May 13, 2021

Volume XI, Number 133


May 13, 2021

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May 12, 2021

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May 11, 2021

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Bridging the Week: June 5-9, June 12, 2017 (SEC Disgorgement Actions Are Not Forever; Keep Suspicions in SARs; Audit Trail Requirements) [VIDEO]

The United States Supreme Court ruled last week that the Securities and Exchange Commission cannot bring enforcement actions seeking disgorgement more than five years after alleged wrongful conduct has occurred. In 2013, the Court previously precluded such untimely filings for SEC enforcement actions seeking civil penalties. The logic of these decisions should equally apply to enforcement actions brought by the Commodity Futures Trading Commission as well as other federal regulatory agencies that do not have their own distinct statute of limitations. In addition, the SEC brought an enforcement action against a broker-dealer for not only failing to file suspicious activity reports, but also for filing SARs without adequately explaining the rationale for such filings. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Diamonds May Be Forever, but US Supreme Court Rules SEC Ability to Seek Disgorgement Limited to Five Years (includes Legal Weeds);

  • SEC to Broker-Dealer in Enforcement Action: Include Basis for Suspicions in Suspicious Activity Reports (includes Compliance Weeds and Valuable Lessons Learned);

  • CME Clearing Member Settles Charges for Allegedly Not Retaining Required Audit Trail of Direct Access Client; Two CBOT Members Settle Charges Related to Purported Position Limit Violations (includes Compliance Weeds); and more.

Video Version:

Diamonds May Be Forever, but US Supreme Court Rules SEC Ability to Seek Disgorgement Limited to Five Years:

The United States Supreme Court ruled last week that the Securities and Exchange Commission may only commence enforcement actions seeking disgorgement within five years after the date of the alleged wrongdoing.

The Court grounded its decision on its prior determination in 2013 that enforcement actions brought by the SEC seeking civil penalties are also subject to a five-year statute of limitations. (Click here to access the Court’s decision in Gabelli v. Securities and Exchange Commission.)

According to the Court, disgorgement is a form of civil penalty subject to an applicable catch-all federal statute of limitations that “finds its roots in a law enacted nearly two centuries ago.” This law establishes a five-year statute of limitations for “an action, suit or proceeding for the enforcement of any civil fine, penalty or forfeiture.” (Click here to access 28 USC §2462.)

In an unanimous ruling, the Court found that SEC disgorgement is a form of penalty because it is imposed by courts (1) as a result of violating public laws and (2) for punitive purposes. In reaching this conclusion, the Court rejected the SEC’s view that disgorgement is remedial and not punitive. The Court said this is the case because, among other reasons, SEC disgorgement is sometimes “ordered without consideration of a defendant’s expenses that the reduced the amount of illegal profit.”

The Court issued its decision in an appeal of a disgorgement award assessed against Charles Kokesh. Mr. Kokesh was accused by the SEC in 2009 of misappropriating US $34.9 million in connection with two investment adviser firms he operated from 1995 to 2009. After a jury found that Mr. Kokesh violated applicable law, the federal trial court assessed a disgorgement judgment of US $34.9 million of which US $29.9 million was attributable to violations outside the limitations period. A federal court of appeals upheld the decision of the trial court.

Separately, the Attorney General of the United States prohibited the US Department of Justice from including payments to non-governmental third parties unconnected to the alleged harm as part of any settlement to federal charges of wrongdoing.

Legal Weeds: Although the US Supreme Court in its Kokesh decision and in 2013 explicitly addressed enforcement actions seeking civil penalties and disgorgement brought by the SEC, the logic of the decisions should equally apply to enforcement actions brought by the Commodity Futures Trading Commission and other federal regulatory agencies that do not have their own distinct statutes of limitations. As the Court wrote in its Kokesh opinion (quoting from one of its own prior opinions), statutes of limitations “se[t] a fixed date when exposure to the specified Government enforcement efforts end[d]… Such limits are vital to the welfare of society and rest on the principle that even wrongdoers are entitled to assume that their sins may be forgotten.”


