Improper Mutual Fund Distribution Fees Generate $40 Million Fine from SEC


A Securities & Exchange Commission initiative to protect mutual fund shareholders has settled its first case brought because of the SEC’s Distribution-in-Guise Initiative, started in 2013. The defendants used mutual fund assets to improperly pay for distribution-related services instead of paying for them out of their own resources.

This rendered the disclosures made by the mutual fund to the board and fund shareholders related to the payment for these services inaccurate. The investment adviser told the board that the payments were for accounting services, known as sub-transfer Agency fees. Sub-TA fees are paid to transfer agents to maintain account records and execute trades.

Payments from the fund can only come from fund assets if it is pursuant to a written Rule 12b-1 plan approved by a fund’s board. Rule 12b-1 of the Investment Company Act of 1940 was originally designed to allow for the mutual fund to pay advertising and marketing expenses.

In this case, the mutual fund advisers failed to uphold their fiduciary duty to their clients and were charged with violating the Investment Advisers Act and the ’40 Act. Earlier this year, Julie Riewe, Co-Chief of the Division of Enforcement’s Asset Management Unit, told an IA Compliance Conference that conflicts of interest like that exposed here are rife among Registered Investment Advisers.

The improper fees were paid from 2008 until 2014. According to the government press release, the settlement will be distributed to shareholders to compensate them for their loss.

The media has seized on the language in the press release to indicate that there will be more cases brought against either asset managers or broker-dealers similar to the one against First Eagle Investment Management and FEF Distributors. If this is the case, it could be a fertile area for a SEC whistleblower to report violations of the law to the U.S. Government. The whistleblower program would pay eligible individuals between 10 and 30 percent of monetary sanctions recovered when over $1 million.

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Accounting Fraud Cases Up in 2014


Allegations of accounting fraud in securities class actions or SEC enforcement actions were up in 2014 compared to the prior two years, according to a report by Cornerstone Research. These cases involved auditing violations, weaknesses in internal controls or allegations of failing to follow US Generally Accepted Accounting Principles.

Class actions involving accounting issues grew 47 percent on a year over year basis and there was a similar increase in the number of enforcement actions filed by the Securities & Exchange Commission between the 2013 and 2014 fiscal years.  The increase in accounting cases was remarkable because the number of securities class actions filed remained roughly the same in 2013 and 2014.

A large number of the cases dealt with the restatement of financials. The percentage and number of these cases was at their highest level in seven years.

Accounting issues can be the basis for whistleblower tips to both the SEC and the Internal Revenue Service because they result in either inadequate disclosures to investors or the nonpayment of taxes to the government.  The government whistleblower programs may pay between 10 and 30 percent to eligible individuals for tips after a successful enforcement action and qualifying information which meets the rules for a reward.

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More Companies Make FCPA Disclosures Over Brazil’s Petrobras


It’s been a few months since we’ve discussed the massive corruption case coming out of Brazil related to Petrobras, a state-owned enterprise that is facing allegations its employees both took and paid bribes in the company’s contract dealings. We’ve been following this issue closely because of the potential for individuals with information about bribery of “foreign officials” by publicly traded companies, which violate the FCPA, to report them to the U.S. Securities and Exchange Commission (SEC) under the whistleblower program and receive a monetary reward for the information if more than $1 million in penalties occur as a result.

Ensco, an oil and gas serves company headquartered in London which operates offshore well drilling, was the company in the news today. It disclosed to the SEC that Petrobras canceled its contract because its investigation revealed it was acquired through bribery. The rig charter was originally operated by a third company and purchased by Ensco in 2011. Ensco made an initial disclosure to the SEC earlier but I presume today’s disclosure was notifying its investors of the cancellation of a material contract.

The potential for bribery at Ensco came to light publicly over the summer when Brazilian police arrested the former director of Petrobras’ international division, Jorge Zelada. In July, Ensco announced that an internal compliance review revealed no evidence of wrongdoing by its employees or other representatives.

Zelada was also suspected of receiving bribes for a contract of Vantage Drilling as well. Vantage is also listed on the New York Stock Exchange and subject to the FCPA – so it has disclosed potential issues to the SEC as well.

