SEC COMMISSIONER PIWOWAR'S SPEECH TO U.S. CHAMBER OF COMMERCE

FROM:  SECURITIES AND EXCHANGE COMMISSION 
Advancing and Defending the SEC’s Core Mission
 Commissioner Michael S. Piwowar
U.S. Chamber of Commerce
Washington, D.C.
Jan. 27, 2014

Thank you, Chris (Donahue), for that very kind introduction. David Hirschmann, I commend you for the work that you do at the Chamber’s Center for Capital Markets Competitiveness to promote America’s global leadership in capital formation. I have had the pleasure of working with a number of talented people at the Center over the past few years and I want to take a moment to acknowledge just a few. Tom Quaadman, it has been great to join you in your efforts to ensure that the financial regulatory agencies are following the law and basing their decisions on the best available information about a regulatory action’s likely economic consequences. Jess Sharp, who was in the trenches with me at the White House during the height of the global financial crisis, please continue to advocate for bringing regulatory and public transparency to the over-the-counter derivatives markets while preserving Main Street’s ability to hedge their business risks. Alice Joe, I have enjoyed working with you on money market fund reforms that are consistent with the Securities and Exchange Commission’s (SEC’s or Commission’s) goal of preserving the benefits of the product for investors and the short-term funding markets.

I also want to thank everyone for being so understanding about rescheduling my speech due to the federal government shutdown last October. I am happy to finally be here to talk about some of the issues we are facing at the Commission. Before proceeding, I need to provide the standard disclaimer that the views I express today are my own, and do not necessarily reflect the views of the Commission or my fellow Commissioners.

I would like to take the opportunity today to articulate how I believe an SEC Commissioner should approach each and every issue that comes before the Commission. As you know, the SEC is confronted with a wide range of matters including rulemakings, exemptive requests, interpretive guidance, and, of course, enforcement actions. Regardless of the area, when making decisions, a Commissioner should be guided by the SEC’s core mission: to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

My overarching philosophy as an SEC Commissioner is pretty simple. It boils down to a question that I ask myself every morning on my way to work: What can I do today to help advance and defend the SEC’s core mission? I choose the words “advance” and “defend” carefully. They are words that can be used to describe both sports strategies and military strategies, which are appropriate analogies for an SEC Commissioner. Some days I feel like I am in a friendly competition that involves well-defined and well-enforced rules. Other days I seem to be in hand-to-hand combat with outside forces.

First, I will explain what I mean when I say “advance the SEC’s core mission,” by highlighting some items that I believe should be priorities for the Commission over the next several months. Then, I will focus on how we can and should “defend the SEC’s core mission.” By way of example, and as I will discuss further, money market fund reform presents an opportunity to both advance and defend the SEC’s mission. I have not yet reached any conclusions on the substance of money market reform, but I do want to preview how I am approaching the issue. Finally, time permitting, I am happy to answer any questions you may have.

Advancing the SEC’s Core Mission

Obviously, the Commission is quite busy with our Dodd-Frank Act and JOBS Act mandates. Nonetheless, there are areas in which we can and should undertake efforts to advance our core mission. Let me highlight five.

Comprehensive Review of Equity Market Structure: I recently gave a speech in which I called for a comprehensive equity market structure review program that draws on lessons from the 1963 “Report of the Special Study of Securities Markets of the Securities and Exchange Commission”[1] and the 2012 UK Foresight Programme report on “The Future of Computer Trading in Financial Markets – An International Perspective.”[2] Without going into great detail, there are two key features of my vision for a comprehensive review of equity market structure. First, in order to allow us to cover a wide range of topics, it should be a multi-year review. Second, so that each issue can be considered and addressed in sufficient depth, the Commission should leverage the resources of outside parties by leading a collaborative effort with market structure experts from the private sector and the academic world.[3]

Tick Size Pilot Program for Small Capitalization Companies: It is clear that the one-size-fits-all approach to market structure is not working for small capitalization companies. One idea to test how to allow the securities of small cap companies to trade more efficiently is to create a pilot program for alternative minimum tick sizes. I support such a pilot and would like to see it implemented as soon as possible. Even if increasing the tick size does not produce the benefits that proponents suggest it will, a pilot program will provide useful information about the dynamics of liquidity in our equity markets.

Incremental Fixed-Income Market Structure Changes: During my previous tour at the Commission, I was very involved with price transparency initiatives in the corporate bond and municipal bond markets. In one research study, my colleagues and I were able to show that providing post-trade prices on corporate bond transactions decreased transaction costs, which translated to investor savings of more than $1 billion per year.[4] Subsequent research shows that more can be done to enhance the fixed-income markets for the benefit of investors and issuers, including opportunities to “pick low-hanging fruit.” For example, while commissions on agency transactions must be disclosed, the same is not true for markups and markdowns on riskless principal transactions, even though the trades are economically equivalent. Therefore, I have asked the staff of the Commission’s Office of Municipal Securities to work with me to develop a few proposals to improve how the fixed-income markets operate.

Over-Reliance on Proxy Advisory Firm Recommendations: I see many similarities between the influence that proxy advisory firms wield today and how credit rating agencies were relied upon pre-crisis, including an over-reliance by investors on their recommendations.[5] Investment advisers are increasingly looking to the recommendations of proxy advisory firms for purposes of satisfying their fiduciary duty in connection with voting (or not voting) client securities. This reliance, in effect, shifts the fiduciary duty from the advisers to the proxy advisory firms, which, due to their relationships with issuers of the securities, may have their own distinct conflicts of interest. The Commission hosted a very productive Proxy Advisory Services Roundtable last month that highlighted these issues and made clear that we cannot continue to ignore the need for reform.[6] The Commission must not lose the momentum that was generated from the roundtable and should quickly move forward with initiatives to curb the unhealthy over-reliance on proxy advisory firm recommendations.

Compliance with Section 2 of Executive Order 13579 – Retrospective Analyses of Existing Rules:[7] Over two years ago, President Obama signed an Executive Order that, among other things, directs independent agencies such as the SEC to develop and implement a plan to conduct ongoing retrospective analyses of existing rules. The stated goal is “to determine whether any such regulations should be modified, streamlined, expanded, or repealed so as to make the agency’s regulatory program more effective or less burdensome in achieving the regulatory objectives.” The Commission has not yet undertaken a serious effort to conduct a retrospective analysis of our existing rules in accordance with the directive. This must change.

 As if the SEC does not already have enough to do to advance our core mission, we are also faced with the need to defend it. Currently, I see two outside forces that are threatening our ability to effectively protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

The first threat is special interests, from all parts of the political spectrum, that are trying to co-opt the SEC’s corporate disclosure regime to achieve their own objectives. The Commission, therefore, should carefully consider whether any additional disclosures benefit investors or whether they enable the agenda of special interests to the detriment of investors.

With simply our current disclosure requirements, I worry that investors are already suffering from what former SEC Commissioner Troy Paredes calls “information overload.” Commissioner Paredes points out that “[i]ronically, if investors are overloaded, more disclosure actually can result in less transparency and worse decisions, in which case capital is allocated less efficiently and market discipline is compromised.”[8] Last year, he called for a top-to-bottom review of the Commission’s disclosure regime.[9] I wholeheartedly agree. Such a review could help us identify special-interest disclosures that may have crept into our present disclosure regime and are counterproductive to creating informed investors.

