Securities Industry Commentator by Bill Singer Esq

June 3, 2021

Three FINRA AWCs and One Mess of an Arbitration Raise Unanswered Questions About Supervision ( Blog)

Framework for Chief Compliance Officer Liability in the Financial Sector (Report by the New York City Bar Association/Compliance Committee, Association for Corporate Growth, American Investment Council, and SIFMA)
As set forth in the Report's "Introduction":

For several years now, chief compliance officers (CCOs) in the financial sector have voiced a sustained tide of concern, detailed in the New York City Bar Association Compliance Committee's (Compliance Committee) February 2020 report on Chief Compliance Officer Liability in the Financial Sector (Report), from increased enforcement actions holding CCOs personally liable, in particular for actions that do not result from fraud or obstruction on their part. These career-ending enforcement actions discourage individuals from becoming or remaining compliance officers and performing vital functions that regulators stretched too thin would otherwise be unable to perform, particularly when other options, such as providing legal advice or becoming an outside compliance service provider or businessperson, involve less personal risk. In response to this concern, numerous U.S. Securities and Exchange Commission (SEC) Commissioners and Staff members, including Commissioner Hester Peirce in multiple speeches, Division of Examinations Director Peter Driscoll, Co-Chief of the Asset Management Unit of the Division of Enforcement Adam Aderton, former Director of the New York Regional Office of the SEC and former Acting Director of the Division of Enforcement Marc Berger, former Commissioner Daniel Gallagher, and former Director of the Division of Enforcement Andrew Ceresney, have repeatedly discussed the issue in public speeches and conference appearances and attempted to offer comfort and guidance. Several Financial Industry Regulatory Authority (FINRA) executives have also discussed the matter in public appearances, including Executive Vice President and Head of Enforcement Jessica Hopper. 

While regulators are paying increased attention to the compliance function, we believe that the creation of a formalized regulatory framework (Framework) describing nonbinding factors for the SEC to consider in determining whether to charge a CCO is a crucial next step to providing the enforcement clarity CCOs seek. Notably, in an October 2020 speech before the National Society of Compliance Professionals, Peirce called for the creation of such a Framework, which is consistent with recommendations we made in the Report. 

The Compliance Committee, in partnership with the Securities Industry and Financial Markets Association, the American Investment Council, and the Association for Corporate Growth, submits this proposal of nonbinding factors for the SEC to consider in creating a Framework under which to evaluate whether to bring charges against CCOs for conduct relating to their compliance-related duties (CCO Conduct Charges) under the federal securities laws.1 Many of the factors in our proposed Framework are likely already used to some extent in decisions regarding whether to prosecute, but we believe that formalizing such factors will help provide clear guidance to CCOs and enable them to confidently engage in their necessary work. We also believe that a Framework will be useful and necessary to all enforcement philosophies, given how much CCOs help extend regulatory resources. By instituting a Framework, the SEC and the compliance industry will more fully realize their shared interests which, in turn, will ultimately benefit the investing public. 

There is significant precedent for such a Framework. As noted in the Report, other regulatory bodies, such as the U.S. Department of Justice (DOJ), have similar frameworks, and existing guidance largely outlines substantive areas of focus for a compliance department rather than the potential liability of an individual CCO. Offers of support that the SEC may punish the employer if it does not support the CCO are of little comfort for CCOs whose employment prospects will also be deeply damaged by any enforcement case against an employer where they worked. 

In proposing these factors, we fully appreciate that each situation is unique. Given the special role that CCOs play and the compliance community's legitimate concerns, we believe that instituting a Framework of nonbinding factors will provide the compliance community with the guidance it needs balanced against regulators' need for ultimate discretion. We first discuss affirmative factors that should be present to bring a charge, and then list mitigating factors that, if present, should weigh against a CCO Conduct Charge.

