STATE OF ILLINOIS CHARGED WITH SECURITIES FRAUD

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., March 11, 2013 — The Securities and Exchange Commission today charged the State of Illinois with securities fraud for misleading municipal bond investors about the state’s approach to funding its pension obligations.

An SEC investigation revealed that Illinois failed to inform investors about the impact of problems with its pension funding schedule as the state offered and sold more than $2.2 billion worth of municipal bonds from 2005 to early 2009. Illinois failed to disclose that its statutory plan significantly underfunded the state’s pension obligations and increased the risk to its overall financial condition. The state also misled investors about the effect of changes to its statutory plan.

Illinois, which implemented a number of remedial actions and issued corrective disclosures beginning in 2009, agreed to settle the SEC’s charges.

"Municipal investors are no less entitled to truthful risk disclosures than other investors," said George S. Canellos, Acting Director of the SEC’s Division of Enforcement. "Time after time, Illinois failed to inform its bond investors about the risk to its financial condition posed by the structural underfunding of its pension system."

Elaine Greenberg, Chief of the SEC’s Municipal Securities and Public Pensions Unit, added, "Regardless of the funding methodology they choose, municipal issuers must provide accurate and complete pension disclosures including the effects of material changes to their pension plans. Public pension disclosure by municipal issuers continues to be a top priority of the unit."

According to the SEC’s order instituting settled administrative proceedings against Illinois, the state established a 50-year pension contribution schedule in the Illinois Pension Funding Act that was enacted in 1994. The schedule proved insufficient to cover both the cost of benefits accrued in a current year and a payment to amortize the plans’ unfunded actuarial liability. The statutory plan structurally underfunded the state’s pension obligations and backloaded the majority of pension contributions far into the future. This structure imposed significant stress on the pension systems and the state’s ability to meet its competing obligations – a condition that worsened over time.

The SEC’s order finds that Illinois misled investors about the effect of changes to its funding plan, particularly pension holidays enacted in 2005. Although the state disclosed the pension holidays and other legislative amendments to the plan, Illinois did not disclose the effect of those changes on the contribution schedule and its ability to meet its pension obligations. The state’s misleading disclosures resulted from various institutional failures. As a result, Illinois lacked proper mechanisms to identify and evaluate relevant information about its pension systems into its disclosures. For example, Illinois had not adopted or implemented sufficient controls, policies, or procedures to ensure that material information about the state’s pension plan was assembled and communicated to individuals responsible for bond disclosures. The state also did not adequately train personnel involved in the disclosure process or retain disclosure counsel.

According to the SEC’s order, Illinois took multiple steps beginning in 2009 to correct process deficiencies and enhance its pension disclosures. The state issued significantly improved disclosures in the pension section of its bond offering documents, retained disclosure counsel, and instituted written policies and procedures as well as implemented disclosure controls and training programs. The state designated a disclosure committee to assemble and evaluate pension disclosures. In reaching a settlement, the Commission considered these and other remedial acts by Illinois and its cooperation with SEC staff during the investigation. Without admitting or denying the findings, Illinois consented to the SEC’s order to cease and desist from committing or causing any violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.

The SEC’s investigation was conducted by Peter K. M. Chan along with Paul M. G. Helms in the Chicago Regional Office and Eric A. Celauro and Sally J. Hewitt in the Municipal Securities and Public Pensions Unit. They were assisted by other specialists in the unit including Joseph O. Chimienti, Creighton Papier, and Jonathan Wilcox.

"PLASMA ENGINE" INVESTMENT SCHEME HALTED BY SEC

FROM: SECURITIES AND EXCHANGE COMMISSION

SEC HALTS "PLASMA ENGINE" INVESTMENT SCHEME OPERATED BY JOHN ROHNER AND HIS NEVADA COMPANIES

The Securities and Exchange Commission today announced an enforcement action previously filed under seal in federal court in Las Vegas. The SEC has obtained an emergency order to halt an investment scheme that has defrauded at least 98 people nationwide out of at least $1.4 million since 2009.

