review 2011 Year in Review: SEC and FINRA Selected Enforcement Cases and Developments Regarding Broker-Dealers www.morganlewis.com TABLE OF CONTENTS Page Executive Summary ..................................................................................................... 1 The SEC.............................................................................................................. 1 FINRA.................................................................................................................. 3 U.S. Securities and Exchange Commission .............................................................. 6 Personnel Changes............................................................................................. 6 Enforcement Statistics......................................................................................... 8 Focus on Individuals.......................................................................................... 12 Judicial Criticism of SEC Settlement Practices.................................................. 13 Insider Trading and Parallel Proceedings.......................................................... 17 The Rajaratnam Criminal Conviction and SEC Judgment................................. 17 SEC Efforts to Enhance its Penalty Authority.................................................... 18 The Commission’s Use of Negligence Rather Than Scienter-Based Fraud Charges .............................................................. 19 Cooperation Initiatives ....................................................................................... 19 Cooperation Agreements........................................................................ 20 Deferred Prosecution Agreements.......................................................... 20 Nonprosecution Agreements .................................................................. 21 Dodd-Frank Whistleblower Provisions............................................................... 21 Whistleblowers Protected from Retaliation ............................................. 22 Rules Relating to Eligibility for an Award ................................................ 22 Reporting Through Internal Compliance Procedures.............................. 23 Original and Voluntary Information ......................................................... 23 Misconduct and Aggregation .................................................................. 24 Impact on FCPA Investigations............................................................... 24 Impact on Covered Entities..................................................................... 25 Whistleblower Statistics .......................................................................... 25 Developments in Administrative Proceedings ................................................... 25 Penalties in Cease-and-Desist Proceedings........................................... 25 Collateral Bars ........................................................................................ 26 Immunity Requests............................................................................................ 26 i TABLE OF CONTENTS (continued) Page Commissioner Paredes Sounds a Cautionary Note Regarding SEC Enforcement.................................................................. 27 Criticism of Defense Counsel Tactics and Multiple Representations................. 27 Cooperation with Foreign Regulators ................................................................ 28 SEC Office of Inspector General Investigations and Reports............................ 29 SEC Enforcement Priorities Regarding Broker-Dealers .................................... 29 Enforcement Actions ......................................................................................... 30 Auction Rate Securities........................................................................... 30 Fraudulent Trading Schemes.................................................................. 32 Insider Trading........................................................................................ 39 Marketing and Sales of Collateralized Debt Obligations......................... 43 Misappropriation of Fund Assets ............................................................ 48 Municipal Bond Actions........................................................................... 49 Mutual Fund Pricing................................................................................ 54 Privacy and Confidentiality of Client Information..................................... 56 Record Keeping...................................................................................... 58 Registration............................................................................................. 59 Regulation SHO...................................................................................... 60 Securities Exchanges, Alternative Trading Systems and SROs ............. 62 Securities Offerings ................................................................................ 65 Suitability ................................................................................................ 66 Supervision............................................................................................. 67 Swaps Trading........................................................................................ 71 Unregistered Offerings............................................................................ 73 Financial Industry Regulatory Authority.................................................................. 75 Personnel Changes........................................................................................... 75 Enforcement Statistics....................................................................................... 76 Enforcement Policy Developments.................................................................... 77 Sanctions................................................................................................ 77 Enforcement Process.............................................................................. 77 ii TABLE OF CONTENTS (continued) Page Collaboration Within FINRA.................................................................... 78 On-Site Investigations............................................................................. 78 New Self-Reporting Requirements and Cooperation......................................... 78 Revisions to FINRA’s Sanction Guidelines........................................................ 79 Revolving Door Restrictions Proposal ............................................................... 80 Targeted Examination Letters and Sweeps....................................................... 80 Cooperation with Foreign Regulators ................................................................ 81 Disciplinary Actions Database ........................................................................... 81 Additional 2011 FINRA Efforts Complementing Its Enforcement Program........ 82 Risk Alert on Broker-Dealer Branch Inspections................................................ 82 Current FINRA Enforcement Priorities............................................................... 83 Enforcement Actions ......................................................................................... 84 529 Plans................................................................................................ 84 Anti-Money Laundering........................................................................... 85 Auction Rate Securities........................................................................... 87 Collection of Fines .................................................................................. 95 Commissions, Fees and MarkUps/Downs .............................................. 96 Customer Confidential Information ......................................................... 99 Directed Brokerage............................................................................... 100 Insider Trading...................................................................................... 102 Mortgage-Backed Securities................................................................. 103 Municipal Securities.............................................................................. 106 Private Placements............................................................................... 107 Prospectus Delivery.............................................................................. 109 Real Estate Investment Trusts.............................................................. 111 Short Sales/Regulation SHO ................................................................ 113 Structured Products .............................................................................. 121 Supervision........................................................................................... 127 Trading Practices.................................................................................. 138 Variable Life Settlements...................................................................... 140 iii Executive Summary This Outline highlights key U.S. Securities and Exchange Commission (the “SEC” or the “Commission”) and Financial Industry Regulatory Authority (“FINRA”) enforcement developments and cases regarding broker-dealers during 2011.* The SEC The SEC brought a record number of enforcement actions in FY 2011.1 In its first complete fiscal year since the