  • SEC to Broker-Dealer in Enforcement Action: Include Basis for Suspicions in Suspicious Activity Reports: The Securities and Exchange Commission filed an enforcement action against Alpine Securities Corporation, a registered broker-dealer, in a federal court in New York City, in connection with the firm’s filing of allegedly untimely and inadequate suspicious activity reports. According to the SEC, from at least May 17, 2011, through December 31, 2015, Alpine failed to include in 1,950 SARs filed with the United States Treasury Department’s Financial Crimes Enforcement Network “material, ‘red-flag’” information which it was required to report under its own compliance program that explained the rationale for the firm’s filing. The SEC charged that Alpine also filed SARs in approximately 1,900 circumstances in connection with clients’ deposit of a security, but not when the security was liquidated or the proceeds from such liquidations were transferred to the customer or a third party, “despite the fact that the subsequent liquidation and transfers were additional suspicious transactions.” (Alpine mostly handled microcap stock transactions for other firms, alleged the SEC.) Alpine’s deficiencies occurred, claimed the SEC, despite being advised by the Financial Industry Regulatory Authority in September 2012, following an examination, that “narratives for all SARs reviewed were substantively inadequate as they failed to describe why the activity was suspicious.” The SEC seeks an injunction and fines, among other penalties, against Alpine.

Compliance Weeds: Applicable law and FinCEN rules require broker-dealers and other covered financial institutions (banks, Commodity Futures Trading Commission-registered future commission merchants and introducing brokers and SEC-registered mutual funds) to file a SAR with FinCEN in response to transactions of at least US $5,000 which a covered entity “knows, suspects, or has reason to suspect” involve funds derived from illegal activity; have no business or apparent lawful purpose; are designed to evade applicable law; or utilize the institution for criminal activity. The Financial Industry Regulatory Authority has recently brought numerous disciplinary actions against broker-dealers and senior officers for failing to file SARs in response to allegedly suspicious transactions. (Click here for background.) The SEC has also recently filed an enforcement action against a broker-dealer and its former chief compliance and chief anti-money laundering officer for such purported failures. (Click here for background.) This SEC action reminds covered financial institutions that not only must they abide by their obligation to file SARs in the first instance, but they must also ensure that such SARs adequately describe the basis for the filing.

Valuable Lessons Learned: In its complaint, the SEC alleged that Alpine's compliance program did not accurately represent what the firm did day-to-day. According to the SEC, "[a]s implemented in practice, Alpine's policies and procedures did not result in the filing of SARs in the manner required [by applicable law] and by Alpine's [compliance program]." As a result, the SEC charged Alpine with failing to maintain an anti-money laundering program that complied with FinCEN's requirements and thus violated the SEC's own recordkeeping rule (click here to access SEC Rule 17a-8). Recently the CFTC filed and settled an enforcement action against Advantage Futures LLC (a registered futures commission merchant), Joseph Guinan, its majority owner and chief executive officer, and William Steele, who until May 2016 was Advantage’s chief risk officer. The CFTC similarly alleged that Advantage failed to follow the firm's own risk management program (RMP) regarding the role of its credit committee; the use of risk ratings; the account opening process; and the implementation and review of risk tolerance levels. However, the CFTC went one step beyond the SEC in its complaint against Alpine. The CFTC claimed that, when Advantage submitted its RMP manual, credit and risk policies and procedures manual and chief compliance officer annual report to it on “multiple occasions” between November 2013 and May 2015 (as required by CFTC regulations), Mr Guinan and Mr. Steele “knew that the documents did not accurately represent Advantage’s actual practices” and therefore contained false or misleading statements in violation of applicable law. (Click here to access Commodity Exchange Act Section 6(c)(2), 7 USC §9(2).) In other words, the CFTC alleged that, not only were Advantage's policies and procedures inaccurate, but by filing such inaccurate documents with the CFTC, the firm made a false filing. (Click here for background regarding the CFTC's Advantage enforcement action.)  The valuable lesson learned: regulators expect that policies and procedures should be reasonably designed to assist a registrant comply with applicable regulatory requirements. However, policies and procedures must also be regularly reviewed and updated to reflect actual practices of a firm, and not just its theoretical obligations.