The SEC’s complaint alleges that Nevada resident John P. Rohner and his companies Inteligentry, Ltd., PlasmERG, Inc. and PTP Licensing, Ltd., have been operating a fraudulent investment scheme. Rohner and his companies solicited investors for the scheme by claiming that they have developed, tested and patented an operational "plasma engine" fueled by abundant and inexpensive noble gases (such as helium), which they claim will replace the internal combustion engine. Rohner and his companies claim that the engine is non-polluting and has unlimited uses to generate electricity in homes, businesses, boats, and aircraft. For example, Rohner told at least one investor that one of his plasma engines has been running a generator on a dairy farm for 18 months and he claimed on company websites that the pollution-free engine "can run for over 3 months on a $12 gas fill". As alleged in the complaint, Rohner originally offered securities in Iowa-based PlasmERG, Inc. from 2009 to early 2011, and from May 2011 to the present Rohner has offered securities in Nevada-based Inteligentry, Ltd., using PlasmERG and PTP Licensing as related business entities.

Rohner and his companies lured investors into purchasing stock by claiming that the companies would be worth billions of dollars when the plasma engine is publicly revealed, repeatedly promising to publicly show his operational engine at stockholder meetings and trade shows. However, the claims were and are entirely fictitious. Rohner and his companies have never run an engine fueled by noble gases, nor have they obtained patents relating to the engine or the plasma technology.

Rohner and his companies also made false and misleading statements to investors that Rohner has advanced degrees from the Massachusetts Institute of Technology and Harvard University, and that they have trademarks relating to the purported engine and its plasma process. As alleged in the complaint, these representations are false. Rohner has never attended or obtained degrees from MIT or Harvard, and has never been assigned a trademark related to the engine or its purported technology.

According to the SEC’s complaint, Rohner, Inteligentry, PlasmERG, and PTP Licensing used investor funds to pay Rohner’s personal expenditures as well as business expenses. The complaint alleges that a significant portion of the funds raised from investors was used for personal expenses, including among other things the purchase of a home in Iowa for Rohner and his wife, the purchase of vehicles for Rohner’s family members and Inteligentry employees, the purchase of home goods, and the payment of personal expenses including automobile repair services and insurance, medical services, and meals at restaurants.

None of the defendants charged in the SEC’s enforcement action has ever registered with the SEC to sell securities.

On March 7, 2013, the Honorable Gloria M. Navarro granted the SEC’s request for a temporary restraining order to prevent Rohner, Inteligentry, PlasmERG, and PTP Licensing from further engaging in the issuance, offer, or sale of any security in an unregistered transaction. The Court also granted the SEC’s request for an order freezing the assets of all the defendants, requiring accountings, and prohibiting the destruction or alteration of documents. The Court unsealed the action on March 8, 2013, at the SEC’s request.

The SEC’s complaint alleges that Rohner, Inteligentry, PlasmERG and PTP Licensing violated the antifraud provisions of the federal securities laws and that Rohner, Inteligentry and PlasmERG violated the securities registration provisions of the federal securities laws. Specifically, the complaint alleges Rohner, Inteligentry, and PlasmERG each violated Sections 5(a) and 5(c) of the Securities Act of 1933 (Securities Act), and that Rohner, Inteligentry, PlasmERG and PTP Licensing violated Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5 thereunder; and that Rohner aided and abetted violations of Securities Act Section 17(a) and Exchange Act Section 10(b) and Rule 10b-5. The SEC seeks permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest thereon, and civil monetary penalties against each defendant, and a bar prohibiting Rohner from serving as an officer or director of any public company.

GRIM'S REMARKS TO INVESTMENT MANAGEMENT INSTIITUE 2013

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Remarks to the Investment Management Institute 2013

by
Norm Champ, Director, Division of Investment Management
as delivered by
David W. Grim, Deputy Director, Division of Investment Management
U.S. Securities and Exchange CommissionNew York, NY
March 7, 2013
Introduction
Good morning. I am pleased to be here today on behalf of Norm Champ, Director of the Division of Investment Management. Norm very much wanted to be with you today, and I am very pleased to have the opportunity to step in for him and deliver these remarks on his behalf.

Before I begin, let me remind you that the views I express are my own and do not necessarily reflect the views of the Commission, any of the Commissioners, or any of my colleagues on the staff of the Commission.

