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Government Investigations and White Collar Litigation Group
Securities and Commodities

Congress Affirms and Extends SEC’s Disgorgement Powers

On January 1, 2021, the United States Senate joined the House of Representatives in overriding President Trump’s veto, and the National Defense Authorization Act (NDAA) became law. The NDAA was passed chiefly to authorize appropriations for military activities of the Department of Defense. The NDAA also includes a provision codifying the U.S. Securities and Exchange Commission’s (SEC) authority to seek in federal court actions disgorgement up to five years after the occurrence of securities laws violations, and expands that authority to ten years where those violations involve scienter-based (intentional) fraud. The new law resolves the much debated issues regarding the SEC’s disgorgement authority and the extended period during which the SEC now may seek disgorgement will have an immediate, significant impact on individuals and entities involved in SEC investigations and litigation.

Some context for the new law is useful. The provenance of the law is two Supreme Court opinions, Kokesh v. S.E.C., decided in 2017, and Liu v. S.E.C., decided in 2020. In Kokesh, the Supreme Court reviewed the SEC’s position on seeking disgorgement under Section 2462 of the United States Code (Time for Commencing Proceedings), which imposes a five year statute of limitations on civil fines, penalties, and forfeitures. The SEC argued, and the Tenth Circuit affirmed, that disgorgement did not constitute a penalty under Section 2462, and therefore no statute of limitations period applied. Kokesh v. S.E.C., 137 S. Ct. 1635, 1641 (2017). The Supreme Court reversed and held that disgorgement sought by the SEC in an enforcement action is subject to a five-year statute of limitations. The Supreme Court found that federal courts ordered disgorgement as a consequence of violating public law and treated the violation as an offense against the United States with disgorged funds being paid to the Treasury rather than to an individual. The Court concluded that disgorgement functioned as a penalty rather than a remedial tool, therefore subjecting it to the five-year statute of limitations under Section 2462. However, the Court clarified that this holding should not be interpreted as “an opinion on whether courts possess the authority to order disgorgement in SEC enforcement proceedings.” Kokesh, 137 S. Ct. 1642 (fn. 3).

Next came Liu. In Liu, the Court answered the question left unanswered by the Supreme Court in Kokesh, holding that disgorgement, properly tailored, was not a penalty but rather an equitable remedy under Section 21(d)(5) of the Securities Exchange Act (Investigations and Actions; Equitable Relief). Liu v. S.E.C., 140 S. Ct. 1946 (2020). Therefore, the SEC could seek disgorgement as a remedy in civil enforcement actions. However, consistent with disgorgement’s character as an equitable remedy, the Court limited the SEC’s ability to seek disgorgement to recover net profits from wrongdoers and that the disgorged funds be returned to the victims of the fraud.  Liu, 140 S. Ct. at 1940-1942. The Court left for the lower courts to sort out (1) what constituted “net profits,” (2) whether joint and several liability for disgorgement is prohibited, given the general rule against joint and several liability at equity, and (3) to what extent disgorgement could be paid into the Treasury, as opposed to being returned to victims in instances where victims are not easily identified. Further, the Court did not address whether disgorgement properly tailored to meet these limitations was subject to the five-year statute of limitations in Kokesh.

Now Congress. Section 6501 (Investigations and Prosecution of Offenses for Violations of the Securities Laws) of the NDAA amends Section 21(d) of the Securities Exchange Act and expressly authorizes the SEC to seek disgorgement in any federal court proceeding brought under any provision of the securities laws and resolves any lingering question over the time period in which it must do so. The new law provides that the SEC may bring a claim for disgorgement within five years of the latest date of the violation which gives rise to the action, and then goes one step further by extending the limitations period to ten years if the underlying conduct involved scienter-based fraud under the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisors Act of 1940, and any other statute under the securities laws for which scienter must be established. While the SEC’s authority and timing on disgorgement is clear, the statute is silent on the scope of disgorgement and the manner in which the SEC may seek it. Thus, it remains to be seen whether the SEC will have to abide by the limitations the Court imposed in Liu.

