Securities Mosaic® Blogwatch
October 31, 2014
Bingham discusses FINRA's Proposed Rule to Implement CARDS
by Michael R. Weissmann

FINRA is seeking comments on a proposed rule to implement the Comprehensive Automated Risk Data System ("CARDS").[1] FINRA published a CARDS concept proposal on December 23, 2013 (the "Concept Proposal"),[2] to which it received approximately 800 comment letters.[3] According to FINRA, CARDS initially will collect account information, transaction activity, and security identification information on a standardized, automated and regular basis.[4] FINRA explained that CARDS will be the "next step in the evolution of FINRA's risk-based surveillance and examination programs" by automating its data compilation and surveillance functions.[5] In its Rule Proposal, FINRA seeks industry comment on 14 specific questions geared towards assessing the impact of CARDS.[6] Firms are encouraged to submit comments to FINRA on the Rule Proposal before the comment period expires on December 1, 2014.[7]


According to FINRA, CARDS will enable the regulator to collect, manage and access standardized account and transaction data to detect potential trading and supervisory violations.[8] While FINRA's current industry surveillance and examination programs collect key customer and trading information, CARDS would gather "more up-to-date and complete data" to enable FINRA to act swiftly to prevent market abuse and fraud.[9] FINRA also says that it will provide firms with access to the firms' own data to serve as a monitoring and compliance tool.[10]

CARDS would mark a substantial change in FINRA's surveillance program and firms raised numerous issues in response to the Concept Proposal.[11] The most common complaint was that CARDS would collect personally identifiable information ("PII").[12] Firms were also concerned that CARDS would displace their current surveillance functions.[13] In addition, firms did not understand FINRA's interest in CARDS given the pending development of a seemingly duplicative data collection system, i.e. the Consolidated Audit Trail ("CAT").[14] In its current proposal, FINRA has attempted to address these and other concerns.[15]

FINRA's Proposed Rule

FINRA's proposal includes the following key features:

  • Phased Approach: FINRA proposed that CARDS be launched in two phases, Phase 1 and Phase 2.

Phase 1: Phase 1 would apply to clearing (including self-clearing) and carrying firms only and would require them to provide only data that already resides on their systems. The proposed rule lists eighteen types of data potentially to be reported, grouped into four categories:

    • Securities transactions, including data on purchases, sales and dividend reinvestments;
    • Account transactions, including various data on ACAT transfers, non-ACAT transfers, and account additions and withdrawals;
    • Holdings, including stock records, allocation pair-off details, and security account balances; and
    • Account profiles, including account type, information about the person or entity associated with the account, representative servicing the account, and if the firm collects it for its own accounts, suitability information.

Firms would also be required to provide certain reference data related to the data in the listed categories. In a marked departure from the Concept Proposal, which focused only on customer account information, the Rule Proposal applies to "all of the firm's securities accounts."[16] FINRA has, however, limited the reporting requirements to purchases and sales of securities products that are held, custodied at or executed through the clearing firm, thereby excluding products such as variable annuities and private placements.[17]

Phase 2: Fully disclosed introducing firms would be required to submit 15 data elements (collectively the "Select Account Profile Data Elements") related to suitability and supervision (e.g. investment time horizon, investment objective, net worth, representative identification including groups and commission splits, and whether the customer fits into certain special categories such as control person of a public company, politically exposed person, or employee of another broker-dealer) either directly or through a third party (which could be the clearing firm).[18] The proposal makes clear that, regardless of whether the introducing firm relies on a third party, the responsibility to provide this data remains with the introducing firm. This is another significant change from the Concept Proposal, which strongly suggested that clearing or carrying firms would be principally responsible for providing all CARDS data, even though these firms might have needed to rely on introducing firms to provide suitability information the clearing firms do not routinely collect. Moreover, while FINRA Rule 4311 allows introducing firms to shift responsibility for certain regulatory requirements to the clearing firm (e.g. generation of confirmations and account statements), introducing firms will not be able to avoid CARDS responsibility.

For both Phase 1 and 2, FINRA would require submission monthly by the 10th business day of the following calendar month.[19] Errors identified through FINRA's validation process would require correction within seven business days.[20] While FINRA plans to specify data formats for many categories, it has said that firms will be allowed to report specified data elements, generally related to security descriptions and certain suitability information, in free format text fields, giving firms flexibility to transmit these data elements in the fashion in which they may already be collected and retained.[21]

  • Collection of PII and Data Security: Responding to its critics, in both Phase 1 and 2, FINRA has categorically stated that it will not collect PII, such as customer account name, address or tax identification number.[22] To further reassure the public regarding the security of CARDS data, prior to launching CARDS, FINRA has said that it will obtain Service Organization Controls ("SOC") 2 and 3 reports to demonstrate its security and privacy controls.[23]
  • Onboarding and testing: FINRA would require firms to register with CARDS business operations and to test the connection and delivery systems before reporting data to the CARDS production environment.[24]
  • Implementation date and historical information: FINRA proposed implementation dates of nine months after the rule is approved by the SEC for Phase 1 and 15 months for Phase 2.[25]

In the Release, FINRA summarized its views on the costs and benefits of the proposed system. FINRA acknowledged that firms will be forced to incur significant front-end and ongoing expenses associated with CARDS, some of which may ultimately be borne by customers, and FINRA itself expects to spend $8–12 million to build out its own systems.