As I said, it is a privilege to deliver Norm Champ’s keynote address at this year’s Investment Management Institute. It is a privilege because I have the opportunity to open up the conference on behalf of a number of seasoned and expert legal practitioners who are speaking to you today. They are very knowledgeable and highly regarded in their fields.

It is a privilege because I have the opportunity to hear from and interact with two prior Directors of the Division of Investment Management, each of whom used his time and energy in that job to shape the regulatory landscape for the benefit of investors.

But most of all, it is a privilege to be here today because we have an audience comprised of professionals who want to learn more about the law; improve your own legal skills; and take back practical, real-world lessons and implement them at your own firms and offices.

Programs of this type are always enriching and beneficial to those who are willing to take the time to improve their own legal skills and add to their base of knowledge. Both Norm and I genuinely commend you for it.

* * *

Norm Champ has been on the job as Director of the Division of Investment Management for eight months. And I have been serving as Deputy Director for nearly two months.

For those of you who are not familiar with the role of the Division of Investment Management at the SEC, our mission is to work for American investors by:
protecting investors
promoting informed investment decisions and
facilitating appropriate innovation in investment products and services
through regulating the asset management industry.

The issues we work on are interesting, but more importantly, they have great consequence for America’s investors. I would hazard that nearly everyone in this room has invested in a mutual fund, an ETF or another investment product regulated under statutes administered by the Division of Investment Management.

The rules we help construct; the disclosure we review; and the new products we analyze have an impact on you and on millions of American investors like you. We have a lot of responsibility on our plate. And we take it very seriously.

Regulatory Initiative Process

What most SEC-watchers are always interested in hearing about is rulemaking activity, so, on behalf of Norm, I plan to focus on that. But that is in no way intended to diminish the important disclosure review; exemptive applications analysis; data review; and development of legal guidance that the Division of Investment Management performs.

Like the rest of the SEC, our Division is focused on implementation of our statutorily mandated rulemaking under the Dodd-Frank Act and the JOBS Act. In most cases, however, the bulk of statutorily required rulemaking that affects entities regulated within the Division of Investment Management’s jurisdiction is either complete, such as the required registration of advisers to private funds, or is being led by other parts of the agency and we are serving as consultants to assure that the asset management industry is covered consistently, such as in the general solicitation rules. In other areas, such as the Commission’s review of the standards of conduct and regulatory requirements that apply to broker-dealers and investment advisers, we are partnering with other parts of the SEC and are not the sole lead.

Where the Division of Investment Management has, under Norm Champ’s leadership, spent a lot of time focusing our energy and trying to become smarter, more strategic and more targeted, is on so-called "discretionary" or non-mandated rulemaking initiatives.

The Division of Investment Management, in close consultation with the Chairman and the Commissioners, went through a very thoughtful and deliberate approach to analyze potential regulatory initiatives.

In this era of limited budgets, one of my goals since taking the helm of the Division has been to ensure that we are allocating our resources wisely. Toward this end, Norm Champ asked the staff to take a fresh look at policy initiatives with a view to analyzing those matters based on four factors. These factors also will be used to analyze potential policy initiatives going forward.

The first factor is identification of the risk to be mitigated or the problem to be solved. This is key to the discussion of any policy initiative.

The second factor is the urgency associated with a particular initiative. Urgency may arise from risks to investors, registrants, efficient markets, or capital formation.

The third factor is the potential impact of an initiative on investors, registrants, capital formation, efficient markets, and the Division’s and SEC’s operational efficiency.

The fourth and final factor is the resources associated with a policy initiative. As with all our activities and projects, senior staff in the Division need to assess how best to allocate scarce resources.

We’re looking at factors that we believe would further the SEC’s mission as well as the impact that various regulatory initiatives would have on investors, capital formation, and efficient markets. The analysis has helped to inform the Chairman, collaborating with the Commissioners, in her determination of which regulatory priorities the Commission will pursue.

At this point you are probably asking yourselves what specific future regulatory priorities came out of this process. There are three short term and five longer term core priorities.

Short-Term Regulatory Priorities

Potential Money Market Mutual Fund Reform

The first short-term regulatory priority is money market funds, which may be the most high-profile issue on the Division’s plate these days.

