Keynote Address at Compliance Week 2014

Andrew Ceresney

Director of the Division of Enforcement

Washington D.C.

May 20, 2014

At the outset, let me give the requisite reminder that the views I express today are my own and do not necessarily represent the views of the Commission or its staff.

It is a real pleasure to be here with a group of legal and compliance professionals.  In my time in private practice, and now as the Director of Enforcement, I have come to appreciate how your work is invaluable to the SEC’s mission of protecting investors and ensuring the integrity of our markets.  You serve as a critical line of defense against securities law violations.

I recently reached my one-year anniversary since joining the Commission, and so I want to share with you today my thoughts on some of our accomplishments over the last year, including some of the significant changes we have made, and what lies ahead.   As I often like to say, this is a great time to be in the Enforcement Division.

Let me first salute the Division staff.  I have been truly amazed every day by the talent, ingenuity and commitment of the people in Enforcement.  They possess a tremendous wealth of knowledge and experience and are wholly devoted to the mission of the Agency. In all of their actions, they are tough and aggressive but fair.  Thanks to their efforts, we achieved a great deal in my first year.  

I could stand here and give you statistics about the number of enforcement actions brought last year and the amounts of disgorgement and penalties that were ordered as a result of those actions.  But you can obtain those numbers from our website, and such quantitative metrics do not fully capture the effectiveness of our enforcement efforts.  When measuring our performance, we primarily consider the quality, breadth, and impact of our efforts.   And by that standard, it was a banner year, as our cases spanned the full breadth of the securities industry, served as a strong deterrent to misconduct, punished securities violators, returned funds to injured investors, and sent important messages to the market.  Those cases included actions against exchanges to ensure they operate fairly and in compliance with applicable rules, actions against investment advisers and broker-dealers for taking undisclosed fees and for disrupting the markets through failures in their automated trading systems, important financial reporting cases against issuers, actions against auditors and others who serve as gatekeepers to our financial system, FCPA cases against large multinational corporations, actions against municipal issuers, and landmark insider trading cases.  We covered the proverbial waterfront of securities violations.

Specialized Units 

As you know, pursuing violations related to the financial crisis has been one of our key priorities.  But after successfully addressing such misconduct over the last five years, we now have shifted our attention to other areas and redeployed our resources accordingly.  Let me touch on some of those areas. 

My predecessor, Rob Khuzami, created five specialized units relating to areas of significant concern.  The idea was to build expertise and knowledge in each of these areas, and to have unit personnel solely focused on making cases in these important areas.  As I like to say, these units were designed not just to eat a piece of the “Enforcement pie” – by working on cases that we otherwise would have brought – but to make the pie bigger by creating initiatives to examine practices that may not have in the past received sufficient attention and bringing cases for violations related to those practices.  The units have been incredibly successful in accomplishing these goals.

Over the last couple of years, the Asset Management Unit has launched a series of innovative initiatives – often in partnership with OCIE – focusing on important regulations like the custody rule and on undisclosed principal transactions and conflicts of interest; identified funds with aberrational returns that engaged in misconduct and investment advisers with deficient compliance programs; and brought cases against boards that did not exercise their responsibilities to determine investment adviser fees or to value their funds’ holdings properly.[1]

The Municipal Securities and Public Pensions unit this year brought the first action against a municipal issuer for materially misleading statements made outside of its securities disclosure documents,[2] the first case in which the Commission assessed a financial penalty against a municipal issuer,[3] and helped bring significant cases against individuals, including a City of Miami budget director and several City of Victorville officials.[4]

The FCPA Unit has teamed with DOJ to bring significant cases against issuers and individuals this past year, including reaching global settlements with Alcoa for over $380 million,[5] with Weatherford International for over $250 million,[6] and with Hewlett-Packard for over $108 million.[7]

The Complex Financial Instruments Unit was incredibly productive in addressing misconduct arising from the financial crisis, bringing CDO and RMBS cases against several prominent financial institutions.[8]  The unit has now shifted its attention to the next frontier and I expect it to zero in on the structuring, rating, valuation, sale, and use of other types of complex financial products, such as CMBSs, structured notes, and CDSs, while also preparing to enforce new Dodd-Frank rules like the Volcker Rule.