Nonetheless, FINRA argued, the costs are justified by enhanced investor protection arising from its increased effectiveness in overseeing the industry and detecting problematic conduct at an early stage. FINRA continued to claim, as they argued in the Concept Proposal, that firms' expenses in implementing CARDS will be partially offset by savings in not having to collect and provide transaction related data on an ad hoc basis in exams, sweeps, and other inquiries, as well as by FINRA's plan to retire INSITE and AEP once CARDS is implemented. FINRA also noted that the data CARDS would collect has only limited overlap with the data in CAT, making both programs necessary. Responding specifically to comments, FINRA advised that CARDS will not replace firm's supervisory and surveillance responsibilities, but it expects that the data it will make available to firms may assist firms (particularly smaller firms) in these efforts.

Requests for Comments

In the Release, FINRA listed fourteen areas in which it is seeking comments, including information regarding economic impacts (and possible cost savings), potential use of third parties to transmit data to FINRA, possible exclusion of firms with no or limited retail business, industry interest in receiving data from FINRA to use in a firm's own compliance efforts, and implementation timing.


FINRA developed the Rule Proposal to address industry concerns about various aspects of the Concept Proposal and to lay out the implementation of CARDS.[26] While receiving and analyzing this information will no doubt give FINRA new market surveillance abilities, there will also be substantial financial and compliance burdens across the industry associated with collecting and properly reporting this vast amount of data to FINRA. Interested parties should provide comments to FINRA about the costs and scope of the Rule Proposal no later than December 1, 2014.


[1] FINRA Requests Comment on a Rule Proposal to Implement Comprehensive Automated Risk Data System, Regulatory Notice 14-37 ("Notice 14-37") available at

[2] Comprehensive Automated Risk Data System, FINRA Requests Comment on a Concept Proposal to Develop the Comprehensive Automated Risk Data System, Regulatory Notice 13-42 ("Notice 13-42") at 1, available at For a summary of the initial concept proposal, see FINRA Proposes a New Method to Obtain Transaction Information: Comprehensive Automated Risk Data System (Jan. 6, 2014).

[3] Notice 14-37 at 5.

[4] Notice 13-42 at 1.

[5] Notice 14-37 at 3.

[6] Id. at 20-23.

[7] Id. at 1. See also The Securities Industry and Financial Markets Association's ("SIFMA") Statement on FINRA CARDS Regulatory Notice discussing plans to submit comments to FINRA available at

[8] Id. at 3-5.

[9] Id. FINRA explained that such real-time information would provide FINRA with a greater understanding of a firm's business profile, product mix, overall risk profile, anti-money laundering program and transaction patterns.

[10] Id. at 4. FINRA explained that the data access would serve a useful function for smaller firms in particular who often cannot afford to develop their own compliance tools.

[11] Notice 14-37 at 5, 13-14.

[12] Id. at 5.

[13] Id. at 13.

[14] Id. at 14. For additional information about the CAT, see

[15] Id. at 3-23.

[16] Cf. Notice 13-42 at 5 with Notice 14-37 at 7, 21 n.3 (defining "securities account")

[17] Notice 14-37 at 11 for a complete list of the Select Account Profile Data Elements. FINRA suggested that it may modify this requirement at a later stage of CARDS.

[18] Id. at 9-11. FINRA explained that, although it would allow firms to submit data through a third party, compliance with CARDS rests with the carrying or clearing firms. Further, Phase 1 would not include the Select Account Profile Data Elements for accounts the firm clears or carriers on a fully disclosed or omnibus basis.

[19] Id. at 11.

[20] Id.

[21] Id. at 12.

[22] Id. at 5.

[23] Notice 14-37 at 6.

[24] Id.

[25] Id. at 13.

[26] Id.

The full and original memorandum was published by Bingham McCutchen LLP on October 13, 2014, and is available here.

October 31, 2014
Regulators Hone Risk Management Focus, Experts React
by Edith Orenstein

The release of the Joint Final Rule on Risk Retention by federal banking agencies and the SEC, coming two days after the announcement by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) of the launch of its project to update its 2004 Enterprise Risk Management Framework, marked further progression in the regulatory and private sector's response to the financial crisis and changing risk management approaches.

We asked leading risk management experts to share their thoughts on the potential implications.

COSO's Update of its ERM Framework

Jim DeLoach, managing director at Protiviti, notes: "As we look back since the COSO ERM framework was issued in 2004, we see a period in which the initial years were focused largely on getting financial reporting controls right and then a period of time during which the marketplace was hit by the financial crisis when the "poster child" for risk management - the financial services industry - lost its bragging rights. The financial crisis teed up the need for emphasis on board risk oversight. During this 10-year period, we have seen some - but not much - progress in terms of implementing ERM. For these reasons, it's a good time for COSO to revisit the ERM framework."

