SEC CHARGES HEDGE FUND MANAGERS WITH SECURITIES FRAUD

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
SEC Charges Connecticut Hedge Fund Managers With Securities Fraud

In February 26, 2013, the Securities and Exchange Commission filed a civil injunctive action in the United States District Court for the District of Connecticut against Connecticut-based hedge fund managers David Bryson and Bart Gutekunst ("Gutekunst") and their advisory firm, New Stream Capital, LLC, ("New Stream") for lying to investors about the capital structure and financial condition of their hedge fund. New Stream was an unregistered investment adviser based in Ridgefield, Connecticut that managed a $750-plus million hedge fund focused on illiquid investments in asset-based lending. The SEC also charged New Stream Capital (Cayman), Ltd. ("Cayman Adviser"), a Caymanian adviser entity affiliated with New Stream, Richard Pereira ("Pereira"), New Stream’s former CFO, and Tara Bryson, New Stream’s former head of investor relations, for their role in the scheme. Tara Bryson has agreed to a proposed settlement relating to her conduct in this matter.

According to the SEC’s complaint, in March 2008, David Bryson and Gutekunst, New Stream’s lead principals and co-owners, decided to revise the fund’s capital structure to placate their largest investor, Gottex Fund Management Ltd. ("Gottex"), by giving Gottex and certain other preferred offshore investors priority over other investors in the event of a liquidation. Gottex had threatened to redeem its investment in the New Stream hedge fund because a wholesale restructuring of the fund just a few months earlier had created two new feeder funds and -- without Gottex’s knowledge -- granted equal liquidation rights to all investors, thereby eliminating the preferential status previously enjoyed by Gottex. Gottex’s investment totaled nearly $300 million at the time.

The SEC alleges that, even after revising the capital structure to put Gottex ahead of other fund investors, David Bryson and Gutekunst directed New Stream’s marketing department, led by Tara Bryson, to continue to market the fund as if all investors were on the same footing, fraudulently raising nearly $50 million in new investor funds on the basis of these misrepresentations. The marketing documents failed to disclose the March 2008 revisions to the capital structure to the new investors. In addition, Pereira, New Stream’s CFO, falsified the hedge fund’s operative financial statements to conceal the March 2008 revisions to the capital structure.

As further alleged in the complaint, disclosure of the March 2008 changes to the capital structure would have made it far more difficult to continue to raise money through the new feeder funds and would have spurred further redemptions from existing investors in the new feeder funds. As such, disclosure of the March 2008 changes would have adversely affected the defendants’ own pecuniary interests by, among other things, jeopardizing the increased cash flow from a new, lucrative fee structure that they had implemented in the fall of 2007. The defendants also misled investors about the increased level of redemptions after Gottex submitted its massive redemption request in March 2008. When asked by prospective investors about redemption levels, New Stream did not include the Gottex redemption and others that followed. For example, Gutekunst falsely told one investor in June 2008 that there was nothing remarkable about the level of redemptions that New Stream had received and that there were no liquidity concerns.

The SEC further alleges that by the end of September 2008, as the U.S. financial crisis worsened, the New Stream hedge fund was facing $545 million in redemption requests, causing it to suspend further redemptions and cease raising new funds. After several attempts at restructuring failed, New Stream and affiliated entities filed Chapter 11 bankruptcy petitions in March 2011. Based on current estimates, the defrauded investors are expected to receive approximately 5 cents on the dollar -- substantially less than half the amount that Gottex and other investors in its preferred class are expected to receive.

The SEC’s complaint charges New Stream, David Bryson and Gutekunst with violations of Section 17(a) of the Securities Act of 1933 ("Securities Act"), Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder, and Sections 206(1), 206(2) and 206(4) of the Investment Advisers Act of 1940 ("Advisers Act") and Rule 206(4)-8 thereunder. The Cayman Adviser is charged with violating Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. The SEC’s complaint charges Pereira and Tara Bryson with violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder. The SEC also contends that David Bryson, Gutekunst and Pereira are each also liable pursuant to Section 20(a) of the Exchange Act as a controlling person for New Stream’s violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; and David Bryson and Gutekunst are each further liable pursuant to Section 20(a) of the Exchange Act as a controlling person for the Cayman Adviser’s violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Finally, the SEC charges that David Bryson, Gutekunst, Pereira, and Tara Bryson are each also liable pursuant to Section 20(e) of the Exchange Act for aiding and abetting each other’s violations, and New Stream and the Cayman Adviser’s violations, of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; David Bryson and Gutekunst are each further liable pursuant to Sections 209(d) and 209(f) of the Advisers Act for aiding and abetting each other’s violations, and New Stream’s violations, of Sections 206(1) and 206(2) of the Advisers Act; and, in addition, David Bryson, Gutekunst, Pereira and Tara Bryson are each also liable pursuant to Sections 209(d) and 209(f) of the Advisers Act for aiding and abetting violations of Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder by New Stream, the Cayman Adviser, David Bryson and Gutekunst.

The complaint seeks a final judgment permanently enjoining the defendants from committing future violations of these provisions, ordering them to disgorge their ill-gotten gains plus prejudgment interest, and imposing financial penalties.

In offering to settle the SEC’s charges, without admitting or denying the allegations, Tara Bryson consented to the entry of a final judgment that permanently enjoins her from violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. The settlement is subject to court approval. Tara Bryson also consented to the entry of a Commission order barring her from associating with any investment adviser, broker-dealer, municipal securities dealer, or transfer agent.