The second threat to our core mission is banking regulators trying to impose their bank regulatory construct on SEC-regulated investment firms and investment products. Yet the Commission – not the banking or prudential regulators – is responsible for regulating markets. My concern is that the banking regulators, through the Financial Stability Oversight Council (FSOC or Council), are reaching into the SEC’s realm as market regulator. Therefore, one of my first acts as a Commissioner was to request that I be afforded an observational role at FSOC meetings. I also asked that, in addition, or in the alternative, my counsels be allowed to attend the biweekly FSOC Deputies Committee meetings. To be clear, I understand that the Dodd-Frank Act designates the SEC’s Chair as the Commission’s only voting member of the FSOC.[10] However, the statute also designates the Commission as a “member agency” of the Council.[11]

Unfortunately, my requests to attend FSOC meetings as a non-participating guest were denied. I do not think that they were unreasonable requests, and I did not ask for any special favors. I simply asked the FSOC to treat the SEC the same way it treats the Federal Reserve. If you look at the minutes from past FSOC meetings, which are publicly available on the FSOC’s website, you will see that three people from the Federal Reserve regularly attend FSOC meetings – the Chairman of the Federal Reserve Board of Governors (the Federal Reserve’s voting member), and his two guests: a Federal Reserve Governor (Daniel Tarullo), and the President of the Federal Reserve Bank of New York (William Dudley). I would like the FSOC to extend the same courtesy to the SEC and other member agencies.

One of the responses I received to my request was that, if the SEC started bringing multiple people to the Council meetings, then every agency would want to do the same. My answer to that concern is that the FSOC should get a bigger table. Or, it should stop allowing the Federal Reserve to bring three people to the Council meetings when other member agencies are afforded only one seat. This issue is not just an abstract one for me. The FSOC, within which the banking and prudential regulators exert substantial influence, represents an existential threat to the SEC and the other member agencies.

Last September, the Department of Treasury’s Office of Financial Research (OFR) published a study – and I use the term “study” loosely – prepared for the FSOC on the asset management industry.[12] The study sets the groundwork for the regulation of asset managers by the FSOC. Among the Council members, only the SEC solicited public feedback regarding the study.[13] I applaud Chair White for doing so. In response, the Commission has received more than 30 comment letters, including one from the Chamber. I vehemently believe that before the FSOC decides whether further study or action is warranted, the collective voices of the public and the SEC should be heard by the members of the Council. This is all the more important because the vast majority of asset management firms are SEC-regulated entities.

Another issue on which the SEC has ceded ground to the FSOC and banking regulators is money market fund reform. One of the most shocking decisions in the 80-year history of the SEC was the wholesale abdication of the Commission’s responsibility to the FSOC on money market funds.[14] This choice has been widely criticized by former chairmen, commissioners, and SEC senior staff as threatening the independence of the SEC and the other independent financial services regulatory agencies.[15] I am in complete agreement. The only somewhat coherent systemic risk argument about money market funds that I have heard articulated is that a run on money market funds could lead to banks failing because they cannot rollover short-term debt. The moral of that story is not that money market funds have “structural vulnerabilities.” It is that banks are too reliant on short-term funding. The banking regulators have the ability to address such a bank regulatory shortcoming directly. Nothing in the Dodd-Frank Act weakened or repealed that authority.

Instead of the FSOC spending time enabling bank regulators to encroach on the SEC’s jurisdiction in securities regulation, where we have superior expertise, the Council should focus on fulfilling its own mission of identifying threats to the financial stability of the United States. I have identified three entities that the FSOC should consider reviewing as non-bank systemically important financial institutions (non-bank SIFIs): the Federal Government, the Federal Reserve, and the Basel Committee on Banking Supervision.

Serious academic research, previous actions by the FSOC, and common sense support designating all three of these entities as non-bank SIFIs. Deborah Lucas, a prominent MIT economist and former assistant director at the Congressional Budget Office, makes a compelling case that the government is a significant source of systemic risk, and therefore it falls under the mandate of the FSOC and OFR to monitor and study it.[16] Viral Acharya, a respected NYU financial economist, posits that governments effectively operate as “shadow banks” in the financial sector, that their role as shadow banks have been at the center of the financial crisis, and that they continue to pose a threat to financial stability.[17] Even the FSOC itself recognizes that the Federal Government has a significant impact on the economy – at a recent meeting the Council discussed the effects of a government shutdown and a debt ceiling impasse on the economy and financial markets, including short-term funding markets.[18] With respect to the Federal Reserve, its balance sheet stands at over $4 trillion in assets and continues to grow at a current tapered pace of $75 billion per month.[19] Andrew Haldane, the Bank of England’s Executive Director of Financial Stability, co-wrote a paper famously titled “The Dog and the Frisbee,” in which the academic case is made for simplicity in banking regulations.[20] Among other things, the paper explores why complex regulation, such as Basel risk-weighted capital standards, are not only costly and cumbersome, but suboptimal for preventing and controlling financial crises.

Money Market Fund Reform – Advancing and Defending the SEC’s Core Mission
I thought I would end with some words on how I am thinking about whether additional money market fund reforms are needed, and, if so, how I will be evaluating each alternative.

As an economist, one of the first questions I ask in the context of any rulemaking is “What is the baseline?” In other words, what is the starting point from which I will evaluate the costs and benefits of any proposed regulatory change? In the case of money market funds, it is tempting to start with a baseline of September 2008, when the Reserve Primary Fund “broke the buck.” However, the Commission adopted a number of new money market fund regulations in 2010.[21] The stated objectives of those rules were to “increase the resilience of money market funds to economic stresses and reduce the risks of runs on the funds.”[22]

Therefore, the proper baseline from which to evaluate any additional money market fund rule proposals is the current regulatory framework, which includes the 2010 reforms. From a cost-benefit perspective, the next relevant questions are “What are the marginal benefits of additional regulations”; and “what are the marginal costs of those additional regulations?” In order to answer those questions, we need to understand how effective the 2010 regulations were. The Commission’s Division of Economic and Risk Analysis (“DERA”) has done an excellent job providing the answers to those questions in their 2012 staff report “Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher,”[23] and in the economic analysis in the Commission’s 2013 proposing release for additional money market fund reforms.[24]

After carefully reading both of those documents and engaging in numerous discussions with Commission staff and money market fund participants, I have concluded that the 2010 money market fund regulations were, in economist-speak, “necessary, but not sufficient.” They provided much-needed investor protection improvements in the areas of disclosure, liquidity, credit quality, and operations. However, the reforms were not sufficient to address remaining investor protection concerns in at least two areas. Namely, more should be done to mitigate the first mover-advantage enjoyed by investors who run during times of heavy redemptions. There also remains a need to provide investors with more timely information about funds’ holdings, including the value of those holdings.

I have not reached any conclusions on which alternatives in the Commission’s outstanding rule proposal best address these investor protection concerns while preserving the benefits of money market funds for investors and the short-term funding markets. I will be working with Commission staff over the coming weeks and months to evaluate the marginal benefits of the various alternatives – floating NAV, fees, gates, additional disclosures, etc. – and their associated costs.

Thank you all for your attention. I am happy to answer any questions you may have.


[1] Report of Special Study of Securities Markets of the Securities & Exchange Commission, all chapters available at  http://www.sechistorical.org/museum/papers/1960/page-2.php under the heading “SEC Special Study of the Securities Markets.”

[2] See http://www.bis.gov.uk/assets/foresight/docs/computer-trading/12-1086-future-of-computer-trading-in-financial-markets-report.pdf .

[3] See The Benefit of Hindsight and the Promise of Foresight: A Proposal for A Comprehensive Review of Equity Market Structure, Commissioner Michael S. Piwowar, U.S. Securities and Exchange Commission, London, England (Dec. 9, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540470552.