Olga Kaparova, a Director with Deloitte & Touche LLP says, "Lessons learned from the last financial downturn have led to significantly increased focus and expectations around enterprise risk management from a variety of stakeholders, including regulators," adds Kapraova, noting, "In the last few years alone, there have been a number of changes in practices around risk management, including regulatory guidance around concepts such as risk appetite, risk aggregation and reporting, and risk culture."

Kaparova says the COSO ERM Framework provides a strong foundation for building an effective risk management program, but notes that increasing complexity in the business environment since 2004, particularly in the financial services industry, points to a need to take a look at updating the 2004 COSO guidance.

Kaparova cites the following regulatory guidance as examples of the recent emphasis on risk:

Risk Appetite

Risk Aggregation and Reporting

Risk Culture

Referencing COSO's recent update of its Internal Control framework, slated to supersede COSO's 1992 Internal Control framework on Dec. 15, 2014, Kaparova adds, "We believe COSO's update of the ERM framework is very timely... As companies continue to focus on managing risk across all facets of the business (not just internal control) an updated ERM Framework will be very useful."

Pam Martin, managing director, KPMG notes, "Requirements for strengthened risk management in the financial services sector in response to the financial crisis, including recommendations from the Financial Stability Board, Section 165 of the Dodd-Frank Act, and heightened expectations of the Office of the Comptroller of the Currency, led to requirements that generally, financial institutions with over $50 billion in assets were required to strengthen their risk management infrastructure and governance."

Looking ahead to potential new guidance that may emanate from COSO, Martin adds: "For the larger financial services firms, it should not require them to change their structures - the regulatory bar has been raised so significantly coming out of the financial crisis, those firms have been required to enhance their risk management framework significantly already."

She adds regulators have incorporated stress testing into the overall supervisory process, and,"A big part of stress testing includes the firms' capital management plans, which includes an assessment of risk management practices around the capital allocation process. Firms must demonstrate that they have the ability to assess risk and assign capital.

"The financial crisis was a bit of a wake-up call for regulatory authorities and industry as a whole, that the industry's risk management practices were not as strong as many thought," Martin says, adding, "Post-crisis, there has been an increased strengthening of risk management, across all regulatory bodies."

In response to the question, "Who 'owns' the ERM function, Martin says: "It's the risk committee and the board," noting that Federal Reserve Board requirements, and Section 165 of the Dodd-Frank Act require a Chief Risk Officer (CRO) reporting jointly to the board and the CEO. "One thing the regulators look at... is that the CRO has 'stature' within the company. That's why they require the CRO to report jointly to the board and the CEO.

Professor Mark Beasley, Director of the ERM Initiative at North Carolina State University and a former member of the COSO board, explains the difference between ERM and risk management in the video.

Asked to reflect on COSO's recent announcement of its project to update its 2004 ERM Guidance, Beasley observed, "The speed of change and complexity of the global business environment is exponentially escalating the volume and sophistication of emerging risks that may impact an organization’s core business model and its ability to achieve its strategic objectives. At the same time, expectations that organizations need to enhance their risk oversight capabilities continue to evolve along with expectations for greater levels of accountability for risk management, as illustrated by the recently released Joint Final Rule on Risk Retention."

"As senior executives and boards of directors respond to the rapidly evolving risk landscape and increasing expectations for more effective risk oversight ownership" continued Beasley, "they are in need of up-to-date and relevant principles to shape their organization's approach to overseeing evolving risks affecting their core business drivers." He termed COSO's recent announcement as a direct response to this need, noting that an updated ERM framework, "has the potential to provide tremendous value in helping organizations think through those elements most critical to effective and robust enterprise-wide risk oversight in light of today's risk environment."

Joint Final Rule on Risk Retention

Moving to the Joint Final Rule on Risk Retention, KPMG Martin observed, "There has been a great deal of commentary as to whether the risk retention rule has had a dampening effect on the securitization market I think the effects have been widely known for a long time, I don't think the finalization of that rule will require any firm to change their overall strategy, it was telecast so widely in advance."

Phoebe Moreo, a Partner at Deloitte & Touch, LLP shared her thoughts on particular points of focus in the Joint Final Rule. "In the banking community, the recent SEC release on risk retention creates a challenge for those who are sponsors of securitizations, calling for constant monitoring of securities retained under the rule and increased disclosures to a widening circle of investors in addition to the many disclosure and tracking requirements already required for securitizations under Basel III, the LCR rule and the qualified mortgage/ability to repay rules."

Protiviti's DeLoach observes, "The Joint Final Rule is a positive development in our view, because it incents sponsors to ensure the assets underlying securitization transactions are high quality, otherwise they will incur a portion of any resulting losses from default."

Moreo continues, "The final rule does not require a fair value calculation if risk retention is in the form of an eligible vertical slice, but it does if risk retention is in the form of an eligible horizontal slice. Such fair value information is to be as of the closing date of the transaction and provided to investors in written form "a reasonable time period" prior to the sale of the ABS securities. The final rule also allows for the sponsor to utilize a range of fair values, however the disclosure of how such fair values are derived is extensive."