SEC OFFICIAL'S COMMENTS AT THIRD ANNUAL INTERNATIONAL REGULATORY SUMMIT

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION,
Crisis and Conflicts
by
Ethiopis Tafara
Director, Office of International Affairs
U.S. Securities and Exchange Commission
Director, Office of International Affairs
U.S. Securities and Exchange Commission
International Centre for Financial Regulation
Third Annual International Regulatory Summit
Regulation and Policy Priorities: Growth, Stability and Sustainability
25-26 September, 2012

Thank you, Barbara (Ridpath), and thanks to the International Center for Financial Regulation for inviting me here today. Before I get into any substance, I should give the SEC’s standard disclaimer that these remarks are my own views and do not necessarily represent the views of the Securities and Exchange Commission or other members of the Commission staff.

When I was first told about the topic of the conference, "Growth, Stability and Sustainability," I was intrigued by the combination of several seemingly mutually exclusive concepts; a "we can have it all" approach befitting election year campaigning in the United States, but perhaps problematic in real-life.

But upon reflection, this trinity makes sense. We are right now still recovering from the worst financial crisis since the 1920s and 30s. Financial instability has depressed economic growth around the world – just as in the 1920s and 30s. And recent labor reports in the United States and economic growth reports in Europe and Asia suggest that economic growth is not enough. It is about stable and sustainable economic growth. After several years of global economic weakness, with high and persistent unemployment, it is no comfort to the millions of unemployed workers that many countries are no longer technically in a recession. We may have growth, but if you can’t count on the source of your next paycheck, or even whether there will be a next paycheck, life is very unstable.

Growth, Sustainability and Stability and Capital Markets

Global prosperity depends of on economic growth and we know from history that financial markets are essential to that growth. This is a truism. But that doesn’t lessen the importance of the corollary that a return to economic growth depends on a strong financial market.

As for "sustainability," it is a term we hear overused quite a bit these days – calling into question its meaning. The meaning of sustainability in the context of a limited but renewable resource is clear: Don’t cut down a forest faster than new trees can grow; don’t continually plant the same crop on the same land lest you deplete the soil’s nutrients. But what "sustainability" means in the context of a market is less clear. Financial markets have seen bubbles and resulting financial crises on a periodic, very unpleasant, yet quite sustainable basis for almost 300 years now. A fan of economists such as Schumpeter or Minsky might even suggest that it is these very financial crises that correct for market over-exuberance and make financial markets sustainable.

As for "stability," for those of us involved in the financial markets, it is one of the most common terms we hear these days. Following the financial crisis, we saw the creation of the Financial Stability Board and the formation of the Financial Stability Oversight Council in the United States and the European Financial Stability Facility. The US Treasury Department even formed a new webpage, financialstability-dot-gov. The 2008 financial crisis has been defined as a crisis of instability – as if any fraud, poorly designed incentive structures, regulatory holes, and macro-economic structural problems were fundamentally problems because they introduce instability to the system, like a restaurant table with one of its legs a bit too short. And if only we could wedge a folded up supervisory napkin under that leg, in the form of better prudential controls and greater capital requirements, the system would be "stable." As you may have guessed, I don’t agree with that view.

Risk Avoidance and Risk Promotion


It’s true that the 2008 financial crisis was fundamentally a banking crisis. And the fears that keep banking supervisors up at night are fears of instability – bank runs and contagion, and the inherent maturity mismatch between banking assets and liabilities. However, the financial system is more than just the banking system. In our rush to prevent another banking crisis, the banking system has become the lens through which the entire financial system is viewed. And improving "financial stability" has come to mean porting traditional banking supervisory concepts over into other areas of the financial system, often in ways for which they are ill-suited and possibly quite harmful.

We can already see the effects on the broader economy. Banking supervision is, at its heart, about managing risk. The recent financial crisis shows what happens when banks, and entities engaging in bank-like behavior, take on excessive risk. So it’s natural that banking supervisors will want to oversee bank risk and monitor bank capital. After all, banks are often investing insured deposits, sometimes in illiquid assets. Catastrophe is always just around the corner if depositors lose faith in the banking system and collectively withdraw their assets.

Faith in the system is also critical to our capital markets, but it is always a very different sort of faith. For financial markets, some degree of instability has to be assumed. After all, economic growth is predicated on risk-taking, of some sort or another. A new company founded, a new product line launched, a new factory built always involves risk. And to paraphrase the guys on an American TV show called "Mythbusters," risk implies that failure is always an option.

Of course, banks and banking supervisors know that risk implies potential failure. They also recognize the risks this poses to the financial system – the "instability" it produces. But the effects of risk are quite different where capital markets are concerned. Capital markets qua markets – and by this I mean real capital markets, not banking activity masquerading as capital market activity – assume this risk and distribute it according to risk tolerance. While we all know that a run on a money market fund may look very much like a bank run, investor panic, by itself, does not necessarily affect the viability of, say, a mutual fund or a broker-dealer the way it would a bank. Where properly regulated, segregated investor assets are liquidated, and investors assume their losses. Capital may become dearer as a result, but there is no systemic contagion the way there is with a bank run. Investor assets may be insured against broker-dealer operational risk, but investors bear the market risk of their investments themselves – a fact of which they are aware.

Market Integrity, Information Asymmetry and Conflicts of Interest


As a consequence, capital markets play a very different role in our financial markets. Capital markets – and by this I mean both the public and private markets – are places where the large risks are financed. Failure is commonplace and accounted for in the cost of raising capital. Consequently, the issue that keeps securities regulators up at night isn’t necessarily contagion in the banking sense – where concerns about the solvency of one firm leads to a run on otherwise solvent firms everyone, creating a self-fulfilling prophecy of bank failures. It’s not concern about faith in the stability of the system, where stability means solvency and capital adequacy. Rather, what keeps us securities regulators up at night are fears about a widespread loss of faith in the integrity of the market – that is, a loss of investor confidence. Investor confidence in a market’s integrity is central to the integrity of the overarching financial system, but integrity and investor confidence mean very different things to a securities regulator than financial market integrity might mean for a banking supervisory. Risk, itself, is not necessarily a problem. It’s not so much that investors might fear that a particular issuer isn’t as healthy as they previously thought. It’s not so much that investors don’t happen to be winning. That occurs every day. No, the problems arise when investors begin to think that the market is a rigged game that they cannot win.