The ten-year limitations period also applies to actions with respect to other “equitable remedies,” such as injunctions, bars and suspensions. While the statute includes injunctions, bars, and suspensions as equitable remedies, similar to disgorgement, this too has been an area of dispute with some courts finding that under certain circumstances these remedies are not equitable, but instead constitute penalties and therefore subject to the five year statute under Section 2462 as set forth in Kokesh. It is not clear whether the statute by itself resolves the issue, but for sure the SEC will have at most 10 years to seek this kind of relief.

What Does This Mean?

The newly conferred authority will have an immediate impact on both SEC investigations and settlements as the amendments apply to “any action or proceeding that is pending on, or commenced on or after, the date of enactments.” Companies and individuals can expect the SEC to be aggressive first in determining to pursue investigations with older conduct, and then also in defining the initial scope and time-periods of those investigations. The SEC also may be reluctant to pare down broad requests for documents and information at the inception of those investigations. Furthermore, the SEC may be less flexible in resolving matters without scienter-based charges in order to obtain disgorgement of ill-gotten gains from conduct dating up to ten years old, as well as in imposing other equitable remedies at its disposal.

Further, given the disgorgement limitations imposed in Liu, companies, individuals, and litigants still can expect to expend considerable investigative resources in seeking to apply those limitations, and even potentially having to seek judicial intervention to enforce them. Finally, the industry can expect litigation over when exactly the limitations period begins to run (what exactly is the “latest date of the violation which gives rise to the action”) and the penal v. equitable nature of injunctions, bars, and suspensions in light of current case law.


Securities Enforcement & Litigation Team

Atlanta: Cheryl L. Haas
Los Angeles: Molly M. White
New York: William E. GoydanNoreen Kelly and Helen J. Moore
Pittsburgh: Alexander M. Madrid
Raleigh: Aline M. McCullough
Richmond: Anitra T. Cassas
Washington, D.C.: Emily P. GordyLouis D. GreensteinElizabeth J. Hogan and E. Andrew Southerling

Supreme Court Team

Matthew A. Fitzgerald
Brian D. Schmalzbach
John D. Adams
Kathryn M. Barber
Gilbert C. Dickey
Michael Francisco
Benjamin L. Hatch
Andrew G. McBride

Corporate Team

Rakesh Gopalan
Stephen Older
Katherine K. DeLuca


Securities Enforcement Defense

McGuireWoods is a national leader in securities enforcement defense. The firm’s securities enforcement and litigation team is part of an experienced and respected Government Investigations and White Collar Litigation Department that has been twice recognized as a Law360 Practice Group of the Year. We are comprised of former senior SEC and FINRA enforcement attorneys and litigators, as well as high-level federal prosecutors, and are experienced at managing every stage of complex regulatory investigations. Our team builds upon decades of experience of practicing before government agencies and regularly represents financial firms, audit committees, public companies, and their members, professionals and executives in internal and government criminal and civil investigations.

Appeals & Issues

McGuireWoods’ Appeals and Issues practice team includes eight former U.S. Supreme Court clerks and handles hundreds of appeals in state and federal appellate courts each year. The National Law Journal named McGuireWoods to its prestigious 2018 Appellate Hot List honoring leading firms that achieved success before the U.S. Supreme Court and federal appeals courts.

Securities & Compliance

McGuireWoods’ securities and compliance team assists private and public companies in capital-raising efforts through private and public offerings, and assists public companies with their reporting obligations under the Securities Exchange Act of 1934, including forms 10-K, 10-Q and 8-K, Section 16 reports and DEF 14A (proxy statements), as well as with Regulation FD and Regulation G compliance. We prepare insider-trading policies, develop training programs and assist with other aspects of securities transactions engaged in by company officers, directors and significant security holders, including 10b5-1 plans and Rule 144 compliance.

