SEC PROPOSES RULES ON EXECUTIVE COMPENSATION CLAWBACKS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

SEC Proposes Rules Requiring Companies to Adopt Clawback Policies on Executive Compensation

07/01/2015 12:45 PM EDT

The Securities and Exchange Commission today proposed rules directing national securities exchanges and associations to establish listing standards requiring companies to adopt policies that require executive officers to pay back incentive-based compensation that they were awarded erroneously.  With this proposal, the Commission has completed proposals on all executive compensation rules required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Under the proposed new Rule 10D-1, listed companies would be required to develop and enforce recovery policies that  in the event of an accounting restatement, “claw back” from current and former executive officers incentive-based compensation they would not have received based on the restatement.  Recovery would be required without regard to fault.  The proposed rules would also require disclosure of listed companies’ recovery policies, and their actions under those policies.

“These listing standards will require executive officers to return incentive-based compensation that was not earned,” said SEC Chair Mary Jo White.  “The proposed rules would result in increased accountability and greater focus on the quality of financial reporting, which will benefit investors and the markets.”

Under the proposed rules, the listing standards would apply to incentive-based compensation that is tied to accounting-related metrics, stock price or total shareholder return.  Recovery would apply to excess incentive-based compensation received by executive officers in the three fiscal years preceding the date a listed company is required to prepare an accounting restatement.

Each listed company would be required to file its recovery policy as an exhibit to its annual report under the Securities Exchange Act.  In addition, a listed company would be required to disclose its actions to recover in its annual reports and any proxy statement that requires executive compensation disclosure if, during its last fiscal year, a restatement requiring recovery of excess incentive-based compensation was completed, or there was an outstanding balance of excess incentive-based compensation from a prior restatement.

The comment period for the proposed rules will be 60 days after publication in the Federal Register.

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FACT SHEET

Listing Standards for Clawing Back Erroneously Awarded Executive Compensation

SEC Open Meeting

July 1, 2015

Action

The Commission will consider whether to propose rules directing national securities exchanges and associations to establish listing standards requiring companies to develop and implement policies to claw back incentive-based executive compensation that later is shown to have been awarded in error.  The proposed rules are designed to improve the quality of financial reporting and benefit investors by providing enhanced accountability.  The proposed new rules required by Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act would be the last of the executive compensation rules to be proposed.

Highlights of the Proposed Rules

Listing Standards – Proposed Rule 10D-1 under the Securities Exchange Act

The proposed rules would require national securities exchanges and associations to establish listing standards that would require listed companies to adopt and comply with a compensation recovery policy in which:

Recovery would be required from current and former executive officers who received incentive-based compensation during the three fiscal years preceding the date on which the company is required to prepare an accounting restatement to correct a material error.  The recovery would be required on a “no fault” basis, without regard to whether any misconduct occurred or an executive officer’s responsibility for the erroneous financial statements.

Companies would be required to recover the amount of incentive-based compensation received by an executive officer that exceeds the amount the executive officer would have received had the incentive-based compensation been determined based on the accounting restatement.  For incentive-based compensation based on stock price or total shareholder return, companies could use a reasonable estimate of the effect of the restatement on the applicable measure to determine the amount to be recovered.

Companies would have discretion not to recover the excess incentive-based compensation received by executive officers if the direct expense of enforcing recovery would exceed the amount to be recovered or, for foreign private issuers, in specified circumstances where recovery would violate home country law.
Under the proposed rules, a company would be subject to delisting if it does not adopt a compensation recovery policy that complies with the applicable listing standard, disclose the policy in accordance with Commission rules or comply with the policy’s recovery provisions.
Definition of Executive Officers

The proposed rules would include a definition of an “executive officer” that is modeled on the definition of “officer” under Section 16 under the Exchange Act.  The definition includes the company’s president, principal financial officer, principal accounting officer, any vice-president in charge of a principal business unit, division or function, and any other person who performs policy-making functions for the company.  

