SEC ENFORCEMENT. Quarterly SEC ANNOUNCES THE FIRST-EVER WHISTLEBLOWER AWARD TO A CORPORATE OFFICER

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1 1st Quarter 2015 Each quarter, Sidley s Securities & Derivatives Enforcement and Regulatory Practice publishes this review of recent developments in SEC enforcement and regulatory matters. IN THIS ISSUE: SEC Announces the First-Ever Whistleblower Award to a Corporate Officer...1 In Separate Speeches, SEC Commissioners Continue to Debate When to Grant Bad Actor Waivers...1 Speech by Enforcement Director Ceresney Again Stresses the Need for Integrated Compliance Programs...2 Recent SEC Staff Changes...4 Two Recent SEC Speeches Again Highlight the Issue of Conflicts of Interest for Investment Advisers...5 FCPA Focus...6 SEC ANNOUNCES THE FIRST-EVER WHISTLEBLOWER AWARD TO A CORPORATE OFFICER On March 2, 2015, the SEC announced its first-ever whistleblower award to a former corporate officer. The corporate officer will receive between $475,000 and $575,000, according to the SEC s redacted order. The SEC s Whistleblower Program was established with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in To qualify for an award, a whistleblower must provide original information, derived from the whistleblower s independent knowledge or analysis, that results in an enforcement action with sanctions exceeding CONTINUED ON PAGE 2 IN SEPARATE SPEECHES, SEC COMMISSIONERS CONTINUE TO DEBATE WHEN TO GRANT BAD ACTOR WAIVERS VISIT SIDLEY.COM FOR MORE INFORMATION ON SIDLEY S SECURITIES & DERIVATIVES ENFORCEMENT AND REGULATORY PRACTICE Sidley Austin provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Prior results do not guarantee a similar outcome. Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, ; One South Dearborn, Chicago, IL 60603, ; and 1501 K Street, N.W., Washington, D.C , Recent speeches by SEC Commissioners have shed further light on the ongoing debate among the Commissioners about how the SEC should exercise its discretion when deciding whether to grant waivers from the statutory disqualification provisions of the federal securities laws. Many federal securities statutes include provisions that can allow firms in good standing to avoid burdensome registration requirements and certain limitations on the types of statements the firms can make about their products. These CONTINUED ON PAGE 3

2 THE FIRST-EVER WHISTLEBLOWER AWARD TO A CORPORATE OFFICER CONTINUED FROM 1 $1,000,000. In most cases, the Whistleblower Program excludes corporate officers from the Program and will not consider information to be derived from [a whistleblower s] independent knowledge or analysis if the whistleblower obtained the information because he or she was [a]n officer, director, trustee, or partner of an entity and was informed of the allegations by another person or through the entity s compliance efforts. The rationale behind this exclusion is that corporate officers should ultimately be responsible for maintaining the integrity of internal compliance programs and should be prohibited, in fulfilling this responsibility, from seeking monetary incentives contrary to the interests of the company. However, the Whistleblower Program includes several exceptions to this exclusion, none of which had ever been used prior to the present case. The exception that was used in the present case allows awards when a corporate officer reports original information to the SEC more than 120 days after the designated compliance personnel possessed the information and failed to address the issue. Another exception allows an officer to be eligible for an award when the officer knows, or has reason to believe, that shareholders will be substantially harmed absent immediate reporting to the SEC. A third exception allows an officer to be eligible for an award if he or she knows, or has reason to believe, that the company is impeding an investigation (e.g., destroying evidence of securities law violations). Because of the SEC s anonymity policy, little is known about the circumstances leading to the award in this case. But the SEC s announcement does suggest that the corporate officer whistleblower became aware of information of interest to the SEC, reported the information internally, and when responsible personnel failed to rectify the issue, the corporate officer went to the SEC. The award again demonstrates that the SEC expects companies to implement compliance reporting programs that address internal whistleblower tips quickly and efficiently even if they come from high-ranking decision makers in the company. As Sean McKessy, the Chief of the SEC s Office of the Whistleblower, noted, companies must have rigorous internal compliance programs that adequately address and remedy potential violations voiced by their employees as well as by their officers, directors, or other individuals. SPEECH BY ENFORCEMENT DIRECTOR CERESNEY AGAIN STRESSES THE NEED FOR INTEGRATED COMPLIANCE PROGRAMS On February 25, 2015, the Director of the SEC s Division of Enforcement, Andrew Ceresney, spoke to a group of anti-money laundering (AML) compliance professionals about the pitfalls of failing to maintain a fully integrated compliance program at broker-dealers and other securities firms. While Ceresney s audience was focused on AML and Bank Secrecy Act compliance issues, Ceresney s message was broader. He stressed that all of the various compliance