Bridging the Week by Gary DeWaal: January 12 to 16 and 19, 2015 (SEC Examination Priorities; In Life as in Literature; Unregistered CTA Sanctioned)

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Published Date: January 18, 2015

Last week, the Securities and Exchange Commission followed the Financial Industry Regulatory Authority’s lead earlier this month by publishing examination priorities for 2015. Also, an SEC-registered investment adviser and its owner—featured in a best-selling book by Michael Lewis—were sanctioned by an administrative law judge before the SEC for misrepresentation and fraud in connection with their role in the purchase of subprime mortgage-backed assets for certain collateralized debt obligations that subsequently were sold to investors. As a result, the following matters are covered in this week’s Bridging the Week:

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Cybersecurity, Potential Equity Order Routing Conflicts and AML Among the Top Examination Priorities for SEC in 2015

The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations published its priorities for examinations of investment advisers, broker-dealers and transfer agents during 2015.

In addition to matters relevant to business with retail investors, OCIE indicated it will focus on:

Earlier this month, the Financial Industry Regulatory Authority highlighted its focus for its 2015 reviews of broker-dealers. (Click here to access the article, “FINRA Highlights Member Examinations Focus for 2015,” in the January 5 to 9 and 12, 2015 edition of Bridging the Week.”)

(Click here for further information in the article, “SEC 2015 Examination Priorities Focus on Liquid Alternatives and Fixed-Income Funds” in the January 16, 2015 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)

In Life as in Literature: The Big Short Featured Investment Adviser Misled Investors Says SEC Administrative Law Judge

Harding Advisory LLC and Wing Chau, two of the subjects in Michael Lewis’ The Big Short: Inside the Doomsday Machine, were held liable last week in an administrative law judge’s initial decision before the Securities and Exchange Commission for misrepresentation, failure to follow an appropriate standard of care, and fraud for their role in the purchase of subprime mortgage-backed assets for certain collateralized debt obligations that subsequently were sold to investors. (The Big Short is a recount of certain investors who profited by trading against the subprime mortgage bond market during the 2008-2009 financial crisis.)

The SEC’s Division of Enforcement previously instituted these proceedings in October 2013.

The Division charged that, during 2006, Harding, acting as a collateral manager for one CDO—Octans I CDO Ltd.—structured and marketed by subsidiaries of Merrill Lynch & Co.—granted a third-party hedge fund—Magnetar—the right to review all collateral before purchase and effectively exercise veto rights. This was never disclosed to debt investors in Octans I, claimed the SEC. Subsequently, Harding deferred to Magnetar’s collateral suggestions, which was helpful to the hedge fund, but not to the CDO’s investors, claimed the SEC.

The SEC also charged that, during 2007, without adequate credit analysis, Harding acquired tranches of another CDO—Norma CDO I—to include in other CDOs that it managed—as a favor to Merrill and Magnetar—to the detriment of the other CDOs' investors.

At all relevant times, Harding was an SEC-registered investment adviser, while Mr. Chau was the firm’s owner and founder.

The judge ruled that Harding violated only some but not all of the specific allegations made by the Division, while Mr. Chau was primarily liable for and solely caused Harding’s Norma (not Octans)-related violations. Notwithstanding, the judge imposed penalties of over US $1 million in disgorgement and prejudgment interest against both respondents; imposed a fine of US $1.7 million against Harding and a fine of US $340,000 against Mr. Chau; revoked Harding’s investment adviser registration; and barred Mr. Chau from association with the securities industry.

A film version of The Big Short—starring Brad Pitt, Ryan Gosling, Christian Bale and Steve Carell—is expected in the near future (click here for details). A legal action by Harding and Mr. Chau against Mr. Lewis and others for libel was dismissed by a US federal court in New York in March 2013, and the dismissal was upheld by a US federal appeals court in November 2014 (click here for the decision).

Harding and Mr. Chau previously failed in their efforts before a United States federal court in New York to have the SEC litigate this case in a federal court and not before the SEC. (Click here for details in the article, “SEC Okay to Prosecute Cases Before Administrative Tribunals Rather Than Federal Courts Says US Judge,” in the December 8 to 12 and 15, 2014 edition of Bridging the Week.”)

And briefly:

Compliance Weeds: As I emphasized in the preceding article, the test for CTA exemption is two part: a person who advises no more than 15 persons and does not hold themselves out to the public as a CTA. For startups, it is important not to undercut the numerical basis for an exemption from registration by claiming on a website or other promotional literature to provide advisory or risk management services regarding the value or advisability of trading in swaps or futures for compensation.

And even more briefly:

For more information, see:

Canadian Citizen Charged by SEC With Unlawful Layering Involving Traders in China and Korea:

See also, criminal indictment:,%20Aleksandr%20Complaint.pdf

CFTC Extends No-Action Relief Regarding Reporting of Certain Identifying Information in Various Enumerated Jurisdictions:

Cybersecurity, Potential Equity Order Routing Conflicts, and AML Among the Top Examination Priorities for SEC in 2015:

FIA Publishes Overview of ESMA Technical Advice and Consultation on MiFID II:

ICE Futures U.S. Settles a Number of Position Limit Offenses; Requires Disgorgement in One Instance:


In Life as in Literature: The Big Short Featured Investment Adviser Misled Investors Says SEC Administrative Law Judge:

Magical, Not a Mystery Tour: CFTC Chairman Visits Asia:

See also, HK speech of Chairman Massad: 

NFA Grants Good Faith Relief Through March 31 to Members That Conduct Business With Previously Exempt CTAs and CPOs:

SEC Proposes Reporting Regime for Security-Based Swaps:

Summit Energy Services, Inc. Fined by CFTC US $140,000 for Acting as an Unregistered CTA in Providing Risk Management Advice:

Two Legacy Exchanges Previously Owned by Direct Edge Holdings Settle Charges for Not Fully Describing Order Types to SEC:

UK FCA Issues Final Rules to Implement European Recovery and Resolution Directive:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of January 18, 2015. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP and/or Gary DeWaal may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.

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