SEC COMMISSIONER GALLAGHER'S REMARKS ON EVOLVING ROLE OF COMPLIANCE

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

Introductory Remarks at The Evolving Role of Compliance in the Securities Industry Presentation

Commissioner Daniel M. Gallagher

Washington, D.C.

May 12, 2014

Thank you, David [Blass].  I’m very pleased to be here this morning to kick off today’s discussion of a timely and critical topic: the evolving role of compliance professionals.  I’d be remiss if I didn’t begin by expressing my thanks to the team responsible for today’s event: Mike Stone, who suggested the event in the first place, our panelists Howard Plotkin and Jerry Baker, and David Blass [and Steve Benham] from the Division of Trading and Markets, who worked with our panelists to put together today’s event.  It’s very heartening to me that there are people like Mike, Howard, and Jerry who are willing to so generously volunteer their time to help the Commission better understand the myriad and complicated challenges facing today’s compliance professionals.  I often speak of the scoundrels and miscreants in the securities industry; it’s a genuine pleasure to be here today with folks from the other end of the spectrum.

In recent years, a variety of factors have combined to significantly expand the scope and complexity of the issues facing compliance officers at securities firms.  Today’s compliance personnel have to address an ever-broadening array of complex and novel financial products, new trading and communication technologies, and multiple, diverse market venues.  They must do so in the face of an unprecedented torrent of new laws and regulations promulgated in response to the financial crisis, most particularly the Compliance Officer and Securities Attorney Full Employment in Perpetuity Act of 2010, or as it’s more commonly known, Dodd-Frank.  

And although securities firms have been generally increasing the amount of resources they devote to compliance matters, compliance budgets have increased in a linear manner while the demands faced by compliance officers have increased exponentially.  A member of the House Financial Services Committee, citing a study issued by the Committee,[1] stated, “It will take over 24 million man hours to comply with Dodd-Frank rules per year.  It took only 20 million to build the Panama Canal.”[2]  On the plus side, at least Dodd-Frank has caused fewer deaths by malaria or yellow fever.

Our system of oversight for regulated entities such as broker-dealers and investment advisers is predicated upon the active participation of compliance personnel.  It is a system of shared responsibility, in which the Commission oversees the firms that, in turn, oversee their associated persons, with SROs providing an additional level of oversight for broker-dealers.  Broker-dealer and investment adviser firms in essence serve as the first line of defense in this system, and the system does not work if firm legal and compliance officers are too timid to jump into the difficult regulatory issues firms face on a regular basis.

All the more important, then, that the Commission does everything in its power to encourage a robust, effective compliance function at the entities we regulate.  This includes, crucially, providing additional certainty on the topic of “failure to supervise” liability.  The Exchange Act vests the Commission with the authority to impose sanctions on a person associated with a broker-dealer if that person “has failed reasonably to supervise, with a view to preventing violations of the provisions of [the securities] statutes, rules, and regulations, another person who commits such a violation, if such other person is subject to his supervision.”[3]  Nearly identical language in the Investment Advisers Act grants the Commission the same authority with respect to associated persons of investment advisers.[4]

The Commission’s ability to impose sanctions for failures to supervise is a valuable part of our regulatory toolkit, encouraging a broker-dealer or investment adviser’s managers and executives to proactively monitor subordinate employees’ compliance with laws and regulations.  We must make sure, however, that our rules establishing failure to supervise liability do not act as a deterrent to in-house legal and compliance officers, discouraging them from departing from their clearly delineated roles.

After all, we don’t want compliance officers or in-house attorneys spending their days drafting policies and sending out memoranda while avoiding interaction with the individuals governed by those policies or the recipients of those memos out of fear of being deemed a supervisor and subjecting themselves to liability.  Indeed, we want to encourage such personnel to bring their expertise to bear in addressing important, real-world compliance issues and in providing real-time advice for concrete problems the firms and their employees face.

To do so, we need to provide guidance that is as clear as possible on our position on supervisory liability for legal and compliance personnel.  In this vein, I was especially pleased when last September, the Division of Trading and Markets, in an effort led by David Blass, issued a set of FAQs on the topic of failure to supervise liability.[5]  The feedback on these FAQs has been very positive, and I hope and expect that we will continue to address new or unsettled issues in this manner.

