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2009 Year in Review: SEC and SRO Selected Enforcement Cases and Developments Regarding Broker-Dealers

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review 2009 Year in Review: SEC and SRO Selected Enforcement Cases and Developments Regarding Broker-Dealers www.morganlewis.com TABLE OF CONTENTS Page Executive Summary ....................................................................................................... 1 The SEC ................................................................................................... 2 Developments Relating to Bernard Madoff’s Ponzi Scheme..................... 4 Auction Rate Securities............................................................................. 4 FINRA....................................................................................................... 4 NYSE Regulation...................................................................................... 5 U.S. Securities and Exchange Commission ................................................................... 7 Enforcement Developments at the SEC in 2009 ................................................. 7 Changes in Personnel and Division of Enforcement Structure ................. 7 Enforcement Statistics .............................................................................. 9 Policy Developments .............................................................................. 11 Financial Fraud Enforcement Task Force............................................... 13 Financial Crisis Inquiry Commission ....................................................... 13 Legislative Developments....................................................................... 14 Current SEC Enforcement Priorities ....................................................... 14 SEC Enforcement Actions ................................................................................. 15 Fraudulent Sales to Investors ................................................................. 15 Gifts and Gratuities ................................................................................. 19 Insider Trading........................................................................................ 19 Just and Equitable Principles of Trade ................................................... 29 Market Manipulation and Provision of Information to the Marketplace ................................................................................. 30 Pay to Play.............................................................................................. 33 Ponzi Schemes....................................................................................... 34 Proxy Disclosures ................................................................................... 36 Registration Requirements ..................................................................... 37 Regulation SHO...................................................................................... 38 Regulation S-P........................................................................................ 40 Revenue Sharing .................................................................................... 41 Selection of Money Managers ................................................................ 42 i TABLE OF CONTENTS (continued) Page Specialists............................................................................................... 44 Supervision ............................................................................................. 47 Bernard Madoff’s Ponzi Scheme.................................................................................. 56 Report of Investigation, U.S. Securities and Exchange Commission Office of Inspector General, Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme........................................................................................ 60 U.S. Securities and Exchange Commission OIG, Program Improvements Needed Within the SEC’s Division of Enforcement................................................................................. 61 FINRA’s Special Review Committee Report ........................................... 62 SEC, FINRA, and State Regulators: Auction Rate Securities ..................................... 63 Financial Industry Regulatory Authority........................................................................ 65 Changing of the Guard in 2009............................................................... 65 Structural Changes Regarding FINRA’s Enforcement Efforts................. 65 Changes in the FINRA Enforcement Program ........................................ 66 An Overview of FINRA’s Enforcement Process: Regulatory Notice 09-17 .............................................................. 66 Cooperation with Foreign Regulators ..................................................... 66 Creation of the Office of the Whistleblower............................................. 67 Enforcement Statistics ............................................................................ 67 Sweep Examinations .............................................................................. 68 Current FINRA Enforcement Priorities.................................................... 69 FINRA Enforcement Actions.............................................................................. 70 Anti-Money Laundering........................................................................... 70 Anti-Reciprocal Rule ............................................................................... 75 Breakpoint Pricing Self-Assessment....................................................... 76 Credit Default Swaps .............................................................................. 78 Excessive Mark-Ups and Commissions.................................................. 79 Failure to Cooperate – Rule 8210........................................................... 80 Fee-Based Brokerage............................................................................. 81 Foreign Currency Exchange Business.................................................... 82 ii TABLE OF CONTENTS (continued) Page Global Research Analyst Settlement ...................................................... 83 Market Manipulation ............................................................................... 84 Mutual Fund Sales Practices .................................................................. 87 Offering Documents and Marketing Materials......................................... 90 Operational Issues.................................................................................. 92 Prospectus Delivery................................................................................ 94 Regulation S-P........................................................................................ 95 Research Disclosures............................................................................. 96 Retention of Electronic Communications ................................................ 98 Sales of Restricted Securities ................................................................. 99 Soft Dollar Payments ............................................................................ 100 Stock Loan............................................................................................ 101 Supervision ........................................................................................... 102 Supervision of E-mail Communications ................................................ 105 Supervision of Outsourced Responsibilities.......................................... 106 Tax-Related Trading Strategies ............................................................ 107 Trade Reporting.................................................................................... 108 Variable Annuity Sales.......................................................................... 113 NYSE Regulation ....................................................................................................... 121 NYSE Regulation Enforcement Actions........................................................... 121 MOC/LOC............................................................................................. 121 Rule 92 ................................................................................................. 124 Supervision of Algorithmic Trading ....................................................... 125 Supervision of Branch Offices............................................................... 127 Transaction Reporting........................................................................... 128 NYSE Arca Enforcement Actions .................................................................... 130 Pre-Arranged Trading ........................................................................... 130 Regulation SHO.................................................................................... 131 iii Executive Summary This outline highlights selected U.S. Securities and Exchange Commission (the “SEC” or the “Commission”), Financial Industry Regulatory Authority (“FINRA”), and NYSE Regulation enforcement actions and developments regarding broker-dealers during 2009.* The economic crisis of 2008 and the Ponzi scheme of Bernard Madoff led government officials, the public and the media to call for an increase in securities enforcement activity. As a result, 2009 was a year of change at the SEC and FINRA. The SEC installed new leadership who perceived a mandate to restore investor confidence by aggressively pursuing companies and individuals who engage in wrongdoing affecting the securities markets.
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