Big Firms Fare Better in SEC Enforcement Actions

So says a study conducted by Berkeley Law School professor, Stavros Gadinis.  The article appears in The Business Lawyer, published in the May 2012 issue  (Volume 67, Number 3)  by the American Bar Association. The study covers SEC enforcement actions against investment banks and brokerage houses during a period just before the 2007-2008 economic crisis (the dataset covers 2005, 2006, and the first four months of 2007); and the data suggests that defendants in smaller firms fared far worse in SEC enforcement actions.  According to Professor Gadinis, there are three dimensions to the data.

The first is that when the SEC action involved big firm misconduct, the preferred choice was corporate responsibility as opposed to individual liability.  In short, this sounds,  in part, like some of the criticism heaped on the Bush and Obama Justice Department for failing to bring criminal cases against some individual senior officers in the banking industry responsible for the financial debacle.  Often in these SEC actions, neither the individual who actually participated in the violative conduct nor high-level supervisors were subject to additional sanctions.

Even though both legal venues are open to them, a second factor involves the SEC’s more likely decision to bring adminstrative proceedings against big firms instead of court proceedings.  Hence, the study found that financial professionals subjected to court proceedings resulted in stiffer sanctions, including higher penalties and even bans from the securities industry.

Concomitantly, with administrative proceedings, a third factor arises.  For the same violation and comparable levels of harm to investors, the study found that big firms and their employees were less likely to be banned from the securities industry, even after controlling for violation type and harm to investors.

Skepticism over the legal and public policy implications of not holding individuals liable for violations noted in the Gadinis article (and as we discussed in our January 2, 2012 post) has been raised some courts like Judge Jed Rakoff’s criticism and rejection of the SEC’s settlements with Citi Bank and Bank of America.

To be fair, the article makes clear that “[w]hile… [these theories] seek to explain the SEC’s enforcement strategy… they do not purport to represent an exhaustive list of potential explanations of the [SEC’s] motives.”  Instead, the data raises and addresses major issues about the future implications of the SEC’s activities in recent years.

FINRA’s Outdated Rules

In a recent AdvisorOne article entitled “Resolved: FINRA Should Review These 10 Outdated Rules,” the authors address 10 FINRA rules they believe are outdated and often subject to confusion in their interpretations.  One can only hope that they’ve shared their thoughts with FINRA’s advisory and standing committees.  While FINRA’s rulemaking process is fairly open and transparent, affording industry and the public the opportunity to comment about the merits of its rules,  the process is time consuming, complex and fraught with delays.  Don’t expect FINRA to reconsider or modernize these rules anytime soon.   At best, FINRA might decide to provide additional interpretative guidance on these 10 areas.  The question one has to ask is whether that guidance will be consistent with the letter of the particular rule.

SEC Chairman Mary Schapiro: “[A]n unprecedented ability to effectively oversee the markets we regulate”

That was one of  the pronouncements coming this week from SEC commissioners when the Securities and Exchange Commission approved a new rule  requiring national securities exchanges and the Financial Industry Regulatory Authority (FINRA) to establish a market-wide consolidated audit trail.  The aim is to increase, significantly, regulators’ ability to monitor and analyze trading activity.

While exchanges use their own separate audit trail system to track information relating to orders in their respective markets,  currently no single database of comprehensive and readily accessible data regarding orders and executions exists for regulators to monitor.  Now, the exchanges and FINRA must jointly submit a comprehensive plan detailing how they would develop, implement, and maintain a consolidated audit trail that would “collect and accurately identify every order, cancellation, modification, and trade execution for all exchange-listed equities and equity options across all U.S. markets.”

The new rule will become effective 60 days after its publication in the Federal Register.  Self Regulatory Organizations are required to submit the NMS plan to the Commission within 270 days of the rule’s publication in the Federal Register.

SEC and FINRA Alert Investors About Annuity Risks

Last Tuesday, officials from the SEC and FINRA issued new warnings to the
variable annuity marketplace. During a URI 2012 Government, Legal &
Regulatory Conference last week, Susan Nash, Associate Director of the
Division of Investment Management at the SEC explained that despite sales of
variable annuities increasing approximately 12% in 2011 from 2010, some
established firms in the VA space have either left the business or curtailed
offerings. Nash also commented on other changes taking place in the variable
annuity market that include reductions in investment choices and living
benefits. “It is essential that offering materials clearly highlight the
costs and limitations associated with living benefits, so that investors can
make an informed decision, Nash explained.

Fortunately, the SEC is reportedly considering a new disclosure framework
for VAs to improve understandability of certain contracts. FINRA is looking
closely at disclosure, suitability and yield chasing practices associated
with VAs. “The dynamic climate of changing economics and changing
participants in the business make this a time that calls for care in design
of variable products and attention to investor protection,” Nash explained.

As investors seek low-risk investments to guarantee their retirement
savings, VAs may grow more popular and even more complex.  Daniel Sibears,
Executive Vice President of member regulation programs at FINRA, urged
investors to conduct  proper due diligence when making investments. VAs
today “are more complicated with more riders and features,” he explained.