Finally, the Market Abuse Unit has been focused on complex insider trading and market structure cases.  Let me spend a few minutes on market structure, since that is an area that has received much attention recently. 

Market Structure

Our markets have been radically transformed over the last five or so years due to the proliferation of sophisticated technological tools and the increased use of high-frequency trading, complex algorithmic trading, and off-exchange trading venues, including so-called “dark pools.” Although other divisions within the Commission handle the policy and rulemaking questions arising out of these developments, Enforcement’s role is to prosecute violations of the law.  To ensure fair trading and equal access to information in the securities markets, we have brought significant actions in the past year against exchanges, broker-dealers, and other key market participants relating to failures in controls and the use of manipulative trading strategies.    

For example, in the last three years, we have pursued a number of cases against national securities exchanges. Most recently, we charged NYSE and two affiliated exchanges with failing to conduct their operations in accordance with Commission-approved exchange rules, which resulted in a $4.5 million penalty.[9]  This action comes on the heels of our other recent cases against national exchanges, including charges against NASDAQ for violations in connection with the Facebook IPO[10] and the Chicago Board Options Exchange (CBOE) for breakdowns in its role as a self-regulatory organization, including its failure to oversee compliance with Reg SHO.[11]  NASDAQ and CBOE ultimately paid $10 million and $6 million, respectively – the two largest SEC penalties ever levied against exchanges.   After many decades of never assessing a single penalty against a securities exchange, we now have had six exchanges collectively pay over $25 million in less than two years.  And through these actions, we have sent a strong, unmistakable message that exchanges need to institute appropriate controls and closely monitor trading. 

Our market structure cases have not been limited to exchanges.  A substantial amount of trading—recently reported to be over one-third of all trading—occurs off-exchange, and we are expanding our presence in this realm.  Indeed, the Commission has already brought actions against two dark pool operators in recent years[12] and will continue to pursue Reg ATS violations, including the failure to implement safeguards that protect ATS subscribers’ confidential trading information as required by Reg ATS.  Considering the volume of trading at these venues, investors must be able to trust that off-exchange trading is fair and reliable. 

In addition to trading venues like exchanges and dark pools, we also must continue to focus on broker-dealers that route much of the order flow in today’s markets.  Rule 15c3-5, known as the “Market Access Rule,” requires brokers-dealers to have reasonably designed controls and supervisory procedures to manage the risks of having market access, including both financial controls to prevent problems like erroneous orders and trades that exceed capital and credit limits, and regulatory controls that ensure compliance with our rules and regulations.[13]

Last fall, we brought our first enforcement case under Rule 15c3-5 against Knight Capital related to the firm’s August 2012 trading incident that disrupted the markets.  The action included a $12 million penalty and our investigation showed, among other things, that Knight did not have adequate controls for its smart order router.[14]  This is an important area for us and you can expect continued scrutiny relating to compliance with the Market Access Rule.

We also have been focused on other issues related to high-frequency and automated trading, including potential abuses of order types, net capital rules, and manipulative trading.  For example, we have brought cases involving a manipulative trading practice known as “layering,” which involves the use of fictitious orders that a trader intends to cancel before they are executed, to induce others to buy or sell securities at prices that do not represent actual supply and demand.  Indeed, the Commission charged the owner of a brokerage firm last month with engaging in layering over a three-year period.[15]

As the primary regulator of the securities industry, the SEC remains committed to bringing enforcement actions whenever parties jeopardize the integrity of our markets or otherwise fail to operate within the rules.  Through these efforts, we will continue to ensure that our markets remain fair, efficient, and reliable for all investors.