[4] See Edwards, A. K., L. E. Harris, & M. S. Piwowar (2007): “Corporate Bond Market Transaction Costs and Transparency,” Journal of Finance, 62, 1421–1451.

[5] See Opening Statement at the Proxy Advisory Services Roundtable, Commissioner Michael S. Piwowar, U.S. Securities and Exchange Commission, Washington, D.C. (Dec. 5, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540449928.

[6] See http://www.sec.gov/spotlight/proxy-advisory-services.shtml.

[7] See Executive Order 13579 – Regulation and Independent Regulatory Agencies (July 11, 2011). See also M-11-28 – Memorandum for the Heads of Independent Regulatory Agencies (July 22, 2011).

[8] See Remarks at The SEC Speaks in 2013, Commissioner Troy A. Paredes, U.S. Securities and Exchange Commission, Washington, D.C. (Feb. 22, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1365171492408#.Ut2WJbROmM8.

[9]Id.

[10] See Section 111 of the Dodd-Frank Act.

[11] See Section 102 of the Dodd-Frank Act.

[12] See http://www.treasury.gov/initiatives/ofr/research/Documents/OFR_AMFS_FINAL.pdf.

[13] See http://www.sec.gov/divisions/investment/comments-ofr-asset-management-study.shtml. Comments are available at http://www.sec.gov/comments/am-1/am-1.shtml.

[14] See Statement at SEC Open Meeting – Proposed Rules Regarding Money Market Funds, Commissioner Daniel M. Gallagher, U.S. Securities and Exchange Commission, Washington, D.C. (June 5, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1365171575594.

[15] See letter from Former Chairmen, Commissioners, and Senior Staff of the U.S. Securities and Exchange Commission to the Members of the Financial Stability Oversight Council, Re: Jurisdiction of Independent Financial Services Regulatory Agencies (Feb. 20, 2013), available at

http://www.preservemoneymarketfunds.org/wp-content/uploads/2011/04/Former-SEC-staff.pdf .

[16] See Deborah Lucas, Evaluating the Government as a Source of Systemic Risk, First Draft: Sept. 30, 2011, available at  http://dlucas.scripts.mit.edu/docs/SystemicRisk111012.pdf .

[17] See Viral V. Acharya, Governments as Shadow Banks: The Looming Threat to Financial Stability, Sept. 2011, available at http://www.federalreserve.gov/events/conferences/2011/rsr/papers/Acharya.pdf.

[18] See Financial Stability Oversight Council, Meeting Minutes, Oct. 31, 2013, http://www.treasury.gov/initiatives/fsoc/council-meetings/Documents/Oct%2031,%202013.pdf.

[19] See Total Assets of the Federal Reserve, available at http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm.

[20] See Andrew G. Haldane & Vasileios Madouros, The Dog and the Frisbee (Aug. 31, 2012). The paper was presented at the Federal Reserve Bank of Kansas City's 36th economic policy symposium “The Changing Policy Landscape,” Jackson Hole, Wyoming, available at http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech596.pdf .

[21] See Money Market Fund Reform, Investment Company Act Rel. No. 29132 (Feb. 23, 2010), available at http://www.sec.gov/rules/final/2010/ic-29132fr.pdf.

[22] See http://www.sec.gov/news/press/2010/2010-14.htm.

[23] The staff report can be found at http://www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf. At the time the report was conducted, DERA was known as the Division of Risk, Strategy, and Financial Innovation.

[24] See Money Market Fund Reforms; Amendments to Form PF, Investment Company Act Rel. No. 30551 (June 5, 2013), available at http://www.sec.gov/rules/proposed/2013/33-9408.pdf.

FORMER EXECUTIVE SENTENCED FOR ROLE IN INSIDER TRADING CASE

FROM:  SECURITIES AND EXCHANGE COMMISSION 
Former Executive of Massachusetts-Based Company Sentenced in Insider Trading Case

The Commission announced today that, on January 21, 2014, Joseph M. Tocci, was sentenced for insider trading in the securities of Massachusetts-based American Superconductor Corporation.  The criminal charges against Tocci arose out of the same conduct for which the Commission filed a securities fraud action against Tocci in 2013.  Tocci pled guilty to the charges of insider trading on August 29, 2013.

According to the criminal information filed on August 12, 2013, Tocci, a former assistant treasurer of American Superconductor, learned in a call on or about March 31, 2011 with American Superconductor’s chief financial officer that the company’s primary customer, Sinovel Wind Group Co. Ltd., would not make past due payments and would not accept shipments scheduled for the end of the quarter on March 31, 2011.  The criminal information further stated that following the call and discussions with other members of the finance staff, Tocci knew that American Superconductor’s actual financial results for fiscal year 2010 (ended March 31, 2011) would likely be well below analysts’ expectations for the company.  According to the information, Tocci knew that he was not allowed to trade in American Superconductor shares based on material, nonpublic information about the company.  However, on April 1, 2011, while in possession of material, nonpublic information concerning Sinovel, he purchased 100 American Superconductor put option contracts.  In the context of stock transactions, a “put option” is the right to sell a particular stock at a certain price (the “strike price”) by a certain date (“expiration date”).  For the put options that Tocci purchased, if American Superconductor’s stock price declined significantly before May 21, 2011, Tocci stood to profit from the put option contracts.  On April 5, 2011, American Superconductor made a public announcement that Sinovel had refused to accept scheduled shipments and that the company expected Sinovel to reduce its level of inventory before accepting further shipments and that American Superconductor expected its revenues for the fourth quarter and/or fiscal year 2010 (ended March 31, 2011), and its expected earnings, to be substantially below prior forecasts.  On April 6, 2011, American Superconductor’s stock price dropped 42%, closing at $14.47 per share.  Tocci sold his put options for $95,092.37, earning a profit of approximately $82,440.  Tocci was sentenced to one year probation, a $100 fine, and was required to continue to pay disgorgement, prejudgment interest, and civil penalties he previously agreed to with the Commission.

In a parallel Complaint filed on August 12, 2013, in the U.S. District Court for the District of Massachusetts in Boston, the SEC alleges that Tocci, age 59, of Belmont, Massachusetts, used confidential information he obtained as the assistant treasurer of American Superconductor to purchase option contracts through which Tocci essentially bet that the company’s stock price would soon decrease on the release of negative news.  Tocci agreed to settle this case by consenting to a judgment enjoining him from future violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and ordering him to pay disgorgement of $82,439 (representing his ill-gotten gains) plus prejudgment interest of $6,109 and a civil penalty of $82,439.

The SEC’s investigation was conducted by Asita Obeyesekere, Michael Foster, and Kevin Kelcourse in the SEC’s Boston Regional Office.  The Commission acknowledges the assistance and cooperation of the U.S. Attorney’s Office for the District of Massachusetts and the Federal Bureau of Investigation’s Boston Field Office.  The Commission also thanks the Options Regulatory Surveillance Authority and the Financial Industry Regulatory Authority for their assistance.