Late in 2012, the SEC’s economists published a significant study on money market funds that responded to questions posed by three SEC Commissioners. The results of that study have served as a catalyst for renewed and energized focus by the SEC staff and Commissioners on additional structural reform of money market funds.

At the direction of the Chairman, the staff is engaged with the Commissioners and hard at work on developing a money market fund reform recommendation.

Identity Theft Red Flags Rules

The second of the Division’s short-term rulemaking priorities involves rules to detect and prevent theft of the identities of mutual fund investors and clients of asset managers. The growth and advancement of information technology and electronic communication have made it increasingly easy to collect, maintain and transfer personal information about individuals. Advancements in technology, however, also have led to increasing threats to the integrity and privacy of personal information.

In February 2012, the SEC proposed rules and guidelines jointly with the CFTC to require many of the entities we regulate to establish identity theft detection and prevention programs. These proposed rules were designed to help protect individuals, and help individuals protect themselves, from the risks of theft, loss, and abuse of their personal information.

The rules would give effect to the transfer of authority, under the Dodd-Frank Act, from the Federal Trade Commission to the SEC and CFTC for responsibility for overseeing the identity theft and protection programs of the entities we regulate. The comments on the proposed rules were generally supportive, and the Division is working on final identity theft red flags rules to recommend to the Commission.

Valuation Guidance

Striking an appropriate and accurate net asset value each trading day is one of the most important, and often one of the most challenging, functions that mutual funds and other investment companies perform. It is one thing to identify prices for a large cap equity fund that is investing in frequently-traded, highly-liquid securities. It is quite another for a fund that is heavily invested in thinly-traded bonds, derivative instruments and other securities that have no readily-available market price to draw from.

The Division is working to provide the fund industry, fund directors, and the public with guidance under the Investment Company Act regarding funds’ and fund directors’ valuation responsibilities. In addition to wanting to assure accuracy of mutual fund transaction prices, valuations also affect performance claims. Furthermore, fund advisers’ fees are usually calculated and paid based on asset valuations. There is a natural incentive for advisers to want those valuations to be as high as possible.

Inaccurate valuations will lead to inaccurate performance claims; inaccurate fee payments; inaccurate transaction prices and ultimately mis-pricing can muddy the integrity of the fund industry. When it comes to valuation, the Division of Investment Management believes that we need to level set requirements and make sure funds and their directors are aware of prudent practices that will lead to fair and accurate valuations.

In developing valuation guidance, the staff recognizes the benefit of input from the public and those who work hard every day to strike an accurate NAV. We therefore are exploring ways to assure that the staff and the Commission get meaningful public input on any valuation guidance.

Longer-Term Regulatory Initiatives

Each of the three short-term regulatory priorities I mentioned is actively being worked on by staff in the Division of Investment Management. In addition, there are five longer-term rulemaking projects that we are scoping the terms of and allocating resources toward. These projects are in a less advanced stage, but we want to share them so that investors, funds and advisers, taxpayers and others are aware of where we are focused and devoting resources.

Variable Annuity Summary Prospectus

A few years ago, the Commission adopted a streamlined "summary prospectus" for mutual fund investors. That document contains key information about fund investment objectives and strategies, risks, and fees and provides the ability to "click through" or request more detail for those who want it. This initiative was a revolution in communicating to investors the core information they most want while simultaneously making more detailed information readily accessible to investors, intermediaries, the financial press, and others who are interested.

The Division is beginning work on a rule that would create a similar summary prospectus for variable annuities, a type of hybrid insurance and investment product. The insurance benefits offered by these products, and the limitations on those benefits, are often complex; their costs can be difficult to understand; and they frequently offer a wide array of investment options. These and other factors often result in disclosure that is long and difficult to understand. Our goal is to facilitate the communication of concise, user-friendly information to investors considering variable annuities and enhance the transparency of the benefits, risks, and costs of these products.

ETF Rule

In 2008, the Commission proposed a rule that would basically codify exemptive relief that we routinely grant for exchange-traded funds. This rule would allow ETFs to operate without obtaining individual exemptive relief -- a process that, while important for novel products, can be costly and time-consuming.

