Corporate Investigations & White Collar Defense - January 2016

by Manatt, Phelps & Phillips, LLP
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In This Issue:

  • The FCPA in 2016: DOJ and SEC Focus on International Cooperation and Investigation of Individuals
  • Spotlight on the False Claims Act
  • Securities Fraud—What Do RMBSs, EB-5s and Political Intelligence Have in Common?
  • DFS and FinCen—The Rise of the New Enforcers
  • Keeping an Eye Out—Updates and Briefly Noted

The FCPA in 2016: DOJ and SEC Focus on International Cooperation and Investigation of Individuals

Why it matters: As we reported in our December 2015 newsletter, both SEC Enforcement Director Andrew Ceresney and DOJ Assistant Attorney General Leslie Caldwell gave speeches on November 17, 2015 at the American Conference Institute's 32nd Annual International Conference on the FCPA reviewing their respective agencies' FCPA enforcement efforts in Fiscal Year 2015 and discussing their goals and expectations for Fiscal Year 2016. One of the topics Enforcement Director Ceresney addressed was the vital importance of effective coordination between the SEC and international regulators and law enforcement. Just a little over a week later on November 30, 2015, the SEC and the U.K. Serious Fraud Office announced a coordinated effort that resulted in a $36.9 million global settlement with ICBC Standard Bank as well as the Serious Fraud Office's first-ever deferred prosecution agreement. Assistant Attorney General Caldwell spoke about the DOJ's renewed focus on holding individuals accountable for FCPA corporate wrongdoing, and December 2015 saw numerous announcements about criminal charges and prison sentences involving individuals in FCPA cases. We recap it for you here.

Detailed discussion: In their separate "state of the union" addresses at the American Conference Institute's 32nd Annual International Conference on the FCPA on November 17, 2015, SEC Enforcement Director Andrew Ceresney and Assistant Attorney General Leslie Caldwell spoke about the important FCPA enforcement actions and developments for their agencies in Fiscal Year 2015 and gave strong indications that we can look forward to the same if not increased FCPA focus in Fiscal Year 2016. In this article, we discuss two of the areas Ceresney and Caldwell focused on in their speeches, and the announcements within weeks thereafter that proved illustrative of their points.

In his speech, Enforcement Director Ceresney attributed a large part of the success of the SEC's FCPA program in recent years to the SEC's increasingly effective coordination with international regulators and law enforcement. Ceresney pointed to the "important trend of significant growth in focus and legislation on corruption issues worldwide over the last few years" which has greatly assisted the SEC's FCPA investigations because they "routinely rely on evidence obtained from foreign jurisdictions, and often are conducted in parallel with foreign governments." Case in point: Roughly a week after Ceresney's speech on November 30, 2015, the SEC and the U.K.'s Serious Fraud Office (SFO) jointly announced that, in a coordinated effort, they had reached a $36.9 million global settlement with London-based ICBC Standard Bank involving a $6 million bribe paid in connection with a 2013 private placement of debt in Tanzania. Particularly noteworthy was the SFO's announcement of two "firsts": Its first prosecution brought under Section 7 of the Bribery Act of 2010 (the U.K.'s version of the FCPA) and its first-ever deferred prosecution agreement (DPA).

Briefly, the background: The admitted facts show that, in March 2013, a former sister company of Standard Bank, Stanbic Bank Tanzania (SBT), made a $6 million payment to Enterprise Growth Market Advisors (EGMA), a private Tanzanian firm. One of the directors of EGMA was a Tanzanian government official, and the payment by SBT to EGMA was made for the purpose of inducing Tanzanian government officials to select a proposal by Standard Bank and SBT for a $600 million private placement of debt. The private placement generated transaction fees of $8.4 million, shared by Standard Bank and STB. In its private placement materials circulated to investors, Standard Bank failed to disclose SBT's $6 million payment to EGMA.

The SEC charged Standard Bank with materially misleading investors in violation of the Securities Act of 1933 by failing to disclose the $6 million bribe in its private placement offering materials. Standard Bank paid a fine of $4.2 million to the SEC to resolve its portion of the investigation. In its press release, the SEC stated that "[t]he SEC would not have jurisdiction to bring charges under the FCPA because Standard was not an 'issuer' as defined by that Act."

