LexisNexis Corporate & Securities Law Community 2011 Top 50 Blogs

Bon mots

"You can observe a lot just by watching." Yogi Berra

"We do not distain to borrow wit or wisdom from any man who is capable of lending us either." Henry Fielding, Tom Jones

"In our complex society the accountant's certificate and the lawyer's opinion can be instruments for inflicting pecuniary loss more potent than the chisel or the crowbar." United States v. Benjamin, 328 F.2d 854, 862 (2d Cir. 1964)

FINRA Denial of Membership Application Upheld

Asensio & Co., Inc., Exchange Act Rel. 68505, December 20, 2012

Asensio & Co. appealed from a Finra decision to deny its membership application. This wasn't surprising as it was controlled by Manual Asensio, who was barred in 2006 from associating with a Finra member for failure to provide information in a Finra investigation.

Exchange Act § 19(f) requires the Commission to dismiss such appeals if it finds that the Finra decision is factually sound, Finra acted in accordance with its rules, and the rules were applied consistently with the purposes of the Exchange Act.

In an unsurprising conclusion, the Commission found that the Finra denial was appropriate and dismissed the appeal.

CPA Suspended for 6 Months

Wendy McNeeley, CPA, Exchange Act Rel. 68431, December 13, 2012

McNeeley was charged with improper conduct while an audit manager for an investment adviser and a mutual fund. The ALJ found that she violated GAAS and suspended her from practicing before the Commission for one year.

This is a red flag case. At heart the Commission alleged that the auditors failed to follow-up sufficiently based on information about certain potentially irregular transactions. Ultimately it turned out that the insufficiently investigated transactions were part of a scheme whereby $10 million of investor funds were misappropriated by a fund manager who was criminally convicted.

The opinion in this case highlights the need for auditors to exercise appropriate skepticism and presents a good summary of the investigative standards in GAAS. Here, the decision was founded on the Commission's conclusion that McNeeley relied too heavily on assurances from the client without attempting to verify them. The primary evidence was the lack of any documentation in the work papers of investigation.

Despite finding that McNeeley's conduct was "highly unreasonable" and indicated "a risk that she will commit future violations", the Commission lowered the suspension from the one year imposed by the ALJ to six months. The Commission explained that it was doing so because McNeeley was relatively inexperienced and had relied on a supervisor who had failed to comply with his own auditing duties.

Muni Adviser and Rating Agency Bars Not Retroactive Under Landgraf

John W. Lawton, IA Act Rel. 3513, December 13, 2012

Lawton was associated with an investment adviser and was enjoined and criminally convicted based on anti-fraud violations.

The ALJ barred him from associating with any adviser, broker, dealer, muni dealer, or transfer agent. The trial judge declined to enter bars from associating with a muni adviser or rating organization ruling that those bars were impermissibly retroactive under Landgraf v USI Film Products. Those sanctions were created by Dodd-Frank which was enacted after Lawton's conduct occurred.

The Division appealed and the Commission majority agreed that under Landgraf the muni adviser and rating agency bars were not retroactive. This was a 3-2 ruling. The dissenters promised to file opinions at a later date.

SEC Bars Enjoined Accountant

Michael C. Pattison, CPA, Exchange Act Rel. 67900, September 20, 2012.

