SEC Charges Government Contractor With Inadequate Controls and Books and Records Violations

The Securities and Exchange Commission today announced that L3 Technologies Inc. (formerly known as L-3 Communications Holdings Inc.), a contractor for U.S. and various foreign government agencies, has agreed to pay a $1.6 million penalty to settle charges that it failed to maintain accurate books and records and had inadequate internal accounting controls. 

An SEC investigation found that in December 2013, L3’s Army Sustainment Division (ASD) – part of L3’s Aerospace Systems segment – improperly recorded $17.9 million in revenue from a contract with the U.S. Army by creating invoices associated with unresolved claims against the U.S. Army that were not delivered when the revenue was recorded.  While certain employees immediately reported their concerns to L3’s ethics department, the subsequent ethics review failed to uncover the misconduct due, in part, to a failure by internal investigators to adequately understand the billing process.  In October 2014, following a subsequent investigation conducted by outside advisors, L3 concluded it had material weaknesses in its internal controls over financial reporting for the fiscal year ended Dec. 31, 2013 and for the first quarter of 2014.  L3 revised its financial statements from 2011 to 2014.

“Adequate internal accounting controls function as a critical safeguard against the type of improper revenue recognition that occurred at L3,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office.  “L3 failed to have such controls in place, which rendered inaccurate its books and records.”

According to the SEC’s order, in or around August 2013, ASD executives developed a “Revenue Recovery Initiative” that identified approximately $50 million in work performed under a contract with the U.S. Army that had not been billed.  Because L3 and the U.S. Army had not reached any agreement on payment for the work performed, any revenue recognition for that work would have been improper under relevant accounting rules.  Nonetheless, in December 2013, a senior finance official at ASD requested that 69 invoices be generated – but not delivered – to the U.S. Army, which caused ASD to recognize almost $18 million in revenue.  Because of that revenue, ASD employees barely satisfied an internal target for management incentive bonuses.

The SEC’s order finds that immediately after the 69 invoices were generated, ASD employees internally reported to L3’s ethics department, but a subsequent internal investigation concluded that there was no improper revenue recognition and the issue was not promptly raised to the L3’s Audit Committee.  In June 2014, L3 retained outside advisors to conduct an internal investigation, which concluded that the revenue recognized on the undelivered invoices was improper.  This investigation uncovered additional accounting errors in L3’s Aerospace Systems segment from 2011 to 2014, which combined with the improper accounting associated with the 69 undelivered invoices had the effect of overstating the company’s pre-tax income by $169 million.

Without admitting or denying the findings, L3 agreed to pay the $1.6 million penalty and consented to the entry of the SEC’s cease-and-desist order finding that it violated the books and records and internal controls provisions of the federal securities laws.  

The SEC’s continuing investigation is being conducted by H. Gregory Baker, David Oliwenstein, Christopher Mele, and Steven G. Rawlings of the New York Office, and the case is being supervised by Sanjay Wadhwa.

SEC: Port Authority Omitted Risks to Investors in Roadway Projects

The Securities and Exchange Commission today announced that the Port Authority of New York and New Jersey has agreed to admit wrongdoing and pay a $400,000 penalty to settle charges that it was aware of risks to a series of New Jersey roadway projects but failed to inform investors purchasing the bonds that would fund them.

The SEC’s order finds that the Port Authority offered and sold $2.3 billion worth of bonds to investors despite internal discussions about whether certain projects outlined in offering documents, including the Pulaski Skyway, ventured outside its mandate and potentially weren’t legal to pursue.  One internal memo noted, “There is no clear path to legislative authority to undertake such projects.” Another memo explicitly identified “the risk of a successful challenge by the bondholders and investors” in connection with the funding of the roadway projects.  But the Port Authority omitted any mention in its offering documents about these risks surrounding its ability to fund the projects.  Its offering documents stated that it issued bonds “only for purposes for which the Port Authority is authorized by law to issue bonds.”

“The Port Authority represented to investors that it was authorized to issue bonds while not disclosing significant known risks that its actions were not legally permitted,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office.  “Municipal bond issuers must ensure that their disclosures are complete and accurate so that investors can make fully informed decisions about whether to invest.”

The Port Authority is the first municipal issuer to admit wrongdoing in an SEC enforcement action.