If ETFs of new sponsors could come to market without having to obtain their own exemptive relief, the Division could reallocate staff resources from the review of "plain vanilla" applications to more novel applications. The Division has renewed its efforts to pursue implementation of this type of ETF rule.

Enhancements to Fund Disclosures about Operations and Portfolio Holdings

As part of the money market fund reforms adopted by the SEC in 2010, the SEC required new monthly reporting on portfolio holdings by those funds to both investors and the SEC. This new data has been invaluable. Some have called it a game-changer. We are able to use it to monitor trends, identify outliers and better inform our rule-writing efforts.

Many believe we need similar structured data reporting for other mutual funds and investment companies. The patchwork of outdated data collection and disclosure forms is not working, and the staff is examining how to enhance and streamline our data collection efforts.

The purpose of this initiative is to improve the quality and usefulness of information that funds provide to investors and to the SEC, and to eliminate duplicative filings or disclosures. It could make the SEC a better regulator and it could make investors better informed.

Review of the Rules that Apply to Private Fund Advisers

In 2012, approximately 1,500 advisers to hedge funds and other private funds registered with the Commission as investment advisers as a result of the Dodd-Frank Act. Private fund advisers now account for nearly 40% of our registered investment advisers.

Given the increase in the number and variety of registered private fund advisers, the Division is reviewing Advisers Act rules for aspects that should be updated to address investor protection concerns and the business models of private fund advisers.

Derivatives Concept Release

And finally, the Division also continues to consider the numerous issues raised in the Commission’s 2011 concept release on funds’ use of derivatives. When the Investment Company Act was enacted in 1940, it did not contemplate funds investing in derivatives as many do today. Indeed, the use and complexity of derivatives have grown significantly over the past two decades.

Over the years, the SEC and the Division have addressed a number of issues raised by the use of derivatives on a case-by-case basis. The purpose of the derivatives concept release was to elicit public input on a variety of regulatory issues raised by funds’ use of derivatives, including valuation, diversification and leverage limitations.

The staff is now analyzing the feedback on the concept release to assess whether, and if so how, the mutual fund and investment company regulatory regimes should be revised to adequately account for the role of derivatives and incorporate more targeted requirements.

Conclusion

Having just gone through our priorities list, it feels a little daunting. But it is important work and these are issues that must be tackled.

In addition, neither Norm Champ nor I would not want to leave you with the misimpression that rulemaking is all we do. The reality is far from it. We have numerous staff devoted to reviewing disclosure; answering investor and industry questions; helping to shape enforcement cases and examination priorities; analyzing requests for exemptive relief and no-action guidance. It is this entire body of work that makes the SEC an effective regulator.

And as Director of the Division of Investment Management, Norm Champ has been committed to continuous improvement in all phases of the Division’s work – not just the rulemaking phase. Norm and I are hopeful, however, that the remarks today showed the benefit of a coordinated and thorough analysis of potential policy initiatives. And we further hope that our approach leads to effective results and achievable goals.

We look forward to the challenging work we have ahead of us. And we look forward to a continued dialogue with our stakeholders: investors; taxpayers; industry leaders and, of course, legal practitioners such as yourselves.

Thank you.

SEC OBTAINS FINAL JUDGMENT AGAINST SCOTT KUPERSMITH IN FREE-RIDING CASE

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

The Securities and Exchange Commission announced today that on March 6, 2013, the Honorable Katharine S. Hayden of the United States District Court for the District of New Jersey entered a final judgment against defendant Scott I. Kupersmith. The final judgment imposes on Kupersmith a permanent injunction against future violations of certain antifraud provisions of the federal securities laws and orders that his obligation to pay disgorgement of $640,000 and prejudgment interest thereon be deemed satisfied provided that the combined restitution orders in the related criminal federal and state proceedings against him exceeded such amount.

In its Complaint, the Commission alleged that Kupersmith orchestrated a "free-riding" scheme of selling stocks before paying for them during 2009 and 2010 that allowed him to reap approximately $640,000 in illicit profits, while causing approximately $2 million in losses to the victim broker-dealers that he used to operate the scheme. According to the Complaint, Kupersmith interchangeably bought and sold the same quantity of the same stock in different brokerage accounts with the intention of profiting on swings up or down in the stock price. Unbeknownst to broker-dealers, Kupersmith did not have sufficient securities or cash on hand to cover the trades, and instead used proceeds from stock sales in one brokerage account to pay for the purchase of the same stock in another brokerage account. The scheme unraveled when Kupersmith failed to deliver shares to settle or cover long sales.

