Gary DeWaal and Associates LL

Gary DeWaal’s Bridging the Week: March 3 to 7 and 10, 2014 (Alleged Law Firm Fraud; Possible FX Manipulation)

Bridging the Week Compliance Weeds

Published Date: March 10, 2014

Criminal and civil legal actions against former employees of a major, worldwide defunct law firm, highlighted news in the financial services industry last week, giving many legal and compliance professionals a moment of pause. This week leaders of the exchange-traded derivatives industry will flock to Boca Raton, Florida for the annual FIA International Futures Industry Conference to assess evolving market structure (including the launch of Swap Execution Facilities in the US), cross-border issues, the impact of regulation, and new capital and liquidity requirements, among other topical matters. As a result, the following matters are all covered this week on Gary DeWaal’s Bridging the Week:

Lawyers and Financial Personnel Criminally Indicted and Sued Civilly in Connection with Collapse of Formerly Highly Regarded Law Firm (includes Compliance Weeds);
Bank of England Confirms Ongoing Review to Assess Its Own Possible Involvement in FX Manipulation; Suspends One Employee (includes Compliance Weeds);
Three Nominees for CFTC Commissioner Provide Glimpses of Regulatory Priorities;
HK SFC Bans Former Bank Employee for Life for Hiding Trading Losses;
SEC Fines Proprietary Trading Firm US $7.2 Million for Short Selling Violations; Issues Alert on Short Sales in Connection with Public Offerings;
SEC Commissioner Attacks New FRB Foreign Banking Organization Rules That Effectively Impose New Requirements on Broker Dealer Subsidiaries;
CFTC Extends No Action Relief Related to Swap Trades between Certain Affiliated Counterparties; and
CME Amends Certain Rules Related to Transfer Trades And Position Adjustments.

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Lawyers and Financial Personnel Criminally Indicted and Sued Civilly in Connection with Collapse of Formerly Highly Regarded Law Firm

Both the Securities and Exchange Commission and the District Attorney of Manhattan took legal actions against former senior officers of the defunct law firm Dewey & Leboeuf, alleging that they engaged in accounting fraud to deceive the firm’s lenders, investors and others. The Manhattan DA filed criminal indictments in a Manhattan criminal court against two former senior lawyers of Dewey & Leboeuf, Steven Davis and Stephen Dicarmine, who were its Chairman and Executive Director, as well as against its former Chief Financial Officer, Joel Sanders. A former client relations manager, Zachary Warren, at the firm was also indicted. The SEC sued Messrs. Davis, Dicarmine, and Sanders, as well Frank Canellas and Tom Mullikin, the firm’s former finance director and controller, respectively. The SEC’s action was filed in a US Federal Court in Manhattan. Both the SEC and the criminal indictment allege that the named firm employees participated in an ongoing multi-year scheme falsely to amend Dewey & Leboeuf’s financial statements to help disguise a materially worsening financial predicament and inability to satisfy various loan covenants. The SEC’s complaint related specifically to alleged fraud by the firm through the named employees in connection with its issuance of a US $150 Million bond offering during April 2010, as well as in certain quarterly certifications required by the firm afterwards. The SEC is seeking disgorgement and financial penalties as well as permanent injunctions against all five defendants, among other sanctions. According to the SEC’s complaint:

“Unbeknownst to investors, the Defendants - a collection of Dewey's senior most legal and business professionals - had orchestrated and executed a bold and long-running accounting fraud intended to conceal the firm's precarious financial condition. Investors believed they were purchasing bonds issued by a prestigious law firm that had weathered the financial crisis and was poised for growth; in reality, the financial results disclosed in the [private placement memorandum for the bond offering] were materially misstated.“

The criminal indictment alleged fraud both in connection with the same bond offering, as well as well as various loans from 2008 through 2012. In bringing these actions, both the SEC and the Manhattan District Attorney are relying on large number of emails which they allege support their allegations, including one where a defendant in the SEC action expressly discloses his preference not “…to cook the books anymore” and another is captioned “Accounting Tricks.”