Events like today's training complement outward-facing initiatives such as the FAQs by providing our own staff with informed and current guidance on compliance issues, and I'm glad to be able to add my enthusiastic support.  Once again, thank you to our panelists, and thanks as well to the SEC staff here today for taking advantage of this wonderful opportunity to learn from our distinguished guests. I wish you all a productive and educational training.


[1] Dodd-Frank Burden Tracker (spreadsheet), House of Representatives Committee on Financial Services, available at http://financialservices.house.gov/uploadedfiles/dodd-frank_pra_spreadsheet_7-9-2012.pdf.

[2] Rep. Randy  Randy Neugebauer, quoted at Dodd-Frank Burden Tracker, House of Representatives Committee on Financial Services, available at http://financialservices.house.gov/burdentracker/default.aspx.

[3] 15 U.S.C. 78o(b)(4)(E)

[4] 15 U.S.C. 80b-3(e)(6).

[5] Frequently Asked Questions about Liability of Compliance and Legal Personnel at Broker-Dealers under Sections 15(b)(4) and 15(b)(6) of the Exchange Act, U.S. Securities and Exchange Commission, Division of Trading and Markets, available at http://www.sec.gov/divisions/marketreg/faq-cco-supervision-093013.htm.

Statement on Jury’s Verdict in Case Against the Wylys:

Statement on Jury’s Verdict in Case Against the Wylys:

SEC CHARGES FRIENDS AND BUSINESS ASSOCIATES OF HOME DIAGNOSTICS, INC., CHAIRMAN IN INSIDER TRADING SCHEME

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION

SEC Charges Three Friends and Business Associates of Former Chairman of Home Diagnostics, Inc., in Insider Trading Scheme

The Securities and Exchange Commission today announced charges against three friends and business associates of the former Chairman of the Board at Home Diagnostics Inc., George H. Holley, for trading on the basis of inside information about an impending acquisition of the company that was illegally tipped to them by Holley.

In Complaints filed in the U.S. District Court in Trenton, New Jersey, the SEC alleges that, in 2010, Holley, who co-founded Home Diagnostics, provided his friends John Campani and John Mullin, and employee Alan Posner, with confidential information about the impending acquisition of Home Diagnostics by Nipro Corporation. Campani, Mullin, and Posner each purchased Home Diagnostics stock on the basis of Holley’s tips for combined profits of more than $105,000. The SEC previously had charged Holley and other tippees with insider trading based on the same material nonpublic information (SEC v. George H. Holley, et al., No. 3:11-cv-00205-MLC-DEA (D.N.J.)).

The SEC’s complaints charge Campani, Mullin, and Posner with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, the general antifraud provisions of the federal securities laws, and Section 14(e) of the Exchange Act and Rule 14e-3 thereunder, the tender offer fraud provisions. Without admitting or denying the allegations in the SEC’s Complaint against him, Campani, Mullin, and Posner each has consented to the entry of a final judgment that permanently enjoins him from future violations of Sections 10(b) and 14(e) of the Securities Exchange Act and Rules 10b-5 and 14e-3 thereunder. In addition, the judgment against Campani will require him to pay $26,700 in disgorgement plus prejudgment interest in the amount of $2,387, and a civil penalty of $13,350; the judgment against Mullin will require him to pay disgorgement of $10,450 plus prejudgment interest in the amount of $896, and a civil penalty of $5,225; and the judgment against Posner will require him to pay disgorgement of $67,910 plus prejudgment interest in the amount of $5,820, and a civil penalty of $33,955. The settlements are subject to approval by the Court.

Campani, Mullin, and Posner cooperated with the U.S. Attorney’s Office for the District of New Jersey in its criminal prosecution of Holley. Holley ultimately pleaded guilty to insider trading. The SEC’s civil action against Holley is continuing.

The SEC thanks the U.S. Attorney’s Office for the District of New Jersey, the Federal Bureau of Investigation, and FINRA, for their cooperation and assistance in this matter.