The final judgment permanently enjoins Kupersmith from violating Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5 and 10b-21 thereunder. In addition, the final judgment orders that Kupersmith’s obligation to pay disgorgement of $640,000 and prejudgment interest thereon be deemed satisfied provided that he was ordered to pay restitution in excess of such amount on a combined basis in the parallel criminal proceedings against him. Kupersmith consented to the entry of the final judgment.

On May 29, 2012, Kupersmith pleaded guilty to federal criminal charges for securities fraud in a parallel criminal action before the District Court for the District of New Jersey in United States v. Kupersmith, 2:12-cr-00375 (D.N.J.). On March 4, 2012, Kupersmith was sentenced to 33 months in prison followed by three years of supervised release and ordered to pay $1,796,151 in restitution.

In a related state criminal action, on May 7, 2012, Kupersmith pleaded guilty to criminal charges, including securities fraud under New York penal law, before the Supreme Court of the State of New York for the County of New York in State of New York v. Scott Kupersmith et al., Ind. No. 04360/2011 (Sup. Ct. N.Y. County). On March 5, 2013, Kupersmith was sentenced to a one-to-three year state prison term to run concurrently with the federal prison sentence and ordered to pay $684,703 in restitution, including a five-percent administration fee.

The Commission acknowledges the assistance of the U.S. Attorney's Office for the District of New Jersey, Federal Bureau of Investigation, and Manhattan District Attorney's Office.

SEC PROPOSES NEW RULES TO PROTECT MARKETS FROM TECHNOLOGY ISSUES

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., March 7, 2013 — The Securities and Exchange Commission today unanimously proposed new rules to require certain key market participants to have comprehensive policies and procedures in place surrounding their technological systems.

The SEC’s proposal called Regulation SCI would replace the current voluntary compliance program with enforceable rules designed to better insulate the markets from vulnerabilities posed by systems technology issues.

Self-regulatory organizations, certain alternative trading systems, plan processors, and certain exempt clearing agencies would be required to carefully design, develop, test, maintain, and surveil systems that are integral to their operations. The proposed rules would require them to ensure their core technology meets certain standards, conduct business continuity testing, and provide certain notifications in the event of systems disruptions and other events.

"While it’s not possible to prevent every technological error that market participants may commit, we must ensure that our regulations are designed to minimize their impact on our markets and ultimately investors," said SEC Chairman Elisse B. Walter. "Reg SCI would provide more explicit technology and control standards to help ensure that our markets remain resilient against technological vulnerabilities."

The SEC will seek public comment on Reg SCI for 60 days following its publication in the Federal Register.

FACT SHEET

Improving Systems Compliance and Integrity

SEC Open Meeting
March 7, 2013

Background

Today’s securities markets rely extensively on technology more than ever before. As with any industry, the consequences can be significant when technology goes awry.

The high-speed automated trading that occurs both on national securities exchanges and alternative trading systems has heightened the potential for a technological problem to broadly impact the market.

Following the Flash Crash in May 2010, the SEC approved a series of measures to help limit the impact of such technological errors. For instance, the SEC approved rules to halt trading when a stock price falls too far, too fast as well as rules to provide certainty in advance of when an erroneous trade would be broken and rules to eliminate stub quotes.

Additionally, the SEC approved a rule known as the market access rule, which requires brokers and dealers with market access to put in place risk management controls and supervisory procedures designed to manage the financial, regulatory, and other risks posed to the markets by a malfunctioning of their technological systems.

Automation Review Policy

There are no mandatory rules governing the automated systems of self-regulatory organizations, such as national securities exchanges, clearing agencies, FINRA, and the MSRB. Instead, for the past two decades, they have followed a voluntary set of principles articulated in the SEC’s Automation Review Policy and participated in what is known as the ARP Inspection Program.