MARKET VOLATILITY FRAUDSTERS RECEIVE COURT JUDGEMENT AGAINST THEM

FROM:  SECURITIES AND EXCHANGE COMMISSION 
Court Enters Judgment Against Three Wall Street Brokers for Defrauding Customers

The Securities and Exchange Commission announced today that, on January 14, 2014, pursuant to settlement agreements, The Honorable John F. Keenan of the United States District Court for the Southern District of New York entered judgments against defendants Marek Leszczynski, Benjamin Chouchane, and Henry Condron in the SEC’s fraud case, SEC v. Leszczynski, at al., Civil Action No. 1:12-cv-07488 (S.D.N.Y.). The judgments permanently enjoin Leszczynski, Chouchane, and Condron from violations of 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 the judgments, Leszczynski was ordered to disgorge $1,500,000; Chouchane was ordered to disgorge $2,007,408 plus prejudgment interest of $442,169; and Condron was ordered to disgorge $168,336 plus prejudgment interest of $39,339. The Court has reserved the issue of whether to impose a civil penalty on the defendants pending their continued cooperation with the SEC. Acknowledging the facts to which they have admitted as part of their guilty pleas in parallel criminal cases, Leszczynski, Chouchane, and Condron consented to the entry of these judgments.

The SEC charged these brokers, who formerly worked on the cash desk at a New York-based broker-dealer, with illegally overcharging customers $18.7 million by using hidden markups and markdowns and secretly keeping portions of profitable customer trades. The brokers made their scheme difficult for customers to detect because they deceptively charged the markups and markdowns during times of market volatility in order to conceal the fraudulent nature of the prices they were reporting to their customers. The surreptitiously embedded markups and markdowns ranged from a few dollars to $228,000 and involved more than 36,000 transactions during a four-year period.

The SEC further alleged that when a customer placed a limit order seeking to purchase shares at a specified maximum price, the brokers filled the order at the customer’s limit price but used opportune times to sell a portion of that order back to the market to obtain a secret profit for the firm. They falsely reported back to the customer that they could not fill the order at the limit price.

The SEC’s litigation has been conducted by John V. Donnelly III and G. Jeffrey Boujoukos of the Philadelphia Regional Office. The SEC’s investigation was conducted by A. Kristina Littman and Kingdon Kase, under the supervision of Daniel M. Hawke, Chief of the Division of Enforcement’s Market Abuse Unit and Director of the Philadelphia Regional Office.

INVESTMENT ADVISOR CONCEALS LOSSES AND GETS SANCTIONED

FROM:  SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission announced sanctions against a California-based investment adviser for concealing investor losses that resulted from a coding error and engaging in cross trading that favored some clients over others.

Western Asset Management Company, which is a subsidiary of Legg Mason, agreed to pay more than $21 million to settle the SEC’s charges as well as a related matter announced today by the U.S. Department of Labor.

According to an SEC order instituting settled administrative proceedings, Western Asset serves as an investment manager primarily to institutional clients, many of which are ERISA plans.  Western Asset breached its fiduciary duty by failing to disclose and promptly correct a coding error that caused the improper allocation of a restricted private investment to the accounts of nearly 100 ERISA clients.  The private investment that was off-limits to ERISA plans had plummeted in value by the time the coding error was discovered, and Western Asset had an obligation to reimburse clients for such losses under the terms of its error correction policy.  Instead, Western Asset failed to notify its ERISA clients until nearly two years later, long after the firm had liquidated the prohibited securities out of those client accounts.  

“When the coding error was discovered, Western Asset put its own interests above its clients and avoided telling investors what had caused losses in their accounts,” said Michele W. Layne, director of the SEC’s Los Angeles Regional Office.  “By concealing the error, Western Asset avoided reimbursing clients for their losses.”

In a separate order involving a different set of client accounts, the SEC finds that Western Asset engaged in a type of cross trading that was illegal.  Cross trading is the practice of moving a security from one client account to another without exposing the transaction to the market, and when done appropriately it can benefit both clients by avoiding market and execution costs.  However, cross trading also can pose substantial risks to clients due to the adviser’s inherent conflict of interest in obtaining best execution for both the buying and the selling client.

The SEC’s order finds that during the financial crisis, Western Asset was required to sell mortgage-backed securities and similar assets into a sharply declining market as registered investment companies and other clients sought account liquidations or were no longer eligible to hold these securities after rating agency downgrades.  Instead of selling the securities at prices that Western Asset believed did not represent their long-term value, it arranged for certain broker-dealers to purchase the securities from the Western Asset selling clients and sell the same security back to different Western Asset clients with greater risk tolerance in prearranged sale-and-repurchase cross trades.  Because Western Asset arranged to cross these securities at the bid price rather than a price representing an average between the bid and the ask price, the firm improperly allocated the full benefit of the market savings on the trades to buying clients and denied the selling clients approximately $6.2 million in savings.

“Cross trades serve a legitimate purpose and benefit both parties when done appropriately,” said Julie M. Riewe, co-chief of the SEC Enforcement Division’s Asset Management Unit.  “But by moving securities across client accounts in prearranged, dealer-interposed transactions, Western Asset unlawfully deprived its selling clients of their share of the savings.”

The SEC’s orders find that Western Asset violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7, and aided and abetted and caused violations of Sections 17(a)(1) and 17(a)(2) of the Investment Company Act of 1940.  Without admitting or denying the findings, the firm agreed to be censured and must cease and desist from committing or causing any further such violations.  For the disclosure violations related to the coding error, Western Asset must distribute more than $10 million to harmed clients and pay a $1 million penalty in the SEC settlement and a $1 million penalty in the Labor Department settlement.  For the cross trading violations, Western Asset must distribute more than $7.4 million to harmed clients and pay a $1 million penalty in the SEC settlement and a $607,717 penalty in the Labor Department settlement.  An independent compliance consultant must be retained to internally address both sets of violations.

The SEC’s investigation of the disclosure violations was conducted by Diana K. Tani and DoHoang T. Duong of the Los Angeles office.  An examination that led to the investigation was conducted by Charles Liao, Yanna Stoyanoff, and John Lamonica.  The SEC’s investigation of the cross trading violations was conducted by Asset Management Unit staff Valerie A. Szczepanik and Luke Fitzgerald of the New York office.  An examination identifying the cross trading issues was conducted by Margaret Jackson and Eric A. Whitman.  The SEC appreciates the assistance of the Labor Department and the Special Inspector General for the Troubled Asset Relief Program (SIGTARP), which assisted with the SEC and Labor Department investigations.

SEC CHAIR WHITE'S SPEECH AT ANNUAL SECURITIES REGULATION INSTITUTE

The SEC in 2014

 Chair Mary Jo White

41st Annual Securities Regulation Institute
Coronado, Calif.

Jan. 27, 2014

This keynote address is named in honor of Alan B. Levenson. Alan was a co-founder of this Institute and a true legend of the securities bar. He served with great distinction as a private practitioner, academic and, from 1970 to 1976, as the SEC’s sixth Director of the Division of Corporation Finance. It was his vision to bring the best of the private bar and SEC staff together yearly on the West Coast to share perspectives, rightly believing that talking face-to-face would result in a better understanding of the need and optimal way to protect investors and enable our capital markets to safely thrive. This Institute is a living tribute to Alan Levenson and I am privileged to speak to you today in his honor.

It is great to be back at the Institute. I was scheduled to be here last year for the enforcement panel, as I have been for about ten years, but I was called to Washington where the President announced my nomination as the 31st Chair of the Securities and Exchange Commission. It seemed like a good enough reason to cancel – well, it did at the time.

My first appearance at the Institute was in 1998 when I was also asked to give the keynote address. I was the United States Attorney for the Southern District of New York at the time and the title of my remarks was “White Collar Crime: No Place for Timidity.” In 2001, I was asked again to make the keynote address and spoke about the importance of companies’ compliance programs.

