Compliance officers and anti-money laundering played a prominent role in material matters impacting financial services firms last week. Two chief compliance officers were suspended and fined by FINRA for supervisory and AML violations. Meanwhile, in SEC administrative tribunals, a chief compliance officer was only required to take additional training for his alleged law violation and another compliance officer was not sanctioned at all despite altering documents provided to the Commission. Separately, Promontory Financial Group was penalized by a New York regulator for its role in assessing AML violations by a client. As a result, the following matters are covered in this week’s edition of Bridging the Week:
- New York Regulator Penalizes Promontory Financial for Alleged Lack of Independent Judgment in Handling Standard Chartered Bank Review;
- One CCO Sanctioned, Another Not, in SEC Enforcement Actions (includes My View);
- Federal Judges in NY and Georgia Rule Against SEC for Enforcement Action Forum Choice Because of ALJ Selection Process;
- IB Fined by NFA for Late Independent Testing of AML Program and Training (includes Compliance Weeds);
- SEC Finalizes Registration Procedures for Security-Based Swap Entities and Proposes Rule to Permit Statutorily Disqualified Associated Persons (includes My View);
- FINRA Fines and Suspends Two CCOs for Supervisory and AML Violations;
- BNP Paribas Securities (Asia) Fined Almost US $2 Million by Hong Kong Regulator for Dark Pool-Related Failures;
- CFTC Commissioner Giancarolo Says Little Progress If At All in Sensibly Revising Swaps Trading Rules;
- Commodity Pool Operator Sued by CFTC for Making False Statements to NFA and Other Violations; and more.
- New York Regulator Penalizes Promontory Financial for Alleged Lack of Independent Judgment in Handling Standard Chartered Bank Review:
The New York State Department of Financial Services claimed that Promontory Financial Group “exhibited a lack of independent judgment” in connection with its review of Standard Chartered Bank’s compliance with anti-money laundering requirements. The NYSDFS also claimed that certain testimony by Promontory witnesses during the course of the department’s investigation into the firm’s conduct “lacked credibility.”
Promontory was retained by SCB in 2010 after the bank reported to various regulators, including the New York State Banking Department, that, from at least 2001 through 2007, it had engaged in conduct related to the evasion of sanctions against certain foreign nationals designated by the Office of Foreign Asset Control of the US Department of Treasury.
Subsequently, in 2012, SCB agreed to pay US $340 million to the NYSDFS for providing US dollar clearing services to prohibited Iranian customers with respect to approximately 59,000 transactions through the bank’s New York branch. Later, SCB agreed to pay an additional US $300 million penalty to NYSDFS for certain failures in its anti-money laundering monitoring system that the bank did not disclose prior to its 2012 settlement.
The NYSDFS claimed it relied on Promontory’s review of SCB at least in part to evaluate the bank’s conduct for the purpose of assessing the 2012 penalty. Because of Promontory’s alleged wrongful conduct, the NYSDFS said it would deny all requests to provide the firm with confidential supervisory information “until further notice.” No monetary penalty was assessed. (Click here for further information on the prior NYSDFS actions against SCB in the article, “Standard Chartered Bank Agrees to Pay NYS Department of Financial Services US $300 Million for Failing to Fix AML Problems” in the September 1, 2014 edition of Bridging the Week.)
In its Report of Investigation related to this matter, the NYSDFS cited multiple occasions “where Promontory, at the direction of the Bank or its counsel, or at its own initiative, made changes to ‘soften’ and ‘tone down’ the language used in its reports, avoid additional questions from regulators, omit red flag terms or otherwise make the reports more favorable to the Bank.” The NYSDFS also provided examples of answers that Promontory employees provided to questions posed by NYSDFS staff that “were directly contradicted by the plain language of the documents they were shown in [depositions] – in many cases emails that they had themselves written.”
Promontory said it will seek a court stay of the NYSDFS action against it, “and defend [itself] against this regulatory overreach.”