The SFO indicted Standard Bank for failure to prevent bribery under Section 7 of the Bribery Act of 2010. As stated in the SFO's press release, "This was … the first use of Section 7 of the Bribery Act of 2010 by any prosecutor." Under the SFO's first ever DPA entered into with Standard Bank—of which SFO Director David Green said "[t]his landmark DPA will serve as a template for future agreements"—Standard Bank is required to pay penalties to the U.K. and Tanzanian governments of $25.2 million and $7 million, respectively. The DPA also requires, among other things, that Standard Bank cooperate with the SFO and retain an independent consultant to review its "existing anti-bribery and corruption controls, policies and procedures regarding compliance with the Bribery Act of 2010 and other applicable anti-corruption laws." In its press release, the SFO noted its great appreciation to the SEC and other U.K. and U.S. agencies, including the DOJ, "for their assistance in resolving this investigation and deferred prosecution."

In her remarks, Assistant Attorney General Caldwell spoke about the DOJ's renewed focus on holding individuals accountable for corporate criminal conduct in the context of FCPA investigations, stating that companies seeking credit "must affirmatively work to identify and discover relevant information about the individuals involved through independent, thorough investigations. Companies cannot just disclose facts relating to general corporate misconduct and withhold facts about the individuals involved. And internal investigations cannot end with a conclusion of corporate liability, while stopping short of identifying those who committed the underlying conduct." In the six weeks following Caldwell's speech, individuals involved in corporate FCPA investigations were criminally charged or sentenced to prison in the following cases, underscoring that individual accountability for corporate wrongdoing in FCPA cases will remain a priority for the DOJ in 2016:

  • December 21, 2015—Two men arrested and charged with FCPA violations and money laundering relating to $1 billion bribery scheme to secure energy contracts from state-owned Petroleos de Venezuela S.A. (PDVSA): The indictment unsealed in the Southern District of Texas on December 21, 2015 stated that Roberto Rincon, a U.S. lawful permanent resident residing in Texas, and Abraham Shiera, a Venezuelan national residing in Florida, were involved in a scheme to pay approximately $1 billion in bribes to PDVSA officials between 2009 and 2014 in order to secure energy contracts from PDVSA.
  • December 16, 2015—A former executive of SAP International was sentenced in the Northern District of California to 22 months in prison for his role in a scheme to bribe Panamanian officials to secure the award of government technology contracts in violation of the FCPA: Vicente Eduardo Garcia pleaded guilty in August 2015 to one count of conspiracy to violate the FCPA. On July 15, 2015, Garcia and the SEC entered into a settlement in the parallel SEC investigation under which Garcia agreed to disgorge $85,965.
  • December 15, 2015—A former broker-dealer for Direct Access Partners LLP was sentenced in the Southern District of New York to three years in prison for his role as the middleman in a scheme to bribe a Venezuela state bank official in exchange for bond trading work in violation of the FCPA: Jose Alejandro Hurtado, who pleaded guilty to FCPA violations and money laundering in 2013, was also ordered to forfeit $11.9 million. Four other executives of Direct Access Partners LLP pleaded guilty to similar charges and were also recently sentenced to prison and/or ordered to forfeit monetary penalties in connection with the case.
  • December 15, 2015—A former Russian nuclear energy official was sentenced to 48 months in prison for money laundering in connection with FCPA violations: The Maryland-based individual, Vadim Mikerin, was sentenced in the District of Maryland to 48 months in prison for conspiracy to commit money laundering in connection with his role in arranging and receiving more than $2 million in corrupt payments to secure improper business advantages for U.S. companies from the Pan American Department of JSC Techsnabexport (TENEX), the sole supplier and exporter of Russian Federation uranium and uranium enrichment and a subsidiary of Russia's State Atomic Energy Corporation. Two other individuals pleaded guilty to similar charges in connection with the payment scheme.

We will watch with interest what 2016 brings from the SEC and the DOJ by way of FCPA investigations and resolutions and report back.

See here to read the U.K. Serious Fraud Office's 11/30/15 press release titled "SFO agrees first UK DPA with Standard Bank."

See here to read the SEC's 11/30/15 press release titled "Standard Bank to Pay $4.2 Million to Settle SEC Charges."

See here to read the 12/21/15 New York Times article titled "U.S. Charges 2 With Corruption Linked to Venezuelan Oil Company," by William Neuman.