Fast forward to today and I am now privileged to return to the Institute and occupy the seat that David Ruder so successfully held from 1987 to 1989, as Chairman of the SEC. While I talk about a lot of other things these days, I still also talk about the importance of strong enforcement and robust compliance programs. One might say the more things change the more they stay the same – or do they?

For nearly 80 years, the Securities and Exchange Commission has been playing a vital role in the economic strength of our nation. Year after year, the agency has steadfastly sought to protect investors, make it possible for companies of all sizes to raise the funds needed to grow, and to ensure that our markets are operating fairly and efficiently.

That is our three-part mission.

But, while commitment to this mission has remained constant and strong over the years, the world in which we operate continuously changes, sometimes dramatically.

When the Commission’s formative statutes were drafted, no one was prepared for today’s market technology or the sheer speed at which trades are now executed. No one dreamed of the complex financial products that are traded today. And, not even science fiction writers would have bet that individuals would so soon communicate instantaneously in so many different ways.

It is because we operate in this vast, fast, and ever-evolving securities market that the Commission, as the regulator of that market, must constantly adapt in order to continue to be effective.

With that in mind, I thought I would speak this morning about some of the transformative changes at the SEC in 2014 and, while doing that, also preview a few of the specific rulemakings and other initiatives that I expect to be on our 2014 agenda.

Evolving with Market Technology

While there have been many significant changes since the SEC’s inception, few have had as much impact on our markets as the advances in technology. The manual trades on the exchange floor of the 1930s have given way to trading that is high-tech, high-speed, and widely dispersed among many different venues, some of which did not even exist when I last gave this address, but which now occupy significant parts of the market landscape.

And that landscape changes and evolves further every day.

It is not only our job to keep pace with this rapidly changing environment, but, where possible, also to harness and leverage advances in technology to better carry out our mission.

And, despite significant resource challenges, we are doing precisely that across the agency. Let me give you a few examples.

NEAT

Our Quantitative Analytics Unit in our National Exam Program has, for example, developed a revolutionary new instrument called “NEAT,” which stands for “National Exam Analytics Tool.”

With NEAT, our examiners are able to access and systematically analyze massive amounts of trading data from firms in a fraction of the time it has taken in years past. In one recent exam, our exam team used NEAT to analyze in 36 hours literally 17 million transactions executed by one investment adviser.

Among its many uses, NEAT can search for evidence of potential insider trading by comparing a database of significant corporate activity like mergers against the companies in which a registrant is trading and analyze how the registrant traded at the time of those significant events. NEAT can review all the securities the registrant traded and quickly identify the trading patterns of the registrant for suspicious activity.

In 2014, our examiners will be using the NEAT analytics to identify signs of not only possible insider trading, but also front running, window dressing, improper allocations of investment opportunities, and other kinds of misconduct.

MIDAS

This past year, we also brought on-line another transformative tool that enables us to collect and sift through massive amounts of trading data across markets instantaneously, an exercise that once took the staff weeks or months. We call this technology MIDAS – the Market Information Data Analytics System.

Every day, MIDAS collects one billion records of trading data, time-stamped to the microsecond. Previously, only sophisticated market participants had access to this type and amount of trading data and even fewer were able to process it. At the SEC of 2014, we are aggregating this data and presenting it on our website along with a wide range of analyses. We have made these analyses readily accessible on your computer or even your tablet, with data available in clear, easy-to-read charts and graphs.

MIDAS is already revealing some important, data-based realities that may resolve some of the speculations about behavior in today’s market structure. Just earlier this month, for example, the SEC staff published an analysis showing that for the most part the advent of public transparency for “odd lot” trades does not seem to correspond with a decline in such trades.[1] The staff noted that this result suggests that a lack of transparency may not have been one of the drivers for breaking trades into odd lots, which some observers have suggested is a technique to hide trading activity.

In the coming weeks, we are expecting to post further staff analysis of off-exchange trading, a review of research on high-frequency trading, and a data series on depth-of-book liquidity. I encourage you, after my remarks, to take a look at all of this – right on sec.gov.[2] This is not your father’s SEC – or your mother’s or even your older brother or sister’s. In this rapidly changing environment, we must stay on top of advances in technology. NEAT and MIDAS are important tools that will help us keep pace with evolving technology.

Operational Integrity

Our approach to technology in 2014, however, is not limited to building systems like these for us to keep pace with the evolving technology of the markets. We are also focused on ensuring that the technology used by exchanges and other market participants is deployed and used responsibly in a way that reduces the risk of market disruptions that can harm investors and undermine confidence in the integrity of our markets.

Most recently, following the interruption of trading in Nasdaq-listed securities last August, I met with the leaders of the equities and options exchanges. At my urging, they pledged to work toward enhancing the integrity of market systems, including the critical market infrastructures that can prove to be “single points of failure,” such as public feeds of quotes and trades.[3]

They have since been working hard to develop and implement such measures, and I expect more to be done to address these vulnerabilities in 2014.

In addition, I anticipate that the Commission’s 2014 rulemaking agenda will include consideration of the adoption of Regulation SCI – which stands for Systems Compliance and Integrity.[4] As some of you know, Regulation SCI would put in place new, stricter requirements for the use of technology by exchanges, large alternative trading systems, clearing agencies, and securities information processors. Regulation SCI can be – and should be – the market-side counterpart to the intermediary-focused Market Access Rule adopted by the Commission in 2010 to better regulate how broker-dealers manage the technological and other risks associated with direct access to markets.[5]

Evolving with New Financial Products

OTC Derivatives

It is not just technology that has changed over the life of the agency. So too have the financial products that investors, businesses, and other market participants use.

In 1990, for instance, few people would have heard of a credit default swap or any of a number of the other products that make up today’s over-the-counter derivatives market. Yet two decades later, such derivatives comprise a multi-trillion dollar market.

The Dodd-Frank Act directed the SEC – for security-based swaps – and the CFTC – for all other swaps – to create an entirely new regulatory regime for this massive market.[6] Once this regime is fully in place, many over-the-counter derivatives will be traded and cleared on venues accessible by a wide range of market participants, with trade data made readily available to regulators and disseminated to the public. What was once an opaque, bilateral market will largely become a transparent, centrally cleared market.

The Commission has proposed substantially all of the rules required to implement this new regulatory framework.[7] With our proposal for the cross-border application of this framework last year,[8] I expect the Commission in 2014 to move forward with finalizing and implementing these rules.

Money Market Funds

Even when a product is not as new as an over-the-counter derivative, the use of the product may reveal previously unanticipated risks that suggest an evolution in our regulatory approach is warranted. The recent financial crisis provided an unwelcome laboratory for a number of these products.

Money market funds, for example, have for decades been an important part of the financial marketplace. As we saw in the financial crisis, however, they can be exposed to substantially heightened redemptions if investors believe that a fund is about to lose value. The resulting instability in their value can harm investors as well as the entities that turn to money market funds for financing.

In 2010, the SEC took a first step to address this heightened redemption risk by making the funds more resilient. The rule amendments adopted by the Commission in 2010 were designed to reduce the interest rate, credit, and liquidity risks of money market fund portfolios. The Commission said at the time that it would continue to consider whether further, more fundamental changes to money market fund regulation is warranted.[9]

Currently, the Commission is considering two significant proposals for additional reform that were put out for comment last June.[10] One is a floating NAV for prime institutional money market funds – the type of fund that experienced problems during the financial crisis. The other proposal would require money market funds under certain circumstances to impose a liquidity fee and permit the imposition of redemption gates. This proposal is designed to stop a “run” and limit the resulting instability. These proposals could be adopted alone or together.