Last year, the NYSDFS fined PricewaterhouseCoopers LLP US $25 million and required it to implement certain practice reforms for allegedly failing to “demonstrate the necessary objectivity, integrity, and autonomy that is now required of consultants performing regulatory compliance work for entities supervised by the Department.” (Click here for details.) In 2013, Deloitte Financial Advisory Services LLP was likewise fined US $10 million and required it to implement certain practice reforms by the NYSDFS for allegedly similar problematic conduct. (Click here for details.) Both firms agreed to the payment of their fine as part of a settlement with NYSDFS.
- One CCO Sanctioned, Another Not, in SEC Enforcement Actions:
One chief compliance officer was required to take training in connection with an enforcement action before the Securities and Exchange Commission, while in a separate, unrelated action, another compliance officer was let off with no sanction despite being found to have altered a document submitted to the SEC and subsequently being less than candid regarding her actions.
F. Robert Falkenberg
In the first case, involving Parallax Investments, LLC, an SEC-registered investment adviser, the SEC found that, from at least January 2009 through November 2o11, contrary to applicable rules, the firm engaged in at least 2,000 securities transactions with advisory clients on a principal basis through an affiliated broker-dealer without prior written disclosure or obtaining consent from such clients. The SEC also found that Parallax, contrary to rules, failed to provide pooled investment vehicle investors with audited financial statements on a timely basis; failed to adopt, implement and annually review written policies and procedures reasonably designed to prevent violations of applicable law; and failed to establish, maintain and enforce a written code of ethics.
For these offenses, Parallax and John Bott II, the firm’s owner and manager were jointly ordered to reimburse certain advisory clients an aggregate amount of US $450,000 and to implement certain undertakings.
In addition, F. Robert Falkenberg, the firm’s CCO, was held to have aided and abetted each of the firm’s violations, except those related to Parallax’s principal trading. Among other evidence of Mr. Falkenberg’s wrongful conduct, the SEC found that he backdated evidence of an alleged review of the firm’s compliance policies and procedures for 2010 that he, in fact, prepared untimely, only after requested to provide evidence of such review by SEC staff in connection with a routine examination of Parallax in 2011.
As a penalty, Mr. Falkenberg was ordered to take 30 hours of relevant compliance training. He was subject to no other penalty. Mr. Falkenberg worked for the Financial Industry Regulatory Authority prior to serving as CCO of Parallax.
Separately, Judy Wolf was a compliance consultant to Wells Fargo Advisors LLC and in 2010 reviewed the trading of Waldyr Da Silva Prado Neto, a registered salesperson for the firm. The SEC later sued Mr. Prado for insider trading.
In December 2012, Ms. Wolf altered a document she previously prepared evidencing her review of Mr. Prado’s trading. She changed the document, in anticipation of an SEC inquiry, to make it appear her review was more thorough; failed to disclose this alteration when the document was produced to the SEC; and later, initially denied making the alteration when asked by SEC staff. The SEC filed charges against Ms. Wolf, claiming that she aided and abetted Wells Fargo’s violation of securities laws, namely the firm’s failure to produce accurate records to an SEC representative, and the firm’s production of altered records. (Click here for details regarding the SEC’s charges in the article “Investment Advisor Compliance Officer Charged by SEC for Altering Document Related to Insider Trading Probe” in the October 19, 2014 edition of Bridging the Week.)
The ALJ hearing this matter concluded that the SEC’s Division of Enforcement “satisfied its burden of showing that Wolf acted with scienter and rendered substantial assistance in the commission of [Wells Fargo’s] primary violation.” However, the ALJ refused to impose sanctions on Ms. Wolf, claiming that “[t]here is real risk that excessive focus on violations by compliance personnel will discourage competent persons from going into compliance, and thereby undermine the purpose of compliance programs in general.”
In determining to assess no sanctions against Ms. Wolf, the ALJ cited a warning recently made by departing SEC Commission Daniel Gallagher that “we should strive to avoid the perverse incentives that will naturally flow from targeting compliance personnel who are willing to run into the fires that so often occur at regulated entities.” (Click here for additional information on Commissioner Gallagher’s views on CCOs in the article “Investment Adviser Chief Compliance Officer Blamed in SEC Lawsuit for President’s Theft of Client Funds; SEC Commissioner Criticizes Enforcement Actions Against CCOs Generally” in the June 21, 2015 edition of Bridging the Week.)