The bottom line, Moreo says, is that "Large bank sponsors will need to have systems in place to track retained ABS securities and have policies and procedures in place to make sure the restrictions on sales, financing and hedging are being followed. As the rules on index hedging are complex they will also need the ability to track the securities making up indices used in their hedging programs to ensure they are not inadvertently hedging their retained ABS securities."

Looking at the two risk management developments announced last week - companies clearly need to manage risk, and the sophistication of their risk management systems will likely vary with the sophistication of the underlying types of transactions and complexity of how the business is operated.

The post Regulators Hone Risk Management Focus, Experts React appeared first on Financial Executives International Daily.

October 31, 2014
Another Accounting Scandal-Related Securities Suit
by Kevin LaCroix

Earlier this week I wrote about the accounting scandal that has hit the UK-based grocer, Tesco, and the securities class action lawsuit against the company that followed in its wake. Now another company has reported accounting irregularities - and the company involved has also been hit with a securities class action lawsuit.

On October 29, 2014, before the markets opened, real estate investment trust American Realty Capital Properties issued a press release (here) in which it disclosed the existence of an accounting error and subsequent cover-up relating to its financial statements for this year's first two quarters. The company announced that adjusted funds from operations had been overstated for the first quarter. ("Adjusted funds from operations" is a key metric of a REIT's performance and cash flow.) The press release stated that the "error was identified but intentionally not corrected," and that other adjusted funds from operations and financial statement errors "were intentionally made," resulting in an overstatement of adjusted funds from operations and understatement of net loss for first three and six months of the year. In the press release, the company also said that its audit committee is investigating the company's 2013 financial statements as well.

The company further announced that the company's audit committee's discovery of these accounting errors had forced the resignation of Brian Block, the company's CFO, and Lisa McAlister, the company's chief accounting officer.

An October 30, 2014 Wall Street Journal article about these developments (here) reported that the SEC intends "to launch an inquiry into the accounting irregularities" at the company. According to the Journal article the total amount by which the adjusted funds from operations was overstated in the first quarter was $12 million, or 8.8%, and for the second quarter was $10.9 million, or 5.6%. The Journal article also quotes a statement from the company's CEO that the audit committee began its investigation of the company's accounting in September after "an employee altered the company's audit committee about the irregularities."

When I read the Journal article, I wondered how long it would be before plaintiffs' lawyers filed a securities class action based on these developments at the company. I didn’t have to wait long to find out the answer.

Within a few hours, on October 30, 2014, plaintiffs' lawyers filed a securities class action lawsuit in the Southern District of New York against the company. Block, and McAlister. A copy of the complaint in the action can be found here. The complaint relies heavily on the company's October 29 press release and also cites the Journal article cited above. The complaint also relies heavily on the fact that the company released its now withdrawn first quarter financial results on May 8, 2014, just days before the company's May 28, 2014 secondary offering, in which the company raised net proceeds of approximately $1.59 billion. The plaintiff's lawyers October 30, 2014 press release about the complaint can be found here.


Another shareholder filed a second complaint yesterday, as well, The second complaint, which can be found here, names defendants the company's founder and its CEO as well as Block and McAlister.

It is interesting to note that in this case, as was also the case with Tesco, the account problems first came to light as a result of an internal whistleblower. As I also noted with respect to Tesco, it is interesting that the whistleblower chose to report the concerns internally rather than reporting the issue to the SEC and potentially lining up a whistleblower bounty payment.

In any event, this new lawsuit along with the one filed against Tesco late last week represent the latest examples of a something that I think we will be seeing a lot more of - that is, securities class action suits being filed after a whistleblower's revelation of accounting or other improprieties. As I noted in an earlier post (here), particularly in light of the incentives that the Dodd-Frank whistleblower bounty provides, we will likely see many more securities suits following after whistleblower reports.

One final thought has to do with larger patterns in securities class action lawsuit filings. The ebb and flow of securities class action lawsuit filings is the source of a great deal of discussion as commentators (including even this blog) attempt to explain what may be driving a reported increase or decrease in the number of securities class action lawsuit filings. One thing is for sure about the number of lawsuits, if more companies are reporting accounting miscues, there will be more lawsuits. While it is far too early based solely on this case and the Tesco case to proclaim that there has been an increase in the number of companies reporting accounting problems leading to lawsuits, it is nevertheless interesting to note that these two high-profile accounting-related suits have arisen in quick succession.

The problems at the two companies are obviously entirely unrelated, but if there were to be more companies reporting accounting issues (perhaps as a result of increased whistleblower activity), it could certainly lead to an accompanying upsurge in securities suit filings.

October 31, 2014
This Week In Securities Litigation (Week ending October 30, 2014)
by Tom Gorman

The Commission brought a series of administrative proceedings this week and one civil injunctive action. The civil injunctive action was an insider trading case. The administrative proceedings centered on FCPA violations, the custody rule, churning, Rule 105, internal controls, a failure to comply with the auditor rotation rule and undisclosed related party transactions.