We have received hundreds of letters on the proposals with a wide range of differing views that we are reviewing closely. Completing these reforms with a final rule is a critical priority for the Commission in the relatively near term of 2014.

Securitization

The financial crisis also revealed how another product – asset-backed securities – could create undue risks to market integrity and investors. Shortly after the financial crisis, the Commission proposed a new set of disclosure rules for asset-backed securities, which have evolved with the Dodd-Frank Act.[11] Finalizing these new disclosure rules remains an important priority for the Commission in 2014.

A related effort is the rules we are required to adopt jointly with several other agencies governing the retention of a specified amount risk by the sponsor of an asset-backed security. We re-proposed those rules late last year, and finalizing them will be a priority for 2014.[12]

Evolving with New Paths to Capital Formation

Just as we have seen market technology and products evolve over time, we also have seen massive change in the ease and speed with which information and capital flows. This, in turn, has led companies, investors, Congress, the SEC and others to reconsider how companies can seek capital and communicate with potential investors. Indeed, we are at the start of what promises to be a period of transformative change in capital formation.

In 2013, according to our estimates, capital raised in public offerings totaled $1.3 trillion, as compared to $1.6 trillion raised in offerings not registered with the SEC, with over 65% raised in new and ongoing Rule 506 offerings.[13] So the private offering markets already rival the public markets in terms of capital raised.

And, in 2012, Congress passed the JOBS Act, directing the Commission to implement rules that will have a significant impact on the private offering markets. I know you will be hearing a fair amount about this subject on your panels today, so let me provide just a brief overview of what the SEC will be working on in this space in 2014.

In July, the Commission adopted rules implementing the JOBS Act mandate to lift the ban on general solicitation, and the rules became effective on September 23, 2013.[14] Although existing Rule 506 continues to be a popular method for capital raising, issuers are taking advantage of the new rule. Preliminary information collected by our Division of Economic and Risk Analysis shows that through December 31, approximately 500 offerings were conducted, raising approximately $5.8 billion.

Then, in October and December of last year, the Commission proposed rules to implement the JOBS Act mandates with respect to crowdfunding and Regulation A.[15] While the final framework of these two exemptions is yet to be determined by the Commission, if the enthusiasm for them is any indication, I expect strong interest in raising capital through these mechanisms.

Together, these changes should provide new and expanded ways for companies of all sizes, but particularly smaller companies, to raise capital. The final implementation of crowdfunding and an updated Regulation A is an important priority in 2014, and I expect that the Commission, after thorough consideration of all comments, will move expeditiously to finalize these rules.

These rule changes for the private offering market are just the start of the Commission’s efforts. For the changes demand that the Commission stay focused on the ongoing implementation of the exemptions, what market practices develop, how much capital is being raised, how investors are impacted, and whether fraud or other misconduct is occurring in these markets.

So, staff from across the agency is also set to monitor the developments in the markets following all of these changes. An agency-wide working group has been formed to monitor offering practices and other developments in the Rule 506 market. I have also directed the staff to form similar working groups for both crowdfunding and the new Regulation A.

One key step in the effort to improve our monitoring of Rule 506 offerings will be the adoption of final rules – also proposed in July – relating to amendments to Regulation D, Form D and Rule 156.[16] I know that you have a session later today during which you will discuss these proposed amendments, and I know, from the comment file, what many of you think. We are considering those comments very carefully. Advancing these important rules, after due consideration of the comments we have received, is another important priority for me in 2014.

Disclosure Reform

As we move to complete our rulemaking in the private offering area, it is important for the SEC not to lose focus on the public markets.

I recently spoke about some of my ideas about disclosure reform[17] and in December the staff issued a report mandated by the JOBS Act that gives an overview of Regulation S-K and the staff’s preliminary recommendations as to how to update our disclosure rules.[18] I have asked the staff to begin an active review of our disclosure rules.

We can all probably identify particular disclosure requirements that we might eliminate or modify, but that is not the kind of review and reform I am primarily focused on – and it certainly is not the kind of thoughtful and comprehensive review that I think our disclosure rules demand. I believe we should rethink not only the type of information we ask companies to disclose, but also how that information is presented, where and how that information is disclosed, and how we can take advantage of technology to facilitate investors’ access to information and make it more meaningful to them.

I have asked the staff to seek input from issuers, investors, and other market participants in 2014 as part of this effort, and I encourage all of you to share your views and ideas. The ultimate objective is for the Commission to improve the disclosure regime for the benefit of both companies and investors.

Vigorous Enforcement in 2014

The agency’s evolution in response to a rapidly changing market is not confined to rulemaking or market oversight. We have also found it necessary to adapt our policies, priorities, and approach with respect to enforcement as well. And no discussion of the SEC in 2014 would be complete without my touching on some of these changes and giving you some idea of what to expect this year. The coming year promises to be an incredibly active year in enforcement, as we continue to vigorously pursue wrongdoers and bring enforcement actions across the entire industry spectrum.

Admissions

As you know, for many years, the SEC, like virtually every other civil law enforcement agency, typically did not require entities or individuals to admit wrongdoing in order to enter into a settlement. This no admit/no deny settlement protocol makes a great deal of sense and has served the public interest very well. More and quicker settlements generally mean that investors receive as much (and sometimes more) compensation than they would after a successful trial – and without the litigation risk or the inevitable delay that comes with every trial. Settlements also can achieve more certain and swifter civil penalties, and bars of wrongdoers from the industry or from serving as officers or directors of public companies – all very important remedies for deterrence and the public interest.

So, why modify the no admit/no deny protocol at all? It is not a new question and one that many of you continue to ask. Even before my arrival as Chair, the Enforcement Division decided to require admissions where parallel criminal or other regulatory cases were brought with admissions.[19] Why? Because admissions can achieve a greater measure of public accountability, which can be important to the public’s confidence in the strength and credibility of law enforcement and the safety of our markets. It is not surprising that there has also been renewed public and media focus on the accountability that comes with admissions following the financial crisis, where so many lost so much.

And it should be no surprise that my views on admissions were formed long before recent events and were shaped by my time as United States Attorney. In the criminal realm, guilty pleas are accompanied by admissions of guilt, which eliminate any doubt about the conduct of the defendant and provide additional accountability for the crime.

As United States Attorney, I made the decision that companies should, in certain circumstances, admit their wrongdoing, even if they were not criminally charged, but where there was a special need for public accountability and acceptance of responsibility. That is why, when I negotiated the first deferred prosecution for a company, back in 1994, I required an admission of wrongdoing, and I brought that mindset to the SEC when I became Chair last April.

After studying and discussing the issue with the staff and my fellow Commissioners, I decided to modify the SEC’s protocol to demand admissions in an expanded category of settlements. That change occurred in June and you have begun to see it play out in a number of cases. When we first announced the change in approach, we outlined broad parameters of the types of cases in which we will consider requiring admissions as part of any settlement. And now, we have a number of cases with admissions that illuminate those categories.

So, for example, we have said we will consider admissions in cases involving egregious conduct, where large numbers of investors were harmed, where the markets or investors were placed at significant risk, where the wrongdoer poses a particular future threat to investors or the markets, or where the defendant engaged in unlawful obstruction of the Commission’s processes. Just last month, we required three brokerage subsidiaries to admit to a scheme in which they repeatedly deceived their customers about their compensation on securities transactions – and in some cases even provided falsified trading data to their customers in an effort to avoid detection.[20] The conduct was egregious and harmed many investors, thereby justifying admissions.