Recent technological issues in the securities markets including those that arose during the initial public offerings of Facebook and BATS Global Markets as well as the Knight Capital trading incident have shown that investors can be put at risk when technology fails, and confidence in the markets can falter.

The SEC convened a roundtable in October 2012 to discuss how market participants could prevent or at least mitigate systems issues, and how the response to such issues could be improved. The market closures following Superstorm Sandy also highlight the importance of having a robust market technology infrastructure. These events and discussions have helped shape the development of the rulemaking being proposed today.

Proposed Rule — Regulation SCI

The set of rules proposed by the Commission — called Regulation Systems Compliance and Integrity (Regulation SCI) — would formalize and make mandatory many of the provisions of the SEC’s Automation Review Policy that have developed during the last two decades. The proposed rule applies the policy and proposes additional measures to entities at the heart of U.S. securities market infrastructure in order to protect that infrastructure.

Regulation SCI would seek to ensure:
Core technology of national securities exchanges, significant alternative trading systems, clearing agencies, and plan processors meet certain standards.
These entities conduct business continuity testing with their members or participants.
These entities provide certain notifications regarding systems disruptions and other types of systems issues.
Regulation SCI is intended to reduce the chance of technology problems occurring in the first place and ensure that key entities are well-positioned to take appropriate corrective action if problems do occur.

SEC COMMISSIONER LUIS A. AGUILAR SPEAKS ABOUT AUTOMATED SYSTEMS

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Developing Solutions to Ensure that the Automated Systems of Our Marketplace are Secure, Robust, and Reliable
byCommissioner Luis A. Aguilar
U.S. Securities and Exchange CommissionWashington, D.C.
March 7, 2013


In recent years, the securities markets have undergone significant changes, and none has had more impact than the development of technology systems with ever-increasing speed and capacity. These systems are so fast that, in a blink of an eye, millions of trades can take place and billions of dollars can be transferred from buyers to sellers.<sup>Unfortunately, these systems can just as quickly become a destructive force with devastating consequences.

Some of the better-known examples of recent system-related issues include:
The Flash Crash of May 6, 2010.
 During the flash crash, in just a matter of minutes, certain equities experienced severe price movements — both up and down — with more than 20,000 trades in over 300 securities executed at prices more than 60% away from their market values. In just a few minutes, nearly $1 trillion in market value evaporated, before making a partial recovery.
The October 2011 system errors at Direct Edge exchanges where, in just over four minutes, the exchanges caused about 27 million shares of excess trading. These shares had an approximate market value of $773 million across roughly one thousand securities. The exchanges realized a net loss of $2.1 million in connection with the positions that were assumed and liquidated.
 The Commission sanctioned the Direct Edge entities for violations of the federal securities laws. In its Order, the Commission noted that the "violations occurred against the backdrop of weaknesses in Respondents’ systems, processes, and controls."6
Knight Capital Group Inc.’s $440 million trading loss in August 2012.
 In just 45 minutes, Knight Capital’s computers rapidly bought and sold millions of shares. Those trades pushed the value of many stocks up, and the company’s losses appear to have occurred when it had to sell the overvalued shares back into the market at a lower price. As a result, Knight Capital lost approximately $10 million per minute, almost had to go into bankruptcy, and subsequently agreed to be purchased.8
The systems issues associated with the initial public offerings of BATS Global Markets, Inc., and Facebook, Inc., in March and May 2012, respectively.
 As a result of systems issues, the BATS IPO was abandoned, and the Facebook fiasco resulted in NASDAQ offering up to $62 million to accommodate members for losses attributable to the systems issues.
The recent admission by BATS that, for a period of more than four years, its computer systems for two equity exchanges and an options platform allowed trades to take place at prices that violated the Commission’s regulations, which require exchanges to ensure that investors receive the best price.


These recent events highlight the need for the Commission to develop a secure, robust, and reliable regulatory framework to ensure that our capital markets develop and maintain systems with sufficient capacity, integrity, resiliency, availability, and security.

Today’s rule proposal, Regulation SCI (Systems Compliance and Integrity), is a step in the right direction. It is an important step forward from the purely voluntary program we have today as a result of the Commission’s 1989 policy statement, which states that SROs, on a voluntary basis, should establish comprehensive planning and assessment programs to determine systems capacity and vulnerability. At that time, the Commission noted the impact that systems problems and failures could have on public investors, broker-dealer risk exposure, and market efficiency.
 Clearly, the voluntary program has failed, as the above examples illustrate.