Remarks: Commissioner Kara Stein addressed the Los Angeles County Bar Association 47th Annual Securities Regulation Seminar (Oct 24, 2014). Her remarks focused on capital formation and overhauling the current system (here).

Remarks: Norm Champ, Director, Division of Investment Management, addressed the SIFMA Complex Products Forum, New York, New York (Oct. 29, 2014). His remarks focused on enhanced risk monitoring by the Division (here).

SEC Enforcement - Filed and Settled Actions

Statistics: This week the SEC filed 1 civil injunctive action and 8 administrative proceedings, excluding 12j and tag-along-actions.

Investment fund fraud: SEC v. Coughlin, Civil Action No. 1:14-cv-00562 (S.D. Ind.) is a previously filed action which names as defendants Timothy Coughlin, OICU Ltd. and OICU Investment Corp. The complaint alleged that from June 2007 through December 2009 the defendants raised over $12.8 million from about 5,000 investors who thought they were purchasing an interest in a credit union. In fact the venture was a classic Ponzi scheme. The Court entered final judgments by consent against each defendant enjoining them from future violations of the antifraud provisions of the federal securities laws. The order also bars them from participating in the issuance, purchase, offer or sale of any security. A permanent officer and director bar was imposed on Mr. Coughlin. In addition, the two entities were ordered to jointly and severally pay disgorgement of $10,053,234 together with prejudgment interest and a penalty of $775,000. No financial penalties were imposed on Mr. Coughlin in view of the restitution order imposed in the parallel criminal case in which he pleaded guilty. Disgorgement orders were also entered against the relief defendants. See Lit. Rel. No. 23123 (October 30, 2014).

Custody rule: In the Matter of Sands Brothers Asset Management, LLC, Adm. Proc. File No. 3-16223 (October 29, 2014). Named as Respondents are the registered investment adviser, Steven Sands, Martin Sands and Christopher Kelly. Sands Brothers Asset provides investment advisory service to a number of pooled investment vehicles. Steven and Martin Sands are co-founders of the adviser. Attorney Kelly is the chief compliance and operating officer of the adviser. Previously, the adviser and two co-founders were named as Respondents in a Commission administrative proceeding charging violations of the custody rule. That proceeding was settled with the entry of a cease and desist order and the payment of a penalty. The two brothers have also been sanctioned by state regulators for securities law violations. From 2010 through 2012 Sand Brothers Asset continued to have custody of client assets. Yet the adviser did not submit to a surprise examination by an independent public accountant. The adviser did distribute its funds' audited financial statements for fiscal years 2010 to 2012 but after the 120 time limit. The circumstances which caused the audits to be delayed were predictable and not unforeseeable. For example, for 2012 the auditors noted that there was a delay in receiving information from management regarding the valuation of assets. Steven and Martin Sands aided and abetted the violations since they were responsible for ensuring that compliance personnel had the authority to implement whatever procedures and policies were necessary to ensure that the adviser complied with the Advisers Act. Mr. Kelley, who was tasked in the compliance manual with ensuring compliance with the restrictions and requirements of the custody rule, knew that the audited financial statements were not being distributed on time. Yet at most he reminded people of the time deadline but failed to take any other steps. The Order alleges violations of the custody rule. The action will be set for hearing.

Churning: In the Matter of Eli D. Okman, Adm. Proc. File No 3-16218 (October 28, 2014) is a proceeding which names as a Respondent Eli Okman, now a retired Merrill Lynch account executive. From January 2010 through September 2011 he exercised de facto control over a customers account and churned it in violation of Securities Act Section 17(a). To resolve the proceeding Mr. Okman consented to the entry of a cease and desist order based on the Section cited in the Order. He was also suspended for a period of 12 months from the securities business and directed to pay disgorgement of $31,964, prejudgment interest and a penalty equal to the amount of the disgorgement. A fair fund will be established for the benefit of the customer.

Manipulation: SEC v. AutoChina International Limited, Civil Action No. 1:12-CV-10643 (D. Mass.) is a previously filed action against the company and Ge Dong, Victory First Limited, Rainbow Yield Limited, Yong Qi Li, Ai Xi Ji, Ye Wang, Zhong Wen Zhang, Li Xin Ma, Yong Li Li and Shu Ling Li. The Court entered a financial judgment by consent as to each defendant enjoining them from future violations of Securities Act Sections 9(a)(1), 9(a)(2) and Exchange Act Section 10(b). Each was ordered to pay a civil penalty of $150,000. The action was based on the manipulation of the AutoChina's stock. See Lit. Rel. No. 23121 (Oct. 28, 2014).

Rule 105: In the Matter of Thrasos Tommy Petrou, Adm. Proc. File No. 3-16217 (October 27, 2014) is a proceeding which names the professional trader as a Respondent. Mr. Petrou has served as a trader for a number of entities. From mid-December 2009 through mid-January 2009, while trading for his account, as well as those of two unregistered entities, he purchased offering shares from an underwriter or broker participating in a follow-on or secondary offering after having sold short during the restricted period twenty times. The Order alleges violations of Rule 105 of Regulation M. The proceeding will be set for hearing.