Task Forces

Over the last year, we also have amplified the division’s focus on other areas of growing concern, beyond the ones covered by the specialized units.  We have accomplished this by launching several task forces, which have enabled us to quickly mobilize a core group of attorneys, professionals, and industry experts to concentrate on high-priority areas and share their expertise and promising leads division-wide.

For example, we launched the Financial Reporting and Audit Task Force to renew our attention on financial reporting and accounting fraud.[16]  The importance of pursuing financial fraud cannot be overstated. Comprehensive, accurate and reliable financial reporting is the bedrock upon which our markets are based because false financial information saps investor confidence and erodes the integrity of the markets.    

The Task Force’s mandate is to incubate financial reporting cases by finding promising investigations.  It brings together an experienced group of attorneys and accountants who are developing state-of-the-art techniques for identifying and uncovering accounting fraud.  The team relies on the latest data analytic tools and outside services to identify high-risk companies and potential accounting issues.[17]  And it is already off to a great start, having helped generate several promising leads.

Meanwhile, we have brought a series of financial reporting cases over the last few months, including significant actions against CVS, Diamond Foods, AgFeed, and Dewey & LeBouf.[18]  More such cases will be coming down the pike.

In addition to more closely monitoring financial reporting, we also have bolstered our focus on financial reporting “gatekeepers.”[19]   In every financial reporting investigation, we evaluate the conduct of the auditors, seeking to determine whether they followed audit procedures and performed their role according to generally accepted auditing standards.

We also are more closely monitoring and pursuing misconduct related to microcap securities. Abuses in this area frequently involve entities that use false or misleading marketing campaigns and manipulative trading strategies, largely at the expense of less sophisticated, retail investors. Over time, these abuses have proliferated due to the increased use of the Internet and social media to publicize fraudulent schemes and lure in unsuspecting investors.

To stay on top of this, we created a Microcap Fraud Task Force, which is focused on developing proactive initiatives that target executives, gatekeepers and other repeat players who help facilitate these schemes. [20]  The Task Force also aims to identify and shut down schemes in their early stages, with tools like trading suspensions and asset freezes. And it has had an immediate impact. We have opened numerous investigations because of their work and brought 15 trading suspensions in recent months.  These efforts have enabled us to more quickly halt misconduct and mitigate investor harm, while sending an unmistakable message to the microcap community.[21]

We also recently launched a Broker-Dealer Task Force that is focusing on current issues and practices within the broker-dealer community.  The group is liaising closely with the broker-dealer program within OCIE, as well as the Division of Trading and Markets, to develop initiatives that can be implemented division-wide.  Their early efforts include initiatives relating to anti-money laundering regulations and recidivist brokerage firms that shelter rogue brokers and engage in abusive activities.  

The Division also is focused on enforcing some of the Commission’s new and upcoming rules.  For example, last year we launched the JOBS Act Task Force, a nationwide group dedicated to preparing the Division to enforce the new capital-raising rules under the JOBS Act, including rules related to general solicitation and crowdfunding.  The group has created risk-based initiatives to identify parties that are not adhering to the new regulations, including issues related to inadequate efforts to verify accreditation.[22]

New Approach to Settlements

The changes in the last year have not been limited to substantive areas of focus.  One of the first changes implemented after Chair White and I arrived at the SEC last year was to modify the SEC’s longstanding no admit/no deny settlement protocol by requiring admissions in certain types of cases.  Our prior practice had been to settle all cases, except those with a guilty plea or criminal conviction, on a no admit/no deny basis.  This practice had served the SEC well for many years.  When we settle enforcement cases on a no admit/no deny basis, we often are able to get the same – or even higher – penalties than we would have if we litigated and won the case.  Such settlements also speed up our ability to reclaim ill-gotten gains and return funds to wronged investors, avoid the delay and uncertainty inherent in trials, and allow us to use our finite resources more efficiently.

But there are some cases where the need for accountability and acceptance of responsibility is critical to the success of our program.  In such cases, admissions enhance the message and strength of the action, and enable us to achieve a greater measure of public accountability, which, in turn, bolsters the public’s confidence in the safety of our markets.