For securities regulators, this is systemic risk, and it’s a type of system risk that the normal tools of banking supervision do not address. The problems that we have seen in our capital markets as a result of the financial crisis fall squarely into this category. Many banks around the world were certainly under-capitalized and making risky investments without acknowledging or perhaps even understanding the risks they were taking. But investor losses were different. In many cases, investors either weren’t informed about critical information regarding securities they were investing in, or they were not aware of – and in some cases could not be aware of – underlying conflicts of interest that would have an impact on the performance of their investments.

Regulators need to refocus on conflicts of interest and information asymmetries facing all market participants, rather than imposing a banking supervisory approach to regulation of markets and market intermediaries ill-suited to such a model. In doing so, we will rebuild investor confidence, to the benefit of issuers and investors alike. Fortunately, securities regulators have tools at their disposal to address information asymmetry. Indeed, where problems potentially might arise from a lack of critical information, securities regulators have nearly 80 years of experience in devising disclosure requirements to address them. Not only are the disclosure requirements in a major market such as the United States’ extensive, but there exists an overarching regulatory principle in the form of something like the SEC’s Rule 10b-5 that acts as a catchall to cover contingencies that investors and regulators might not yet imagine.

Rule 10b-5 plays a critical component in the vast majority of SEC enforcement cases and is at the heart of the SEC’s oversight of issuers and markets. As regulators go, it is a model of simplicity. It says – and I am paraphrasing the entire rule minimally:
It shall be unlawful for any person to lie, by admission or omission, cheat or steal in connection with the purchase or sale of any security."
Rule 10b-5 applies in the US to both the public and private markets. And when you combine it with the SEC’s mandatory initial and ongoing disclosure requirements for publicly traded securities, and the sophistication requirements for actors involved in the US private markets, "information asymmetries" between buyers and sellers is not so great today as to pose a serious risk to market integrity. This does not mean that fraud doesn’t exist – and, as we saw with Enron, Bernie Madoff and others, information asymmetries as a result of fraud are a serious threat to the integrity of any market. But this is fraud, and a violation of existing laws and rules. These threats have to be addressed with better detection and deterrence.

The Crisis, Conflicts and Controls


By contrast, what we have seen arising out of the recent financial crisis often had less to do with lack of disclosure about critical information regarding a given security or issuer, and more to do with conflicts of interest among key market participants. We saw accusations of just these kinds of conflicts of interest with credit rating agencies and asset-backed security originators "rating shopping" to get higher credit ratings; with mortgage brokers, who got paid by the number of mortgages they arranged, regardless of the credit quality of those taking out the mortgages. We saw these accusations with banks and ABS originators themselves, who lent money for mortgages which were then packaged into asset-backed securities in such a way that the banks and originators had no incentive to police the quality of those mortgages. And we have seen accusations of such conflicts of interest in the way employees of banks are compensated, where big, highly leveraged bets that pay off in the short term are heavily rewarded, regardless of the risks they pose to the firm over the medium and long-term.

Of course, these types of conflicts of interest are hardly new – even if the exact form of the conflict of interest may be. Given that conflicts of interest are endemic to any market, disclosure itself has often proven to be the best tool to combat the problems created by these conflicts. But disclosure itself is not always enough. We have seen lots of new conflicts of interest over the past decade or so – the use of special purpose entities with pernicious effects on the incentives management of an issuer face, interlocking chains of market participants involved in designing, marketing and selling a particular security; the increasing reliance by retail investors on institutional investors when participating in the market, etc. They all have translated into a landscape of conflicts of interest that evolves too fast and involves so many permutations that, in order to address them, disclosure requirements alone would either have to be so extensive that even professional investors could not read through and understand them all, or else so broad that they would lose their usefulness.

We all recognize the problem in one form or another, and we can see how regulators have tried to grapple with this problem over the past decade. After Enron, we required new disclosures and new checks on the auditing system. We prohibited some kinds of clearly conflicted relationships, such as public audit firms providing consulting services to their audit clients. Following the recent crisis, we have developed a raft of new requirements for market participants, designed to limit or manage the conflicts of interest that led to the financial meltdown.

But, to some degree, all of these efforts are an attempt to close the barn doors after the horses have fled. As the old saying goes, it’s tough to make predictions, especially about the future. But I will offer one up here – the next financial crisis will not involve the same conflicts of interest as this last one, anymore than this last one.

Because we are always going to be playing catch-up, I suggest we change tack and approach conflicts of interest with the simplicity that we approach the disclosure of material information. And by that, I mean through a principle similar to Rule 10b-5. In other words, rather than trying, to nail down every potential conflict of interest and develop a formal policy towards it – prohibit it, disclose it, or manage it in some way – we shift the onus into the relevant market participants themselves. If a market participant involved in selling, buying, underwriting, or arranging securities on behalf of others, should have an obligation to identify conflicts of interest that might affect their relationship with clients or customers, and address them in an adequate manner.

This might be through disclosure. It might be through other means. But the obligation would be the market participant’s. Because this would be a principle-based rule like 10b-5 rather than a check-the-box style rule, if a conflict later appears that the market participant should have recognized and should have addressed, the regulator can take appropriate action. And it could take this action without necessarily having to identify the conflict before the conflict becomes a problem, in much the same way that a regulator such as the SEC doesn’t necessarily have to identify every form of mistruth before bringing an enforcement action under Rule 10b-5.