My View: It almost borders on insulting to suggest that “competent persons” would refrain from becoming compliance personnel because a compliance officer might be penalized for amending a previously written compliance report after the initiation of a review by the Securities and Exchange Commission, and then being less than forthcoming about the changes. That being said, compliance personnel should not be penalized for borderline interpretations that impose obligations on them that seem not to exist in the plain language of a relevant law or rule – as happened a few weeks ago when the SEC fined the chief compliance officer of SFX Financial Advisory Management Enterprises because the firm’s compliance policies allegedly were not “reasonably designed …to prevent the misappropriation of client funds” after the firm’s former president stole customer money. (Click here for more details regarding the SFX matter in the article, “Investment Adviser Chief Compliance Officer Blamed in SEC Lawsuit for President’s Theft of Client Funds; SEC Commissioner Criticizes Enforcement Actions Against CCOs Generally” in the June 21, 2015 edition of Bridging the Week.)
- Federal Judges in NY and Georgia Rule Against SEC for Enforcement Action Forum Choice Because of ALJ Selection Process: In two separate cases, federal courts in New York and Georgia rejected efforts by the Securities and Exchange Commission to stop respondents subject to enforcement actions before administrative law judges from challenging the validity of such forum choice. The case in Georgia involved Gray Financial Group, Inc. There the plaintiff sought to enjoin the SEC from proceeding with an enforcement case against it in an administrative law tribunal. The case in New York involved Barbara Duka. There the SEC moved to dismiss a complaint filed by Ms. Duka that likewise sought to stop the SEC from proceeding in an enforcement action against her in an administrative forum. In both cases, the plaintiffs argued that the appointment of the relevant administrative law judge violated the Appointments Clause of the US Constitution. This is because, claimed plaintiffs, ALJs are so-called “inferior officers” under the US Constitution (as they exercise “significant authority pursuant to the laws of the United States”) and Congress can vest the authority to appoint such officers only in the “President alone, in the Courts of Law, or in the Heads of Departments.” Since SEC commissioners themselves did not appoint the relevant ALJs, the Appointments Clause was violated, claimed the plaintiffs. In both cases, the courts ruled that, since it was likely that the plaintiffs would ultimately prevail with their arguments, by not halting their administrative proceedings, they would be irreparably harmed. The NY court declined to decide plaintiff’s application for a preliminary judgment for seven days, however, because “it appears the [SEC] is reviewing its options regarding potential ‘cures’ of any Appointments Clause violations.” In a third case involving Timbervest, LLC and certain related persons, the same judge that decided the Gray Financial Group matter, ruled against the plaintiffs in their motion that involved many of the same arguments in both the Gray Financial Group and Ms. Duka actions. Although the judge agreed with Timbervest’s essential legal argument – that the SEC’s appointment of the ALJ hearing the case was likely unconstitutional – she refused to enjoin the SEC from publicly disseminating or publishing an opinion potentially adverse to the plaintiffs. This was because an initial opinion was already published by the relevant ALJ and was widely available since 2014. As a result, even if the order requested by plaintiffs was granted, the damage they seek to avert has already occurred.
- IB Fined by NFA for Late Independent Testing of AML Program and Training: DMFiala Ltd. (DMF), an introducing broker registered with the Commodity Futures Trading Commission, settled an administrative complaint filed by the National Futures Association for alleged violations of NFA rules in connection with the firm’s anti-money laundering program. NFA charged that DMF failed to complete on a timely basis its NFA-required annual independent review of the adequacy of its AML program for 2013, and likewise failed to provide AML training on a timely basis, as required by NFA rules, to all its registered associated persons for 2014. According to NFA, DMF was required to complete its 2013 annual audit AML audit by May 31, 2013, but did not finish it until August 8, 2013. Likewise, claimed NFA, the firm was required to complete its AP training by March 2014, but did not do so until July 2014. DMF agreed to settle this matter by payment of a US $15,000 fine to NFA. NFA claimed that, previously, it had discussed with DMF its late 2011 annual AML audit, and that the firm was also late in completing its 2007 AML audit.