Internal controls: In the Matter of Great Lakes Dredge & Dock Corporation, Adm. Proc. File No. 3-16215 (October 27, 2014) is a proceeding naming the firm as a Respondent. Great Lakes has two operating divisions, a dredging segment responsible for most of the firm's revenue and a demolition segment. In the second and third quarters of 2012 the firm overstated revenue in the demolition segment by recording revenue for pending change orders without having sufficient proof of customer acceptance of those changes. As a result, revenue was overstated during the year-end audit. This resulted from a material weakness in internal controls. The company discovered the issue and announced a restatement. To resolve the proceeding the company consented to the entry of a cease and desist order based on Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). The firm will also pay a penalty of $150,000. The Commission considered the remedial acts of the company and its substantial cooperation.

Insider trading: SEC v. Slawson, Civil Action No. 1:14-cv-3421 (N.D. Ga. Filed October 24, 2014). Stephen Slawson is the co-founder and manager of hedge fund TCMP3 Partners L.P. In eight instances, beginning in 2006 and continuing through 2010, he is alleged to have traded on inside information which traces back to a Carter's, Inc. and generated over $500,000 in illicit trading profits or losses avoided. Typically the information came to him from Dennis Rosenberg, a research analyst retained by the hedge fund. Mr. Rosenberg obtained the inside information obtained from Eric Martin, a Carter's vice president of investor relations before he was terminated in March 2009. Mr. Martin is currently serving a two year prison term after pleading guilty to one of eleven counts in an indictment charging him with securities fraud. Subsequently, the information came from Richard Posey, a Carter's vice president of operations who furnished it to Mr. Martin who then tipped Mr. Rosenberg who then tipped Mr. Slawson. During his employment Mr. Martin tipped analysts such as Mr. Rosenberg who covered the company to develop his relationship with them. Mr. Slawson "knew or should have known that Rosenberg's source at Carter's was disclosing the information in violation of a fiduciary or similar duty of trust and confidence," according to the complaint. Following the termination of Mr. Martin, he obtained inside information from Mr. Posey which he then transmitted to Mr. Rosenberg and ultimately to Mr. Slawson in two instances and on another occasion, directly to the hedge fund manager. Mr. Posey furnished the information to Mr. Martin "by virtue of their close friendship and Posey's desire to enhance his reputation." The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The U.S. Attorney's Office filed parallel criminal charges. Both cases are pending. See Lit. Rel. No. 23118 (October 24, 2014).

Pump and dump: SEC v. Recycle Tech Inc., Civil Action No. 12-cv-21656 (S.D. Fla.) is a previously filed action centered on a market manipulation scheme. Defendants Anthony Thompson, OTC Solutions LLC, Jay Fung, Ryan Gonzales and Pudong LLC all settled the action. The Court entered final judgments permanently enjoining each settling defendant from future violations of Securities Act Sections 5(a) and 5(c), and Exchange Act Section 10(b). In addition, Messrs. Thompson, Fung and Pudong and OTC are enjoined from future violations of Securities Act Section 17(a). The final judgment against Mr. Gonzalez is also based on Exchange Act Section 13(a). The Court also entered penny stock bars against Messrs. Thompson, Fung and Gonzales. Mr. Gonzales is bared from serving as an officer and director of a public company. In addition, Mr. Thompson and OTC are jointly and severally liable for disgorgement in the amount of $349,504.61 and prejudgment interest. Messrs. Fung and Pudong are jointly and severally liable for disgorgement in the amount of $456,457 along with prejudgment interest. Messrs. Thompson and Fung are required to each pay civil penalties of $120,000. Mr. Gonzalez was not ordered to pay a penalty based on financial position. See Lit. Rel. No. 23117 (Oct. 24, 2014).

Auditor rotation: In the Matter of Berman & Company, P.A., Adm. Proc. File No. 3-16212 (October 24, 2014) is a proceeding which names as Respondents, the Florida audit firm, which is registered with the PCAOB, and its owner, Elliot Berman. For five years Mr. Berman served as the engagement partner on the audits of Client. For the next year Mr. Berman assigned a firm employee to serve as the lead partner. The employee was not a CPA registered with the state of Florida or with the PCAOB. In addition, Mr. Berman performed a number of the services that would typically be done by the lead partner. The Order alleges that the Respondents violated Exchange Act Section 10A(j), Rule 2-02 of Reg. S-X, caused Client to violate Exchange Act Section 13(a) and engaged in unprofessional conduct within the meaning of Rule 102(e)(1)(ii). To resolve the proceeding Respondents consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. In addition, Mr. Berman is denied the privilege of appearing or practicing before the Commission as an accountant. Respondents will jointly and severally pay a penalty of $15,000. The proceeding is part of Operation Broken Gate.