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Footnote 1: This proposal does not discuss the unique concerns of CCOs in the banking sector, or regulatory oversight of that function by regulators focused on the banking sector such as the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, or the Federal Reserve. Similarly, it does not discuss the unique concerns of CCOs or regulatory oversight of swap dealers or major swap participants or other categories of registrants by the Commodity Futures Trading Commission or National Futures Association (or security-based swap dealers or major security-based swap participants by the SEC and FINRA, when and where applicable).
FINRA Rule 2010 is applied in a disparate fashion against smaller member firms and the industry's associated persons in contrast to larger FINRA firms and powerful industry interests. For me, Rule 2010 is an overly elastic, rubbery bit of nonsense that gets stretched to fit the misconduct of the little guys but just never seems to get pulled around the big boys. As such, Rule 2010 is a lovely bit of aspirational regulation, but, in truth, it's a joke. As things tend to work out under Rule 2010's shadow, the small fry get expelled and barred for their transgressions of the industry's purported standards and principles; however, when the big boys screw up, FINRA tends to find mitigation and cooperation and explanations, and, well, you know, self-regulation looks quite different depending upon whether you're looking through the prism of the powerful versus the powerless. 

Former Financial Advisor Sentenced To Five Years In Prison For Fraud (DOJ Release)
David Aaron Rockwell, 45, pled guilty in the United States District Court for the Middle District of Florida to wire fraud and bank fraud, and he was sentenced to five years in prison and ordered to pay a money judgment of $1,018,000. As alleged in part in the DOJ Release:

[R]ockwell, a financial advisor, managed investment and retirement accounts for his clients. Beginning in October 2017, Rockwell began to defraud clients and misappropriated his clients' funds for his own purpose. Rockwell also defrauded a federally insured bank when he applied for two lines of credit, totaling $700,000, in the names of his clients, without their knowledge or permission. Rockwell forged the clients' signatures on the loan applications and pledged the clients' assets as collateral for the loans, all without their knowledge or authorization. Rockwell used the funds that he had obtained from the loans for his own use and benefit. 

Furthermore, Rockwell persuaded another client to invest in low-income housing in Florida. However, once the client transferred approximately $400,000 to fund the investment, Rockwell used the money to pay his personal credit cards and to purchase a home.
In a Complaint filed in the United States District Court for the Western District of Pennsylvania,, the SEC charged Kevin T. Carney, Jonathan D. Freeze, and Robert J. Irey with violating Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. A parallel criminal action was filed against the Defendants. As alleged in part in the SEC Release:

[C]arney, Freeze, and Irey sold more than $2 million in promissory notes and equity in their purported renewable energy company, Alternative Energy Holdings, LLC, to dozens of investors, some of whom were Freeze's brokerage customers prior to his being barred from the securities industry. According to the complaint, the majority of the notes, many of which also conferred equity, promised annual returns of 120% or higher, even though the company had no sources of revenue from which it could reasonably be expected to repay investors. The complaint alleges that, among other misrepresentations, Carney, Freeze, and Irey told investors that their money would be used to defray costs related to financing a waste-to-energy plant in South Carolina. However, according to the complaint, the defendants split the majority of investor funds among themselves and used them for personal expenses unrelated to the business, such as casino visits, vacations, and to pay a fine arising from Carney's prior criminal conviction.
Without admitting or denying the allegations in an SEC Complaint filed in the United States District Court for the District of Minnesota, 
  • Jeffrey C. Mack; and
  • Lawrence C. Blaney 
consented to the entry of final judgments enjoining them from violating the antifraud provisions of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5thereunder, the books and records provisions of Section 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder, and from aiding and abetting any violations of the books and records and reporting provisions of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11 and 13a-13 thereunder. Also, Mac is enjoined from violating the books and records and reporting provisions of Rules 13a-14 and 13b2-2 of the Exchange Act. Further, Mack and Blaney are both barred from serving as an officer or director of any public company. Mack is ordered to pay $71,341.45 in disgorgement and prejudgment interest and a $195,047 civil penalty;  and Blaney is ordered to pay $35,670.73 in disgorgement and prejudgment interest and a $160,000 civil penalty. As alleged in part in the SEC Release:

[B]etween September 2016 and July 2017, Jeffrey C. Mack, Digiliti's then CEO, and Lawrence C. Blaney, Digiliti's then VP of Sales, induced Digiliti's largest customer into signing sales contracts worth more than $1.8 million by covertly entering into a series of undisclosed side letters with favorable terms for the customer. The side letters allegedly gave the customer an unconditional right to cancel the contracts in the future, a contractual term which would preclude revenue recognition under generally accepted accounting principles (GAAP). According to the complaint, Mack and Blaney concealed the side letters from Digiliti's finance and accounting personnel, Board of Directors, and external auditor and, as a result, Digiliti improperly recognized revenue on the sales in the third and fourth quarters of 2016 and the first quarter of 2017. During this same period, Digiliti raised more than $18 million from investors.