The SEC’s order finds that the Port Authority violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.  The SEC’s order acknowledges the Port Authority’s cooperation and prompt remedial acts.  The projects at issue have proceeded as planned.

The SEC’s continuing investigation is being conducted by Osman Nawaz and Celeste Chase of the New York office.  The case is being supervised by Sanjay Wadhwa.     

SEC Charges Two Brokers With Defrauding Customers

The Securities and Exchange Commission today charged two New York-based brokers with fraudulently using an in-and-out trading strategy that was unsuitable for customers in order to generate hefty commissions for themselves.

The SEC’s complaint alleges that Gregory T. Dean and Donald J. Fowler did no reasonable diligence to determine whether their investment strategy involving frequent buying and selling of securities could deliver even a minimal profit for their customers.  Their strategy, which generally involved selling the securities within a week or two of purchase and charging customers a commission for each transaction, allegedly resulted in substantial losses for 27 customers.

“This case marks another chapter in the SEC’s pursuit of brokers who deploy excessive trading as a strategy in customer accounts to enrich themselves at customers’ expense,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office and Co-Chair of the Enforcement Division’s Broker Dealer Task Force.  “The allegations in our complaint are based on our examination of trading patterns across more than two dozen customer accounts, and this trading data shows that only the brokers stood to profit from this cost-laden in-and-out strategy.”

The SEC today issued an Investor Alert warning about excessive trading and churning that can occur in brokerage accounts. 

“Investors should be wary of unauthorized trading, frequent sales and purchases, or excessive fees in their brokerage accounts,” said Lori J. Schock, Director of the SEC’s Office of Investor Education and Advocacy.  “If you do not know why a trade was made or why a fee was charged, ask your broker to explain it to you.”

The SEC’s complaint, filed in federal court in Manhattan, charges Dean and Fowler with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.

The SEC’s investigation was conducted by Kristin M. Pauley, David Stoelting, Barry O’Connell, Nathaniel I. Kolodny, Michael P. Fioribello, Leslie Kazon, and Thomas P. Smith Jr. in the New York office.  The litigation will be led by Mr. Stoelting and Ms. Pauley.  The case is being supervised by Sanjay Wadhwa.  The examination that led to the investigation was conducted by Jennifer A. Grumbrecht, Jeffrey Berfond, Glen Riddle, and Margaret Lett.

Chinese Traders Charged With Trading on Hacked Nonpublic Information Stolen From Two Law Firms

The Securities and Exchange Commission today charged three Chinese traders with fraudulently trading on hacked nonpublic market-moving information stolen from two prominent New York-based law firms, racking up almost $3 million in illegal profits.  The SEC also is seeking an asset freeze that prevents the traders from cashing in on their illicit gains.  The enforcement action marks the first time the SEC has charged hacking into a law firm’s computer network.

The SEC’s complaint alleges that Iat Hong, Bo Zheng, and Hung Chin executed a deceptive scheme to hack into the networks of two law firms and steal confidential information pertaining to firm clients that were considering mergers or acquisitions. 

According to the SEC’s complaint, the alleged hacking incidents involved installing malware on the law firms’ networks, compromising accounts that enabled access to all email accounts at the firms, and copying and transmitting dozens of gigabytes of emails to remote internet locations.  Hong and Zheng in particular coveted the emails of attorneys involved in mergers and acquisitions as they exchanged a list of partners who performed the work at one of the law firms prior to the hack at that firm.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges.

“We used enhanced trading surveillance and analysis capabilities that we developed over the last few years to identify the broad scope of the defendants’ alleged scheme, including the use of both U.S. and offshore accounts to carry it out,” said Stephanie Avakian, Acting Director of the SEC’s Enforcement Division.  “This action demonstrates our commitment and effectiveness in rooting out cyber-driven schemes no matter how sophisticated.”

“As we allege, the defendants’ ‘hacking to trade’ scheme involved numerous levels of deception as they gained broad access to the nonpublic networks of two law firms, stole confidential information and then used it for substantial personal gain,” said Antonia Chion, Associate Director of the SEC’s Division of Enforcement.  “This action marks the end of their alleged deception and serves as a stark reminder to companies and firms that your networks can be vulnerable targets.”