Compliance Weeds: Futures Commission Merchant and Introducing Broker members of the National Futures have been required to have an anti-money laundering program in place since April 2002. Among the elements of such program include adoption of a policy statement that clearly outlines the registrant’s policy against money laundering, and specifies the consequences of employees not following the firm’s written anti-money laundering policies procedures and controls. An FCM's and IB's procedures and controls should enable appropriate personnel to form a reasonable belief that they know the true identity of each customer; recognize suspicious customers and transactions; and require personnel to report suspicious or unusual activity to appropriate supervisory personnel, including senior management, and to the Financial Crimes Enforcement Network of the US Department of Treasury. A specified person or persons must be designated to oversee the firm’s AML program, and ongoing education and training for appropriate persons must be conducted at least once every 12 months. Written records must be maintained to evidence compliance with the training requirement. Finally, there must be independent testing of the adequacy of each FCM’s and IB’s compliance program at least once every 12 months. (Click here for a complete discussion of the NFA’s requirements related to FCMs’ and IB’s AML program.)
- SEC Finalizes Registration Procedures for Security-Based Swap Entities and Proposes Rule to Permit Statutorily Disqualified Associated Persons: The Securities and Exchange Commission finalized rules related to the registration of security-based swap dealers and major security-based swap participants (collectively, SBS Entities). At the same time, it proposed a new rule of practice so that SBS Entities could apply to the Commission for authority to permit certain persons subject to statutory disqualifications to continue transacting security-based swaps “if such continuation is consistent with the public interest.” Unlike for the registration of swap dealers and major swap dealers under the regime established by the Commodity Futures Trading Commission, the SEC will directly process all SBS Entities’ registration applications, as opposed to a self-regulatory organization; under the CFTC’s regime, the National Futures Association handles the processing of all swap dealer and major swap participant registrations. In applying for registration, SBS Entities would be required to file two certifications with the SEC. One would come from a senior officer who would be required to certify that, “after due inquiry,” he or she reasonably determined that the applicant had developed and implemented policies and procedures to avoid violations of federal securities laws or rules, and that he or she had documented the process to permit such a conclusion. In addition, the chief compliance officer or his or her designee would be required to file a certification that he or she neither knows or “in the exercise of ‘reasonable care’ should have known” that any person associated with the SBS Entity who transacts in security-based swaps is not subject to a statutory disqualification, unless otherwise authorized. The registration rules will be effective sixty days after their publication in the Federal Register. (Click here for additional information regarding the registration requirements in the article “SEC Adopts Registration Rules for Security-Based Swap Dealers and Major Security-Based Swap Participants” in the August 7, 2015 edition of Corporate & Financial Weekly by Katten Muchin Rosenman LLP.)
My View: It is too late to bemoan the failure of Congress to create a single financial services regulator in the US to oversee both the futures and securities markets and industry. This was an opportunity most recently lost during the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act. However, as much as possible, the Securities and Exchange Commission and the Commodity Futures Trading Commission should work together to maximize efficiency for industry participants. The SEC devising an entirely different registration regime and process from the CFTC for swap entities required to be registered is not consistent with this objective. It would have been far more desirable for the SEC to have leveraged off of the registration process that the CFTC already has instituted for swap dealers and major swap participants than to create a new regime from scratch.