SEC CHARGES BROUGHT AGAINST HEDGE FUND ADVISORY FIRM FOR DISTRIBUTING FAKED PERFORMANCE RESULTS

FROM:  SECURITIES AND EXCHANGE COMMISSION 

SEC Announces Charges and Asset Freeze Against Hedge Fund Advisory Firm Distributing Falsified Performance Results

The Securities and Exchange Commission filed fraud charges and sought emergency relief on May 5, 2014, against a New York-based investment advisory firm and two executives for distributing falsified performance results to prospective investors in two hedge funds they managed.

The SEC's complaint filed in U.S. District Court for the Southern District of New York alleges that Aphelion Fund Management, LLC's (Aphelion) chief investment officer Vineet Kalucha fraudulently altered an outside audit firm's report reviewing the performance of an investment account he managed. Aphelion's chief financial officer George Palathinkal allegedly learned about Kalucha's falsifications, which essentially changed an investment loss into a major investment gain in the account. Nevertheless, the falsified report showing the phony gain instead of the actual loss was distributed to prospective investors. Furthermore, investors were separately provided false information about Aphelion's assets under management and Kolucha's litigation history.

Kalucha, who is majority owner and managing partner of the firm in addition to chief investment officer, also is charged with siphoning investor proceeds for his luxury car payments and settlements of legal actions against him personally that are unrelated to Aphelion.

In response to the SEC's request for emergency relief for investors, U.S. District Court Judge Jed S. Rakoff issued a temporary restraining order, imposed an asset freeze to protect client assets, and temporarily prohibited the defendants from soliciting new investors or additional investments from existing investors. A hearing on the SEC's motion for a preliminary injunction has been scheduled for May 15 before Judge Richard M. Berman.

According to the complaint, Aphelion serves as the investment adviser and general partner for two unregistered hedge funds: Aphelion US Fund LP and Aphelion Offshore Fund Ltd. Kalucha has been managing investor funds since 2009 using a proprietary investment model that he developed. The outside auditor's report showed an investment loss of more than 3 percent during a 15-month period in an account that Kalucha managed. However, the fraudulent report distributed to investors showed a phony investment gain of 30 percent during an 18-month period. In addition to distributing the altered report, Aphelion, Kalucha, and Palathinkal also misled investors about Aphelion's assets under management. While Kalucha and Palathinkal told investors at various times during 2013 that Aphielion had $15 million or more in assets under management, the firm never had more than $5 million in assets under management at any point during that year.

The complaint further alleges that the defendants misrepresented Kalucha's litigation history to investors. Under the legal proceedings section in a due diligence questionnaire included in Aphelion's marketing materials, Kalucha answered "None" and added a lengthy, materially misleading explanation of a civil proceeding in which he was involved. The proceeding, which he did not identify by name, was a case against him by the U.S. Department of Labor for breaching fiduciary duties. By virtue of a consent judgment in the case, Kalucha and Aphelion are prohibited from acting as investment advisers to many types of common retirement plans, which often invest in hedge funds. Investors were deprived of this information in the due diligence questionnaire.

According to the complaint, Aphelion, Kalucha, and Palathinkal raised $1.5 million in investments for Aphelion from 2013 to March 2014 by representing to investors that the funds would be used for Aphelion's operating expenses. Kalucha actually used more than 40 percent of the funds raised in 2013 for his personal benefit. He has withdrawn investor proceeds for such things as settlement of a foreclosure action involving his personal residence, settlement of a breach of contract action filed against him in his personal capacity, down payment of a luxury BMW sedan, and payment for tax and accounting services for his personal finances. Palathinkal approved all of Kalucha's withdrawals. The complaint alleges that Aphelion, Kalucha, and Palathinkal violated 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. In addition, the complaint alleges that Aphelion and Kalucha violated Sections 206(1), (2) and (4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder and that Palathinkal aided and abetted these violations.

The SEC's investigation and litigation have been conducted by David Benson, Paul Montoya, Eric Phillips, Delia Helpingstine, Kristine Rodriguez, and Joan Price-McLaughlin of the Chicago Regional Office.

SEC BRINGS FRAUD CHARGES AGAINST INVESTMENT ADVISORY FIRM, EXECUTIVES FOR FALSIFYING PERFORMANCE RESULTS

FROM:  U.S SECURITIES AND EXCHANGE COMMISSION 

May 8, 2014

The Securities and Exchange Commission today announced fraud charges and an asset freeze against a New York-based investment advisory firm and two executives for distributing falsified performance results to prospective investors in two hedge funds they managed.

