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SecuritiesEnforcementForum2017October26,2017

TenQuestionsKeytotheCurrentRegulatoryClimate

BAKERBOTTS

CurrentStateofFinancialRegulation

• SECpenaltiesdown66%yearoveryear• FINRAenforcementnumbersalsodecliningfromrecord2016• SECandFINRAleadershipfocusingonretailinvestorprotection

– Ponzischemes,boilerrooms,pennystocks,affinityfraud,salespracticeabuse

• Theseareaswillremaintheprioritiesuntilovertakenbyeventsorpoliticalchange• Expectadeclineinnon-scienter andsupervision-basedactions• RegulatorsandCongressalignedinthefocusonfraudandintentionalmisconduct• Stateattorneygeneralsremainactiveandunpredictable• Classactionsonarecordpace,drivenbyqualitativematerialitytheories• Customerarbitrationclaimsatrecordlowlevels

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ParticularChallengesFacingFINRA

• Migrationofassetstoadvisoryaccounts/fiduciarydutyrule/lackofjurisdictionoveradvisoryaccounts

• Riseofindexinvestingandfintech• Declineintaxabletradingvolumes• FailuretowinCATprocessor/viabilityofRSA business• Declineinbroker-dealers

– 80percentormoreofregisteredrepresentativesworkfor20largestfirms– NumberofB/D's stillexceedshistoricallevels

• Absenceofpoliticalsupportforlargerrole• Unpredictablecashflowstreams• FINRA360Reviewdesignedtoidentifyrisksandopportunities

– combinationofduplicativeenforcementandexaminationfunctions– rightsizeorganizationtoitsrevenuestream

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SECChairClayton'sEnforcementPhilosophy

• Limitedrecord:– confirmationtestimony– speechtotheEconomicClubofNewYork,July12,2017– limitednumberofenforcementactions

• Strongfocusonretailinvestorprotection"Mr.&Mrs.401(k)"• Vigorouspursuitofthosewho"lie,cheatandsteal"• Skepticalofsystemsandsupervisioncases• Compliancecostsversusbenefitstoinvestors

– AML,controlarchitecturefailures

• Individualaccountabilityprovidesthegreatestdeterrence• Penaltiestiedtoshareholderbenefit,shareholderloss,existenceofa"real"victim,

andlevelofintent

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Question1:Isitsafertooperateingrayareas?

• No• NeithertheSECnortheDepartmentofJusticehasmuchofanappetiteforpursing

negligence-basedcaseswherethereisnobenefittoshareholdersoridentifiablevictims,butthereiseveryindicationthatintentionalviolationsofcriminalandcivilstatutesgoverningbusinessconductwillbevigorouslypursued.

• Companywouldbefoolishtocourtdisasterbycuttingbackonsystemsorcomplianceortakingmoreaggressivepositionsonitsfinancialreportinginhopesthatregulatorswillnotpursuetheconduct.

• NoindicationthatwillfulblindnesswillbetoleratedinsuchhighpenaltyareasastheForeignCorruptPracticesAct,theSecuritiesActof1933andtheSecuritiesandExchangeActof1934,insidertrading,ormailandwirefraud.

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Question2:Doindividualshavealowerriskofprosecution?

• No• TheHolyGrailofcorporateenforcementactionsremainstheprosecutionof

responsibleindividuals.• OneofthefirststatementsofferedbyChairClaytonduringhisconfirmationwas

thatnothingprovidesdeterrencelikethevigorousprosecutionofindividuals.• TheDepartmentofJusticeproceduresareexplicitinrequiringprosecutorsto

justifythefailuretonameindividualcorporateemployeesiftheyproposesettlingacorporateprosecutionwithanactionsolelyagainstthecorporation.

• PerAGSessions“theDepartmentofJusticewillcontinuetoemphasizetheimportanceofholdingindividualsaccountableforcorporatemisconduct.Itisnotmerelycompanies,butspecificindividuals,whobreakthelaw.”

• FINRAalsofocusedonnamingindividuals,particularlyinhighriskareas

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Question3:Haswhistleblowerriskdeclined?

• No• Noindicationthatwhistlebloweractivityisdrivenbyenforcementpolicies• VastmajorityofthewhistleblowercomplaintsreceivedbytheSECarefiledby

lawyersonbehalfofclientsseekingbountypayments• Whistleblowercomplaintshavealsobecomeakeystrategicleverinemployment

disputes,ofteninanefforttogaintheprotectionofanti-retaliationprovisions• Othermotivatingfactorsaretheabsenceofinternalreportingmechanisms,

distrustofthecorporateculture,andagenuinefeelingthattheemployeehasbeenaggrieved

• SECexpandingthepoolofeligiblewhistleblowerstoincludestateandlocalgovernmentpersonnelinnon-enforcementpositionsandthoseparticipatinginthewrongdoing

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Question4:Canweexpectlowerfinesandpenalties?