  • CME Clearing Member Settles Charges for Allegedly Not Retaining Required Audit Trail of Direct Access Client; Two CBOT Members Settle Charges Related to Purported Position Limit Violations: INTL FCStone Financial, Inc., a clearing member of the Chicago Mercantile Exchange, agreed to pay a fine of US $40,000 to resolve charges that, during 2014, it failed to maintain complete audit trail data containing all mandatory fields, as required, for five years. According to CME Group Rules, clearing members that guarantee connections to Globex are obligated to maintain or cause to be maintained such audit trail data, except where the direct connect client is another clearing firm or an equity member firm. In such circumstances, subject to conditions, the other clearing member or equity member firm is required to maintain the audit trail data. CME also had charged INTL FCStone with certifying to it that it had maintained or caused to be maintained required audit trail data, when the certification was incorrect. Separately, Merrill Lynch Commodities agreed to pay a fine of US $35,000 to the Chicago Board of Trade and disgorge profits of US $124 for allegedly exceeding spot month position limits in Soybean futures contracts for one day in February 2017. CBOT said this was the firm’s third position limit violation in five months. Similarly, E. Davison Massey agreed to pay a sanction of US $30,000 to the CBOT and be suspended from trading on all CME Group markets for 10 days for also violating spot month position limits for Soybean Oil futures contracts on one date in November 2016. Finally, Carter Ohrt settled a CBOT enforcement action for alleged spoofing-type conduct by consenting to pay a fine of US $60,000, disgorging profits of US $32,300, and serving a 120-trading-day suspension from all CME Group markets. The CBOT alleged that, on various days from March 2014 through October 2014, Mr. Ohrt placed multiple larger orders on one side of the market in various commodities, and a single small lot order on the opposite side. When the smaller order was executed, Mr. Ohrt purportedly cancelled the larger orders. CBOT said, “the effect of this strategy was to induce other market participants to trade opposite the small resting orders.”

Compliance Weeds: Under CME Group rules, clearing members have rigorous recordkeeping obligations in connection with the audit trails of direct access clients for which they guarantee connection to Globex. (Click here to access CME Group Rule 536.B.) CME Group recently proposed making clearing members strictly liable for the accuracy of a large number of mandatory fields of such audit trails by their direct access clients. However, CME Group backed down from imposing such a potentially onerous requirement and solely mandated that clearing members take “appropriate action” for a direct access client’s input of each mandatory audit trail field “if it has actual or constructive knowledge that a non-member has failed to accurately input” mandatory audit trail fields. 

More briefly:

  • ESMA Chair Says No Delay in Forthcoming MiFID II January 2018 Roll-Out: The roll-out of MiFID II will not be postponed again, said Steven Maijoor, Chair of the European Securities and Markets Authority, in a keynote address at the annual Futures Industry Association IDX Conference held last week in London. MiFID II is scheduled to come into effect on January 3, 2018. In his speech, Mr. Maijoor also expressed concern that in response to Brexit, some UK-based market participants may seek to relocate entities, activities or functions in the European Union in order to maintain access to EU financial markets. When relocating, such entities may still maintain the bulk of their operations in the United Kingdom. However, Mr. Maijoor warned that “[o]utsourcing or delegation arrangements should not result in entities becoming letterbox entities nor in creating obstacles to effective and efficient supervision.”

  • Acting CFTC Chairman Explains Zero-Based Budgeting Approach to Congressional Committee in Defending Request for Increased 2018 FY Funding: Last week, J. Christopher Giancarlo, Acting Chairman of the Commodity Futures Trading Commission, proposed a 12.6 percent increase in the agency’s funding from fiscal year 2017 to 2018, in an appearance before the House of Representatives Committee on Appropriations Subcommittee on Agriculture. To effectively oversee the evolving derivatives market, Chairman Giancarlo claimed that an overall funding level increase of US $35.1 million and an increase in authorized staffing of 36 full-time equivalents was necessary. He said that he derived the proposed budget applying a zero-based budgeting principles. Vice-Chairman of the Committee, Rep. David Valadao, expressed his concern, however, that because of ongoing collective bargaining issues with CFTC employees, “[t]here is no guarantee that providing the CFTC an increase would further [its] major priorities such as improving economic analysis or the financial technology sector.”