Of course, Rule 10b-5, in some cases, already captures some common conflicts of interest, since issuers, in particular, must disclose material information about the securities they are selling and known conflicts of interest clearly fall under these disclosure requirements. But issuers are not the only market participants facing dangerous conflicts of interest. As the past few decades have shown, such conflicts are rife throughout the market – and arguably, some cases unavoidable. But even where unavoidable, they need to be identified and addressed, in one form or another.

As part of the Commission’s Technical Assistance Program, my office works with a range of different governments. We advise them that their capital markets are necessary for sustainable economic growth and that these markets are distinct from credit markets. The formula for success in designing a capital market requires attention to information asymmetry and conflicts of interest. We also warn them against regulating capital markets in the interest of banks – to the detriment of market finance for the benefit of operating companies. Developed economics would do well to heed the same advice.

SEC ACCUSES TWO HEDGEFUND MANAGERS WITH INVESTOR FAVORITISM

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Feb. 26, 2013 — The Securities and Exchange Commission today charged a pair of hedge fund managers and their Connecticut-based advisory firm New Stream Capital with lying to investors about their fund’s structure and financial condition before it failed during the financial crisis.

The SEC alleges that the firm’s co-owners David Bryson and Bart Gutekunst secretly revised the fund’s capital structure before it collapsed in order to placate its largest investor, Gottex Fund Management. Bryson and Gutekunst then directed New Stream’s marketing department to continue marketing the hedge fund as though all investors were on the same footing when in fact Gottex had priority over other fund investors in the event of the fund’s liquidation.

The SEC additionally charged New Stream’s former chief financial officer Richard Pereira and former head of investor relations Tara Bryson, who is David Bryson’s sister. She agreed to settle the SEC’s charges. New Stream’s Cayman Islands affiliate also was charged in the scheme, which allowed the hedge fund managers to raise nearly $50 million and receive lucrative fees while leaving investors with nearly worthless holdings when the fund went bankrupt.

"Hedge fund managers who put greed ahead of full disclosure to investors violate a fundamental trust," said George S. Canellos, Acting Director of the SEC’s Division of Enforcement. "Bryson and Gutekunst told investors they were all investing on equal terms when in fact some were investing in a fund that had been secretly restructured to their detriment."

In a parallel action, the U.S. Attorney for the District of Connecticut today announced criminal charges against Bryson, Gutekunst, and Pereira.

According to the SEC’s complaint filed in federal court in Connecticut, New Stream managed a $750 million hedge fund focused on illiquid investments in asset-based lending. In March 2008, Bryson and Gutekunst revised the fund’s capital structure after Gottex, a fund manager with nearly $300 million invested in New Stream, had threatened to redeem its investment. A restructuring of the New Stream hedge fund a few months earlier had created two new feeder funds and eliminated the preferential liquidation rights previously enjoyed by the feeder fund through which Gottex had invested. Bryson told others at New Stream that if Gottex withdrew, the firm’s hedge fund business would "tank."

The SEC alleges that revealing to all investors that New Stream restructured to favor Gottex would have made it much harder for the firm to attract and retain investors. Public disclosure also would have jeopardized cash flow from a lucrative fee arrangement that the fund’s managers put in place in late 2007. So the fund instead used misleading marketing documents that omitted the change, and Pereira as CFO falsified the fund’s financial statements to conceal the restructuring. Investors who asked about redemption levels were not told about the Gottex redemption request and others that followed. For example, Gutekunst falsely told one investor in June 2008 that there was nothing remarkable about the level of redemptions that New Stream had received and that there were no liquidity concerns.

According to the SEC’s complaint, as the financial crisis worsened in September 2008, New Stream was facing $545 million in redemption requests and was forced to suspend further redemptions and cease raising new funds. After several failed attempts at restructuring, New Stream and its affiliated entities filed for bankruptcy in March 2011.

The SEC’s complaint charges Bryson, Gutekunst, and Pereira with violating Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Bryson and Gutekunst are charged with violating Sections 206(1), 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder, and Pereira is charged with aiding and abetting their violations of Section 206(4). The SEC is seeking a variety of sanctions and relief against them including injunctions, disgorgement of ill-gotten gains with prejudgment interest, and penalties.

In the settlement with Tara Bryson, which is subject to court approval, she agreed to be permanently enjoined from further violations of the provisions of the securities laws at issue in this case. She also agreed to be permanently barred from the securities industry.

The SEC’s investigation, which is continuing, was conducted by Sheldon Pollock, Lisa Knoop, Alan Maza, Kevin McGrath, Alistaire Bambach, Scott York, and George Stepaniuk of the New York Regional Office. The SEC appreciates the assistance of the U.S. Attorney’s Office for the District of Connecticut, the Federal Bureau of Investigation, and the U.S. Department of Labor’s Office of Labor Racketeering and Fraud Investigations.

CFTC CHARGES NYME AND TWO FORMER EMPLOYEES WITH DISCLOSING CUSTOMER TRADES

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
CFTC Charges CME Group’s New York Mercantile Exchange and Two Former Employees with Disclosing Material Nonpublic Information about Customer Trades

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today filed an enforcement action charging the New York Mercantile Exchange, Inc. (CME NYMEX), which is owned and operated by the CME Group, and two former CME NYMEX employees, William Byrnes and Christopher Curtin, with violating the Commodity Exchange Act and CFTC Regulations through the repeated disclosures of material nonpublic customer information over of period of two and one-half years to an outside commodity broker who was not authorized to receive the information.