Similarly, we demanded that a bank admit that its internal controls were deficient in failing to detect and prevent, and then disclose to its board and investors, massive losses by some of its traders, thereby putting millions of shareholders at risk and resulting in inaccurate public filings.[21]

To be sure there was no ambiguity about the misconduct of a defendant who was continuing to deal with investors, we required a hedge fund adviser to not only agree to a bar from the securities industry for five years, but to also admit to misuse of more than one hundred million dollars of fund assets in order to pay his personal taxes through a personal loan that was not timely disclosed to investors.[22]

As we go forward in 2014, you will see more cases involving admissions. When and how we decide to require admissions will continue to evolve and be subject to further articulation in the cases we bring and as we discuss it publicly.

Financial Fraud

This year will likely see us complete our docket of major investigations stemming from the financial crisis. As we do, our focus and resources will naturally turn to other priorities. This shift has already begun.

Last fall, the Enforcement Division formed a Financial Reporting and Audit Task Force. This dedicated group has very talented accountants and attorneys who will broaden and thereby improve the way we look at financial reporting misconduct.

The Task Force is pursuing a number of goals, including building a deep understanding of the state of financial reporting fraud – not just why it happens, because there is plenty of learning on that question, but how it happens and in what specific areas.

As you would expect, we look closely at the auditors in every financial reporting case, but we are also closely focusing on senior executives for possible misconduct warranting charges. The message is that critical accounting issues are the responsibility of all those involved in the preparation and review of financial disclosures.

Market Integrity

As I have discussed, technology has worked a fundamental shift in the way securities are priced and traded – a shift that has only accelerated in the past several years. In the last two years, we have tried to send a strong enforcement message to the exchanges and alternative trading systems that play critical roles in securities market transactions that they must operate fairly, within the rules and with a close eye on their responsibilities to safeguard their technology. Cases have been brought against an exchange that inadequately tested its IPO systems and was therefore unable to handle a highly anticipated IPO and then did not follow its own rules in the aftermath;[23] against a different exchange for compliance failures that gave certain customers an improper head start on trading information;[24] and against a dark pool for failing to protect the confidential trading information of its subscribers.[25]When technology presents new opportunities for innovation, changes must be deployed responsibly, after careful testing, and within the rules and parameters of the trading environment. Market structure integrity actions will remain a priority in 2014.

As you will hear when Andrew Ceresney, our Director of Enforcement speaks to you over the coming days, there are many other enforcement priorities for 2014 that you should be aware of. These include, but are by no means limited to, FCPA, insider trading, and microcap fraud. It will, in short, be a very busy year in enforcement.

Conclusion

I hope I have given you a sense of some of the things we will be doing in 2014 and a flavor for how dramatically and vibrantly things have changed at the SEC as our world and markets have changed. There is more, of course, we will be doing and considering in the coming year, both on our own initiative and as required by the Dodd-Frank and JOBS Acts – equity market structure, duties of brokers-dealers and investment advisers, the management and responsibilities of clearing agencies and credit rating agencies, Dodd-Frank executive compensation, target date funds, systemic risk issues, broker-dealer financial responsibility, and more.

It is a constant, but always exciting, challenge to keep pace and indeed to accurately see around the next corner for the newest market developments or another innovative variant of, or new venue for, fraud. I now am privileged to have an up-close and personal role in all of this. And it is my strong conviction that the women and men of the SEC are, as has always been true, more than up to these challenges. As Alan Levenson said in January 2003, almost eleven years to the day when he spoke about the strength of the SEC: “It was the creativity of the staff… [they] had a drive and a genuine interest in protecting investors and the public interest….”[26]The challenges and tools change, but creativity, drive, and commitment to the mission continue unchanged at the SEC in 2014. Alan Levenson, I think, would be very proud.

Thank you for listening.

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[1] “Odd Lot Rates in a Post-Transparency World,” Data Highlight 2014-01 (Jan. 9, 2014), available at http://www.sec.gov/marketstructure/research/highlight-2014-01.html.

[2] The MIDAS web site and interactive tools are available athttp://www.sec.gov/marketstructure/.

[3] SEC Chair White Statement on Meeting with Leaders of Exchanges (Sept. 12, 2013), available athttp://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539804861.

[4] Regulation Systems Compliance and Integrity, Release No. 34-69077 (Mar. 8, 2013) [78 FR 18083 (Mar. 25, 2013)], available athttp://www.sec.gov/rules/proposed/2013/34-69077.pdf.

[5] Risk Management Controls for Brokers or Dealers with Market Access, Release No. 34-63241 (Nov. 3, 2010) [75 FR 69792 (Nov. 15, 2010)], available athttp://www.sec.gov/rules/final/2010/34-63241.pdf.

[6] For an interactive chart of the current state of the regulatory regime for security-based swaps, see http://www.sec.gov/swaps-chart/swaps-chart.shtml.

[7] For the list of proposals issued by the Commission and the associated comment files, see Comment Periods for Certain Rulemaking Releases and Policy Statement Applicable to Security-Based Swaps Proposed Pursuant to the Securities Exchange Act of 1934 and the Dodd-Frank Wall Street Reform and Consumer Protection Act, Release No. 34-69491 (May 1, 2013) [78 FR 30800 (May 23, 2013)], available athttp://www.sec.gov/rules/proposed/2013/34-69491.pdf.

[8] Cross-Border Security-Based Swap Activities; Re-Proposal of Regulation SBSR and Certain Rules and Forms Relating to the Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants, Release No. 34-69490 (May 1, 2013) [78 FR 30967 (May 23, 2013)], available athttp://www.sec.gov/rules/proposed/2013/34-69490.pdf.

[9] Money Market Fund Reform, Release No. IC-29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] (see Section I, “Background”), available athttp://www.sec.gov/rules/final/2010/ic-29132.pdf. As a study conducted by staff in the SEC’s Division of Economic and Risk Analysis (DERA) stated, “[N]o fund would have been able to withstand the losses that The Reserve Primary Fund incurred in 2008 without breaking the buck, and nothing in the 2010 reforms would have prevented The Reserve Primary Fund’s holding of Lehman Brothers debt.” Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher, a report by staff of the Division of Risk, Strategy, and Financial Innovation, “Executive Summary” (Nov. 30, 2012), available at http://www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf.

[10] Money Market Fund Reform; Amendments to Form PF, Release No. IC-30551(Jun. 5, 2013) [78 FR 36833 (Jun. 19, 2013)], available athttp://www.sec.gov/rules/proposed/2013/33-9408.pdf.

[11] Asset-Backed Securities, Release No. 33-9117 (Apr. 5, 2010) [75 FR 23328 (May 3, 2010)], available at http://www.sec.gov/rules/proposed/2010/33-9117.pdf and Re-proposal of Shelf Eligibility Conditions for Asset-Backed Securities and Other Additional Requests for Comment, Release No. 33-9244 (Jul. 26, 2011) [76 FR 47948 (Aug. 3, 2011)], available at http://www.sec.gov/rules/proposed/2011/33-9244.pdf.

[12] Credit Risk Retention, Release No. 34-70277 (Aug. 28, 2013) [78 FR 57927 (Sept. 20, 2013)], available at http://www.sec.gov/rules/proposed/2013/34-70277.pdf.