Order Determining Whistleblower Award Claim (SEC Whistleblower Award, '34 Act Rel. No. 92086, Whistleblower Award Proc. File No. 2021-54)
The SEC's Claims Review Staff ("CRS") issued a Preliminary Determination recommending that Claimant 1 receive a Whistleblower Award of about $13 million and Claimant 2 receive a Whistleblower Award of about $10 million.  In ordering the Award to the Claimants, the SEC Order found in part that:

[(i)] Claimant 1 submitted a whistleblower tip providing information that led to the initiation of investigations by the Commission and the Other Agency; (ii) Claimant 2 submitted a whistleblower tip providing information that significantly contributed to the Commission's and the Other Agency's investigations; (iii) Claimant 1's and Claimant 2's information led to Redacted actions related to a complex and fraudulent Redacted scheme involving multiple individuals and tens of millions of dollars in ill-gotten gains; (iv) Claimant 1 and Claimant 2 substantially assisted the Commission and the Other Agency by, among other things, submitting information and documents, participating in interviews, and identifying key individuals and systems involved in the investigations; but (v) Claimant 2 unreasonably delayed by waiting several years to report the conduct to the Commission, during which time the conduct continued. Based on the facts and circumstances of this matter, we believe a *** % whistleblower award to Claimant 1 and a *** % whistleblower award to Claimant 2 would recognize the significance of Claimant 1's and Claimant 2's information and the high law enforcement interest involved in this matter. 

Finally, we find that the contributions made by Claimant 1 and Claimant 2 to the Covered Action are similar to Claimant 1's and Claimant 2's contributions to the success of the Related Action, and, therefore, it is appropriate that Claimant 1 and Claimant 2 receive the same award percentage for both actions.
Latoya Stanley, 38, and Johnny Philus, 33, pled guilty in the United States District Court for the Southern District of Florida to one count of conspiracy to commit wire fraud in connection with loan applications for forgivable Paycheck Protection Program ("PPP") and economic Injury Disaster Loans ("EIDL"), and were sentenced, respectively, to 18 and 30 months in prison. As alleged in part in the DOJ Release:

[I]n Stanley's PPP application, she claimed to employ 18 individuals from her company, Dream Gurl Beauty Supply LLC. Philus, meanwhile, stated that he employed 29 individuals at his company, Elegance Auto Boutique LLC. In actuality, Stanley and Philus did not employ anyone at their respective companies. 

According to court documents, in her EIDL application, Stanley claimed to generate over $800,000 in income and to employ five individuals from a farm based in the yard of her Miami home. In his EIDL application, Philus claimed to generate $400,000 in income and to employ 10 individuals from a farm located in the yard of a small residential home. But, in reality, Stanley and Philus employed no one and the farms did not exist.

As they admitted in their plea agreements, Stanley and Philus worked together to effectuate the fraud and ultimately received over $1 million in funds from the fraudulent PPP and EIDL applications before their schemes were uncovered.

GUEST BLOG: FINRA Withdraws Proposed Expungement Rule by Nancy L. Hendrickson Esq ( Blog)
Veteran litigator Nancy Hendrickson has fought it out in the trenches when it comes to employment disputes. As Nancy sees it, FINRA's expungement process isn't exactly a square deal for the men and women trapped within that system -- pointedly, it is costly and time-consuming. So, when FINRA proposed some dubious revisions to its expungement rules and PIABA hectored for more of the same, Nancy felt the need to champion the industry's hundreds of thousands of employees. 

Three FINRA AWCs and One Mess of an Arbitration  Raise Unanswered Questions About Supervision ( Blog)
A recent FINRA regulatory settlement sanctioned a supervisor's alleged failure to "restrict" a trader's "market access." But as the facts emerged, that trader didn't exactly follow compliance policies and engaged in subterfuge to hide his tracks and cover up his trades. All of which raises questions as to whether the supervisor was victimized by the trader and an over zealous regulator. Unfortunately, there just doesn't seem to be a satisfactory answer to that seminal question, which leaves the supervisor in an uncomfortable posture.