In September, the world’s largest offshore rig contractor, Transocean, also was implicated by a former executive of Petrobras testifying in the corruption case that is known as Carwash. At the time, Transocean issued a statement denying any wrongdoing in the acquisition of the Petrobras 10000 contract.

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State Street Investigated Over Solicitation of Public Pensions


State Street Corp. received a Wells notice from the SEC for its use of consultants to solicit business from public pensions prior to 2011. In at least one instance, according to media reports, a consultant hired by the company made political contributions in the time period during and after the state was engaged in public bidding.

A Wells notice informs the company that the SEC may bring a civil enforcement action against it. It notifies them of the substance of the charges that it intends to bring against the recipient. Around 20 percent of those receiving a notice do not end up facing charges, according to a Wall Street Journal study.

State Street is under investigation for public pensions in two states. In November, it disclosed that it was under investigation in connection with a $32 billion contract for Ohio’s three largest retirement systems that it won. The Ohio lobbyist hired by State Street apparently had extensive contact with Ohio’s deputy treasurer at the time. The contract was overseen by the Ohio treasurer’s office.

Many states have banned those making political contributions from seeking pension business, and the SEC introduced restrictions in 2010 targeted investment business awarded to financial institutions by public officials because of campaign contributions, or so called “pay to play” activities.

If you have evidence of improper lobbying for government contracts or business by a public corporation, contact one of our SEC whistleblower attorneys to discuss reporting it via the whistleblower program. An attorney can be reached by either our contact form or by phone call to 1-800-590-4116.

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SEC, CFTC Fines Issued for Market Access and Data Reporting Violations


This was a busy week for the SEC and CFTC in pursuit of enforcement actions for market access and data reporting. The securities and commodities regulators resolved three separate investigations/enforcement actions in these areas.

The Commodity Futures fined Deutsche Bank $2.5 million for issues with its reporting of swap transactions for the past two years. The enforcement action is the first by the CFTC under the Dodd-Frank Act rules on real-time reporting of swaps transactions.

According to a news report, Deutsche Bank failed to report swap transaction cancellations properly. The bank became aware of problems at the end of 2012 but did not investigate or fix it until after the CFTC began investigating in Summer 2014.

The SEC also fined a U.S. subsidiary of Credit Suisse $4.25 million this week for deficient reporting of blue sheet data on customer trades to the securities regulator over a two year period. The SEC discovered the issue by comparing submissions made by certain broker dealers to the data they submitted to the National Securities Clearing Corp.

A Wall Street Journal article this week on an $8 million SEC fine imposed on high-frequency trading firm Latour Trading indicated that the SEC has now brought multiple cases concerning technology glitches recently as it attempts to police market access violations. Latour sent 12 million orders to exchanges between 2010 and 2012 without confirming prices in all of the relevant markets.

As a result, SEC rules to promote the fair and orderly execution of stock trades were not followed. It appears that the software was trading through the national best bid or best offer in violation of Reg NMS. One reason this may have occurred was the elimination of some code by a programmer that altered the way trades were handled by a particular exchange. For problems with their internal controls such as this one, the SEC brought a charge of violation of Rule 15c3-5, which requires them to have a system of risk management controls and supervisory procedures.

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Court Rules on Confidentiality Agreements for SEC Whistleblowers


A U.S. District Court in the Southern District of California has recently ruled on the validity of a SEC whistleblower’s defense to the enforcement of a company’s confidentiality agreement.  In the decision, the Court accepts the validity of a public policy defense to a limited whistleblower disclosure of confidential information concerning securities fraud.

The case arose after a whistleblower sued the company for retaliation.  The company brought counterclaims against the whistleblower-plaintiff for breach of the confidentiality clause of its employment agreement.  The whistleblower then asserted the public policy in favor of whistleblowing as a defense.

These issues have been more frequently litigated in the context of the False Claims Act, where whistleblowers (known as relators) are required to bring a qui tam lawsuit through the judicial system.  This litigation process permits companies to bring counterclaims, unlike standard submissions to the SEC whistleblower program where the whistleblower is not involved in the government’s enforcement action.