The CFTC’s Complaint, filed on February 21, 2013, in the U.S. District Court for the Southern District of New York, alleges that Byrnes and Curtin worked on the CME ClearPort Facilitation Desk and were responsible for facilitating customer transactions reported for clearing through the CME ClearPort electronic system. The Complaint alleges that at least from in or about February 2008 to September 2010, Byrnes knowingly and willfully disclosed material nonpublic information about CME NYMEX trading and customers, including about trades cleared through CME ClearPort, to a commodity broker on at least 60 occasions. The Complaint further alleges that between May 2008 and March 2009, Curtin knowingly and willfully disclosed the same type of information to the same commodity broker on at least 16 additional occasions. The nonpublic customer information unlawfully disclosed by Byrnes and Curtin in conversations — often captured on tape — included details of recently executed trades, the identities of the parties to specific trades, the brokers involved in trades, the number of contracts traded, the prices paid, the structure of particular transactions, and the trading strategies of market participants, according to the Complaint.

The Complaint alleges that the CME NYMEX and the two former employees violated the Commodity Exchange Act and CFTC Regulations, which specifically prohibit the disclosures of this type of customer information.

The CFTC’s Complaint also alleges that in July 2009, a market participant complained to CME NYMEX that the participant believed nonpublic information about trades cleared through CME ClearPort had been disclosed by a CME NYMEX employee named "Billy." Although a CME NYMEX Managing Director who investigated the market participant’s complaint identified "Billy" to be William Byrnes, CME NYMEX did not then question Byrnes, and Byrnes’s illegal disclosures continued for over a year, until at least September 2010. Ultimately, CME NYMEX terminated Byrnes’s employment in December 2010 after yet another market participant complained to CME NYMEX about disclosures of nonpublic customer information. Curtin had previously left CME NYMEX voluntarily.

In its continuing litigation, the CFTC seeks civil monetary penalties, trading and registration bans, and a permanent injunction prohibiting further violations of the federal commodities laws, as charged.

CFTC Division of Enforcement staff responsible for this case include Patrick Daly, James Wheaton, David W. MacGregor, Lenel Hickson, Stephen J. Obie, and Vincent A. McGonagle.

SEC COMMISSIONER GALLAGHER'S REMARKS AT "SEC SPEAKS IN 2013" CONFERENCE

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Remarks at "The SEC Speaks in 2013"
byCommissioner Daniel M. Gallagher
U.S. Securities and Exchange Commission
Washington, D.C.
February 22, 2013

Thank you, Craig [Lewis], for your kind introduction. This is my second year addressing this conference as a Commissioner. Last year, I spoke as one of five Commissioners, while this year, as you well know, we’re temporarily down one member. And so, I understand that the organizers are offering a 20% discount which you can collect after my remarks. Just kidding. The truth is that they asked all of us to give longer speeches, and since I am still the junior Commissioner, the others dumped their extra time on me. So, I hope you are ready for an hour long adventure.

Before I begin, let me remind you that as usual, my remarks today are my own and do not necessarily reflect the views of the Commission or my fellow Commissioners.

On a number of occasions since returning to the SEC as a Commissioner, I’ve spoken about the Commission’s priorities, both in terms of what the Commission is doing and what it should be doing in order effectively to carry out its mandate to protect investors, ensure fair and efficient markets, and facilitate capital formation. Needless to say, the Commission does not operate in a vacuum, and for various reasons, it’s not always easy to execute those priorities as we see fit. The constant stream of external influences on the Commission’s work serves as a significant impediment to its ability to focus on the core mission, including the vital, basic "blocking and tackling" of securities regulation. Today, therefore, I’d like to talk about the Commission’s origin and role as an expert, independent agency — as well as the challenges to that independence — in what has become in recent years a difficult environment for independent agencies.

As I’m sure all of you know, Congress created the SEC in the Securities Exchange Act of 1934. What some of you may not know, however, is that the Securities Act of 1933 originally tasked the Federal Trade Commission with administering the new federal securities laws. Indeed, the FTC was the initial choice of many, including President Franklin Roosevelt, to administer the Exchange Act as well.<sup>1 Ultimately, however, a consensus emerged that the difficult task of administering the federal securities laws required the creation of a new independent, bipartisan agency with a high level of technical expertise in securities matters that could focus exclusively on the nation’s capital markets. For example, during consideration of the House version of the legislation that would ultimately become the Exchange Act, Representative Charles Wolverton cited the "high degree of technical skill and knowledge," that would be necessary to administer the new federal securities laws in his support for the creation of a five-member, expert Commission to take over the administration of those new laws.2 Similarly, during consideration of the corresponding Senate bill, Senator Duncan Fletcher explained the belief among "[m]any people, Members of Congress and others . . . that a special commission ought to be provided to administer the measure because the provisions are largely technical, and we ought to have men experienced in business of the kind involved."3

The final version of the Exchange Act that emerged from Congress in the summer of 1934 provided the newly-established Commission with a broad mix of regulatory and quasi-judicial authority to carry out the legislative policies set forth in the Securities Act and the Exchange Act. The movement toward the establishment of expert, independent agencies represented a major shift in the regulatory paradigm, and it wasn’t long before this model was challenged. A year after Congress created the SEC, the Supreme Court took up the issue of independent agencies in the case of Humphrey’s Executor v. United States, which arose from President Roosevelt’s attempt to remove William Humphrey from his position as an FTC Commissioner. Much to the chagrin of the President, the Court ruled that as "an administrative body created by Congress to carry into effect legislative policies," an independent agency such as the FTC "cannot in any proper sense be characterized as an arm or an eye of the executive. Its duties are performed without executive leave and, in the contemplation of the statute, must be free from executive control."
4 Most recently, in its 2010 decision in Free Enterprise Fund v. PCAOB, the Supreme Court implicitly referenced the Commission’s independence, proceeding on the understanding that SEC Commissioners "cannot themselves be removed by the President except under the Humphrey’s Executor standard of inefficiency, neglect of duty, or malfeasance in office."5 This stands in contrast to, for example, Cabinet secretaries, who, while subject to Senate confirmation, serve at the pleasure of the President.

