Negligence charges gain clout in SEC enforcement arsenal

May 9, 2012

By Julie DiMauro

BOSTON/NEW YORK, May 9 (Thomson Reuters Accelus) – Financial services firms may face more negligence cases brought by the U.S. Securities and Exchange Commission, reflecting a greater willingness by the commission to base charges on negligence findings, industry professionals were told at a Thomson Reuters forum.

“What we are seeing is a willingness to actively go out and charge negligence,” Ian Roffman, a partner at Nutter, McClennen & Fish LLP, told compliance officers and others in a panel discussion on SEC enforcement hosted by the Thomson Reuters Governance, Compliance and Risk division. Negligence charges have traditionally been used as a fallback position in settlements, said Roffman, a former SEC trial attorney who now specializes in securities cases. But an SEC fraud case brought last year was founded on negligence accusations, and several other firms have received “Wells notices” of looming enforcement action or other indications that they may face possible negligence charges from the SEC, he said.

In the 2011 case, the SEC accused former GSC Capital Corp. executive Edward Steffelin of being negligent in the selection and marketing of certain collateralized debt obligations in which investors lost their money. Violations of fraud statutes, the SEC argued, can be “established by showing negligent conduct.” Steffelin is fighting the charge.

John Dugan, associate regional director of the SEC’s Boston office, confirmed what he said was the commission’s interest in the negligence issue but played down the idea that it represented a major shift.

“I don’t know if you’re going to see a lot of these cases, but we have expressed a willingness to bring them recently,” he said, “If there is a point to be made by bringing them, we will, but it’s not going to be widespread, I don’t think.”

The financial industry may strongly resist any trend towards negligence enforcement, Roffman said. “It’s going to be some time before we see how it all plays out.”

“I think there is going to be a lot of pushback on charges of negligence,” he said.

A negligence case can be burdensome for a company. “When the SEC is coming, it’s going to be a long haul. The SEC can move at a snail’s pace, but they expect you to move rapidly,” he said.

“In my view it’s not a good development for securities markets,” he said. The result could be an erosion of SEC authority over time if it excessively focuses on negligence rather than on more intentional wrongdoing. “The power of any SEC action gets diluted if you bring a lot of these negligence cases.”

Still, a negligence charge can spell the end of a person’s career, and the reputational damage to a firm is tremendous, he said.

The panelists at the Boston forum outlined some of the general steps for compliance personnel to take, before and during an SEC investigation:

  • Make sure a firm’s compliance resources are adequate, so you’re prepared for the task of meeting the SEC’s demands.
  • Demonstrate that the way products are marketed and sold match the way they actually function in the marketplace.
  • Examine written marketing materials and oral marketing statements under the applicable SRO’s rules and those of the SEC. Know-your-customer standards and suitability rules apply here.
  • Look for aberrations in performance statistics.
  • Check for conflicts of interest, especially with co-managed funds.
  • Have a matching set of materials to back up documents given to the SEC.

If a requested record cannot be found, give as much as possible to examiners and work swiftly to get them the remaining materials as soon as possible.

Above all, it is essential to be cooperative in attitude and action when the SEC comes calling, Dugan and Roffman said.

“From our perspective, [cooperation] is critical. It can mean a lot when it comes to us deciding what’s going to happen at the end of the day,” Dugan said.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete ( ions/regulatory-intelligence/compliance- complete/) provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)

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