According to the SEC’s complaint, Hong, Zheng, and Chin used the stolen confidential information contained in emails to purchase shares in at least three public companies ahead of public announcements about entering into merger agreements.  The SEC alleges that they spent approximately $7.5 million in a one-month period buying shares in semiconductor company Altera Inc. in advance of a 2015 report that it was in talks to be acquired by Intel Corporation.  Within 12 hours of emails being extracted from one of the firms, Hong and Chin allegedly began purchasing shares of e-commerce company Borderfree so aggressively that they accounted for at least 25 percent of the company’s trading volume on certain days in advance of the announcement of a 2015 deal.  Hong and Zheng also allegedly traded in advance of a 2014 merger announcement involving InterMune, a pharmaceutical company.

The SEC’s complaint charges Hong, Zheng, and Chin with violating the antifraud provisions of the federal securities laws and related rules.  The SEC seeks a final judgment ordering them to pay penalties and disgorge ill-gotten gains plus interest and permanently enjoining them from violating the federal securities laws.  Hong’s mother is named as a relief defendant in the SEC’s complaint for the purpose of recovering ill-gotten gains in her accounts resulting from her son’s alleged illicit trading.

The SEC’s investigation is continuing, and is being conducted by Jennie B. Krasner, Devon Leppink Staren, and staff in the SEC’s Information Technology Forensics Group with assistance from Wendy Kong.  The case is being supervised by Ricky Sachar and Antonia Chion and the litigation is being led by Britt Biles.  The SEC appreciates the assistance of the U.S. Attorney’s Office for Southern District of New York, Federal Bureau of Investigation, Hong Kong Securities and Futures Commission, and Financial Industry Regulatory Authority.  

SEC Names Timothy Husson Associate Director in the Division of Investment Management’s Risk and Examinations Office

The Securities and Exchange Commission today named Timothy Husson Associate Director in the Division of Investment Management’s Risk and Examinations Office.

As Associate Director, Dr. Husson will oversee the management and operations of key data analysis and examination projects and initiatives related to the asset management industry and provide guidance on complex financial and quantitative issues as he leads the Division of Investment Management’s asset management monitoring program.

“Tim is an accomplished quantitative analyst and an insightful colleague who is focused on enhancing the use of data-driven analysis in policymaking and asset management industry oversight,” said David W. Grim, Director of the Division of Investment Management. “As a quantitative specialist, Tim will be a key and complimentary member of the senior management team in the Division of Investment Management.”

Dr. Husson said, “I look forward to continuing to work with the exceptional staff of the Risk and Examinations Office to implement enhanced data analysis and review and inform policy recommendations that promote a fair, efficient, and effective regulatory regime for investment funds and investment advisers.”

Dr. Husson has been a member of the SEC and Division of Investment Management since 2014, serving as Branch Chief, Quantitative Research Analyst (Financial Engineer) and Financial Analyst Fellow in the Division of Investment Management’s Risk and Examinations Office. Prior to his SEC service, Dr. Husson was a Senior Financial Economist at Securities Litigation & Consulting Group, where he provided quantitative analysis and drafted expert reports for arbitrations, state and federal court hearings, and regulatory proceedings.

Dr. Husson is a certified Financial Risk Manager (FRM) and holds a B.A. (with Honors) and Ph.D. in Computational Neuroscience from the University of Chicago, where his work focused on the development and applications of a novel neural imaging system.

SEC Names Sara P. Crovitz Deputy Chief Counsel in the Division of Investment Management’s Chief Counsel’s Office

The Securities and Exchange Commission today named  Sara P. Crovitz Deputy Chief Counsel and Associate Director in the Division of Investment Management’s Chief Counsel’s Office.

As Deputy Chief Counsel, Ms. Crovitz will assist the Chief Counsel in overseeing legal guidance under the Investment Company and Investment Advisers Acts of 1940. Ms. Crovitz also will focus on strategic collaboration between the Chief Counsel’s Office and other offices within the Division of Investment Management and in the Commission and plans to implement leadership initiatives that promote professional development among the staff.

“Sara has a proven track record of expertly handling complex legal matters and providing high quality guidance in an evolving market,” said David W. Grim, Director of the Division of Investment Management. “She also is committed to inspiring collaborative and people-oriented leadership. I know she will be a key voice on our senior team.”