Financial Institution Regulation

FinCEN Director Blanco Comments on Section 314(b)’s New Guidance

On December 10, 2020, FinCEN Director Kenneth Blanco delivered prepared remarks at the ABA’s annual Financial Crimes Enforcement Conference. At the outset, Director Blanco addressed the importance of U.S. national security amidst the unprecedented environment created by the COVID-19 pandemic. In his remarks, Director Blanco announced “important guidance” and “much needed clarity” concerning FinCEN’s voluntary Section 314(b) information sharing program.

Section 314(b) of the USA PATRIOT Act provides financial institutions safe harbor from civil liability when sharing with another financial institution information regarding customers suspected of possible terrorist financing or money laundering activities. 31 C.F.R. § 1010.540(b)(1). Financial institutions share information under this provision to facilitate investigations of suspicious activity and assist in preparing more complete Suspicious Activity Reports (“SARs”).

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Compliance, Enforcement and Prosecution Policy and Trends

New Due Process Protection Act Amends Criminal Rule 5, May Strengthen Defendants’ Brady Rights

A new law will require all federal judges to enter an order at the beginning of every criminal case advising prosecutors of their duties under Brady v. Maryland, 373 U.S. 83 (1963) to disclose exculpatory evidence to the defense. Intentional violations of the orders could subject prosecutors to stern sanctions – up to and including vacating a conviction or disciplinary action against the prosecutor – or even contempt.

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Compliance, Enforcement and Prosecution Policy and Trends, Financial Institution Regulation

Another Cop on the Beat? CFP Board Signals Increased Enforcement Focus

Financial advisors have long used the Certified Financial Planner designation as an indicator to potential clients that they meet high standards of professionalism and ethics within their field.  The Certified Financial Planner Board of Standards, Inc. (the “CFP Board”), which grants the designation, markets it as demonstrating that its holder meets strict ethical standards.  Yet last year the CFP Board came under heavy criticism when investigative reporting showed a not insignificant number of CFP holders failed to disclose potential ethical violations, which resulted in incomplete or inaccurate information on the CFP Board’s website.  This criticism had a major impact:  the CFP Board revised its ethics code, revamped its disciplinary procedures, and is now signaling an increased focus on enforcing its standards.  As a result, financial advisors who previously did not face substantial scrutiny from the CFP Board may soon find themselves the focus of an enforcement regime eager to show its teeth.

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Compliance, Securities and Commodities

Pitfalls to Avoid in Investment Adviser Compliance Programs: SEC OCIE Risk Alert

On November 19, 2020, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a risk alert, OCIE Observations: Investment Adviser Compliance Programs, to provide the industry with insights regarding their findings in their examinations relating to Rule 206(4)-7 under the Investment Advisers Act of 1940 (“Advisers Act”) or the Compliance Rule.
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Compliance, Financial Institution Regulation, Securities and Commodities, Uncategorized

OCIE Finds Supervision Failures at Multiple-Branch Office Investment Advisers

On November 9, 2020, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) announced the results of its examination of nearly 40 SEC-registered investment advisers that operate multiple branch offices (the “Risk Alert”). Most of the firms examined conducted their advisory business out of at least 10 branch offices. OCIE observed a wide range of deficiencies across the advisers it examined, largely stemming from failures to implement policies and procedures designed to ensure compliance with the Advisers Act at branch offices. The Risk Alert serves as a warning, and reminder, to firms operating multiple branches of the need for careful attention to the unique risks posed by this model.

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Financial Institution Regulation, Securities and Commodities, Uncategorized

Yet Another Mutual Fund Fee Issue or “Death by a Thousand Cuts”: FINRA Sweep of Rights of Reinstatement Waivers

What is the Issue?

It may not be “death by a thousand cuts” but it may feel like it, as yet another mutual fund fee issue is being raised by the regulators. FINRA issued a “targeted examination letter” focused on Rights of Reinstatement (“RoR”) due to customers in certain mutual fund sales and purchases. RoRs involve fee waivers or rebates due to customers who redeem or sell shares in a fund and subsequently reinvest some or all of the proceeds from the sale/redemption in the same share class of that fund or another fund within the same fund family subject to stated terms and conditions. Interestingly, the time period between the sale/redemption and subsequent purchase of qualifying shares is determined by the fund issuers and described in the prospectuses or statement of additional information (“SAI”) and can vary from 90 days to 120 days, but can be as long as 365 days.[1] The waivers or rebates may involve a front-end sales charge waiver (often, but not always, involving A shares) or a rebate of all or part of a contingent deferred sales charge fee (“CDSC”) (for example, with C share transactions).