functions at a firm must be fully integrated into an overarching compliance regime. Furthermore, all of the various functions must communicate efficiently and effectively so that if one function identifies a potential compliance issue it will know which other functions in the firm need the information in order to quickly investigate and report the issue, if necessary. To illustrate his point, Ceresney discussed three recent SEC enforcement actions, suggesting each was the result of a breakdown in communication between various aspects of the firms compliance programs. First, Ceresney discussed a case where the AML compliance personnel at a firm flagged a suspicious transaction and attempted to escalate the issue, but another part of the compliance department failed to recognize the red flag and thus did not file a suspicious activity report (SAR). Ceresney suggested that, [h]ad there been better communication amongst the compliance functions, with each function bringing to bear their skills and knowledge, and together reviewing the issue to determine whether there were signs of illegal conduct, this potential illegal activity could have been identified. Second, Ceresney discussed a settlement with a brokerdealer where the firm admitted to violating the securities laws by failing to have sufficient risk controls in place before providing customers with access to the market. During his speech, Ceresney suggested that, had the firm had appropriate policies and procedures on market access, the results of any surveillance could have easily fed into their AML compliance people and led to SAR filings. Finally, Ceresney noted a case that showed what can go wrong when compliance functions operate with silos. CONTINUED ON PAGE 3 2

3 CERESNEY AGAIN STRESSES THE NEED FOR INTEGRATED COMPLIANCE PROGRAMS CONTINUED FROM 2 In that case, although one of a firm s compliance groups learned that a financial advisor had had access to material nonpublic information prior to a trade, the firm did not have policies and procedures in place that directed the group s information into the hands of other compliance personnel that could have identified the insider trading issue. In sum, Ceresney stated that [w]e live in a world now with a wealth of data but we must find ways to ensure that data makes it to the right place. As Ceresney s speech and these recent cases demonstrate, identifying suspicious activity is only half the battle for firms. They must also have in place compliance policies and procedures designed to foster proper communications among control functions and allow for effective investigation and reporting. SEC COMMISSIONERS CONTINUE TO DEBATE WHEN TO GRANT BAD ACTOR WAIVERS CONTINUED FROM 1 statutes also automatically disqualify a firm from gaining these benefits if the firm is found to have violated a federal securities law. However, the statutes allow the firm to request a waiver from automatic disqualification. Not obtaining these waivers can severely restrict a firm s operations. For example, if a firm agreed to settle a case with the SEC related to potential violations of certain securities laws and was not able to obtain a waiver from the automatic statutory disqualification, the firm would be unable to rely on the private-placement safe harbor provisions of Rule 506 of Regulation D, which permit the sale of securities that are not registered with the Commission. Likewise, unless a firm obtained a waiver, it could be an ineligible issuer that would not be able to rely on the flexible securities registration process afforded to well-known seasoned issuers. Until fairly recently, the SEC granted waivers in most cases as a matter of course. However, the Commission s use of waivers became the subject of increased scrutiny beginning in January 2015, when Commissioners Luis Aguilar and Kara Stein dissented from the Commission s decision to grant a financial-services firm a waiver from the automatic disqualification provisions contained in Rule 506 of Regulation D. The dissent challenged the Commission s usual practice of granting waivers from the automatic disqualification provisions when the conduct at issue in the enforcement action was not related to the business or activity that would be affected by the automatic disqualification. The dissenting Commissioners expressed their belief that disqualification was appropriate, regardless of the alleged underlying violation, when the circumstances lead the Commission to question the firm s overall compliance culture. They explained that refusing to grant a waiver from automatic disqualification was a powerful tool, above and beyond other sanctions, that would send a clear message that there are meaningful consequences for firms that repeatedly and deliberately flout applicable laws and rules. Since that dissent, which challenged the settled expectations of regulated entities and the enforcement bar, there has been increased uncertainty about how the waiver process will operate in practice before the Commission. In recent speeches, some of the Commissioners have presented their opinions on how the Commission should treat waiver requests. In mid-february, Commissioner Daniel Gallagher stated, in remarks to the 37th Annual Conference on Securities Regulation and Business Law, that he continued to believe the Commission s past practice with regards to granting waivers was correct. He explained his