Having established the SEC as an expert, independent agency with the authority to administer the federal securities laws, Congress has traditionally provided the Commission with considerable flexibility to exercise that expertise and authority. Historically, Congress has avoided imposing minutely detailed mandates on the Commission. Instead, Congress has, in conjunction with past grants of authority to the SEC, largely left it to the Commission to study issues and formulate rules which the Commission deemed in its discretion to be "in the public interest or for the protection of investors," a phrase that appears time and again in our securities laws.
6 As President Roosevelt himself remarked upon signing the Investment Company Act and Investment Advisers Act into law in 1940, "[E]fficient regulation in technical fields such as this requires an administering agency which has been given flexible powers[.]"7

For nearly eighty years, the Commission, like other independent agencies, has brought its expertise and judgment to bear in fulfilling the legislative mandates established by Congress in the federal securities laws. Yet, in today’s post-financial crisis, post-Dodd-Frank regulatory environment, the Commission is faced with a variety of challenges that carry with them the potential to erode its independence. The Commission must remain alert to these challenges and must respond when appropriate in order to preserve its ability to act independently in fulfilling its core mission. My concerns here do not derive from ideology or a desire to perpetuate seemingly age old agency turf wars. Instead, this is about the need to preserve a long-standing regulatory model that eschews a one-size-fits-all approach in favor of allowing expert, independent agencies to craft rules that, when necessary, are appropriately tailored to the specific entities and products they regulate.

And then came Dodd-Frank. I worry about the limits placed on the Commission’s ability independently to apply its expertise and judgment under the paradigm established by the Dodd-Frank Act. The Act contains approximately 400 specific mandates to be implemented through agency rulemaking, around 100 of which apply directly to the SEC. Many of these mandates are highly prescriptive, and instead of directing the Commission to regulate in an area after studying the relevant issues, compiling data, and determining what, if any, regulatory action may be appropriate, they require the Commission to issue strictly prescribed and often highly technical rules under short deadlines. Unfortunately, although the Commission always has some degree of discretion when implementing a Congressional mandate, these more prescriptive rules limit the Commission’s flexibility in the rulemaking process while occupying time and resources that could be better spent fulfilling the Commission’s other important responsibilities. If one of the duties of an independent agency is to work proactively with Congress to ensure that statutes do not impose unnecessary or inappropriate mandates, then on that front the Commission unfortunately came up short with respect to many Dodd-Frank mandates.

Ideally, when Congress provides the SEC with statutory authority to draft and implement rules in a new area, it will allow the Commission the time and flexibility necessary to study the issues involved and formulate smart regulation that reflects a complete understanding of the underlying data, including the costs and benefits associated with regulatory action. This is, after all, how the Commission was intended to operate when it was established nearly eighty years ago. In fact, I believe it is the Commission’s duty as an expert, independent agency to continue to employ this data-driven approach as best it can even in the face of prescriptive mandates from Congress.

Although the Commission continues to stare down an overflowing plate of Dodd-Frank mandates in addition to its other responsibilities, as an expert, independent agency, the Commission must not allow itself to assume a secondary role in the regulation of matters squarely within its jurisdiction and core competencies. This, I’m afraid, is exactly the role that the Commission has taken thus far with respect to critical initiatives, including the Volcker Rule.

Pursuant to Section 619 of Dodd-Frank, the three Federal banking agencies, the SEC, and the CFTC must together adopt regulations to implement the Volcker Rule’s two prohibitions on banking entities and their affiliates: its prohibition on engaging in proprietary trading and its prohibition on sponsoring or investing in "covered funds" such as hedge funds or private equity funds. Unfortunately, there is little doubt that notwithstanding the valiant efforts of the SEC staff, the Commission for too long has taken a back seat to the banking regulators in this rulemaking process. As I have said in the past, despite the Rule’s ostensible application to banking entities, the Rule is actually focused on the conduct to be regulated, not the entities that engage in this activity. There is no question that the specific trading, hedging, and investing activities to be regulated under the Rule fall firmly within the Commission’s core competencies, as they deal directly with SEC registrants and registration requirements. It makes little sense, therefore, for the Commission to defer to the banking regulators in this area when for decades it has regulated securities market-making in order to facilitate liquidity and promote the efficient allocation of capital.

The implementing rulemaking for the Volcker Rule was proposed in October 2011. Almost a year and a half — and over 18,000 comment letters — later, the Volcker Rule remains at the proposal stage. Indeed, it appears that the proposal’s broad definitions of statutory terms have taken a bad situation and made it worse. Commission staff continue to engage in discussions with the bank regulators and the CFTC regarding the many concerns raised in those 18,000-plus comment letters. For this rule to get done and get done properly, the SEC must take a leadership role. In fact, I believe it is our duty as the independent financial regulator with primary authority over, and expertise in, the activities to be regulated to ensure that the final Rule meets the aims of Congress without destroying critically important market activity that the Rule explicitly intends not to eliminate. Moreover, in accordance with its core mission, it is the Commission’s responsibility to balance the bank regulators’ focus on safety and soundness and Dodd-Frank’s overarching focus on managing systemic risk with legitimate considerations of investor protection and the maintenance of vibrant markets.

This brings me to the elephant in the room: FSOC. FSOC was created, in part, to respond to the realization during the financial crisis that regulatory balkanization had resulted in a lack of communication and information-sharing among financial services regulators, which undoubtedly led to poor policy decisions during the crisis. None of us who lived through the crisis on the ground floor would argue against improvements to the regulatory structure that would facilitate coordination and information-sharing among regulators. However, with FSOC the threats to the Commission’s independence move from the theoretical to the immediate, for already in its short existence, this new body has directly challenged the Commission’s regulatory independence. It is also where just one member of the Commission, the Chairman, can defend that independence. Pursuant to the provisions of Dodd-Frank establishing FSOC, the group is composed not of agencies, but the individual heads of agencies, acting ex officio.