Incentive-Based Compensation Subject to Recovery

Under the proposal, incentive-based compensation that is granted, earned or vested based wholly or in part on the attainment of any financial reporting measure would be subject to recovery.  Financial reporting measures are those based on the accounting principles used in preparing the company’s financial statements, any measures derived wholly or in part from such financial information, and stock price and total shareholder return.

Proposed Disclosure

Each listed company would be required to file its compensation recovery policy as an exhibit to its Exchange Act annual report.

In addition, if during its last completed fiscal year the company either prepared a restatement that required recovery of excess incentive-based compensation, or there was an outstanding balance of excess incentive-based compensation relating to a prior restatement, a listed company would be required to disclose:

The date on which it was required to prepare each accounting restatement, the aggregate dollar amount of excess incentive-based compensation attributable to the restatement and the aggregate dollar amount that remained outstanding at the end of its last completed fiscal year.
The name of each person subject to recovery from whom the company decided not to pursue recovery, the amounts due from each such person, and a brief description of the reason the company decided not to pursue recovery.
If amounts of excess incentive-based compensation are outstanding for more than 180 days, the name of, and amount due from, each person at the end of the company’s last completed fiscal year.
The proposed disclosure would be included along with the listed company’s other executive compensation disclosure in annual reports and any proxy or information statements in which executive compensation disclosure is required.

Listed companies would also be required to block tag the disclosure in an interactive data format using eXtensible Business Reporting Language (XBRL).

Covered Companies

The proposed rules would apply to all listed companies except for certain registered investment companies to the extent they do not provide incentive-based compensation to their employees.

Transition Period

The proposal requires the exchanges to file their proposed listing rules no later than 90 days following the publication of the adopted version of Rule 10D-1 in the Federal Register.  The proposal also requires the listing rules to become effective no later than one year following the publication date.

Each listed company would be required to adopt its recovery policy no later than 60 days following the date on which the listing exchange’s listing rule becomes effective.  Each listed company would be required to recover all excess incentive-based compensation received by current and former executive officers on or after the effective date of Rule 10D-1 that results from attaining a financial reporting measure based on financial information for any fiscal period ending on or after the effective date of Rule 10D-1.

Listed companies would be required to comply with the new disclosures in proxy or information statements and Exchange Act annual reports filed on or after the effective date of the listing exchange’s rule.

What’s Next?

If approved for publication by the Commission, the proposed rules will be published on the Commission’s website and in the Federal Register.  The comment period for the proposed rules would be 60 days after publication in the Federal Register.

SEC CHARGES FOR STOCKBROKER FOR ROLE IN PONZI SCHEME

 FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

07/01/2015 11:55 AM EDT

The Securities and Exchange Commission charged a former stockbroker in Pennsylvania with conducting a Ponzi scheme and stealing investor money to purchase a condominium in Florida and afford his own vacations and other luxuries.

The SEC alleges that Malcolm Segal fraudulently sold so-called certificates of deposits (CDs) to his brokerage customers by falsely claiming that he could get them higher interest rates of return on FDIC-insured CDs than otherwise available to the general public.  In some instances, Segal purchased CDs on behalf of investors but secretly redeemed them early and took the proceeds.  Other times, Segal did not purchase CDs at all despite telling customers he had.  He raised approximately $15.5 million from at least 50 investors.  Besides spending investor money on himself, Segal used it in Ponzi scheme fashion for purported interest payments and principal repayments to earlier investors.

The SEC further alleges that Segal eventually started stealing directly from his customers’ brokerage accounts in a last-ditch effort to keep funding the Ponzi payments.  He forged letters of authorization to facilitate the transfer of customer funds to accounts he controlled, notably forging the signature of one customer’s wife who had died before the date of the transfer.  The scheme collapsed in July 2014.

In a parallel action, the U.S. Attorney’s Office for the Eastern District of Pennsylvania today announced criminal charges against Segal.