view that the common theme among the various disqualification provisions is the goal of keeping so-called bad actors out of the industry and thereby preventing fraud. In a thinly-veiled reference to Commissioners Aguilar and Stein, he cautioned that some considered disqualifications to be sanction enhancements that would be applied on top of more traditional sanctions the Commission could seek. He objected to this approach, noting that in his view automatic disqualifications are not, and were never intended to be, either remedial or punitive in nature. He contended that [t]reating the waiver consideration process like the enforcement sanctions process effectively, and inappropriately, conflates automatic disqualifications with remedial and punitive sanctions. A few days later, at the Practising Law Institute s SEC Speaks in 2015 conference, Commissioner Michael Piwowar appeared to agree with Commissioner Gallagher s approach. Commissioner Piwowar stressed the need for the Commission to apply a consistent approach to its consideration of waivers. Referring to the hurdles that arose in negotiations between the Commission Staff and entities under investigation following the recent dissent, he CONTINUED ON PAGE 4 3

4 SEC COMMISSIONERS CONTINUE TO DEBATE WHEN TO GRANT BAD ACTOR WAIVERS CONTINUED FROM 3 RECENT SEC STAFF CHANGES explained that a consistent approach was particularly important in the context of settlement negotiations because a predictable process would allow a party to determine if it would be able to obtain a waiver if it agrees to settle. Given the effect an automatic disqualification may have on a firm s business, uncertainty over whether the Commission would grant a waiver request threatened to bring negotiations to an impasse. Commissioner Stein also addressed the matter of waivers at SEC Speaks. Adhering to the position she took in her dissent, she rejected as a red herring the argument that automatic disqualifications should not be considered a sanction or an enforcement tool. Rather, she thought the Commission should be concerned with determining whether automatic disqualifications are being applied appropriately and effectively. Commissioner Stein expressed her belief that automatic disqualification is a forward-looking or prophylactic tool that is designed to deter and prevent recidivism and restore trust in the markets. Unlike Commissioners Gallagher and Piwowar, Commissioner Stein appeared less troubled with automatically disqualifying a firm from activity that was completely unrelated to the firm s alleged misconduct. To her, the argument that that we should grant a waiver whenever the reason for the automatic disqualification is unrelated to the waiver defies common sense. Yet, like Commissioner Piwowar, Commissioner Stein stressed the need for a transparent process that would provide market participants with a clear sense of the rules of the road. In another recent speech, SEC Chair Mary Jo White attempted to provide just such transparency. Delivering an address to the Corporate Counsel Institute entitled Understanding Disqualifications, Exemptions and Waivers Under the Federal Securities Laws, Chair White made clear that her bottom line differed sharply from that of Commissioner Stein. Chair White explained that she thought waivers were never intended to be, and we should not use them as, an additional enforcement tool designed to address misconduct or as an unjustified mechanism for deterring misconduct. To Chair White, the Commission should grant a waiver request if the party seeking the waiver can demonstrate that the entity or individual, going forward, can engage responsibly and lawfully in the activity at issue in the particular disqualification. Chair White noted that the automatic disqualifications impose severe firm-wide consequences that may be triggered by misconduct involving a relatively limited number of a firm s employees or a specific business line, [that] is wholly unrelated to the activities that would be the subject of the disqualification. Moreover, Chair White explained her belief that the automatic disqualification provisions could be triggered even in instances where no misconduct was alleged, but simply because a firm agreed to certain undertakings, like hiring a consultant. As these speeches demonstrate, unless or until the SEC provides further official guidance, firms should be cognizant that the waivers that were once viewed as a foregone conclusion may prove more contentious. On January 8, 2015, the SEC named Walter E. Jospin as Regional Director of the Atlanta Office, where he will oversee enforcement and examinations in a region covering five states. On January 13, 2015, the SEC announced the members of a new Equity Market Structure Advisory Committee, which will focus on the structure and operations of the U.S. equities markets. The 17 members of the Committee come from different sectors of the financial services industry, academia, and from public interest groups. The members were approved by all five Commissioners. On January 28, 2015, the SEC announced that Erin E. Schneider had been named the Associate Regional Director for enforcement in the San Francisco Office. Ms. Schneider had served as a member of the Division of Enforcement s Asset Management Unit since its inception in In her new role, Ms. Schneider will oversee the San Francisco Office s enforcement efforts for northern California and the Pacific Northwest. On January 29, 2015, the SEC announced that Robert E. Rice, Chief Counsel to Chair Mary Jo White, will leave the agency. Mr. Rice had been Chief Counsel since June On February 3, 2015, the SEC announced that David Grim had been named as Acting Director of the Division of Investment Management. Mr. Grim had been the division s Deputy Director for the past two years during which time he had been responsible for overseeing all aspects of the Division s disclosure review, rulemaking, guidance, and risk monitoring functions. CONTINUED ON PAGE 5 4