As I have said in the past, the structure of FSOC is particularly troubling for an independent agency like the SEC. While the Secretary of the Treasury and the heads of the FHFA and the CFPB may speak on behalf of their agencies — not to mention the President that appointed them — the same cannot be said of the Chairman of the SEC. To preserve its independence, Congress created the SEC as a bipartisan, five-member Commission and gave each Commissioner — including the Chairman — only one vote. This means that the Chairman has no statutory authority to represent or bind the Commission through his or her participation on FSOC. Yet as a voting member of FSOC, the Chairman of the SEC does have a say in authorizing FSOC to take certain actions that may affect — and indeed have already affected — markets or entities that the Commission regulates. While one might expect that the Chairman of the SEC would always represent the views of the Commission as a whole, there is no formal oversight mechanism available to the Commission to check the Chairman’s participation on FSOC. Moreover, although the Commission’s bipartisan structure insulates it from undue political influence, FSOC’s structure does not. On the contrary, FSOC is composed of individuals who are heads of their agencies — typically making them members of the President’s political party — and led by a Cabinet official who is removable by the President at will. These factors, among others, make FSOC particularly susceptible to political influence which, in turn, can be — and has been — exerted on the agencies led by FSOC’s members.

To further complicate matters, FSOC operates under a different mandate than the SEC, having been established by Congress with a broad mandate to identify systemic risks and emerging threats to the country’s financial stability. Putting aside the fact that FSOC’s designation of certain firms as "systemically important" likely institutionalizes the idea of "too big to fail," FSOC’s core mission is to ensure the safety and soundness of the U.S. financial system — not surprising given that a significant plurality of FSOC is composed of the heads of bank regulators. While this mission is of unquestionable importance, so, too is the distinct mission of the SEC. To be sure, proper oversight of our capital markets should positively impact the safety and soundness of our financial system. Nevertheless, the SEC is not by statute a safety and soundness regulator. In fact, the markets we regulate are inherently risky, and with good reason. By putting money at risk, investors allocate capital in a manner that spurs economic growth in the hopes of a much higher return on their investments than they could obtain from lower-risk, lower-return investments, such as bank accounts. The SEC seeks to protect these investors from fraud and to ensure that the markets in which they put their capital to work are fair and efficient. Our mission is not, and should not be, to make these markets risk-free, nor is it to preserve the existence of any particular firm or firms. Capital markets regulators and bank regulators have drastically different missions and oversee fundamentally different markets and market participants. And, importantly for me and all of those who appreciate and advocate for free markets, we must keep a healthy distance between capital markets regulation, which rightfully assumes no taxpayer safety nets, and bank regulation.

It is not difficult to see the potential tension between the SEC and FSOC missions and the resulting threat to the Commission’s ability to function independently. As the old adage goes: "No one can serve two masters." When the Chairman of the SEC faces this tension, which of these two potentially competing mandates does he or she honor?

Nor is FSOC merely an advisory body without teeth. To carry out its mandate, Congress provided FSOC with extraordinary powers for an inter-agency council. For example, FSOC has the authority to designate a nonbank financial company as "systemically important," and to subject these companies to prudential supervision by the Fed. FSOC may also designate a financial market utility or a payment, clearing, or settlement activity as "systemically important," and direct the Fed, in consultation with the relevant supervisory agencies and FSOC itself, to prescribe risk management standards. To the extent that these "systemically important" utilities or activities are conducted by firms for which the SEC or CFTC is the primary regulator, Dodd-Frank provides "special procedures" pursuant to which the Fed may, if it determines that the risk management standards set by the SEC or the CFTC are "insufficient," impose its own standards. That authority is not simply a threat to the Commission’s independence — if exercised, it would be an outright annexation.

FSOC also has the authority to recommend that a primary financial regulator, such as the SEC, apply new or heightened standards and safeguards for systemically significant financial activities or practices. In this regard, FSOC has been busy in recent months prodding the Commission on money market fund reforms, including through the release of proposed reform recommendations last November.

I won’t recount the history that led to FSOC’s involvement in the regulation of money market funds, an area which unquestionably falls within the core expertise and regulatory jurisdiction of the SEC. But I will emphasize that my colleagues and I have made it clear that, having now been provided with the rigorous study and economic analysis on money market funds that a bipartisan majority of the Commission asked for from the start, we fully expect the Commission to move forward with a rule proposal shortly. Why, then, is FSOC still involved in the process? FSOC was established in part to promote coordination, collaboration, and information-sharing among its member agencies. It is immensely troubling then to think of the FSOC as an institutionalized mechanism for one set of regulators to pressure another in the latter agency’s field of expertise — yet that is exactly what is happening.

Moving on from the threats posed to the Commission’s independence by Congressional mandates and FSOC intervention, there are other, more mainstream, jurisdictional incursions the Commission must monitor and manage. For example, in December 2012, the Fed, acting pursuant to Dodd-Frank authority, issued proposed regulations to apply U.S. capital, liquidity, and other prudential standards to the U.S. operations of foreign bank organizations with total global consolidated assets of at least $50 billion.
8 These rules, if adopted in their current form, would require such organizations to create an intermediate holding company that would house all of their U.S. bank and nonbank subsidiaries.

The Fed proposal would affect SEC registrants as the new holding company capital rules would treat assets held by broker-dealer subsidiaries differently than they are treated in the SEC capital rules because of the proposed leverage standard that would apply to foreign bank organizations. Specifically, a U.S. broker-dealer subsidiary of a foreign bank organization could be required indirectly to hold more capital than would be necessary to satisfy the SEC’s net capital rule to maintain the same positions.