To briefly summarize the important areas of the decision for securities whistleblowers:

  • The public policy exception allowing breach of a confidentiality agreement by a whistleblower applies to SEC whistleblowers providing information to the U.S. Government.
  • The whistleblower has a public policy defense at least allowing a limited removal of documents from the company in order to demonstrate the fraud and protect against document destruction.
  • A SEC whistleblower retaliation complaint can rely on confidential information that is reasonably necessary to demonstrate the retaliation.
  • The whistleblower defense allowed does not offer protections for breach of the confidentiality agreement when a whistleblower provides confidential information to the press.

The ruling strengthens the protections for SEC Whistleblowers.  The SEC has independently pursued civil enforcement actions against companies recently both for retaliation against whistleblowers as well as impeding communications from SEC whistleblowers through a variety of tactics.

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Whistleblower Awards at SEC Backlogged


The SEC whistleblower program is having trouble keeping up with the number of people applying for awards, according to a Wall Street Journal article yesterday. More than 80% of the whistleblowers filing claims for awards since 2011 have not yet received a decision.

According to the numbers obtained for the article, there have been 297 individuals applying for awards. 247 have yet to get a decision from the Commission. Andrew Ceresney, the Director of the Enforcement Division at the SEC, explained to the WSJ that the awards raise complex issues which are being addressed for the first time.

Hopefully, they will be able to work out these issues soon. Because it will be very concerning if the problem grows with the program. The number of tips provided in the first quarter of this year was up more than 20% over last year. If this growth continues, the logjam at the award stage may grow to become a much bigger issue.

The latest whistleblower award can at least provide some insight into the length of the process for awards at the SEC. The settlement of the enforcement action against Paradigm Capital Management was made in mid-June last year. The award for $600,000 was just handed down at the end of April. That’s ten months from start to finish in an application that probably had little controversy, including the three or four months for the deadline of the Notice of Covered Action to pass.

However, some of the awards have been pending for nearly two years now. There have been less than 200 claims made in Fiscal Years 2014 and 2015, so at least some of the tipsters made their claims in FY 2013, which ended September 2013.

At least the percentage of awards out of the claims that have been decided is encouraging. Of the 50 award claims, there have been 17 awards so far. At least several of the denied claims, if memory serves, dealt with tips made prior to the passage of the Dodd-Frank Act. The percentage of awards to denials is also much better than the CFTC. The CFTC has denied 30 claims and paid out on one tip.

According to the Award Determinations posted on their website, the CFTC only made six decisions in all of 2014. Of course, the commodities regulator receives a smaller amount of tips than the SEC every year, about 10% of the number. However, it is the CFTC program right now where a whistleblower could have a decent shot at an award over $100 million. The due date for four of the five Notices of Covered Action in the November Forex fines has just passed. Award claims related to the Citibank action are due next week. Across the three regulators in the United States participating in the settlement and the UK FCA, the banks paid more than $4 billion. This opens up the possibility for a new record Dodd-Frank award. The largest award currently is $30 million.

The Dodd-Frank programs, to this point, have generally been considered a success. They still have a long way to go before they achieve the success of the False Claims Act, which paid out more than $400 million to whistleblowers last year.

Hopefully, the SEC program won’t follow the path of the Internal Revenue Service. Their program has been routinely criticized in the media over the past three years for the absence of awards given the large number of individuals that provide tips to the agency. They have also been criticized by Senator Chuck Grassley, and others, about their lack of communication with the people that are providing them tips.

Have questions? Our SEC whistleblower attorneys can assist you. For a free consultation, please contact us or call 1-800-590-4116 to speak to a lawyer at McEldrew Young.

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SEC Whistleblower Gets Reward for Flash Crash Discovery


Bloomberg has reported the enforcement action and recipient of the first case of a reward for independent analysis by a SEC whistleblower (announced January 2016). The financial professional discovered a stock exchange data feed operating in violation of Regulation NMS on the day of the Flash Crash (May 6, 2010). The Securities and Exchange Commission, per its policy, did not identify the individual’s name or the specific enforcement action when it announced the whistleblower award.