“Sara is a resource throughout the Commission for regulatory knowledge and for promoting inclusive leadership,” said Doug Scheidt, Chief Counsel of the Division of Investment Management. “We all look forward to continuing to benefit from Sara’s counsel as she steps into this new role.”

Ms. Crovitz said, “I am honored to have this opportunity. Having served in the Commission for many years, I have seen the incredible talent and relentless dedication of the Division staff. I welcome the opportunity to work with the Division’s entire staff as we move forward together, dedicated to providing an appropriate regulatory environment in an ever-evolving market environment.”

Ms. Crovitz joined the Commission in 1996 as an attorney in the Office of General Counsel. In 1999, Ms. Crovitz joined the Division of Investment Management as a Senior Counsel in the Office of Investment Company Regulation; and later became a Senior Counsel, a Branch Chief, and an Assistant Chief Counsel in the Chief Counsel’s Office. Prior to her SEC service, Ms. Crovitz was an Associate with Steptoe & Johnson from 1994-1996. Ms. Crovitz received her law degree and bachelor’s degree from the University of Chicago.  Among other honors, Ms. Crovitz received the Chair’s International Award in 2014, the Chair’s Excellence in Leadership Award in 2011, and the Martha Platt Award in 2010.

SEC Issues Annual Staff Reports on Credit Rating Agencies

The Securities and Exchange Commission today issued two annual staff reports that demonstrate compliance and competition continue to increase among the credit rating agencies under SEC oversight as nationally recognized statistical rating organizations (NRSROs). 

“Dedicated oversight of credit rating agencies is a critical part of the SEC’s mission,” said SEC Chair Mary Jo White.  “I am pleased that the firms are advancing initiatives to address the staff’s recommendations, including responses to the comprehensive credit rating reforms adopted by the Commission in August 2014.”

The annual examination report, required by the 2010 Dodd-Frank Act, summarizes the staff’s findings from the most recently completed examinations of each NRSRO, including:

• Policies and procedures for determining, surveilling, or withdrawing ratings.
• Separation of analytical activities from sales and marketing.
• Development, documentation, or application of methodologies, criteria, or models.

The report notes that all of the staff’s findings from prior examinations have been appropriately addressed and their recommendations based on exam findings have identified areas for NRSRO improvement.  The staff found that NRSROs continue to integrate and enhance internal systems and processes to comply with their obligations as regulated entities, such as:

• Implementing IT systems to increase the efficiency, capacity, and accuracy of compliance tasks.
• Adding personnel and resources to anticipate and address risk management issues.
• Increasing the number and frequency of audits and other internal testing.

“As a result of our efforts, NRSROs are redoubling their focus on policy and procedure adherence to achieve enhanced transparency, quality, and integrity,” said Thomas J. Butler, Director of the SEC’s Office of Credit Ratings.  “The firms’ additional investments in information technology and personnel serve to bolster governance, risk, and compliance functions.”

The annual report, mandated by the 2006 Credit Rating Agency Reform Act, discusses the state of competition, transparency, and conflicts of interest at NRSROs.  The report notes that two NRSROs recently became registered in additional ratings categories and that smaller NRSROs continue to actively compete with more established rating agencies, particularly in the asset-backed securities rating category, and also are rating new types of issuances referred to as “esoteric” asset-backed securities. 

The following SEC staff contributed to the examinations and reports: Diane Audino, Michael Bloise, David Bobillot, Sondra Boddie, Rita Bolger, Patrick Boyle, Aaron Byrd, Roseann Catania, Matthew Chan, Leah Clague, Kristin Costello, Doreen Crawford, Scott Davey, Franco Destro, Jill Flory, Ilya Fradkin, William Garnett, Kenneth Godwin, Michael Gonzalez, Karen Healer, Barry Huang, Natalia Kaden, Julia Kiel, Russell Long, David Nicolardi, Sam Nikoomanesh, Kevin O’Neill, Harriet Orol, Abraham Putney, Smeeta Ramarathnam, Jeremiah Roberts, Mary Ryan, Charles Schiller, Andrew Smith, Alexa Strear, Warren Tong, Evelyn Tuntono, Chris Valtin, Kevin Vasel, Andrew Vita, and Michele Wilham.