Compliance Weeds: Employees, no matter how well trained, inevitably will write incriminating matters in firm-supported electronic communications. This is why financial services’ firms should ensure that their electronic communications are routinely and systematically reviewed for problematic or suspicious communications (not just for compliance and financial breaches, but potential employment law issues too). Many surveillance systems can identify electronic communications containing key words; however, employees may mask known key words by using alternative words or phrases, or by purposely misspelling words or using a foreign language. Surveillance systems should have the ability to adapt to such potential subterfuge. Other types of systematic reviews should also be considered (e.g., targeted reviews of specific production groups, employees generating unexpectedly high levels of revenue). Now that firms increasingly are required to retain recordings of certain oral communications, these should regularly be reviewed too.

And briefly:

Bank of England Confirms Ongoing Review to Assess Its Own Possible Involvement in FX Manipulation; Suspends One Employee: Rumored worldwide investigations by multiple government agencies into possible manipulation of FX markets struck home within one regulator last week when the Bank of England announced that it had suspended one of its own employees as part of an internal probe regarding its own possible knowledge of wrongdoing. Although the Bank said that its investigation so far had found no evidence that its “…staff colluded in any way in manipulating the foreign exchange market or in sharing confidential client information,” it suspended the employee pending its investigation into the staff member’s adherence to “internal control processes.” At the same time, the Bank announced that it is continuing to review its own possible involvement in unlawful or improper behavior in connection with the FX market, and that it had retained outside counsel to assist it; the Bank intends to publish a report of its findings “in due course.” Last October 2013, the UK Financial Conduct Authority confirmed that it was conducting investigations “alongside several other agencies” related to FX trading, while the Bank first disclosed it had begun reviewing its own possible knowledge “…of the potential for manipulation.”

Compliance Weeds: As part of its investigation, the Bank of England had reviewed approximately 15,000 emails, 21,000 Bloomberg and Reuters chat room records, and over 40 hours of telephone call recordings. Time will tell how effective the BoE's systematic review of these records were, and if they could have caught potential issues with more effective surveillance earlier. See also Compliance Weeds related to the article "Lawyers and Financial Personnel Criminally Indicted and Sued Civilly in Connection with Collapse of Formerly Highly Regarded Law Firm," above.

Three Nominees for CFTC Commissioner Provide Glimpses of Regulatory Priorities: During their appearances before the Senate Agriculture Committee on March 6, 2014, Timothy Massad, Sharon Y. Bowen, and J. Christopher Giancarlo, all nominated by President Barack Obama to serve as CFTC commissioners (with Mr. Massad additionally nominated to serve as Chairman) all pledged support generally for reform of the US swaps markets that began with the passage of Dodd Frank in 2010. However, each articulated different priorities of where they believe the CFTC should go from here. (For further details access: http://www.garydewaalandassociates.com/?p=2153.)

HK SFC Bans Former Bank Employee for Life for Hiding Trading Losses: A former employee of the Bank of East Asia, Chak Tsz Hoi, was banned from the financial services industry for life as a result of his 2008 efforts to disguise losses from his trading of stock options for the bank. Previously Mr. Chak was convicted in an HK court of obtaining access to a computer with a dishonest intent, and sentenced to 10 months in prison. The bank sustained losses in 2008 of HK $80 Million (over US $10 Million) as a result of Mr. Chak’s losses, which he endeavored conceal by entering false parameters regarding such trades into the bank’s trading system.

SEC Fines Proprietary Trading Firm US $7.2 Million for Short Selling Violations; Issues Alert on Short Sales in Connection with Public Offerings: The SEC filed an administrative complaint against Worldwide Capital, Inc., and its sole owner and president, Jeffrey W. Lynn, for selling short securities in advance of 60 public stock offerings from October 2007 through February 2012. In general, it is prohibited to purchase securities in a public offering where the purchaser has sold short the same securities within a specified time – a so-called “restricted period.” This period typically begins five days before the pricing of the offered securities and ends with the pricing. The respondents, to settle this complaint, agreed to pay US $7.2 Million in sanctions, including disgorgement of slightly more than US $4.2 Million and a fine of over US $2.5 Million. Simultaneous with its issuance of a press release related to this matter, the SEC issued a Risk Alert related to short selling in connection with public offerings.