This case involved a Rule 102(e) proceeding against a CPA who had previously been enjoined in federal court from violating internal accounting controls and books and records provisions of the law when he was the controller of a public company from 2000 to 2005.  
As is standard practice in such matters based on injunctive actions, the administrative law judge ruled on motions for summary disposition. Pattison was found after a jury trial to have committed his violations in connection with backdating of stock options in September 2010. He was enjoined and ordered to disgorge $74,000 and pay a civil penalty of $50,000. His appeal to the Ninth Circuit is pending.
The district court found that Pattison:
  • Systematically backdated stock option grants on a regular basis, 
  • Misrepresented the dates of actual approval by the company's CEO, 
  • Failed to affirmatively disclose the practice to the Board and auditors, 
  • Failed to insure that an accounting expense was taken for the in-the-money option grants he facilitated
  • In doing so he circumvented internal  controls against backdated options.
The Commission's opinion reiterates its long held policy of using administrative rule 102(e) against :
[P]rofessionals who do not possess the requisite qualifications to represent others, lack character or integrity, engage in unethical or improper professional conduct, have violated or have been enjoined from violating or aiding and abetting the violation of the federal securities laws, have had their license to practice revoked or suspended, or have been convicted of a felony or misdemeanor involving moral turpitude.
Given the injunctive order and findings of the district court, the Commission noted that the only substantive issue in the case was whether Pattison could show that he should not be sanctioned, and if not, what sanction is appropriate.
Pattison's primary argument was that it was improper for the Commission to base its proceeding solely on the injunction under Rule 102(e)(3) without any showing of mens rea as required under Rule 102(e)(1) and (2). The Commission rejected this argument. It noted that "a finding by a court of competent jurisdiction that a respondent has violated securities laws, or that an injunction against future violations is warranted, is a sufficient standard of unfitness for practice before the Commission that we 'will afford a hearing only to consider mitigating or other factors why neither censure nor temporary or permanent disqualification should be imposed.'"
The Commission found that Pattison acted with a high degree of scienter and therefore barred him from appearing or practicing before the Commission.
This opinion is useful not so much for the entirely expected conclusion it reached, but for its comprehensive summary of Commission Rule 102(e) decisions.

Another 12j Revocation Imposed

Citizens Capital Corp., Exchange Act Rel. 67313, June 29, 2012

In another blockbuster opinion the SEC has spilled nineteen pages of ink and significant staff resources (two SEC staff are listed as counsel for the Division of Enforcement) upholding an ALJ's decision to revoke the registration of a company for delinquent filings. The company made no periodic filings from late 2001 until May 2011. Concluding the blindingly obvious - the Commission concluded that this constituted a "serious" violation of the reporting provisions. When the company attempted to file complaint reports after the proceedings were instituted those reports had serious faults and were not compliant.

Is it really necessary for the Commission to issue a nineteen page decision when a company has been delinquent in its periodic filings for ten years? Is there any meaningful reason why the Division doesn't move for summary affirmance of the ALJ's initial decision in cases like this?

It's Been Too Long - 12j Suspension Imposed

Calais Resources Inc., Exchange Act Rel. 34-67312, June 29, 2012

The Commission has awakened from a long sleep and entered its first substantive ruling in many months. This is clearly a monumentally important decision - to the shock and surprise of all it has upheld an ALJ's revocation of the registration of a company for failing to file periodic reports since 2003. The company failed to file nineteen quarterly reports and six annual reports over a six year period. Finally, when it did make filings, the company admitted that several were not in technical compliance with SEC rules. Yes KPMG the company's prior auditors refused permission for the company to republish its prior audits, rendering certain of its filings non-complaint. This, the Commission ruled means that financials could not be deemed audited under Reg S-X.

There is nothing to see here, this is purely routine. One has to ask though, why the SEC didn't simply summarily affirm the ALJ's decision. Were there any unique or important issues of law or fact that required the Commission enter into the fray? No. Did the opinion modify any previous Commission doctrine? No. Was there a significant issue of fact that required resolution? No. Have there been numerous similar opinions by the Commission in the past years with the same predictable result? Yes. The company, as is often the case in these situations repeatedly promised that it would soon be in compliance but was never able to achieve this goal.

DTC Action Reversed and Remanded

International Power Group, Ltd., Exchange Act Rel. 66611, March 15, 2012

Depository Trust suspended clearing and settlement of International Power Group's stock. It did so because the Commission had previously brought a civil action in federal court alleging that various defendants had issued unregistered shares of International Power. Neither International Power, nor its officers or directors were defendants in that case.

The Commission ruled that it has the authority to consider  International Power's appeal of DTC's action. DTC had argued that the Commission had no jurisdiction.

The Commission also found that DTC's procedures were deficient. It remanded the the matter to the DTC and instructed that DTC should provide appropriate procedural safeguards and develop a record. It also ordered DTC to develop uniform procedures for suspensions that will be applied to future cases involving issuers.

Bar Vacated

Robert Hardee Quarles, Exchange Act Rel. 66530, March 7, 2012

The Commission vacated the bar order entered against Quarles in 1985 upon his motion. He was suspended by the Commission from associating with a broker or dealer for six months and barred from association in a supervisory or proprietary capacity.