The SEC alleges that Aphelion Fund Management’s chief investment officer Vineet Kalucha fraudulently altered an outside audit firm’s report reviewing the performance of an investment account he managed.  Aphelion’s chief financial officer George Palathinkal allegedly learned about Kalucha’s falsifications, which essentially changed an investment loss into a major investment gain in the account.  Nevertheless, the falsified report showing the phony gain instead of the actual loss was distributed to prospective investors.  Furthermore, investors were separately provided false information about Aphelion’s assets under management and Kolucha’s litigation history.

Kalucha, who is majority owner and managing partner of the firm in addition to chief investment officer, also is charged with siphoning investor proceeds for his luxury car payments and settlements of legal actions against him personally that are unrelated to Aphelion.

“We allege that on multiple occasions, Aphelion, Kalucha, and Palathinkal intentionally overstated the success of their investment strategy,” said Robert J. Burson, associate director of the SEC’s Chicago Regional Office.  “Kalucha also has been using investor money as his own, and emergency action was necessary to protect the interests of investors.”

In response to the SEC’s request for emergency relief for investors, U.S. District Court Judge Jed S. Rakoff issued a temporary restraining order, imposed an asset freeze to protect client assets, and temporarily prohibited the defendants from soliciting new investors or additional investments from existing investors.  A hearing on the SEC’s motion for a preliminary injunction has been scheduled for May 15 before Judge Richard M. Berman.

According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, Aphelion serves as the investment adviser and general partner for two unregistered hedge funds: Aphelion US Fund LP and Aphelion Offshore Fund Ltd.  Kalucha has been managing investor funds since 2009 using a proprietary investment model that he developed.  The outside auditor’s report showed an investment loss of more than 3 percent during a 15-month period in an account that Kalucha managed.  However, the fraudulent report distributed to investors showed a phony investment gain of 30 percent during an 18-month period.  In addition to distributing the altered report, Aphelion, Kalucha, and Palathinkal also misled investors about Aphelion’s assets under management.  While Kalucha and Palathinkal told investors at various times during 2013 that Aphielion had $15 million or more in assets under management, the firm never had more than $5 million in assets under management at any point during that year.

The SEC’s complaint further alleges that the defendants misrepresented Kalucha’s litigation history to investors.  Under the legal proceedings section in a due diligence questionnaire included in Aphelion’s marketing materials, Kalucha answered “None” and added a lengthy, materially misleading explanation of a civil proceeding in which he was involved.  The proceeding, which he did not identify by name, was a case against him by the U.S. Department of Labor for breaching fiduciary duties.  By virtue of a consent judgment in the case, Kalucha and Aphelion are prohibited from acting as investment advisers to many types of common retirement plans, which often invest in hedge funds.  Investors were deprived of this information in the due diligence questionnaire.

According to the SEC’s complaint, Aphelion, Kalucha, and Palathinkal raised $1.5 million in investments for Aphelion from 2013 to March 2014 by representing to investors that the funds would be used for Aphelion’s operating expenses.  Kalucha actually used more than 40 percent of the funds raised in 2013 for his personal benefit.  He has withdrawn investor proceeds for such things as settlement of a foreclosure action involving his personal residence, settlement of a breach of contract action filed against him in his personal capacity, down payment of a luxury BMW sedan, and payment for tax and accounting services for his personal finances.  Palathinkal approved all of Kalucha’s withdrawals.

The SEC’s complaint alleges that Aphelion, Kalucha, and Palathinkal violated the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.  In addition, the complaint alleges that Kalucha and Aphelion Fund Management violated, and Palathinkal aided and abetted violations of, the antifraud provisions of the Investment Advisers Act of 1940.

The SEC’s investigation and litigation have been conducted by David Benson, Paul Montoya, Eric Phillips, Delia Helpingstine, Kristine Rodriguez, and Joan Price-McLaughlin of the Chicago Regional Office.

Remarks to the Council of Institutional Investors

Remarks to the Council of Institutional Investors