- FINRA Fines and Suspends Two CCOs for Supervisory and AML Violations: The Financial Industry Regulatory Authority fined Aegis Capital Corp US $950,000 for selling unregistered penny stocks and related supervisory violations. FINRA also fined two individuals, Charles Smulevitz and Kevin McKenna, who served successively as chief compliance and anti-money laundering officers for the firm. The individuals were fined for supervisory and AML violations. In an Order Accepting Offer of Settlement, FINRA claimed that, between April 2009 and June 2011, Aegis liquidated nearly 3.9 billion shares of five microcap stocks that seven customers had deposited into their accounts at the firm. None of the stocks, claimed FINRA, were registered with the Securities and Exchange Commission or exempt from registration. FINRA claimed that, during the relevant time period, Aegis failed to make meaningful inquiries into the circumstances of the customers’ sales or “supposed registration exemptions” for the sale of these five and an additional five microcap stocks “despite the presence of ‘red flags’ indicating that the sales could be illicit distributions of unregistered stocks.” FINRA also claimed that Mr. Smulevitz and Mr. McKenna, during their respective terms as the firm’s AML officer, failed to “reasonably” detect and review "red flags” of potentially suspicious transactions. As a result, they did not make a “reasoned determination whether or not to report the suspicious transactions to the Financial Crimes Enforcement Network … by filing a Suspicious Activity Report … as appropriate.” For their alleged offenses, Mr. Smulevitz agreed to payment of a fine of US $5,000 and to be suspended for 30 days from serving as a registered principal of any FINRA member firm, while Mr. McKenna consented to be fined US $10,000 and be suspended for 60 days from serving as a registered principal of any FINRA member firm. Aegis also agreed to retain an independent consultant.
- BNP Paribas Securities (Asia) Fined Almost US $2 Million by Hong Kong Regulator for Dark Pool-Related Failures: The Hong Kong Securities and Futures Commission fined BNP Paribas Securities (Asia) Limited HK $15 million (almost US $2 million) for alleged failures in its dark liquidity pool trading services known as the BNP Internal Exchange (BIX). Among other breakdowns, SFC claimed that, in promotional materials provided to clients, BNP represented that orders on BIX would be executed in accordance with order price priority, meaning that bids with higher prices would receive priority over bids with lower prices, and offers with lower prices would receive preference over offers with higher prices. However, said SFC, between November 2009 and April 2011, BIX treated all orders equally, and allocated executions pro rata, based on order size. In addition, after BNPP discovered the unintended order priority issues in April 2011, BNPP suspended BIX’s operations for 13 days, and then did not fully restore all services until December 2011. However, claimed SFC, the firm never disclosed this suspension to SFC despite being required to notify the regulator “about incidents of material service breakdown or disruption of the operations of the BIX affecting its users.” According to SFC, “given the use of dark liquidity pool for trading is on the rise in recent years, it is imperative that BNPP Securities Asia, as a dark liquidity pool trading service provider and operator, must ensure BIX users are provided with sufficient information to enable them to understand how their orders are handled and executed in the BIX.”
- CFTC Commissioner Giancarolo Says Little Progress Made in Sensibly Revising Swaps Trading Rules: Commissioner J. Christopher Giancarlo of the Commodity Futures Trading Commission said there has been little, if any, progress by the CFTC to improve swaps trading since he issued a white paper in January 2015 that severely criticized the Commission’s swaps trading rules and proposed an alternative framework that he claimed more accurately reflected congressional intent. According to Mr. Giancarlo, when Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, it did not prescribe specific execution methods for cleared swaps. Instead, it “expressly permitted [swap execution facilities] to offer various flexible execution methods for swaps transactions using ‘any means of interstate commerce.’” Subsequently enacted CFTC rules, which dictate that swaps be executed solely through a central order book or a request for quote, are therefore not mandated by statute, and are inconsistent with the fundamental nature of swaps as opposed to futures, claimed Mr. Giancarlo. Mr. Giancarlo found scant progress to date with his many recommendations, and argued that if future progress was not made “swaps trading and liquidity will continue to suffer and Congress’s goal of promoting swaps trading on platforms and pre-trade price transparency will not be realized.” (Click here for additional background on Mr. Giancarlo’s white paper in the article “CFTC Commissioner Laments Flawed US Swaps Trading Model” in the February 1, 2015 edition of Bridging the Week.)