  • CME Group Warns Against Pre-Open Test Trades; NASDAQ Futures Amends Electronic Audit Trail Requirements: CME Group issued a Special Executive Report reminding market participants that, under one of its rules, they are prohibited to engage in test trades in a non-test product without the intent to execute a bona fide transaction. Glory Sky Precious Metals Limited recently agreed to settle charges brought by the Commodity Exchange, Inc. that, from May 1, 2015, through May 1, 2016, it entered and cancelled over 7,100 orders in the gold futures markets allegedly to test the latency within those markets. The orders were not intended to be executed, claimed a COMEX business conduct committee. Glory Sky consented to pay a fine of US $55,000 to resolve this matter. (Click here for further details on this action.) Separately, NASDAQ Futures, Inc. proposed updated audit trail guidance. Among other things, futures participants and authorized customers would be obligated to maintain information for all orders and quotes entered into the exchange’s trading system, including order and quote modifications and cancellations. The new guidance will be effective July 3.

  • CFTC Inspector General Expresses General Satisfaction With DSIO Oversight of NFA in First Review Since NFA’s 1981 Creation: Following a recently concluded review, the Office of Inspector General (OIG) of the Commodity Futures Trading Commission said the agency’s Division of Swap Dealer and Intermediary Oversight has fulfilled its oversight responsibilities and demonstrated a high degree of collaboration with the National Futures Association. OIG noted that the Division addressed technical and compliance issues in a timely and efficient manner. OIG also provided several recommendations to facilitate the Division’s oversight performance, including that the Division should make available written copies of its oversight reviews to NFA and CFTC commissioners and adopt written standards for its reviews in the first instance. This was the OIG’s first review of the CFTC’s oversight of NFA since the NFA’s inception in 1981.

  • US-Based Global Broker Ordered to Pay AU $50,000 by Australian National Regulator for Alleged Pre-Arranged Futures Trades on ASX: Citigroup Global Markets Australia was ordered to pay a penalty of AU $50,000 (US $38,000) by the Australian Securities and Investments Commission for allegedly pre-arranging a transaction in New Zealand 90 Day Bank Bill futures contracts executed on the Australia Stock Exchange on July 17, 2015, among the firm’s Chicago sales desk, a firm rates trader located in Sydney, Australia, and the firm’s Sydney-based sales desk. In ordering the fine, ASIC acknowledged various mitigating factors, including that the transaction involved a single incident and the firm cooperated with ASIC in relation to the matter. ASIC’s order was issued as a so-called “Infringement Notice,” without Citigroup admitting or denying guilt or liability.

  • Don't Forget Recently Implemented Rules Expressly Prohibiting Spoofing-Type Trading and Authorizing Expedited Proceedings to Address Potential Violations, Reminds FINRA: The Financial Industry Regulatory Authority issued a reminder to members regarding recent rule changes covering manipulative trading activity. The new rules ban firms from engaging in or facilitating disruptive quoting and trading activity, including acting in concert to effect such activity. The new rules also authorize FINRA to issue, on an expedited basis, a permanent cease and desist order against a person for frequently engaging in disrupting quoting and trading activity.

©2021 Katten Muchin Rosenman LLPNational Law Review, Volume VII, Number 163



About this Author

Gary DeWaal, Securities Attorney, Katten Law Firm, New York
Special Counsel

Gary DeWaal focuses his practice on financial services regulatory matters. He counsels clients on the application of evolving regulatory requirements to existing businesses and structuring more effective compliance programs, as well as assists in defending and resolving regulatory disciplinary actions and enforcement matters. Gary also advises buy-side and sell-side clients, as well as trading facilities and clearing houses, on the developing laws and regulations related to cryptocurrencies and digital tokens.

Previously, Gary was a senior...