Jefferies Settles Market Crisis Failure To Supervise Actions With SEC/USAO

by Dorsey & Whitney LLP
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Registered broker-dealer Jefferies LLC resolved failure to supervise charges tied to the market crisis with the SEC and the U.S. Attorney for the District of Connecticut. The Commission settled with the broker in an administrative proceeding. There Jefferies admitted certain facts, agreed to implement certain remedial relief and to make payments to customers. The firm also agreed to the entry of an order which includes a censure and requires the payment of disgorgement and a penalty. In the Matter of Jefferies LLC, Adm. Proc. File No. 3-15785 (March 12, 2014). The firm resolved similar charges with the U.S. Attorney by entering into non-prosecution agreement in which it also admitted certain facts and agreed to pay a penalty of $25 million.

The fraud

The charges stem primarily from the fraudulent conduct of former Jefferies employee Jesse Litvak, although others were involved. Mr. Litvak was associated with Jefferies from 2008 through 20011 where he served as a managing director and a trader in the firm’s MBS group, resident in the Stamford, Connecticut office. Mr. Litvak was an experienced MBS trader when he joined the firm. His compensation at Jeffries depended in part on sales.

The MBS sold by Mr. Litvak and others on the mortgage backed securities desk were generally illiquid. The markets were opaque. Purchasers were aware that the amount paid for the securities included a charge added to the purchase price of the security paid by Jefferies as either part of the price or an add-on. The lack of transparency in the market, however, meant that there was no way for a purchaser to determine the accuracy of representations made to them about the purchase prices paid by the firm which were the predicate for the broker transaction charges.

Firm customers were overcharged by about $2.6 million in 25 transactions between 2009 and 2011. Two primary methods utilized by Mr. Litvak and others on the MBS desk. In some instances Mr. Litvak or others misrepresented the purchase price paid by the firm for the security. This would increase the commission or spread to Mr. Litvak and Jefferies. In other instances the nature of the transaction was misrepresented. Purchasers were falsely told that the security was being acquired in a transaction from another customer when in fact it was being sold out of inventory. Again the purchase price and payment to Jefferies was increased. Many of the transactions were done through electronic communications such as instant messages, emails and online chats.

Charges against Litvak

Mr. Litvak was charged by the Commission in an action that alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b). That action is still pending. SEC v. Litvak, Civil Action No. 3:13-cv-00132 (D. Conn. Filed Jan. 28, 2013). He was also charged and convicted in a parallel criminal case. The indictment in that case contained eleven counts of securities fraud, one count of TARP fraud and four counts of making false statements. U.S. v. Litvak (D. Conn. Jan. 25, 2013).

Failure to supervise

The firm failed to reasonably supervise Mr. Litvak, according to the Order in the case which names Jefferies as a Respondent. The firm’s policy regarding supervisory review of electronic communications required that each employee’s communications were subject to review by a supervisor. An automated system was used to select a sample of communications by each employee on a daily basis for review by the supervisor.

Respondent failed reasonably to implement this procedure for review “in a manner that would reasonably be expected to detect the misrepresentations about purchase price made by Litvak . . . “ and others on the MBS desk. First, procedures were not reasonably implemented. Specifically, the procedures failed to include Bloomberg group chats. This system failure caused certain communications, including some by Mr. Litvak and others on the MBS desk, to be excluded.

Second, the firm failed to provide direction and the tools to supervisors to meaningfully review the communications with customers about the price. It would have been difficult to review communications involving price without checking at least a sample of the statements against actual pricing information. If Respondent had provided the appropriate tools to its supervisors, along with the Bloomberg group chats, they would “likely” have determined that statements by Mr. Litvak and others that were not true.

Under Exchange Act Section 15(b)(4)(E) broker-dealers are responsible for reasonably supervising persons subject to their supervision. Others involved on the MSB desk (other than Mr. Litvak) violated Securities Act Section 17(a)(2).

Settlement

To resolve the proceeding Jefferies admitted to the facts contained in the Section above labeled “The fraud” (Par. 5-8 in the Order). The firm agreed to implement a series of remedial procedures which include the retention of a consultant who will analyze the procedures of the firm and make recommendations. Jefferies agreed to adopt the recommendations, although it has the option to propose alternatives which it can adopt if the consultant agrees. The firm also agreed to pay $11 million to customers involved in the transactions.

Finally, Jefferies consented to the entry of a censure pursuant to Section 15(b)(4), to pay disgorgement of $4,200,401 along with prejudgment interest and a civil money penalty equal to the amount of the disgorgement.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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