The regulation of broker-dealers is at the heart of the Exchange Act and, as such, has been under the Commission’s regulatory purview for nearly eight decades. Using the expertise it has developed over this period, the Commission has designed capital requirements under Rule 15c3-1 that are tailored to the operations of broker-dealers and the industry in which they operate. Here, it is crucial to understand the differing theories that underlie broker-dealer and bank capital requirements. The Commission’s capital rules are meant to deal with failure, in that they are designed to ensure that when a broker-dealer fails, it has net liquid assets in excess of all non-subordinated liabilities so that the firm can be self-liquidated in an orderly manner and satisfy all creditors, particularly its customers. On the other hand, bank capital standards are not designed to require a bank to maintain sufficient net liquid assets to satisfy all creditors. Instead, banks have access to federal liquidity facilities that can be used as a funding source in the event that the bank cannot find private funding. These facilities allow the bank to be liquidated in a more orderly manner in the case of a failure. And, if the bank is "too big to fail," the facilities can operate as a tax payer-funded life support system. Accordingly, it will be very important for the Fed and the Commission to coordinate carefully as this rule proposal is considered to ensure that legitimate goals can be advanced without undermining SEC oversight.

This Fed rulemaking comes on the heels of the misguided repeal in Dodd-Frank of the Commission’s Supervised Investment Bank Holding Company, or SIBHC, program. This little-known program, which the Commission implemented under the authority of Exchange Act Section 17(i), should have been expanded in Dodd-Frank to allow the SEC to better oversee non-systemically important broker-dealer holding companies. Instead, Dodd-Frank eliminated Exchange Act Section 17(i), and replaced it with a new Fed program.

On a final note, the Commission must also be mindful of the effect that international regulatory bodies, even those like IOSCO and the FSB in which the Commission is a participant, can have on the Commission’s prerogatives as an expert, independent agency. Many of these organizations were formed in large part to foster cooperation, information-sharing, and coordination among financial regulators in different jurisdictions. However, we now often see from these groups one-size-fits-all "recommendations," some of which run contrary to the Commission’s existing regulations or address the substance of specific issues pending before the Commission. I believe that the Commission must remain an active, productive member of these groups, but we must ensure that policymaking remains in the hands of domestic regulators acting with the requisite independence.

Thank you all for coming to this year’s SEC Speaks, and I look forward to seeing you again next February.</sup>

ALLEGED INVESTMENT FRAUD BY ISLAND INVETMENT ADVISER

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., Feb. 21, 2013 — The Securities and Exchange Commission today charged an investment adviser located in the U.S. Virgin Islands with defrauding clients from whom he withheld the fact that he was receiving kickbacks for investing their money in thinly-traded companies. When he faced pressure to pay clients their returns on those investments, he allegedly used money from other clients in a Ponzi-like fashion to make payments.

The SEC’s Enforcement Division alleges that James S. Tagliaferri, through his St. Thomas-based firm TAG Virgin Islands, routinely used his discretionary authority over the accounts of his clients to purchase promissory notes issued by particular private companies. In exchange for financing those companies, TAG received millions of dollars in cash and other compensation — a conflict of interest that was never disclosed to investors. The Enforcement Division further alleges that when the promissory notes neared or passed maturity and his clients demanded payment, Tagliaferri misused assets of other clients to meet those demands.

"Tagliaferri was anything but forthcoming with his clients and he repeatedly failed to act in their best interests," said Andrew M. Calamari, Director of the SEC’s New York Regional Office. "He didn’t tell them about the compensation he received from the companies they were financing, and then compounded his fraud by using client assets to pay other clients when the conflicted investments came due."

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Tagliaferri.

According to the SEC’s order instituting administrative proceedings, Tagliaferri invested TAG clients primarily in conservative and liquid investments such as municipal bonds and blue-chip stocks until around 2007, when he began investing clients in highly illiquid securities. These investments included promissory notes issued by various closely-held private companies that were nothing more than holding companies through which an individual and his family effected personal and business transactions. He also invested at least $40 million of clients’ money in notes of a private horse-racing company, International Equine Acquisitions Holdings, Inc.

According to the SEC’s order, TAG received more than $3.35 million and approximately 500,000 shares of stock of a microcap company in return for placing various investments with these companies. The compensation that TAG received from the companies for the investments that Tagliaferri made on behalf of his clients created a conflict of interest that he was required to disclose to investors.

The SEC’s Enforcement Division alleges that Tagliaferri then further defrauded clients by investing their funds in microcap and other thinly-traded public companies in order to raise at least $80 million to pay the interest or principal due to other clients on certain of the promissory notes. Tagliaferri explained in e-mails he sent in April 2010 to the individual behind the companies that the real motivation for investing TAG clients in one of his microcap companies was to use the proceeds to pay off other clients invested in the initial series of promissory notes. "Where is the $125MM. As you are aware, this money was earmarked to clear all of the notes and other issues facing us both," Tagliaferri wrote. He later added, the "shares you transferred are being sold to clients. With those proceeds, you’re buying back your own notes." TAG clients were unaware, however, that Tagliaferri’s true motivation for having them buy these stocks was to repay other TAG clients on other conflicted investments he had made for them.

According to the SEC’s order, Tagliaferri willfully violated Sections 17(a)(1) and (3) of the Securities Act of 1933, Sections 10(b) and 15(a) of the Securities Exchange Act of 1934 and Rules 10b-5 thereunder, and Sections 206(1), 206(2) and 206(3) of the Investment Advisers Act of 1940.

The SEC’s investigation, which is continuing.