- Commodity Pool Operator Sued by CFTC for Making False Statements to NFA and Other Violations: The Commodity Futures Trading Commission commenced an enforcement action in a US federal court in New York against Wall Street Pirate Management, LLC, an entity that was registered with the Commission as a commodity pool operator from December 2011 through September 2013, and the firm’s sole managing member and employee, Gary Creagh. The CFTC charged that, during the time Wall Street Pirate was registered as a CPO, Mr. Creagh made false statements to, and concealed information from, the National Futures Association. Specifically, alleged the CFTC, during the relevant time, Mr. Creagh represented that a commodity pool he operated on behalf of Wall Street Pirate was not active and he had not solicited customers, when in fact he had solicited funds for the pool, and the pool was active and trading futures contracts. The CFTC also charged that Wall Street Pirate did not keep required books and records, and did not provide account statements and privacy notices to pool customers, as required by its rules. Among other penalties, the CFTC seeks disgorgement of profits, restitution of funds to customers and civil penalties against the respondents.
And more briefly:
- European Commission Mandates IRS Central Clearing: The European Commission adopted new rules to make the clearing of certain interest rate swap contracts mandatory: fixed-to-float, so-called “plain vanilla” IRSs; float-to-float swaps, known as “basis swaps”; forward rate agreements; and overnight index swaps. The IRSs required for clearing are those denominated in euro, pounds sterling, Japanese yen or US dollars that have specific features, including the index used as a reference for the derivative, its maturity and the notional type. The clearing obligation will be phased in over three years. (Click here for additional information regarding the registration requirements in the article “European Commission Publishes Delegated Regulation on Mandatory Clearing for OTC Interest Rate Derivatives” in the August 7, 2015 edition of Corporate & Financial Weekly by Katten Muchin Rosenman LLP.)
- Individual Securities Registrants Soon Able to Complete Periodic Regulator Element Training at Home: The Financial Industry Regulatory Authority announced that the regulatory element component of its periodic training required for individual registrants will be administered through an online process as opposed to through testing centers, as currently done, beginning later this year. Under FINRA’s rules, individual registrants must undergo firm element training every year, and regulatory element training within 120 days after two years of first becoming registered with FINRA, and then within 120 days once every three years thereafter.
- First LIBOR Defendant, Tom Hayes, Found Guilty of Conspiracy to Defraud and Sentenced to 14 Years in Prison: Tom Hayes, a former derivatives trader for UBS and Citigroup, was the first individual prosecuted by the UK Serious Fraud Office who was found guilty by a jury of multiple counts of conspiracy to defraud in connection with his alleged role into the manipulation of the London interbank offered rate (LIBOR). Mr. Hayes’ violative conduct allegedly occurred from August 2006 through September 2010. Mr. Hayes was also sentenced to 14-years imprisonment.
For more information, see:
BNP Paribas Securities (Asia) Fined Almost US $2 Million by Hong Kong Regulator for Dark Pool-Related Failures:
CFTC Commissioner Giancarolo Says Little Progress Made in Sensibly Revising Swaps Trading Rules:
Commodity Pool Operator Sued by CFTC for Making False Statements to NFA and Other Violations: http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfcreaghcomplaint080515.pdf
European Commission Mandates IRS Central Clearing:
Federal Judges in NY and Georgia Rule Against SEC for Enforcement Action Forum Choice Because of ALJ Selection Process:
Gray Financial Group:
FINRA Fines and Suspends Two CCOs for Supervisory and AML Violations:
First LIBOR Defendant, Tom Hayes, Found Guilty of Conspiracy to Defraud and Sentenced to 14 Years in Prison:
IB Fined by NFA for Late Independent Testing of AML Program and Training:
Individual Securities Registrants Soon Able to Complete Periodic Regulator Element Training at Home:
New York Regulator Penalizes Promontory Financial for Alleged Lack of Independent Judgment in Handling Standard Chartered Bank Review:
See also Promontory Press Release:
One CCO Sanctioned, Another Not, in SEC Enforcement Actions:
Parallax Investments (Falkenberg):
SEC Finalizes Registration Procedures for Security-Based Swap Entities and Proposes Rule to Permit Statutorily Disqualified Associated Persons:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of August 9, 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 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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