5 TWO RECENT SEC SPEECHES AGAIN HIGHLIGHT THE ISSUE OF CONFLICTS OF INTEREST FOR INVESTMENT ADVISERS Two recent speeches by SEC officials have drawn attention to the issue of investment advisers and conflicts of interest. The first speech, by Julie Riewe, Co-Chief of the Asset Management Unit (AMU) in the Division of Enforcement, framed conflicts of interest as an urgent problem currently plaguing the investment adviser industry. Chief Riewe s speech was notable for its forceful tone and specificity. She explained that, in her view, conflicts of interest are a problem for advisers in every type of investment vehicle under the AMU s purview and that the AMU is examining potential conflicts in nearly every ongoing matter that the AMU is currently considering. Chief Riewe laid out two options available to advisers that have identified conflicts of interest: either (1) eliminate them or (2) mitigate them and disclose them to boards or investors. She described the question of whether conflicts exist as essentially binary: either they exist or they do not. There is no exception for potential conflicts where the adviser does not act improperly, nor is there a mitigation exception for advisers who believe they have adequately minimized the conflict internally. Chief Riewe made clear that the AMU intends to recommend numerous conflicts cases for enforcement action in the near future and encouraged advisers to subject themselves to rigorous, objective self-examinations in considering how to handle conflicts of interest going forward. In another recent speech, at the Practising Law Institute s SEC Speaks in 2015 conference, SEC Commissioner Daniel Gallagher suggested that the benefits of regulatory action regarding conflicts of interest should be weighed against the potentially negative impact to investors of any such action. Commissioner Gallagher focused on conflicts of interest from a policymaking perspective in light of a leaked White House memo that discussed a 2010 Department of Labor (DOL) proposal to expand the definition of the term fiduciary as it relates to the DOLadministered Employment Retirement Income Security Act (ERISA). Commissioner Gallagher took aim at both the DOL s proposal and the White House memo, arguing that the DOL s proposal essentially amounted to banning certain conflicts of interest by imposing unreasonably burdensome regulatory requirements. In Gallagher s view, such aggressive regulatory proposals risked harming investors by reducing the availability of certain investment products without any clear evidence that they would provide any real benefits or solve the problems that conflicts of interest present. According to Gallagher, there is no evidence that labeling a financial professional as a fiduciary will solve the problem, especially when those problems have not been sufficiently identified and their causes studied. His view is that the SEC s current approach of managing conflicts through a combination of disclosure requirements and enforcement action offers a balanced and beneficial approach to investors. Conflicts exist, that we cannot deny. But, investors and our markets are better off when we RECENT SEC STAFF CHANGES CONTINUED FROM 4 On February 11, 2015, the SEC announced that Heather Seidel had been named Chief Counsel for the SEC s Division of Trading and Markets, where she will provide legal and policy advice to the Commission on matters affecting broker-dealers and securities markets. On February 12, 2015, the SEC announced that Pamela C. Dyson had been appointed as the SEC s Chief Information Officer (CIO) in charge of overseeing the agency s information technology functions. On February 26, 2015, the SEC announced that Karen L. Martinez, Regional Director of the Salt Lake Office, is retiring this summer. On April 7, 2015, the SEC announced that Andrew Bowden, Director of the Office of Compliance Inspections and Examinations (OCIE), will leave the agency at the end of April to return to the private sector. He was named Deputy Director of OCIE in September 2012 and became the Director of OCIE in June seek to manage those conflicts, through disclosures or otherwise, rather than eviscerating entire business models and the benefits they provide. For industry participants, the immediate takeaway is that the SEC remains highly focused on conflicts of interest in the investment adviser space. Advisers must tread carefully when facing potential conflicts of interest as future enforcement actions can be triggered by nothing more than an ordinary SEC exam. 5