G. Jeffrey Boujoukos Named Director of Philadelphia Regional Office

The Securities and Exchange Commission today announced that G. Jeffrey Boujoukos has been named Director of its Philadelphia Regional Office, where he will oversee enforcement and examinations in the Mid-Atlantic region.  His appointment will be effective following the departure of Sharon B. Binger, who is leaving the agency at the end of the year.

Mr. Boujoukos joined the SEC’s Enforcement Division in 2009 as Regional Trial Counsel in the Philadelphia office.  He has been Associate Regional Director for Enforcement in that office since March 2014.

As Associate Regional Director and Regional Trial Counsel, Mr. Boujoukos has participated in and supervised dozens of enforcement matters involving a variety of securities law violations, including:

• Charges against BP p.l.c. for misleading investors regarding the Deepwater Horizon oil spill by significantly understating the flow rate in multiple reports filed with the SEC.
   
• An investment advisory firm that failed to properly prepare clients for additional transaction costs beyond the “wrap fees” they pay to cover the cost of several services bundled together.
   
• Insider trading charges against two brokers who traded on inside information ahead of the $1.2 billion acquisition of SPSS Inc. in 2009 by IBM Corp. and a former BP employee.
   
• Charges against New York-based brokerage firm Linkbrokers Derivatives LLC for unlawfully taking secret profits of more than $18 million from customers by adding hidden markups and markdowns to their trades.

“Jeff’s knowledge, judgment and pragmatism make him an ideal leader of the Philadelphia office,” said Andrew J. Ceresney, Director of the SEC’s Enforcement Division.  “He has led that office’s enforcement program to bring numerous important and impactful cases, and distinguished himself as a trial lawyer and strategic thinker.”

“Jeff has been a strong partner and advocate for OCIE in his previous positions with the SEC,” said Marc Wyatt, Director of the SEC’s Office of Compliance Inspections and Examinations.  “We look forward to his leadership of the exam program in the Philadelphia region and his contribution to the national program.”

Mr. Boujoukos said, “I am incredibly honored to lead the exceptionally talented and hardworking staff of the SEC’s Philadelphia office.  It is a privilege to come to work every day and collaborate with the office’s enforcement and exam staff who have dedicated their professional careers to protecting the nation’s investors and ensuring fair and orderly markets.”

Prior to joining the SEC staff, Mr. Boujoukos was an associate and later a partner in the litigation department of Morgan, Lewis & Bockius in Philadelphia.  He graduated from Lehigh University in 1989, and graduated with honors from Temple University School of Law in 1992.

SEC Charges Former New York Pension Official and Two Brokers in Pay-to-Play Scheme

The Securities and Exchange Commission today announced fraud charges against a former official of the nation’s third largest public pension fund and two brokers accused of orchestrating a pay-to-play scheme to steer billions of dollars to certain firms in exchange for luxury gifts, lavish vacations, and tens of thousands of dollars spent on cocaine and prostitutes.

Navnoor Kang, who served as the director of fixed income for the New York State Common Retirement Fund from January 2014 to February 2016, allegedly used his position to direct up to $2.5 billion in state business to Gregg Schonhorn and Deborah Kelley, who were registered representatives at two different broker-dealers.  In exchange for this lucrative business, which netted Schonhorn and Kelley millions of dollars in commissions, the brokers provided Kang with tens of thousands of dollars in benefits, including:

• More than $50,000 spent on hotel rooms in New York City, Montreal, Atlantic City, and Cleveland.
• Approximately $50,000 spent at restaurants, bars, lounges, and on bottle service.
• $17,400 on a luxury watch for Kang.
• $4,200 on a Hermes bracelet for Kang’s girlfriend, at Kang’s request.
• $6,000 on four VIP tickets to a Paul McCartney concert in New Orleans.
• An extravagant ski vacation in Park City, Utah, including a $1,000 per night guest suite.

“Kang owed a duty not only to the New York State Common Retirement Fund but to the more than one million public servants and beneficiaries that are served by the fund, including police and fire personnel who count on their pensions to take care of them and their families,” said Andrew J. Ceresney, Director of the SEC Enforcement Division.  “This action demonstrates that the SEC will not tolerate public officials who abuse public pension funds to satisfy their own greedy and wanton desires.”