After nearly a year, I am happy to report that the new program is working very well.  We have obtained admissions in eight cases under the new approach – with more in the pipeline.  And we have obtained them across a broad spectrum of defendants – against firms and individuals; against regulated and unregulated entities; and in scienter-based, as well as non-scienter, controls-based cases.

Many originally doubted our ability to implement this new approach. Some expressed concern that we would not be able to obtain admissions because defendants would be overly concerned about collateral consequences.  Others wondered whether our new policy would bog down settlements and cause more parties to go to trial.  But these dire predictions have not materialized and we have been able to obtain significant admissions in cases where we thought they were appropriate. 

Now that we have settled a number of cases with admissions, the types of cases where the Division may seek them can be better appreciated.  We obtained admissions in the ConvergEx matter, for example, where the defendants were regulated entities and their egregious and fraudulent conduct harmed numerous clients.[23]  We obtained admissions from JP Morgan – for conduct related to the so-called “London Whale” trading loss – where the company’s woefully deficient controls created a significant risk to investors.[24]  In our action against Philip Falcone and his advisory firm, admissions helped give the public unambiguous information about the defendant’s actions so they would be empowered to make informed decisions about whether to continue investing in companies with which he was involved.[25]  In the Scottrade matter, we obtained admissions where the company produced inaccurate blue sheet data over an extended period of time, which impeded the SEC’s ability to investigate misconduct and protect investors.[26]   And in Lions Gate, we sent an important message to the market about the perils of misleading investors in the midst of a tender offer battle.[27]

The new admissions approach gives us an additional powerful tool to use in appropriate cases and it has undoubtedly strengthened our program.

Trials

Another area of focus for the Division over the past year has been enhancing our litigation efforts.  We have experienced a significant increase in the number of trials this year – in fact, we had more trials in the first half of this fiscal year than we had during all of the last fiscal year.  This is hardly a bad development – as Mary Jo has said in the past, trials have lots of benefits, including the public airing and adjudication of the facts.  Although it could just be a blip, this uptick in trials means that we must marshal appropriate resources and skills to remain competitive in court against defendants that often have far greater resources at their disposal.  And we have been doing just that. 

We have incredibly talented lawyers at the SEC who I would put up against any defense counsel.  We are ensuring that we provide the strongest advocacy possible in every case, preparing relentlessly for any argument that might be raised at trial.  This renewed focus does not mean we will win every case – though we have been very successful overall and recently, winning our last five jury trials, including our significant victory last week in the Wyly matter.  What it does mean is that defendants know we will not hesitate to go to trial, and that when we are in court, defendants will face skilled, tireless advocates who will present as strong a case as possible on our behalf.  

Use of Technology

We also have been focused on using technology to improve our ability to detect and investigate fraud.  With the increased complexity of the markets, and of schemes more generally, as well as the proliferation of big data, we need to better harness technology in order to keep up with wrongdoers. 

Take insider trading.  Over the last five years, we have filed an unprecedented number of insider trading actions against more than 570 individuals and firms.  We often have learned of this misconduct through surveillance referrals from FINRA and ORSA.  But we also have now developed in-house the Advanced Bluesheet Analysis Program to identify suspicious trading patterns that would suggest relationships among different traders who may be sharing inside information.  Identifying these trading relationships allows us to work backwards to find evidence of connections and sources of the inside information. 

Technology is assisting us in many other areas as well.  We developed a program a couple of years ago that identifies aberrant returns in investment funds, which often can signify misconduct.  We have brought a number of cases identified through this initiative and continue to expand its application as we receive and process new fund data. 

Last year, we launched the Center for Quantitative and Risk Analytics, which is helping us develop technologies to analyze trading and other types of data available to us from a wide variety of venues.[28]  It is critical that we continue to develop tools that mine these massive data sources for possible violations.  This data is a rich source of information for us and we need to take advantage of it.