The case reported by Bloomberg was settled by NYSE and its parent in 2012 for a fine of $5 million, the first financial penalty from the SEC against an exchange. It violated Rule 603(a) of Reg NMS by selling access to fast proprietary data feeds while the company knew certain computer servers provided delayed information to its consolidated data feeds during high volume trading.

Rule 603(a) requires self-regulatory organizations and broker dealers to transmit data to the network processor for the consolidated feeds at the same time or sooner than it independently distributes data. Nevertheless, because of problems in the software providing data to the network processor that was not present in the proprietary data feeds, NYSE was not in compliance with this rule. As a result, some customers got access to NYSE information faster than the consolidated feeds, particularly in times of high trading volume such as the Flash Crash.

The tip reportedly provided three charts to the SEC which made clear that the company was violating Rule 603(a). The tipper wasn’t contacted by the SEC and found out about the enforcement action when the settlement was announced. The individual’s company provides software which gives data feed access to traders. It also provides historical market data to financial professionals.

It took more than three years for the SEC to make the monetary award. There have been discussions of delays in the award process previously but the SEC has defended its determination process. Based on the information that we’ve seen now, it looks like award announcements take between 1 and 3.5 years.

To speak to our SEC whistleblower lawyers about this information or for an evaluation of a potential submission to the SEC, please call 1-800-590-4116.

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Thank You, Whistleblowers!


Today is National Whistleblower Appreciation Day. We would like to take a moment to thank everyone who has come forward to report fraud and other misconduct over the years.

We know that the decision can be a difficult one and it may have unfortunate consequences on your family and career. We thank you for nevertheless doing the right thing.

On this day in 1778, the Continental Congress passed the first whistleblower law in the United States. It encouraged people in the service of the United States to report misconduct to Congress or the appropriate agency. More than 200 years later, we still rely on you to protect us from fraud.

Last year, there were a record 753 qui tam lawsuits filed under the False Claims Act. Thousands more submitted tips to the Internal Revenue Service and Securities and Exchange Commission. And an untold number informed their boss or company’s compliance professional about problems at their place of work.

There is still more to do, both to fight fraud and protect whistleblowers from retaliation. Your bravery continues to inspire us in our fight.

We also would like to thank Senator Chuck Grassley for his relentless support of whistleblowers. Senator Grassley was part of the testimony today about the False Claims Act at a House Judiciary Subcommittee on the Constitution and Civil Justice. His efforts have been instrumental in the advancement of whistleblower law.

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Novartis Settles FCPA Investigation into China for $25 Million


Novartis agreed to settle civil charges with the U.S. Securities and Exchange Commission on Wednesday into its healthcare practices in China. The settlement of the investigation into the Foreign Corrupt Practices Act will result in a payment of more than $25 million to the SEC by Novartis.

The SEC alleged that China based units of Novartis made payments to foreign officials, such as healthcare professionals, in order to increase sales of pharmaceutical products. The SEC brought charges for the FCPA violations based on the inaccurate books & records and failure to maintain adequate internal accounting controls.

Among the examples included in the Administrative Order were:

– Cash and gifts funded through false expense reports were used to increase prescriptions by key customers.

– Transportation, accommodations and meals were arranged for healthcare professionals but the educational purpose was minimal in comparison to the sightseeing or recreational purpose.

– A study designed by the sales and marketing team and not approved by the appropriate clinical quality group provided no legitimate medical data and was instead a means to financially reward prescribers.

– Novartis hired vendors to arrange travel and event planning but did not exercise sufficient controls with respect to these vendors.

As a result of these allegations, Novartis will pay a $2 million civil penalty, $21.5 million in disgorgement and $1.5 million in interest. Although this case appears to only resolve issues with China, the company has had other bribery troubles. South Korean prosecutors raided the Seoul-based unit for kickbacks in February and two years ago an employee pled guilty in a bribery prosecution in Poland.

Health care companies in China have been a hotbed of activity for government investigations into suspected FCPA violations. At the end of last year, Bristol Myers paid $14 million in order to resolve its own SEC investigation. Several others face continuing government investigations

If you have questions about this information or want to speak to one of our FCPA whistleblower lawyers about reporting bribery of a government official through the SEC whistleblower program, please contact us via our online contact form.

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