SEC Commissioner Attacks New FRB Foreign Banking Organization Rules That Effectively Impose New Requirements on Broker Dealer Subsidiaries: In a speech on March 3 before the Institute of International Banks, SEC Commissioner Daniel Gallagher attacked the new requirement of the Board of Governors of the Federal Reserve that requires certain large foreign banking organizations to establish US intermediate holding companies over their US subsidiaries. According to the Commissioner, requiring intermediate holding companies (1) to meet enhanced liquidity risk management standards, (2) to conduct liquidity stress tests, and (3) to hold a buffer of highly liquid assets based on certain projected funding needs during a 30-day stress test, will impede their broker dealer subsidiaries efforts to help support US capital markets by inhibiting their ability to engage in short term funding through securities funding transactions such as repo and reverse repo, securities lending and borrowing and securities margin lending. (For more details on the FRB’s proposal, check out the article: “Federal Reserve Board Requires Establishment of an Intermediate Holding Company for Certain Large Foreign Banking Organizations,” at http://www.garydewaalandassociates.com/?p=2080.) While bank capital supports the safety and soundness of the financial institution operating in a principal capacity, says the Commissioner, broker dealer capital requirements exists to “…manage risk – and the corresponding potential for failure - by providing enough of a cushion to ensure that a failed broker-dealer can liquidate in an orderly manner, allowing for the transfer of customer assets to another broker-dealer.” The FRB’s new rules are thus misguided, says the Commissioner:

“To me, this onslaught of bank regulator rulemaking impacting non-bank markets is the result of a central, albeit unannounced, pillar of Dodd-Frank: the institutionalization of “too big to fail.” The continued focus on “going concern” capital for institutions like broker-dealers that should fail when they take on undue risk can mean only one thing – despite the lessons learned from the financial crisis, despite the rightful disgust the American people directed at the bailouts, the U.S. government is focused on propping up institutions instead of refining the processes by which their failures will be handled. “

CFTC Extends No Action Relief Related to Swap Trades between Certain Affiliated Counterparties: The CFTC extended until December 31, 2014, previously granted no action relief that temporarily exempted from mandatory clearing and execution requirements through March 11, 2014, certain swaps between affiliated entities and unaffiliated counterparties. The exemption is conditioned on the affiliated counterparties satisfying a number of conditions. The CFTC had adopted certain restrictions in connection with swaps between eligible affiliated counterparties and unaffiliated counterparties because of its “…concerns about evasion of the clearing requirement and the systemic risk associated with uncleared, inter-affiliate swaps involving non-US affiliates.”

CME Amends Certain Rules Related to Transfer Trades And Position Adjustments: A number of CME rules potentially permitting, under discreet circumstances, the transfer of trades to correct errors, as well as to net down concurrent long and short positions in physically delivered futures products during the spot month, have been amended to provide the Exchange’s Chief Regulatory Officer or the Clearing House Chief Compliance Officer (as relevant) slightly greater flexibility.

For more information, see:

Bank of England FX Investigation:
http://www.bankofengland.co.uk/publications/Pages/news/2014/044.aspx.

See also: FCA Confirmation of FX Investigation:
http://www.fca.org.uk/news/forex-investigation-statement.

CFTC No Action Relief for Certain Swap Trades Between Affiliated Entities:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-25.pdf.
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/letter/14-26.pdf.
CME Amended Rules:
http://www.cmegroup.com/tools-information/lookups/advisories/market-regulation/files/SER-7027.pdf.
Dewey & Leboeuf Legal Matters

Criminal Indictment (Manhattan District Attorney Press Release):
http://manhattanda.org/press-release/da-vance-chairman-cfo-and-executive-director-dewey-leboeuf-indicted-grand-larceny-and-.
Securities and Exchange Commission:
http://www.sec.gov/litigation/complaints/2014/comp-pr2014-45.pdf.

Speech of SEC Commissioner Daniel Gallagher before the Institute of International Bankers: http://www.sec.gov/News/Speech/Detail/Speech/1370540869879#.UxstF9xvl_g.
HK SFC Bans Former Bank Employee for Life:
http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=14PR27.
SEC: In the Matter of Worldwide Capital et al:
http://www.sec.gov/litigation/admin/2014/34-71653.pdf.

See also SEC Risk Alert re: Short Selling in connection with Public Offerings: http://www.sec.gov/about/offices/ocie/risk-alert-091713-rule105-regm.pdf.

The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of March 8, 2014, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Gary DeWaal and Associates may represent one or more entities mentioned in this article.