Increased Focus on Compliance

Finally, because this is the Compliance Week conference, I thought it would be appropriate to spend a few minutes on compliance programs and compliance officers.  I start from the premise that the companies that have done well in avoiding significant regulatory issues typically have prioritized legal and compliance issues, and developed a strong culture of compliance across their business lines and throughout the management chain.  This is something I observed firsthand while in private practice and have come to fully appreciate from my perch at the SEC.   

I have found that you can predict a lot about the likelihood of an enforcement action by asking a few simple questions about the role of the company’s legal and compliance departments in the firm.  Are legal and compliance personnel included in critical meetings?  Are their views typically sought and followed?  Do legal and compliance officers report to the CEO and have significant visibility with the board?  Are the legal and compliance departments viewed as an important partner in the business and not simply as support functions or a cost center?  Far too often, the answer to these questions is no, and the absence of real legal and compliance involvement in company deliberations can lead to compliance lapses, which, in turn, result in enforcement issues.

When I was in private practice, I always could detect a significant difference between companies that prioritized legal and compliance and those that did not.  When legal and compliance were not equal partners in the business, and were not consulted as a matter of course, problems were inevitable.        

I hope to use my current role to further promote a strong, empowered legal and compliance presence at firms, in part by encouraging legal and compliance personnel to engage and become involved when they see an issue that raises a concern.  You should not hesitate to provide advice and help remediate when problems arise.  And I do not want you to be concerned that by engaging, you will somehow be exposed to liability.  As recent SEC staff guidance makes clear, compliance personnel do not become supervisors solely because they provide advice to, or consult with, business line personnel and the staff does not view compliance or legal personnel generally as supervising business personnel.[29]

But at the same time, I need to be clear that we have brought – and will continue to bring – actions against legal and compliance officers when appropriate.  This typically will occur when the Division believes legal or compliance personnel have affirmatively participated in the misconduct, when they have helped mislead regulators, or when they have clear responsibility to implement compliance programs or policies and wholly failed to carry out that responsibility. 

A recent case illustrates all three of these situations.  Yesterday, the Commission instituted administrative proceedings against the CCO, among others, at what used to be one of the largest independent clearing firms in the country.  In the matter, the Division alleged that the firm violated Reg SHO for more than three years and that the CCO not only knew about the firm’s decision to violate the rules, but also affirmatively participated in the violations by, among other things, failing to implement procedures that he was responsible for implementing and that would have brought the firm into compliance, and then concealing those violations from regulators.[30]

It also is certainly appropriate to bring actions against compliance officers when they fail to carry out their clearly assigned responsibility to implement necessary policies.  For example, we launched the Compliance Program Initiative – a joint effort with OCIE – to identify and bring actions against investment advisers that fail to adopt or implement adequate compliance programs after being notified repeatedly of deficiencies by examination staff.[31]  To date, the Commission has brought ten actions as part of this initiative, including charges against compliance personnel when they were clearly responsible for the failure.

At the end of the day, though, legal and compliance officers who perform their responsibilities diligently, in good faith, and in compliance with the law are our partners and need not fear enforcement action.  In fact, we want to use our enforcement program to support your efforts.  Last year, for example, we filed our first-ever charge against an individual for misleading and obstructing a compliance officer of an investment adviser.  The Commission’s Order was based on factual findings that an assistant portfolio manager had, among other things, attempted to conceal from his firm’s CCO his involvement in more than 600 unauthorized personal trades – many of which involved securities held or acquired by funds that the firm managed.[32]  We will look for more cases like this one.

Conclusion

So you can see that we have been quite busy this past year trying to expand our enforcement footprint.  As markets continue to evolve, we must continue to innovate and devise new strategies that enhance our ability to deter wrongdoers, and broaden our reach within the industry.

I am confident that this next year will be even better and I hope to return in 2015 to report on another great round of innovations that will help us detect misconduct and bring securities violators to justice.  Thanks very much and I look forward to taking your questions.