Bridging the Week by Gary DeWaal: June 5 to 9 and June 12, 2017 (SEC Disgorgement Actions Are Not Forever; Keep Suspicions in SARs; Audit Trail Requirements)

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Published Date: June 11, 2017

The United States Supreme Court ruled last week that the Securities and Exchange Commission cannot bring enforcement actions seeking disgorgement more than five years after alleged wrongful conduct has occurred. In 2013, the Court previously precluded such untimely filings for SEC enforcement actions seeking civil penalties. The logic of these decisions should equally apply to enforcement actions brought by the Commodity Futures Trading Commission as well as other federal regulatory agencies that do not have their own distinct statute of limitations. In addition, the SEC brought an enforcement action against a broker-dealer for not only failing to file suspicious activity reports, but also for filing SARs without adequately explaining the rationale for such filings. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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Diamonds May Be Forever, but US Supreme Court Rules SEC Ability to Seek Disgorgement Limited to Five Years:

The United States Supreme Court ruled last week that the Securities and Exchange Commission may only commence enforcement actions seeking disgorgement within five years after the date of the alleged wrongdoing.

The Court grounded its decision on its prior determination in 2013 that enforcement actions brought by the SEC seeking civil penalties are also subject to a five-year statute of limitations. (Click here to access the Court’s decision in Gabelli v. Securities and Exchange Commission.)

According to the Court, disgorgement is a form of civil penalty subject to an applicable catch-all federal statute of limitations that “finds its roots in a law enacted nearly two centuries ago.” This law establishes a five-year statute of limitations for “an action, suit or proceeding for the enforcement of any civil fine, penalty or forfeiture.” (Click here to access 28 USC §2462.)

In an unanimous ruling, the Court found that SEC disgorgement is a form of penalty because it is imposed by courts (1) as a result of violating public laws and (2) for punitive purposes. In reaching this conclusion, the Court rejected the SEC’s view that disgorgement is remedial and not punitive. The Court said this is the case because, among other reasons, SEC disgorgement is sometimes “ordered without consideration of a defendant’s expenses that the reduced the amount of illegal profit.”

The Court issued its decision in an appeal of a disgorgement award assessed against Charles Kokesh. Mr. Kokesh was accused by the SEC in 2009 of misappropriating US $34.9 million in connection with two investment adviser firms he operated from 1995 to 2009. After a jury found that Mr. Kokesh violated applicable law, the federal trial court assessed a disgorgement judgment of US $34.9 million of which US $29.9 million was attributable to violations outside the limitations period. A federal court of appeals upheld the decision of the trial court.

Separately, the Attorney General of the United States prohibited the US Department of Justice from including payments to non-governmental third parties unconnected to the alleged harm as part of any settlement to federal charges of wrongdoing.

Legal Weeds: Although the US Supreme Court in its Kokesh decision and in 2013 explicitly addressed enforcement actions seeking civil penalties and disgorgement brought by the SEC, the logic of the decisions should equally apply to enforcement actions brought by the Commodity Futures Trading Commission and other federal regulatory agencies that do not have their own distinct statutes of limitations. As the Court wrote in its Kokesh opinion (quoting from one of its own prior opinions), statutes of limitations “se[t] a fixed date when exposure to the specified Government enforcement efforts end[d]… Such limits are vital to the welfare of society and rest on the principle that even wrongdoers are entitled to assume that their sins may be forgotten.”


Compliance Weeds: Applicable law and FinCEN rules require broker-dealers and other covered financial institutions (banks, Commodity Futures Trading Commission-registered future commission merchants and introducing brokers and SEC-registered mutual funds) to file a SAR with FinCEN in response to transactions of at least US $5,000 which a covered entity “knows, suspects, or has reason to suspect” involve funds derived from illegal activity; have no business or apparent lawful purpose; are designed to evade applicable law; or utilize the institution for criminal activity. The Financial Industry Regulatory Authority has recently brought numerous disciplinary actions against broker-dealers and senior officers for failing to file SARs in response to allegedly suspicious transactions. (Click here for background in the article “Clearing Firm’s Failure to File Suspicious Activity Reports in Response to Red Flags Charged as Violation of FINRA Requirements” in the March 26, 2017 edition of Bridging the Week.) The SEC has also recently filed an enforcement action against a broker-dealer and its former chief compliance and chief anti-money laundering officer for such purported failures. (Click here for background int he article, "SEC Files Charges Against Broker-Dealer and Chief AML Officer for Failure to File Suspicious Activity Reports" in the January 29, 2017 edition of Bridging the Week.) This SEC action reminds covered financial institutions that not only must they abide by their obligation to file SARs in the first instance, but they must also ensure that such SARs adequately describe the basis for the filing.