“As alleged in our complaint, Segal duped investors by pretending to sell them safe investments while stealing their money for his own benefit and making Ponzi payments to earlier investors,”  said Sharon B. Binger, Director of the SEC’s Philadelphia Regional Office.  “Segal put his own greed above his obligations to customers and violated the law.”

The SEC’s complaint filed in federal court in Philadelphia charges Segal with violations of Section 17(a) of the Securities Act of 1933 as well as Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  The SEC seeks disgorgement plus prejudgment interest and penalties as well as a permanent injunction.

The SEC’s continuing investigation is being conducted by Michael F. McGraw and Brendan P. McGlynn in the Philadelphia Regional Office.  The SEC’s litigation will be led by David L. Axelrod and Michael J. Rinaldi, and the case is being supervised by G. Jeffrey Boujoukos.  The SEC appreciates the assistance of the U.S. Attorney’s Office for the Eastern District of Pennsylvania and the Federal Bureau of Investigation.

SEC SAYS DELOITTE & TOUCHE TO PAY $1 MILLION TO SETTLE ALLEGED AUDITOR INDEPENDENCE RULES VIOLATION

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

07/01/2015 01:35 PM EDT

The Securities and Exchange Commission today charged Deloitte & Touche LLP with violating auditor independence rules when its consulting affiliate maintained a business relationship with a trustee serving on the boards and audit committees of three funds it audited.  Deloitte agreed to pay more than $1 million to settle the charges.

The SEC charged the trustee Andrew C. Boynton with causing related reporting violations by the funds, and charged the funds’ administrator ALPS Fund Services with causing related compliance violations.  They also agreed to settle the charges.

Auditor independence rules require outside auditors to remain independent from their clients to ensure there is not even the appearance of a firm compromising its objectivity and impartiality when auditing financial statements.  According to the SEC’s order instituting a settled administrative proceeding, Deloitte violated the rules with respect to the appearance of independence by failing to follow its own policies and conduct an independence consultation prior to entering into a new business relationship with Boynton.  Deloitte failed to discover that the required initial independence consultation was not performed until nearly five years after the independence-impairing relationship had been established between Deloitte Consulting LLP and Boynton, who was paid consulting fees for his external client work.  Meanwhile, Deloitte represented in audit reports that it was independent of the three funds while Boynton simultaneously served on their boards and audit committees.

“The investing public depends on independent auditors like Deloitte to test the reliability of publicly-reported financial statements, and they have front-line responsibility for ensuring their own independence,” said Stephen L. Cohen, Associate Director of the SEC’s Division of Enforcement. “But they are not alone in safeguarding the audit process, and the other fiduciaries charged in this case failed to fulfill their roles and preserve investor confidence.”

According to the SEC’s order:

Deloitte Consulting acquired a proprietary brainstorming business methodology from Boynton in 2006 and collaborated with Boynton to implement it and serve both internal and external firm clients through 2011.

As a member of the three funds’ boards and audit committees, Boynton was required to complete annual trustee and officer (T&O) questionnaires designed in part to identify conflicts of interest.  Boynton did not identify his business relationship with Deloitte Consulting in response to a question calling for identification of his “principal occupation(s) and other positions.”  Relying on his understanding that Deloitte Consulting was a separate legal entity from Deloitte, Boynton also did not identify the business relationship in his responses to a question added to the questionnaire in 2009 inquiring whether he had any “direct or material indirect business relationship” with Deloitte.

ALPS contractually agreed to assist the funds in discharging their responsibilities yet failed to adopt sufficient written policies and procedures as required to prevent auditor independence violations. The funds’ audit committee charter addressed auditor independence generally, but the T&O questionnaires did not expressly cover business relationships with the auditor’s affiliates.  The funds also did not have sufficient written policies and procedures to prevent other types of auditor independence violations, nor did they provide sufficient training to assist board members in the discharge of their responsibilities related to auditor independence.

