking of auditor independence, Francine McKenna has been writing about the $5 billion lawsuit against PwC that was settled recently. Here’s an excerpt from this blog:

Right now I’d like to take an opportunity to document some interesting information about how the financial side of the firms, in this case PwC, works. Because the TBW v. PwC case went to trial, and a verdict could have included an assessment of punitive damages, we witnessed a highly illuminating series of motions and partial disclosures about PwC’s finances and how they manage them. This kind of information has not been made public by any Big 4 firm in a potential "tipping point" case for at least thirty years.

Broc Romanek

September 30, 2016
Newman Opposes Petition for Certiorari, Relying on Merits of Second Circuit Opinion
by Austin Chambers

The US Supreme Court has taken cert in a case raising issues first addressed in US v. Newman, 773 F.3d 438 (2d Cir. 2014).  See Salman v. United States, 15-628 (Jan. 19, 2016).  The Supreme Court accepted cert in Salman only after rejecting a petition filed by the US in Newman.  This post discusses one of the briefs filed in connection with the Newman cert petition. 

In Brief For Todd Newman In Opposition to the Petition for a Writ of Certiorari to the United States Court of Appeals for the Second Circuit, No. 15-137 (August 24, 2015) regarding United States v. Newman et al., Newman (“Defendant”) argued: (1) resolution of the question presented by the United States (“Plaintiff”) would not affect the outcome of the case as decided by the Second Circuit; (2) the Second Circuit’s decision did not conflict with the Supreme Court’s decision in Dirks v. SEC; (3) the Second Circuit’s decision did not create a circuit conflict; and (4) the Second Circuit’s decision would not undermine insider trader prosecution.

First, Defendant asserted Plaintiff’s question would not affect the Second Circuit’s ruling, because the Second Circuit’s central holding required a tippee to know the tipper received a personal benefit in order to find the tippee liable for insider trading. Here, Defendant argued Plaintiff’s reframed question on whether corporate insiders received a personal benefit from disclosing information to Defendant would not overturn the Second Circuit. Defendant maintained because knowledge of a personal benefit (“gift theory”) was still required, and gift theory was an issue decided by the lower courts and not on appeal.

Second, Defendant argued the Second Circuit’s decision was consistent with the Supreme Court’s ruling in Dirks v. SEC. According to Defendant, Dirks imposed insider trading liability for the gifting of information to a relative or friend. This required a close personal relationship between the tipper and the tippee. Defendant stated the Second Circuit’s reference to an impersonal relationship endorsed the Dirks ruling.

Third, Defendant asserted there was no circuit conflict. Plaintiff contended the Ninth Circuit issued an opinion demonstrating a conflict that required resolution by the Supreme Court. Defendant, however, maintained the Ninth Circuit opinion included a hypothetical that was outside the scope of Newman and further noted that both circuits agreed that a gift of information could result in insider trading.

Finally, Defendant stated the Second Circuit’s decision would not undermine insider trader prosecution. Plaintiff argued personal benefit to a relative or close friend would be impossible to prove under Newman, but Defendant’s assertions illustrated this particular type of personal benefit.

As such, Defendant’s primary assertion was: the issues on appeal, and any subsequent outcome, were insignificant.

The primary materials for this post can be found on the DU Corporate Governance website.

View today's posts

9/30/2016 posts

AG Deal Diary: Antitrust-Related Recent Developments: Second Circuit Confirms Limited Nature of General Personal Jurisdiction
AG Deal Diary: Is Chinese Investment in the U.S. Film and Entertainment Industry the Next Area of CFIUS Scrutiny?
CLS Blue Sky Blog: The Ethics of Representing Founders
The Harvard Law School Forum on Corporate Governance and Financial Regulation: A Unified Theory of Insider Trading Law
The Harvard Law School Forum on Corporate Governance and Financial Regulation: AML Obligations of Broker-Dealers
SEC Actions Blog: This Week In Securities Litigation (Week ending Sept. 30, 2016) Blog: Settling Trades: SEC Proposes T+2!
Race to the Bottom: Newman Opposes Petition for Certiorari, Relying on Merits of Second Circuit Opinion

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