Valuable Lessons Learned: In its complaint, the SEC alleged that Alpine's compliance program did not accurately represent what the firm did day-to-day. According to the SEC, "[a]s implemented in practice, Alpine's policies and procedures did not result in the filing of SARs in the manner required [by applicable law] and by Alpine's [compliance program]." As a result, the SEC charged Alpine with failing to maintain an anti-money laundering program that complied with FinCEN's requirements and thus violated the SEC's own recordkeeping rule (click here to access SEC Rule 17a-8). Recently the CFTC filed and settled an enforcement action against Advantage Futures LLC (a registered futures commission merchant), Joseph Guinan, its majority owner and chief executive officer, and William Steele, who until May 2016 was Advantage’s chief risk officer. The CFTC similarly alleged that Advantage failed to follow the firm's own risk management program (RMP) 
regarding the role of its credit committee; the use of risk ratings; the account opening process; and the implementation and review of risk tolerance levels. However, the CFTC went one step beyond the SEC in its complaint against Alpine. The CFTC claimed that, when Advantage submitted its RMP manual, credit and risk policies and procedures manual and chief compliance officer annual report to it on “multiple occasions” between November 2013 and May 2015 (as required by CFTC regulations), Mr Guinan and Mr. Steele “knew that the documents did not accurately represent Advantage’s actual practices” and therefore contained false or misleading statements in violation of applicable law. (Click here to access Commodity Exchange Act Section 6(c)(2), 7 USC §9(2).) In other words, the CFTC alleged that, not only were Advantage's policies and procedures inaccurate, but by filing such inaccurate documents with the CFTC, the firm made a false filing. (Click here for background regarding the CFTC's Advantage enforcement action in the article, "FCM, CEO and CRO Sued by CFTC for Failure to Supervise and Risk-Related Offenses" in the September 26, 2016 edition of Bridging the Week.)  The valuable lesson learned: regulators expect that policies and procedures should be reasonably designed to assist a registrant comply with applicable regulatory requirements. However, policies and procedures must also be regularly reviewed and updated to reflect actual practices of a firm, and not just its theoretical obligations.

Compliance Weeds: Under CME Group rules, clearing members have rigorous recordkeeping obligations in connection with the audit trails of direct access clients for which they guarantee connection to Globex. (Click here to access CME Group Rule 536.B.) CME Group recently proposed making clearing members strictly liable for the accuracy of a large number of mandatory fields of such audit trails by their direct access clients. However, CME Group backed down from imposing such a potentially onerous requirement and solely mandated that clearing members take “appropriate action” for a direct access client’s input of each mandatory audit trail field “if it has actual or constructive knowledge that a non-member has failed to accurately input” mandatory audit trail fields. (Click here for background in the article “FCM Broad Strict Liability Globex Audit Trail Rule Amendment Revised to a Known or Should Have Known Standard by CME Group” in the June 4, 2017 edition of Bridging the Week.)

More briefly:

For further information:

Acting CFTC Chairman Explains Zero-Based Budgeting Approach to Congressional Committee in Defending Request for Increased 2018 FY Funding:

See also: Statement of Vice-Chairman David Valadao:

CFTC Inspector General Expresses General Satisfaction With DSIO Oversight of NFA in First Review Since NFA’s 1981 Creation:

CME Clearing Member Settles Charges for Allegedly Not Retaining Required Audit Trail of Direct Access Client; Two CBOT Members Settle Charges Related to Purported Position Limit Violations:

CME Group Warns Against Pre-Open Test Trades; NASDAQ Futures Amends Electronic Audit Trail Requirements:

Diamonds May Be Forever, but US Supreme Court Rules SEC Ability to Seek Disgorgement Limited to Five Years:

See also, Attorney General/Third Party Settlements:

Don't Forget Recently Implemented Rules Expressly Prohibiting Spoofing-Type Trading and Authorizing Expedited Proceedings to Address Potential Violations, Reminds FINRA:

ESMA Chair Says No Delay in Forthcoming MiFID II January 2018 Roll-Out:

SEC to Broker-Dealer in Enforcement Action: Include Basis for Suspicions in Suspicious Activity Reports:

US-Based Global Broker Ordered to Pay AU $50,000 by Australian National Regulator for Alleged Pre-Arranged Futures Trades on ASX:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 10, 2017. 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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Gary DeWaal

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

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