FINRA and the SEC have been periodically, but not systematically, raising issues regarding mutual fund sales charges and waivers for almost two decades. Starting with FINRA’s and the SEC’s breakpoint sweeps in 2002 and follow-on enforcement cases in early 2004, through subsequent reviews involving mutual fund sales charge waivers and share class selection (fee-related) for charitable and retirement accounts, 529 accounts, and this most recent RoR sweep.[2]

The RoR sweep is yet another “cut” at the problem of ensuring that customers get waivers and rebates that they are supposed to receive. As we note below, it might be time for the industry, if not the regulators, to take a holistic view of what’s out there in terms of breaks on fees to get ahead of the issue and avoid the next fee area on which regulators choose to focus.

What is FINRA Asking for in its Sweep?

FINRA’s sweep letter, which covers Jan. 1, 2017 through June 30, 2020, requests information on five topics: (1) whether the firm has systems and procedures designed to provide eligible customers with RoR waivers or fee rebates; (2) detail regarding such systems and procedures; (3) explanation of any relevant changes to the firm’s systems or procedures during the review period; (4) any processes for standardizing the timeframe governing RoRs on its platform; and (5) whether the firm identified and missed waivers or rebates, including number of customers and the number and value of missed waivers or fee rebates.

Three Key Takeaways

  • Review your program to ensure that RoRs are addressed. Needless to say, even if a firm does not receive the FINRA sweep (or Targeted Examination) letter, every firm offering mutual fund products should review their systems, processes, and procedures to ensure that they reasonably address this area and have been providing waivers and/or rebates when customers’ sales of mutual fund shares and subsequent purchases entitled them to the waiver or rebate under the rights of reinstatement provisions. If a firm identifies gaps, the firm should put a systems and procedures remediation plan in place and document the plan’s implementation.
  • Remediate customers that should have received waivers or rebates. If customers’ sales and subsequent purchases met RoR conditions and the customers did not receive the waivers or rebates, the firm should consider a remediation process and, of course, document that process.
  • Conduct a holistic review of mutual fund fee/waivers/rebates offered by fund companies. A more widespread review is also recommended. As noted above, FINRA and the SEC have been bringing enforcement actions and issuing guidance for the past 18 years – mostly on an issue-by-issue basis – when they identify that a certain type of fee offered by fund issuers is not made available to customers. Sometimes, this can be remediated by disclosure. (An aside caution, however, is whether disclosure will cure not making certain waivers available in the post-Regulation Best Interest context, when more regulatory scrutiny is expected regarding the review for reasonably available alternatives.) Based on this approach by the regulators, it would be prudent for firms to do their own “sweep” of the prospectuses and SAIs of funds offered on their platforms to ensure that all available factors impacting fee waivers and rebates are accounted for in their offerings. It may also be helpful to periodically undertake a review of what changes mutual fund issuers may be offering regarding fees/waivers/rebates to assess whether clients are already entitled to them, or whether, given the prevalence of use by peer firms, your firm is an outlier. Staying ahead of the regulators in this area will avoid unnecessary concerns down the road.

If you would like assistance in reviewing or revising your firm’s policies and procedures in light of the questions raised by FINRA’s sweep letter, please contact anyone from the experienced McGuireWoods LLP Broker Dealer/Investment Adviser team.


1. This sweep letter follows a FINRA settlement, dated June 1, 2020, involving failure to supervise to ensure that customers eligible for waivers received them. (AWC 2017053494401).