The proposed rule would move beyond the current voluntary program and requires entities to, among other things, (i) establish, maintain, and enforce written policies and procedures reasonably designed to ensure that its systems have adequate levels of capacity, integrity, resiliency, availability, and security to maintain the entity’s operational capability and promote the maintenance of fair and orderly markets; (ii) mandate participation in scheduled testing of the operation of the entity’s business continuity and disaster recovery plans, including backup systems, and coordinate such testing on an industry- or sector-wide basis with other entities; and (iii) make, keep, and preserve records relating to the matters covered by Regulation SCI, and provide them to Commission representatives upon request. The proposal also would require that entities submit all required written notifications and reports to the Commission electronically using new proposed Form SCI. These are all welcomed improvements.

However, although this is a positive step in the right direction, I am concerned that today’s rule proposal does not:
Mandate compliance with a specific set of Commission-identified minimum standards to ensure that entities establish, maintain, and enforce written policies and procedures reasonably designed to ensure that the entity’s systems provide adequate levels of capacity, integrity, resiliency, availability, and security. While the rule proposal provides a set of model policies and procedure for entities to consider, it fails to require minimum standards for policies and procedures. As a result, the rule proposal may not provide enough assurance that the resulting policies and procedures will meet the goals of the rule.
Require that an external review of compliance with Regulation SCI be conducted on a periodic basis by an independent third party in order to reduce the risk of conflicts of interests. Simply stated, an internal review may not be as robust and complete due to competing internal business pressures.
Provide for an entity’s senior officers to certify, in writing, that (i) the entity has processes in place to establish, document, maintain, review, test, and modify controls reasonably designed to achieve compliance with Regulation SCI; and (ii) that the annual budget and staffing levels are adequate for the entity to comply with its obligations under Regulation SCI. As Congress noted in connection with the CEO and CFO Certifications mandated by Section 302 of the Sarbanes-Oxley Act of 2002, "managers should be held accountable for the representations made by their company."
I believe that senior officer certifications would be an important tool to ensure compliance with today’s proposed rule.

Moreover, I am concerned that today’s rule proposal would allow an explicit safe harbor for entities and their employees that establish and maintain policies and procedures that are reasonably designed to comply with Regulation SCI. Although it is not stated in today’s release, I have been told by senior staff that the Commission has never previously included an explicit safe harbor in a Commission rule requiring that regulated entities maintain policies and procedures designed to achieve a particular objective.

In my view, an unprecedented safe harbor in a rule that does not require clear, identifiable, and meaningful standards, and that does not require policies and procedures to be reviewed by an independent third party and certified by senior officers, will result in a rule proposal that falls short of its goal — which is to ensure that our capital markets develop and maintain appropriate systems.

The rule proposal asks a number of important questions that were incorporated at my request to solicit comments from the public. These questions were designed to generate information and assist the Commission in thinking through issues associated with the rule proposal. This is an important part of the Commission’s rulemaking process, which is based on a "notice and comment" procedure. I hope that the comments generated will help make this a better rule.

Despite my concerns, I am willing to support today’s rule proposal because Regulation SCI would apply to more entities than the Commission’s current ARP Inspection Program, and the proposed rule would place obligations on entities not currently included in the Commission’s ARP policy statements. The havoc caused by recent events highlight the need to have an updated and formalized regulatory framework for ensuring that the U.S. securities trading markets maintain systems with sufficient integrity, resiliency, and security. Although, I have concerns, I am hopeful they will be addressed at the adoption stage. By then, we should have a full five-member Commission.

Today’s rulemaking is a positive step in addressing the systems challenges posed by large, automated, complex, and fragmented trading centers. As the country’s capital markets regulator, the SEC must be at the forefront of proactively addressing changes in our capital market structure. The SEC should not merely respond to events that have occurred. Regulation SCI is one such proactive effort.

In closing, I want to thank the staff for its efforts. I look forward to the comments we will receive on this proposal.

Thank you.</sup>