Undisclosed guarantees: In the Matter of James J. Dalton, Jr., Adm. Proc. File No. 3-16214 (October 24, 2014) is a proceeding with names Mr. Dalton, the founder of SecureAlert, Inc. as a Respondent. In 2007 and 2008 the company failed to disclose personal guarantees and material related-party transactions by Mr. Dalton and another officer. The transactions were undertaken in one instance to induce a customer to purchase product and in another to avoid having defective product returned. This resulted in false filings being made with the SEC. Mr. Dalton also made misrepresentations in response to a Corp Fin comment letter. The Order alleges violations of Securities Act Sections 17(a)(2) and (3). To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to the payment of a penalty of $65,000. A related proceeding based on the same core conduct names David Derrick, Sr., the founder of SecureAlert as a Respondent. It alleges willful violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case will be set for hearing. In the Matter of David G. Derrick, Sr., Adm. Proc. File No. 3-16213 (October 24, 2014).


In the Matter of Layne Christensen Company, Adm. Proc. File No. 3-16216 (October 27, 2014). Layne Christensen is a global water management, construction and drilling company. From 2005 through 2010 Layne Christensen, through subsidiaries in Africa and Australia, is alleged to have paid over $1 million in improper payments to foreign officials in the Republic of Mali, the Republic of Guinea, Burkina Faso, the United Republic of Tanzania and the Democratic Republic of the Congo. The payments were made to secure favorable tax treatment, customs clearance for drilling equipment, work permits for expatriates, relief from inspection by immigration and labor officials and to avoid penalties for delinquent payment of taxes and customs duties and the failure to register immigrant workers. Between 2005 and 2009 Layne Christensen paid about $768,000 in bribes to foreign officials in Mali, Guinea and the Democratic Republic of the Congo through subsidiaries to reduce tax liability and penalties, saving about $3.2 million. The company made additional improper payments, this time in 2007 and 2009, to customs officials to avoid paying customs duties and obtain clearance for the import and export of its equipment. The payments were made in Burkina Faso and the Democratic Republic of the Congo through subsidiaries. The Order alleges violations of Exchange Act Section 30A, 13(b)(2)(A) and 13(b)(2)(B). The proceeding was resolved with the company consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, the firm agreed to pay disgorgement of $3,893,472.42, prejudgment interest and a penalty of $375,000. The amount of the penalty reflects the self-reporting and extensive cooperation and remediation efforts of the company.

Criminal cases

Insider trading: U.S. v. Post, Case No. 1:14-cr-00715(S.D.N.Y.) is an action against David Post, who was tipped by his friend, a financial analyst at a pharmaceutical company. The SEC recently amended its complaint against the analyst to add Mr. Post as a defendant (here). Mr. Post pleaded guilty to one count of conspiracy to commit securities fraud and three counts of securities fraud. Sentencing is scheduled for February 6, 2015.


Reg. SHO: The regulator censured Merrill Lynch Professional Clearing Corp. and find the firm $3.5 million for failing to take action to close-out certain fail-to-deliver positions from September 2008 through July 2012 . The firm also did not have adequate systems and procedures in place to address the issue. Its supervisory systems and procedures were inadequate and improperly permitted the firm to allocate fail-to-close positions to the firm's broker-dealer clients based solely on each client's short position without regard to which clients caused or contributed to the situation.

Hong Kong

Improper conduct: The Securities and Futures Commission suspended Ho Siu Po, a registered representative of DBS Vickers Ltd., for seven months. The suspension is based on his disregard of firm policies which included operating accounts on a discretionary basis and accepting cash from a client, both of which are prohibited.

MOU: The SFC entered into a memorandum of understanding with the China Securities Regulatory Commission. It calls for cooperation regarding enforcement, the sharing of information and data, establishes a process for joint investigations and ensures that enforcement actions in both jurisdictions operate to protect the investing public.

October 31, 2014
Corp Fin's Disclosure Effectiveness Project: Comment Letter Themes
by Randi Morrison

About 20 comment letters have been submitted to the SEC so far in connection with Corp Fin's Disclosure Effectiveness project. Common themes include strong investor interest in mandatory disclosure of sustainability/ESG information, and a desire among issuers to eliminate requirements and processes that elicit redundant and outdated disclosures.

The Society of Corporate Secretaries recommends elimination of obsolete and duplicative disclosures (citing specific examples in both categories), and provides other suggestions for enhanced disclosure including elimination of the "glossy" annual report and prior period results in the MD&A; institution of a formal post-adoption review process for significant new disclosure requirements to evaluate the continuing need for such disclosures in light of evolved economic, business and regulatory conditions; and allowing for sustainability disclosure to be effectively communicated outside of '34 Act reports.

The Center for Capital Markets Competitiveness also offers concrete suggestions - including what it characterizes as near-term improvements to Regulation S-K that the SEC can enact expeditiously with the widespread support of multiple stakeholders (e.g., eliminating specifically identified redundant and outdated disclosure requirements), and longer-term projects that reflect more fundamental change such as the CD&A and MD&A.

Near-Term Actions to Enhance Disclosures

In this recent memo, Deloitte summarizes Corp Fin's views and recommendations about steps companies can take now to improve their disclosures pending formal reforms resulting from Corp Fin's Disclosure Effectiveness project. The memo includes a table in the Appendix that identifies specific types of disclosures (e.g., critical accounting estimates in MD&A, risk factors) and suggestions for improvements.