2. See Report of the Joint NASD/Industry Task Force on Breakpoints (July 12, 2003). The Task Force was convened in Jan. 2003, at the request of the SEC, followed NASD’s examination findings and issuance of Special Notice to Members 02-85, dated Dec. 23, 2002, which reminded broker/dealers of their obligation to apply correctly breakpoint discounts to front-end sales load mutual fund transactions. https://www.finra.org/rules-guidance/guidance/reports/industry-task-force-breakpoints. Concurrent examinations by the SEC, NYSE, and NASD resulted in a Joint SEC/NASD/NYSE Report of Examinations of Broker/Dealers Regarding Discounts on Front-End Sales Charges on Mutual Funds, published on March 11, 2003. FINRA’s breakpoint self-assessment initiative began in March 2003. SEC announced: Fifteen Firms to Pay Over $21.5 Million in Penalties to Settle SEC and NASD Breakpoints Charges (Feb. 12, 2004) https://www.sec.gov/news/press/2004-17.htm. FINRA wrapped up its breakpoint self-assessment sweep in 2009, announcing: FINRA Fines 25 Firms More Than $2.1 Million for Failures in Mutual Fund Breakpoint Review, Other Violations; Case Concludes Series of Actions Arising From FINRA’s Mutual Fund Breakpoint Initiative (March 23, 2009) https://www.finra.org/media-center/news-releases/2009/finra-fines-25-firms-more-21-million-failures-mutual-fund-breakpoint.

In 2016, FINRA issued a Targeted Examination Letter, focusing its sweep on mutual fund waivers in retirement and charitable accounts. (Targeted Examination Letter on Mutual Fund Waivers, May 2016, https://www.finra.org/rules-guidance/guidance/targeted-exam-letter/mutual-fund-waiver). This sweep resulted in 56 enforcement cases. See, FINRA Announces Final Results of Mutual Fund Waiver Initiative; Total of 56 Settlements Reached with Member Firms Resulting in $89 Million in Restitution to Eligible Charitable and Retirement Accounts (July 17, 2019) https://www.finra.org/media-center/news-releases/2019/finra-announces-final-results-mutual-fund-waiver-initiative.

Uncategorized

FCA Bans Three People From Working in Financial Services Industry, for Non-Financial Misconduct

On 5 November, the Financial Conduct Authority, the UK’s financial services regulator, permanently banned three men convicted of non-financial criminal offences from ever working in the financial services industry, on the basis that they do not meet criteria defining a fit and proper person.

For details about this latest development and implications for the industry, please see our alert.

Compliance

Ready or Not…Government Contractor Cybersecurity Requirements Roll Out This Month

The Department of Defense is rolling out new regulations over the next five years to set progressive steps toward mandatory cybersecurity certification for government contractors. The first set of requirements goes into effect Nov. 30.

Click here to learn what contractors must do now to ensure they are eligible for award of new contracts, task orders, delivery orders or option terms.

Compliance, Securities and Commodities

2020 NASAA Fintech and Cyber Security Symposium – A Download of Key Comments

On October 27, the North American Securities Administrators Association[1] held its 2020 symposium on Fintech and Cybersecurity. A key theme of the symposium was the impact that the pandemic has had on fintech, cybersecurity, and regulating the financial markets  –  given that regulators and securities industry professionals are largely working from home. The panelists also discussed new technological innovations that are likely to impact both the fintech industry and cybersecurity.

Kavita Jain, previously a Director in FINRA’s Office of Innovation and now the Deputy Associate Director of Innovation Policy at the Federal Reserve Board, delivered the keynote address.  She started the symposium discussing the role of regulators in fostering innovation in the financial services industry. Jain noted the traditional role of banking regulators is to ensure that banks control for risk. Because innovation necessarily involves new risk, regulators need to be prepared to monitor the new types of risk that innovation can introduce. Failing to keep up with innovation can be a type of risk. Jain commented that regulators can facilitate responsible innovation in the financial industry by engaging with key stakeholders, collaborating with other regulators, and providing regulatory clarity.

The keynote address was followed by four panel discussions.