According to the SEC’s complaint, Kang, as a fiduciary to the Fund, had a duty to disclose his solicitation and receipt of the gifts and entertainment he received from Schonhorn and Kelley but failed to do so.  Schonhorn and Kelley knew Kang was not disclosing his activities to the Fund, and they took steps to keep the benefits a secret.  Kang, in soliciting and accepting the benefits without any disclosure, violated the antifraud provisions of the Securities Act and the Exchange Act.  Schonhorn and Kelley participated in the fraudulent scheme and provided substantial assistance to Kang in concealing the scheme from the Fund, thereby violating the antifraud provisions and aiding and abetting Kang’s fraud.

“We allege that rather than compete fairly for business from the New York State Common Retirement Fund’s $50 billion fixed income portfolio, Schonhorn and Kelley bribed their way in, lining their pockets with millions in commissions along the way,” said LeeAnn Ghazil Gaunt, Chief of the SEC Enforcement Division’s Public Finance Abuse Unit.  “Moreover, they allegedly assisted Kang in covering up his misdeeds, with Kelley going so far as to help Kang obstruct the SEC’s investigation.”

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Kang, Schonhorn, and Kelley.

The SEC’s complaint charges Kang, Schonhorn, and Kelley with violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  Schonhorn and Kelley also are charged with aiding and abetting Kang’s violations.  The SEC is seeking an order of permanent injunction and disgorgement plus interest and penalties.  Additionally, the SEC is seeking a conduct-based injunction against Kang that would permanently enjoin him from participating in any decisions involving investments in securities by public pensions as a trustee, officer, employee, or agent.

The SEC’s continuing investigation is being conducted by Public Finance Abuse Unit members Brian Fagel, Eric Celauro, and Jason Howard.  The SEC’s litigation will be led by John E. Birkenheier and Alyssa A. Qualls.  The case is being supervised by Ms. Gaunt and Timothy L. Warren, Associate Regional Director of the SEC’s Chicago Regional Office.  The SEC appreciates the assistance of the U.S. Attorney’s Office for the Southern District of New York and the Federal Bureau of Investigation.

Petrochemical Manufacturer Braskem S.A. to Pay $957 Million to Settle FCPA Charges

The Securities and Exchange Commission today announced that a Brazilian-based petrochemical manufacturer whose stock trades in the U.S. markets has agreed to settle charges that it created false books and records to conceal millions of dollars in illicit bribes paid to Brazilian government officials to win or retain business.

In a global settlement with the SEC, U.S. Department of Justice, and authorities in Brazil and Switzerland, Braskem S.A. agreed to pay $957 million.

The SEC’s complaint alleges that Braskem made approximately $325 million in profits through bribes paid through intermediaries and off-book accounts managed by a private company that was Braskem’s largest shareholder.  Bribes were paid to a government official at Brazil’s state-controlled petroleum company as well as Brazilian legislators and political party officials.

“As alleged in our complaint, Braskem lacked the internal controls to prevent its use of third parties, off-book accounts, and other intermediaries to bribe government officials in Brazil during an eight-year period,” said Stephanie Avakian, Deputy Director of the SEC Enforcement Division.  “Braskem’s misconduct was exposed through the investigative work of authorities in three countries.” 

Braskem agreed to pay $325 million in disgorgement, including $65 million to the SEC and $260 million to Brazilian authorities.  Braskem agreed to pay more than $632 million in criminal penalties and fines.  The company must retain an independent corporate monitor for at least three years. 

The SEC’s investigation is continuing.  It is being conducted by Ernesto Palacios and Thierry Olivier Desmet of the FCPA Unit with assistance from David S. Johnson and Fernando Torres, and supervised by Kara Brockmeyer, Chief of the FCPA Unit.  The SEC appreciates the assistance of the Department of Justice Criminal Division’s Fraud Section, the Federal Bureau of Investigation, the Brazilian Federal Prosecution Service, the Brazilian Federal Police, and the Office of the Attorney General in Switzerland.  

Company Settles Charges in Whistleblower Retaliation Case

The Securities and Exchange Commission today announced that an oil-and-gas company has agreed to settle charges that it used illegal separation agreements and retaliated against a whistleblower who expressed concerns internally about how its reserves were being calculated.