See also this recent FEI article discussing FASB's and the IASB's pending disclosure initiatives, as well as the SEC's.

More on "The Mentor Blog"

We continue to post new items daily on our blog - "The Mentor Blog" - for members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

– Exclusive Forum Bylaws: California State Court Follows Delaware
– Whistleblowers: SEC Receives Two Rulemaking Petitions
– Are the Securities Laws a "First Amendment Free" Zone?
– Why Ralph Whitworth May Be America's Best Board Member
– Compliance: SEC Expectations vs. Current Stats


- by Randi Val Morrison

October 31, 2014
The SEC and Structured Data (Part 1)
by J Robert Brown Jr.

The SEC collects massive amounts of data. Much of the data is submitted in html, a format that is difficult to search. Ten years or so ago, the SEC started to require the filing of some information in an interactive format. The format permitted analysis of large amounts of data through the use of "tools" (software).   

The roll out of structured data engendered significant criticism. The requirement that financial statements be submitted in an xbrl format was criticized as the imposition of an expense with little value. Indeed, the House has adopted a bill that would eliminate tagging for emerging growth companies. See HR 5405

Nonetheless, recent developments suggest that the Commission is returning to, and promoting the use of, structured data.  In 2012, the Commission proposed a rule requiring disclosure by resource extraction issuers that had to be filed using XBRL.  See Exchange Act Release No. 67717 (August 22, 2012).  The decision was not a new found interest in data tagging but a result of congressional command.  See Section 1504of Dodd Frank ("The rules issued under subparagraph (A) shall require that the information included in the annual report of a resource extraction issuer be submitted in an interactive data format.").   Indeed, a contemporaneous rulemaking concerning conflict minerals did not provide that the newly created form would be tagged.     

Nonetheless, by 2013, much stronger evidence of a shift in the Commission's position began to take shape. First, the agency announced, without notice and comment rulemaking, that Forms 13F would be required to be filed using an online form and filers would be required to "construct their Information Table according to the EDGAR XML Technical Specification."  

Added impetus was provided by the recommendation of the SEC's Investor Advisory Committee. In July 2013, the IAC recommended that the Commission adopt a "Culture of Smart Disclosure," something designed to promote the "collection, standardization, and retrieval of data filed with the SEC using machine-readable data tagging formats." The rule proposal that year for Regulation A+ and crowdfunding both include forms that would, if adopted, be tagged. Regulation AB likewise required the disclosure of certain information in a machine readable format.

Perhaps the most interesting addition was the speech by Mark Flannery, the recently appointed chief economist and director of DERA. See The Commission's Production and Use of Structured Data, Data Transparency Coalition's Fall Policy Conference, Washington, DC, Sept. 30, 2014. The talk emphasized the Commission's commitment to making data "useable" by the public. See Id.  ("Making useable data available to the public is a key function of many of the Commission's disclosure rules, and one of the strategies identified in the Commission's Strategic Plan."). 

He confirmed that the requirement of machine-readable formats for financial disclosures had become "a routine part of the rulemaking process." Nothing was automatic. Future endeavors were to consider the appropriateness of tagging ("anticipating what information would be most useful to investors"), the proper format ("Deciding on the right data format involves many considerations, including the complexity of the financial information, need for validation of the reported elements, and the availability of pre-existing industry standards") and the need to "avoid unnecessary implementation challenges." 

The speech also discussed a sore spot with respect to structured data, particularly in connection with financial statements: data quality. As the speech pointed out: "Unnecessarily high usage of custom tags by a filer can therefore impair certain financial analyses," also noting that the "Commission staff is aware" of the issue. Indeed, the speech noted that DERA would continue, "where appropriate," to "work closely with the Division of Corporation Finance to provide guidance to filers based on these observations." This looked to be a warning that the DERA/CorpFin partnership could yield additional letters like the CFO Letter concerning XBRL deficiencies, issued in July 2014. 

The speech also set out in specific terms what could be expected from the Agency:   

  • Hence, expect to see more staff observations and updates of filer practices posted on the SEC website.  DERA staff will continue its outreach to corporate filers through seminars, webinars, conferences, and other educational programs. DERA staff are also exploring ways to make aggregated XBRL data available to investors and financial researchers so that they can more easily access and analyze the financial information reported through XBRL submissions. 

The speech, therefore, suggests significant progress toward the goals of increasing the use of structured data and ensuring the quality of the data received by the SEC. The partnership between DERA and CorpFin will provide additional impetus for progress and will reduce the concern that decisions are made in a silo. It is strong movement in the right direction.

View today's posts

10/31/2014 posts

CLS Blue Sky Blog: Bingham discusses FINRA's Proposed Rule to Implement CARDS
Financial Executives International Daily » Financial Reporting: Regulators Hone Risk Management Focus, Experts React
The D&O Diary: Another Accounting Scandal-Related Securities Suit
SEC Actions Blog: This Week In Securities Litigation (Week ending October 30, 2014) Blog: Corp Fin's Disclosure Effectiveness Project: Comment Letter Themes
Race to the Bottom: The SEC and Structured Data (Part 1)

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