6 FCPA FOCUS The Foreign Corrupt Practices Act continues to be a high enforcement priority of the SEC. Here are some highlights of FCPA enforcement from the past quarter. For more information on the FCPA, please see Sidley s Anti-Corruption. January 22, 2015: PBSJ Corp., a Florida-based engineering and construction firm, agreed to pay approximately $3.3 million for violating the FCPA by paying bribes to win Qatari government contracts. PBSJ agreed to disgorge $2.8 million, pay $140,000 in interest, and pay a penalty of $375,000. The SEC also charged Walid Hatoum, PBSJ s former international marketing director, with FCPA violations. Without admitting or denying the SEC s allegations, Hatoum agreed to pay a penalty of $50,000 to resolve the case. January 27, 2015: BNY Mellon Corp. disclosed in its 10-K filing that it had received a Wells Notice and an additional subpoena from the SEC. The Wells Notice recommended an enforcement action for alleged FCPA violations regarding BNY Mellon s dealings with sovereign wealth funds. The SEC s investigation focuses on whether the bank awarded internships and other employment opportunities to officials and/or relatives of sovereign wealth fund officials and/or other government-related entities. February 6, 2015: President Obama issued a National Security Strategy (NSS). A key goal of the NSS is for the United States to continue leading the global fight against graft, which is a direct threat to peace, the rule of law, human rights, democratic institutions, and public health. The NSS likely signals a renewed commitment by the administration to use the FCPA to prosecute violators. February 24, 2015: Goodyear Tire & Rubber Co. agreed to pay $16.2 million to settle charges brought by the SEC. The SEC had alleged violations of the books and records and internal control provisions of the FCPA after Goodyear s subsidiaries in Kenya and Angola had paid bribes to increase tire sales. Although Goodyear will disgorge $14.1 million and pay pre-judgment interest of $2.1 million, Goodyear will not pay a penalty under the settlement agreement, likely due to its voluntary disclosure to the SEC and cooperation in the investigation. February 25, 2015: General Cable Corp. stated in its Form 8-K/A that it had reserved $24 million for possible disgorgement to settle FCPA charges brought by the SEC. The SEC s case stems from allegedly bribe-tainted sales made in Angola. March 16, 2015: Biomet Inc. announced in a recent SEC filing that the DOJ extended for another year its three-year Deferred Prosecution Agreement (DPA) which had been set to expire on March 26. Biomet had entered into the DPA as part of settling an investigation into possible FCPA violations regarding alleged bribes paid to doctors at government hospitals in Argentina, Brazil, and China between 2000 and March 27, 2015: Direct Access Partners LLC s former CEO and former managing director were each sentenced to four years in prison for conspiracy to violate the FCPA and Travel Act for bribing an official of the Venezuelan state economic development bank in return for bond trading business. They were also ordered to pay approximately $3.63 and $2.67 million, respectively, in forfeiture. 6

7 SECURITIES & DERIVATIVES ENFORCEMENT AND REGULATORY PRACTICE OF SIDLEY AUSTIN LLP Sidley s Securities & Derivatives Enforcement and Regulatory group advises and defends clients in a wide range of securitiesand derivatives-related matters. With more than 150 lawyers in 10 offices worldwide, we provide comprehensive regulatory, enforcement, and litigation solutions in matters involving the Securities and Exchange Commission (SEC), the Commodities Futures Trading Commission (CFTC), the Financial Industry Regulatory Authority (FINRA), self-regulatory organizations (SROs), state attorneys general, and state securities regulators. Our team is distinctive in that it combines the strength of nationally recognized enforcement lawyers with the skills of equally prominent counseling lawyers. We work collaboratively to provide our clients with informed, efficient, and effective representation. Our team features many prominent practitioners and former officials from the SEC, FINRA, and CFTC, as well as state regulators. Our lawyers include a former associate director of the SEC s Division of Enforcement, a former co-head of enforcement and associate regional director of the SEC s Northeast Regional Office, a former deputy director of the SEC s Division of Trading and Markets, a former SEC senior trial counsel, the former head of enforcement for FINRA, and the former chief of the Massachusetts Securities Division. We also understand the inside perspective. Our team includes former general counsels of Charles Schwab and UBS Financial (Paine Webber), as well as the former global head of compliance at J.P. Morgan. Our team has earned acknowledgement in numerous industry publications, including being named in the 2011 U.S. News Best Lawyers Law Firm of the Year for Securities Regulation. In its 2013 edition, Chambers USA ranked us among the best U.S. law firms for Securities. In a recent edition, that publication noted the firm s well-regarded enforcement practice with a considerable depth of resources. Sources told that publication that our practice is highly thought of for public company representations and advisory work. For more information, please contact: Paul V. Gerlach Senior Counsel pgerlach@sidley.com Barry W. Rashkover Partner brashkover@sidley.com Neal E. Sullivan Partner nsullivan@sidley.com sidley.com AMERICAS ASIA PACIFIC EUROPE Sidley Austin refers to Sidley Austin LLP and affiliated partnerships as explained at sidley.com/disclaimer. 7 MN