The first panel, “Algorithms Make the World Go ‘Round,” reviewed some technological advancements in the financial industry. Shawnna Hoffman, the Global Blockchain Offering leader at IBM Watson Health, discussed the advent of quantum computing and the impact that it will likely have. Quantum computing, which will make computers exponentially more powerful than they are now, evokes a need for quantum encryption.  While less than 1% of enterprises budgeted for quantum computing projects in 2017, it was predicted that more than 20% of global enterprises will budget for it in 2023. Usman Ahmed, Head of Global Policy and Research at PayPal, emphasized the important role that fintech companies have in providing access to the economy. During the pandemic, fintech lenders were able to efficiently and safely onboard new customers, which allowed many small businesses to access Paycheck Protection Program loans that they would not have been able access to through traditional lenders.  In discussing the characteristics of fintech companies, Dan Gorfine, Founder and CEO of Gattaca Horizons LLC, emphasized speed, access, and “disintermediation” of traditional processes, noting that regulators historically have regulated through intermediaries, like banks and brokerages.  The panel also discussed the digital dollar project, which is exploring the potential for a digital based currency backed by a central bank (Central Bank Digital Currency – CBDC). Panelists noted that a tokenized dollar could help solve some issues exposed by the pandemic, like tens of millions of people awaiting paper checks from the government, while needing to pay creditors whose bills are automated.

The second panel explored how artificial intelligence (AI) is transforming the financial services industry. While the ability of AI to recognize complex patterns unrecognizable to humans can be a powerful tool in the industry, it call also have pitfalls.  The second panel discussed how AI that is premised on partial or outdated data can potentially lead to  data bias.  Jake van der Laan, with the New Brunswick Financial & Consumer Services Commission, discussed the importance of ensuring that any AI models are thoroughly vetted and continually tested once they are implemented. Firms using AI systems need to ensure that there are guardrails built into the system.  FINRA’s White Paper on Artificial Intelligence in the Securities Industry, in June of 2019, provides some good guidelines in implementing AI. The International Organization of Securities Commissions (IOSCO) and the European Securities and Markets Authority (ESMA) have also published white papers on AI. Each of these guides provides best practices with AI that are helpful to consider and implement.

The third panel, “Technology as a Sword and Shield,” discussed how technology can be used to both perpetrate and defend against cyber attacks. For example, while AI is used to monitor transactions and detect fraud, in the hands of the wrong person, it can be used to enhance phishing scams. The panel emphasized the importance of continually auditing and testing technology used to combat cyber attacks. Ruth Hill Bro, the Co-Chair of the ABA’s Cybersecurity Legal Task Force, said that the volume and sophistication of cyber attacks continue to grow – and in some instances are exacerbated by the pandemic, given the need for millions of people to work from home. The greatest weapon against threats like ransomware, phishing, and malware is a “culture of awareness,” since people are often the weakest link in a firm’s cybersecurity program.

The last panel of the day focused on “Cyber Challenges During a Challenging Time,” emphasizing the impact that the pandemic has had on regulating the financial markets and on cyber security.  Dave Kelley, FINRA’s Director of Member Supervision Specialist Programs – Cybersecurity, said that phishing remains the number one issue during the pandemic.  They have also seen an increase in the number of imposter websites popping up on the Internet.  Thus, while regulators are regulating from home, fraudsters are continuing to scheme from home unabated. Professor Tonya Evans, who is an expert in cryptocurrency and blockchain, noted that with the pandemic there has been an increased reliance on technology. Ransomeware continues to be a big issue – as is blackmail. In both schemes, the perpetrators often demand payment in cryptocurrency, since the payment cannot be retrieved once it has been transmitted.  Dr. Lorrie Cranor, Professor of Computer Science, Engineering and Public Policy at Carnegie Mellon, closed the panel by discussing steps people can take to better secure data in their remote workspaces – such as never using a password twice and using two-factor authentication.

As the pandemic continues, and we continue to adjust to large numbers of regulators, industry professionals, and consumers working remotely, these themes will continue to have a significant impact on fintech  and cybersecurity.


1. NASAA is a voluntary association whose membership consists of 67 state, provincial, and territorial securities administrators in the 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico.

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