The SEC’s order finds that Oklahoma City-based SandRidge Energy Inc. conducted multiple reviews of its separation agreements after a new whistleblower protection rule became effective in August 2011, yet continued to regularly use restrictive language that prohibited outgoing employees from participating in any government investigation or disclosing information potentially harmful or embarrassing to the company.

The SEC’s order further finds that SandRidge fired an internal whistleblower who kept raising concerns about the process used by SandRidge to calculate its publicly reported oil-and-gas reserves.  The employee had been offered a promotion, which was turned down.  Just months later, senior management concluded the employee was disruptive and could be replaced with someone “who could do the work without creating all the internal strife.” The company had conducted no substantial investigation of the whistleblower’s concerns and only initiated an internal audit that was never completed. The employee’s separation agreement also contained the company’s prohibitive language that violated the whistleblower protection rule.

“Ignoring a rule that protects communications between outgoing employees and the SEC, SandRidge flatly prohibited such contact in their separation agreements and at the same time retaliated against an employee who raised concerns about the company to its management,” said Shamoil T. Shipchandler, Director of the SEC’s Fort Worth Regional Office. 

Jane Norberg, Chief of the SEC’s Office of the Whistleblower, added, “Whistleblowers who step forward and raise concerns internally to their companies about potential securities law violations should be protected from retaliation regardless of whether they have filed a complaint with the SEC.  This is the first time a company is being charged for retaliating against an internal whistleblower, and the second enforcement action this week against a company for impeding employees from communicating with the SEC.”

Without admitting or denying the SEC’s findings, SandRidge agreed to pay a penalty of $1.4 million, subject to the company’s bankruptcy plan.

The SEC’s investigation was conducted by Tamara F. McCreary, Timothy L. Evans, and David R. King and supervised by Jonathan P. Scott and David L. Peavler of the Fort Worth office.  

SEC Charges Morgan Stanley With Customer Protection Rule Violations

The Securities and Exchange Commission today announced that Morgan Stanley & Co. LLC has agreed to pay $7.5 million to settle charges it used trades involving customer cash to lower the firm’s borrowing costs in violation of the SEC’s Customer Protection Rule.

The Customer Protection Rule is intended to safeguard customers’ cash and securities so that they can be promptly returned should the broker-dealer fail.  The SEC order finds that from March 2013 to May 2015, Morgan Stanley’s U.S. broker-dealer used transactions with an affiliate to reduce the amount it was required to deposit in its customer reserve account.  According to the order, the transactions violated the Customer Protection Rule, which prohibits broker-dealers from using affiliates to reduce their customer reserve account deposit requirements.

“The Customer Protection Rule establishes crucial safeguards for investors to ensure that their cash and securities are secure when held by a broker-dealer,” said Michael J. Osnato, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit.  “Complex trading schemes designed to artificially reduce the amount a broker-dealer must maintain in its customer reserve account run contrary to these basic obligations.”

According to the SEC’s order, Morgan Stanley had its affiliate, Morgan Stanley Equity Financing Ltd., serve as a customer of its U.S. broker-dealer, a relationship that allowed the affiliate to use margin loans from the U.S. broker-dealer to finance the costs of hedging swap trades with customers.  The margin loans lowered the borrowing costs incurred to hedge these swap trades and reduced the U.S. broker-dealer’s customer reserve account deposit requirements by tens to hundreds of millions of dollars per day.

The SEC order finds that Morgan Stanley’s affiliated transactions violated the Customer Protection Rule and that as a result of inaccurately calculating its customer reserve account requirements, it submitted inaccurate reports to the SEC.  Morgan Stanley provided substantial cooperation during the SEC’s investigation and has agreed to review its compliance with the Customer Protection Rule and to take remedial steps to improve its calculation processes.  Morgan Stanley also significantly increased the amount of excess funds it maintains in its customer reserve account.  Without admitting or denying the findings, Morgan Stanley agreed to pay a $7.5 million civil penalty, to cease and desist from committing or causing any similar violations in the future, and to be censured.

The SEC’s investigation was conducted by Joshua I. Brodsky and Joshua R. Pater with assistance from Eli Bass of the Office of Compliance Inspections and Examinations and Raymond Doherty of the Division of Trading and Markets.  The case was supervised by Mr. Osnato and Daniel Michael.  The SEC appreciates the assistance of the Financial Industry Regulatory Authority.