[13] To make these estimates, staff from DERA used the Securities Data Corporation’s (SDC) New Issues database (Thomson Financial), the Mergent database, and Asset-Backed Alert to obtain data regarding public and private offerings. Data on Rule 144A offerings and asset-backed securities offerings was available for part of 2013 and the estimates were made by extrapolating through the end of 2013. Data on Regulation D offerings was collected from all Form D filings (new filings and amendments) in EDGAR. Subsequent amendments to a new Form D filing were treated as incremental fundraising. If an issuer filed only amended filings in 2013, and those reference a pre-2013 sale date, these amended filings were treated as incremental fundraising.

[14] Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Release No. 33-9415 (Jul. 10, 2013) [78 FR 44771 (Jul. 24, 2013)], available at http://www.sec.gov/rules/final/2013/33-9415.pdf.

[15] Crowdfunding, Release No. 33-9470 (Oct. 23, 2013) [78 FR 66428 (Nov. 5, 2013)], available at http://www.sec.gov/rules/proposed/2013/33-9470.pdf and Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act, Release No. 33-9497 (Dec. 18, 2013) [79 FR 3926 (Jan. 23, 2014)], available at http://www.sec.gov/rules/proposed/2013/33-9497.pdf.

[16] Amendments to Regulation D, Form D and Rule 156, Release No. 33-9416 (Jul. 10, 2013) [78 FR 44806 (Jul. 24, 2013)], available athttp://www.sec.gov/rules/proposed/2013/33-9416.pdf. See also Re-opening of Comment Period for Amendments to Regulation D, Form D and Rule 156, Release No. 33-9458 (Sept. 27, 2013) [78 FR 61222 (Oct. 3, 2013)], available athttp://www.sec.gov/rules/proposed/2013/33-9458.pdf.

[17] The Path Forward on Disclosure, remarks at the National Association of Corporate Directors Leadership Conference 2013 (Oct. 15, 2013), available athttp://www.sec.gov/News/Speech/Detail/Speech/1370539878806.

[18] Report on Review of Disclosure Requirements in Regulation S-K (Dec. 2013),available at http://www.sec.gov/news/studies/2013/reg-sk-disclosure-requirements-review.pdf.

[19] Statement by Robert Khuzami (Jan. 7, 2012) available athttp://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1365171489600.

[20] See Press Release No. 2013-266, “SEC Charges ConvergEx Subsidiaries With Fraud for Deceiving Customers About Commissions” (Dec. 18, 2013), available athttp://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540521484.

[21] See Press Release No. 2013-187, “JPMorgan Chase Agrees to Pay $200 Million and Admits Wrongdoing to Settle SEC Charges” (Sept. 19, 2013), available athttp://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539819965.

[22] See Press Release No. 2013-159, “Philip Falcone and Harbinger Capital Agree to Settlement” (Aug. 19, 2013), available athttp://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539780222.

[23] See Press Release No. 2013-95, “SEC Charges NASDAQ for Failures During Facebook IPO” (May 29, 2013), available athttp://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171575032.

[24] See Press Release No. 2012-189, “SEC Charges New York Stock Exchange for Improper Distribution of Market Data” (Sept. 14, 2012), available athttp://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171484740.

[25] See Press Release No. 2012-204, “SEC Charges Boston-Based Dark Pool Operator for Failing to Protect Confidential Information” (Oct. 3, 2012), available athttps://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171485204.

[26] Securities and Exchange Commission Historical Society, Interview with Alan B. Levenson Conducted on January 14, 2003, by Richard Rowe, pp. 5-6, available athttp://3197d6d14b5f19f2f440-5e13d29c4c016cf96cbbfd197c579b45.r81.cf1.rackcdn.com/collection/oral-histories/levenson011404Transcript.pdf .

DISGORGEMENT AND FINES ORDERED FOR COMMODITY TRADING SYSTEM PROMOTERS

FROM:  COMMODITY FUTURES TRADING COMMISSION 

Federal Court Orders California Defendants CTI Group, LLC, Cooper Trading, Stephen Craig Symons, and James David Kline to Pay Over $29 Million in Disgorgement and Fines for Fraudulent Sale of Automated Trading Systems

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced that Judge Katherine Polk Failla of the U.S. District Court for the Southern District of New York entered a Consent Order for Permanent Injunction (Order) against Defendants CTI Group, LLC, a California limited liability company, Cooper Trading, a California corporation (collectively, CTI), Stephen Craig Symons of Corona del Mar, California, and James David Kline, who was a resident of Van Nuys, California, for fraudulent sales practices in connection with the sale of two automated trading systems (Trading Systems), known as Boomer and Victory.

The court’s Order stems from a CFTC Complaint filed on May 11, 2012, that charged the Defendants with the fraudulent solicitation of clients to subscribe to the Boomer and Victory Trading Systems, which were used by clients to trade E-mini Standard and Poor’s 500 Stock Index futures contracts in managed accounts (see CFTC Press Release 6266-12 and Complaint).

The Order, entered on January 22, 2014, requires Defendants CTI Group and Cooper Trading to pay $10.175 million in disgorgement and a $10 million civil monetary penalty, Symons to pay over $3.150 million in disgorgement and a $4.5 million civil monetary penalty, and Kline to pay over $275,000 in disgorgement and a $1 million civil monetary penalty. The Order further imposes permanent trading and registration bans on the Defendants and prohibits them from violating the anti-fraud and disclosure provisions of the Commodity Exchange Act (CEA) and CFTC regulations, as charged.

The CFTC’s Complaint also named as Relief Defendants California companies Snonys, Inc. and Dragonfyre Magick Incorporated, which, according to the Complaint, were owned or operated by Symons and Kline, respectively. The Order provides for the disgorgement of Relief Defendants’ funds frozen pursuant to a court order that was previously entered on May 14, 2012.

The Order further finds that, since at least in or around August 2009, CTI and its agents and employees made false and misleading statements and omitted material information when soliciting clients to purchase subscriptions to CTI’s Trading Systems, including (1) how long CTI had been in business, (2) CTI’s experience developing and marketing Trading Systems, (3) the identities and professional experience of CTI’s personnel (who used fictitious names when communicating with clients), (4) the track record of CTI’s Trading Systems, (5) the past profitability of CTI’s Trading Systems, (6) the transaction costs associated with trading via CTI’s Trading Systems, and (7) the risks associated with trading futures contracts via CTI’s Trading Systems.

CTI’s salespeople, including Kline, made false statements to clients and prospective clients about CTI’s purported money-back guarantee, and Symons and Kline are liable for all of CTI’s violations because they controlled CTI and actively participated in CTI’s unlawful conduct, according to the Order.

According to the Order, funds were transferred to the Relief Defendants from CTI as a result of the Defendants’ violations of the CEA and CFTC regulations, and the Relief Defendants do not have a legitimate claim to or interest in those funds.

The CFTC thanks the National Futures Association for its assistance.

CFTC Division of Enforcement staff members responsible for this case are R. Stephen Painter, Jr., Michael C. McLaughlin, David W. MacGregor, Lenel Hickson, Jr., and Manal M. Sultan.

CFTC Fraud Awareness Advisories & Customer Protection Information

The CFTC has issued several customer protection Fraud Advisories that provide the warning signs of fraud, including an Advisory covering Commodity Trading Systems Sold on the Internet. This Advisory states that the CFTC has seen an increase in websites that fraudulently promote commodity trading systems and advisory services and provides information designed to help customers identify this potential swindle before they invest.

Customers can file a tip or complaint to report suspicious activities or other information, such as possible violations of commodity trading laws, to the CFTC Division of Enforcement via a Toll-Free Hotline 866-FON-CFTC (866-366-2382) or an online form.