Since 1987 (with a brief hiatus) he has been associated with various firms in a non-supervisory capacity. He has been with his current employer for 20 years. His supervisory bar has been in place for 26 years. He has had no disciplinary issues since the 1987 order. The Division of Enforcement did not oppose Quarles motion for relief.

The Commission has previously taken the position that bars will remain in place absent "compelling circumstances." The Commission, as is unfortunately often its fashion then simply concluded (can you spell ipsi dixit?) that it is appropriate to grant Quarles' motion. It offered no explanation or analysis for this conclusion and simply cited Quarles age (70), his clean employment history and the fact that the bar was imposed 26 years ago.

Commission Lowers Penalties From Third to Second Tier

Eric J. Brown, Matthew J. Collins, Kevin J. Walsh, Mark W. Wells, Exchange Act Rel. 66469, February 27, 2012

The Commission upheld sanctions against three respondents in connection with sales or supervision of sales of variable annuities. It dismissed the case against one individual.

The Commission concluded that Brown fraudulently sold variable annuities after having lost his state license to sell insurance products and to have effected unauthorized transactions in customer accounts. In doing so he aided and abetted violations of the books and records provisions by falsifying customer account forms. He was barred from broker, dealer or adviser association and ordered to: cease and desist, pay disgorgement, and a penalty of $560,000.

Collins was found to have failed to supervise Brown and aided and abetted books and records violations by falsifying customer account forms. He was barred from broker, dealer, or adviser association with a right to reapply after two years and ordered to: cease and desist, pay disgorgement, and a penalty of $310,000.

Walsh was found to have committed fraud in connection with variable annuity sales. He too was barred from broker, dealer, or adviser association and ordered to: cease and desist; pay disgorgement, and a penalty of $255,000.

Respondent Wells was successful in his appeal. Although the ALJ found that Wells had engaged in fraudulent variable annuity sales the Commission disagreed and dismissed the case against him.

The ALJ's initial decision is here.

The discussion of penalties in this decision is of interest. First, the penalties were applied on a per customer basis rather than for each individual misrepresentation. Second, no penalties were imposed for conduct that occurred before the five year statute of limitations. The Commission rejected the Division of Enforcement's argument that such sales were part of a continuing course of conduct. Third, the Commission lowered the penalties from third to second tier as the actual customer losses were relatively small. This last matter is of great significance as it appears that the the Commission now will impose third tier penalties only when customers actually suffer significant economic loss. The statute of course authorizes third tier penalties when there are substantial investor losses or "significant risk of substantial losses." The Commission seems to base its conclusion on the fact that there were no substantial investor losses here and simply conflates that with significant risk of loss. The opinion never explains why there was no risk of greater loss by the customers – it simply concludes that this was so without any meaningful discussion of the issue.

Finra Sanctions Upheld - Mitigating and Aggravating Factors Discussed

Howard Braff, Exchange Act Rel. 66467, February 24, 2012

Finra fined Braff $25,000 and suspended from all associations for two years. He was found to have failed to provide written notice to three employers of outside brokerage accounts and falsely claimed in writing to have no outside accounts. The Commission upheld the sanctions.

Braff was no rookie, he had been a rep since 1983. The Commission used Braff's extensive industry experience to justify its finding that his concealment was intentional. In upholding the sanctions the Commission noted that the following are not mitigating factors when assessing the appropriateness of sanctions:
  • lack of disciplinary history;
  • cooperation with the investigation;
  • absence of monetary gain;  
  • absence of customer harm; and
  • absence of aggravating factors.
Unfortunately, the Commission continues to punish people for defending themselves. Braff claimed that he relied on the advice of an compliance officer at one firm. The Commission found this an aggravating factor characterizing this as an attempt to "shift blame... to others" and a "failure to appreciate ... [his] duty...." It truly is wrong for the Commission to continue to uphold sanctions for purportedly failing to recognize wrongdoing when respondents defend themselves. The Commission can appropriately justify sanctions based on the actual conduct that has occurred. It need not insist on penalizing people for defending themselves.