The SEC’s order censures Deloitte for violating the auditor independence standards of Rule 2-02(b) of Regulation S-X, and sanctioned Deloitte for causing the funds to violate Sections 20(a) and 30(a) of the Investment Company Act and Rule 20a-1 thereunder.  The order finds that Boynton was a cause of the same reporting violations and ALPS caused the funds’ related compliance violations under Rule 38a-1 of the Investment Company Act.  Each party agreed to cease and desist from future violations without admitting or denying the findings.  Deloitte agreed to pay disgorgement of audit fees in the amount of $497,438 plus prejudgment interest of $116,478 and a penalty of $500,000.  Boynton agreed to pay disgorgement of $30,000 plus prejudgment interest of $5,329 and a penalty of $25,000.  ALPS agreed to pay a $45,000 penalty.

The SEC’s investigation was conducted by James J. Bresnicky and Brian M. Privor, and supervised by J. Lee Buck II.

The Role of Chief Compliance Officers Must be Supported

The Role of Chief Compliance Officers Must be Supported

SEC.gov | Making Executive Compensation More Accountable – To Keep It, It Should Be Earned

SEC.gov | Making Executive Compensation More Accountable – To Keep It, It Should Be Earned

SEC CHARGES INVESTMENT ADVISORY FIRM, OWNER WITH "CHERRY-PICKING"

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION
06/29/2015 01:10 PM EDT

The Securities and Exchange Commission announced fraud charges against a Wisconsin-based investment advisory firm and its owner accused of improperly allocating to his personal and business accounts certain options trades that appreciated in value during the course of a trading day while allocating to his clients other trades that depreciated in value.

The SEC Enforcement Division has engaged in a data-driven initiative to identify potentially fraudulent trade allocations known as “cherry-picking,” and this enforcement action is the first arising from that effort.  Working with economists in the agency’s Division of Economic and Risk Analysis, enforcement investigators analyze large volumes of investment advisers’ trade allocation data and identify instances where it appears an adviser is disproportionately allocating profitable trades to favored accounts.

The SEC Enforcement Division alleges that Mark P. Welhouse purchased options in an omnibus or master account for Welhouse & Associates Inc. and delayed allocation of the purchases to either his or his clients’ accounts until later in the day after he saw whether or not the securities appreciated in value.  Welhouse allegedly reaped $442,319 in ill-gotten gains by unfairly allocating options trades in an S&P 500 exchange-traded fund named SPY.  His personal trades in these options had an average first-day positive return of 6.28 percent while his clients’ trades in these options had an average first-day loss of 5.05 percent.

As described in the SEC order instituting administrative proceedings against Welhouse and his firm, SEC staff conducted a statistical analysis to determine whether Welhouse’s profitability in these accounts could have resulted from a coincidental or lucky combination of trades.  After running a simulation test one million times, the staff concluded it could not.

“Cherry-picking schemes can be extremely difficult to detect without an investor astutely noticing that something may be amiss and coming to us with a complaint about the adviser,” said Julie M. Riewe, Co-Chief of the SEC Enforcement Division’s Asset Management Unit.  “We devised this initiative to identify specific custodians providing services to investment advisers and their clients and leverage their trading records and other data to efficiently target preferential trade allocations occurring outside the detection of even the most observant client.”

The SEC Enforcement Division alleges that Welhouse and his firm violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, Section 17(a) of the Securities Act of 1933, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940.  The matter will be scheduled for a public hearing before an administrative law judge for proceedings to adjudicate the Enforcement Division’s allegations and determine what, if any, remedial actions are appropriate.

The SEC’s data-driven enforcement initiative to combat cherry-picking has been led by the Asset Management Unit and the regional offices in Boston and Los Angeles.  The investigation into Welhouse and his firm has been conducted by Robert Baker of the Asset Management Unit and Rachel Hershfang of the Boston Regional Office.  The Enforcement Division’s litigation will be led by Ms. Hershfang, Mr. Baker, and Cynthia Baran of the Asset Management Unit.