• Yes,unlessthereiscompellingevidenceoffraud• SECreturningtotheStatementoftheSecuritiesandExchangeCommission

ConcerningFinancialPenalties,SECRelease2006-4(January4,2006)• Keydriversare(1)thepresenceorabsenceofadirectbenefittothecorporation

asaresultoftheviolation;(2)thedegreetowhichthepenaltywillrecompenseorfurtherharminjuredshareholders;(3)theneedtodetertheparticulartypeofoffense;(4)whethercomplicitywaswidespreadthroughoutthecorporation;(5)thelevelofintentoftheperpetrators;(6)thedegreeofdifficultyindetectingtheparticulartypeofoffense;(7)thepresenceofremedialsteps;and(8)theextentofcooperationwithlawenforcement.

• Appliedliterally,drasticreductionofpenaltiesincomplexsystemsandsupervisioncasesasbydefinitiontheconductinthesemattersdoesnotinvolveintentionalwrongdoing,complicity,orabenefittoshareholders,andthevastmajorityofsystemsfailuresareremediatedbythecorporation.

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Question5:Willthebenefitsofself-reportingbecomemoreapparent?

• Yes• SECappearstobelookingforwaystovisiblyrewardcompanieswhoself-report

misconduct.• Recentenforcementactionssuggestthatfineswillbelowerforthosecompanies

whoself-reportandprovidemeaningfulcooperation.• FINRA,stressingrestitutionoverpenaltiesandrewardingthefirmswhofindand

fixtheirownproblems.• FINRAhasbeenamongthemostaggressiveinrewardingself-reportingdespite

thefactthatFinraRule4530requiresfirmstoself-reportmaterialissues• Evenifyoudonotfindtheissue,promptremedialactionwillbecreditedbythe

regulators

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Question6:WhatwillbetheeffectofKokesh v.U.S.ontheSECEnforcementProgram?

• LimitedpracticaleffectonfinancialremediesinSECactions• Footnote3oftheOpinioninvitesachallengetotheuseofthedisgorgement

remedyasapenaltyunauthorizedbystatute• SECcanalwaysaddwhattheywouldhavegottenasdisgorgementtothepenalty

amount.• Willincreasetheuseoftollingagreements• WillpressureSECtocompletecasesinfiveyears

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Question7:Istheremoreflexibilityindiscipliningsenioremployees?

• Probablynot• Individualdisciplineisoneofthemostcompellingwaysinwhichacorporation

communicatestoregulatorsthatit“getsit”.• Alsoconsistentwitheffectiveremediation• Marketexpectsthatthecorporationwilltakemeaningfulstepstomovebeyond

theissue

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Question8:WillSECandFINRAinvestigationsbecomelessexhaustiveandexpensive?

• No,ifcaseturnsonintentandindividualliability• Toughestchallengeforinvestigatorsincomplexcasesisprovingintentand

identifyingculpableindividuals• Diffusionofresponsibilitiesrequiresmoretestimonyandemailreview• Settlementoffraudchargeswithoutanindividualdefendantwillbemorerare• Companiesshouldcarefulreviewextentofindemnificationobligationsand

insurancecoverage• Notargetingoflegalandcompliancepersonnel,particularlyinsupervisioncases

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Question9:WhatistheeffectofFinra's combinationofenforcementfunctions?

• "Speedcamera"tradereportinganddataentrycasesshoulddecline• MorethoroughvettingofMarketRegulationcasesshouldleadtomorelogical

outcomes• RoleofRSA clientsinenforcementmattersmaydecline• Opensthedoorforabroadrangeofworkstreamimprovements• AccretivewithotherchangeslikelytocomeoutofFINRA360• Expectsignificantturnoveroflongstandingstaff• ClosercoordinationwithSECtoavoidregulatoryduplication

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Question10:Havethestandardschangedforwhentolaunchaninternalinvestigation?

• Yes.• Redflags,hotlinereports,andallegedviolationsofcorporatepoliciesandcodes

ofconductmustberesolvedintheordinarycoursepursuanttoestablishedWSPs.• Thereismoreleewayincraftinganincrementalandrisk-basedresponseto

allegations.• Theuseofinternalmechanisms,suchasin-houselawyers,internalauditors,and

corporatecompliancepersonnelintheinitialstagesisquitereasonablewheretheallegationsdonotimplicateamaterialbusinesslineorseniorcorporateofficers.

• Documentationofthereview,thepreservationofrelevantevidence,theuseofpersonnelwhoseconductisnotatissue,andstrongreportinglinesarekey,asisthewillingnesstochangetheinvestigativeplaniftheevidencesuggestsbroaderissuesoramoresignificantreputationalrisk.

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