See here to read the DOJ's 12/16/15 press release titled "Former Executive Sentenced for Conspiracy to Bribe Panamanian Officials."

See here to read the 12/15/15 Reuters article titled "Brokerage employee gets three years in U.S. prison over Venezuelan bribes," by Nate Raymond.

See here to read the DOJ's 12/15/15 press release titled "Former Russian Nuclear Energy Official Sentenced to 48 Months in Prison for Money Laundering Conspiracy Involving Foreign Corrupt Practices Act Violations."

For more on this topic, read (1) the SEC's 11/17/15 press release of the text of Enforcement Director Andrew Ceresney's speech titled "ACI's 32nd FCPA Conference Keynote Address" and (2) the DOJ's 11/17/15 press release of the text of Assistant Attorney General Leslie Caldwell's speech titled "Assistant Attorney General Leslie R. Caldwell Delivers Remarks at American Conference Institute's 32nd Annual International Conference on Foreign Corrupt Practices Act."

Spotlight on the False Claims Act

Why it matters: The last months of 2015 saw much activity involving the False Claims Act, including myriad DOJ enforcement actions and the U.S. Supreme Court granting certiorari in an implied certification case. Judging from the amount of money the DOJ announced that it had collected from False Claims Act cases in the fiscal year ended September 30, 2015—in excess of $3.5 billion, for the fourth year in a row—it is safe to say that the False Claims Act will remain a top weapon in the DOJ's 2016 arsenal. Read on for a recap.

Detailed discussion: On December 3, 2015, Principal Deputy Attorney General Benjamin C. Mizer, head of the DOJ's Civil Division, announced that the DOJ had collected more than $3.5 billion in settlements and judgments from False Claims Act (FCA) cases in the fiscal year ended September 30, 2015. According to the government, this was the fourth year in a row that the DOJ collected over $3.5 billion from FCA cases, bringing total FCA recoveries to $26.4 billion during the period beginning January 2009 through September 30, 2015. Per the press release, in fiscal year 2015, (1) of the $3.5 billion collected, the largest recoveries came from the healthcare industry ($1.9 billion), followed by resolutions in connection with government contracts ($1.1 billion), and (2) 638 of the cases—the majority—were filed under the FCA's whistleblower, or qui tam, provisions (which allow individuals—a.k.a. "relators"—to file lawsuits alleging false claims on behalf of the government and receive up to 30% of the recovery if the government prevails in the action), pursuant to which whistleblower awards to individuals totaled $597 million. According to Mizer, "The False Claims Act has again proven to be the government's most effective civil tool to ferret out fraud and return billions to taxpayer-funded programs."

If the last months of 2015 and this month are any indication, the DOJ will continue apace with its FCA push in fiscal year 2016—we recap the 11 FCA resolutions announced by the DOJ in November and December 2015 and to date in January 2016 below (we previously reported on five FCA resolutions announced in October 2015 in our December 2015 newsletter). But first we discuss two important developments in FCA court cases that were announced in late 2015:

  • U.S. ex rel. Escobar v. Universal Health Services, Inc.: On December 4, 2015, the U.S. Supreme Court granted certiorari in Escobar to review the question of implied certification of compliance under the FCA. Briefly, the case arose out of the care provided to a teenage girl at Arbour Counseling Services (owned and operated by Universal Health Services) in Lawrence, Massachusetts that, according to the relators, ultimately led to her death in 2009. In February 2013, the girl's parents filed qui tam lawsuits under the FCA and its Massachusetts counterpart alleging that Arbour, in submitting claims to Medicare and MassHealth for reimbursement, had engaged in fraudulent billing by misrepresenting that it and its staff members were in compliance with the requisite legal health standards and were properly licensed and/or supervised as required by relevant law. The district court dismissed the case in its entirety, holding that the relators had not established the requisite falsity to sustain the claims. On appeal, the First Circuit reversed, finding that the relators had stated a claim for "legal falsity" under the FCA because Arbour impliedly certified its compliance with applicable law when it submitted its claims for reimbursement to the government agencies, even though the specific statutory/regulatory language did not require an express statement of compliance as a condition of payment. The Court granted certiorari to resolve the issues of implied certification and legal falsity in an FCA context because the First Circuit's ruling in Escobar created a multicircuit split—as illustrated by the questions the Court will be considering when it hears the case: (1)"Whether the 'implied certification' theory of legal falsity under the FCA—applied by the First Circuit below but recently rejected by the Seventh Circuit—is viable"; and (2) "If the 'implied certification' theory is viable, whether a government contractor's reimbursement claim can be legally 'false' under that theory if the provider failed to comply with a statute, regulation, or contractual provision that does not state that it is a condition of payment, as held by the First, Fourth, and D.C. Circuits; or whether liability for a legally 'false' reimbursement claim requires that the statute, regulation, or contractual provision expressly state that it is a condition of payment, as held by the Second and Sixth Circuits (emphasis original)."
  • U.S. ex rel. Purcell v. MWI Corp.: On November 24, 2015, the D.C. Circuit in this long-running case (the qui tam complaint was filed in 1998; the government intervened in 2002) reversed a federal jury's verdict against MWI, holding that there was insufficient evidence to find that MWI "knowingly" made a false claim under the FCA when it made certifications to the Export-Import Bank in 1992 in order to secure loan financing for the sale of water pumps to Nigeria. The case turned on the undefined term "regular commissions" in the applicable regulatory provision, as to which the government claimed, and the jury found, MWI allegedly falsely certified. The Court held that, in this context, the term "regular commissions" was "undefined and ambiguous" (its connotations could relate to "industry-wide, intra-firm, or individual-agent") and that—absent any evidence that MWI was notified of another interpretation used by the bank or the government—MWI's interpretation of the term was "facially reasonable." The Court thus found that "the FCA's objective knowledge standard … did not permit a jury to find that MWI 'knowingly' made a false claim."

As of this writing, oral argument had not yet been scheduled before the U.S. Supreme Court in Escobar. We will keep an eye out and report back. Back to the DOJ—briefly recapped below are the healthcare and non-healthcare FCA resolutions announced by the DOJ as of this writing in November and December 2015 and January 2016:

Healthcare FCA resolutions:

  • January 8, 2015—Former owner of Bostwick Laboratories agreed to pay up to $3.75 million to resolve FCA allegations of unnecessary testing and kickbacks to physicians: The settlement resolved allegations (neither admitted or denied) that Dr. David G. Bostwick (the owner and CEO of Virginia-based pathology lab Bostwick Laboratories) billed Medicare and Medicaid for medically unnecessary cancer detection tests and offered incentives to physicians to obtain Medicare and Medicaid business. Bostwick Laboratories previously agreed to pay the government over $6.5 million to resolve the same FCA allegations in 2014. Qui tam whistleblower to receive award of $2.5 million.
  • December 18, 2015—21st Century Oncology agreed to pay $19.75 million to resolve FCA allegations related to unnecessary laboratory tests: The settlement resolved allegations (not admitted or denied) that the Florida-based cancer care services provider submitted claims to Medicare for "FISH" tests that were not medically necessary. Qui tam whistleblower to receive award of $3.2 million.
  • December 18, 2015—32 hospitals agreed to pay $28 million to resolve FCA allegations related to kyphoplasty billing: The 32 hospitals, located in 15 states, agreed to pay $28 million to settle allegations (neither admitted nor denied) that they submitted false claims to Medicare charging inpatient costs for minimally invasive outpatient kyphoplasty procedures. With this resolution, the DOJ said that it had now reached settlements with more than 130 hospitals totaling $105 million in connection with the same issue. All but three of the settling hospitals were named as defendants in a qui tam lawsuit. Qui tam whistleblowers to split award of $4.75 million.
  • December 18, 2015—Splint supplier and its president to pay over $10 million to resolve FCA allegations: Maryland-based splint supplier Dynasplint Systems, Inc. and its founder agreed to pay $10.3 million to resolve allegations (neither admitted nor denied) that they violated the FCA by improperly billing Medicare separately for splints provided to patients in skilled nursing facilities when the cost of the splints was already included in the bundled price Medicare was paying to the facilities. Qui tam whistleblower to receive award of $1.98 million.
  • November 20, 2015—Novartis Pharmaceuticals agreed to pay $390 million in fines and forfeiture to settle civil FCA and state false claim charges and charges under the Anti-Kickback Statute: Novartis allegedly gave kickbacks (in the form of non-permissible discount arrangements) to specialty pharmacies in return for recommending two of its drugs, Exjade and Myfortic. As part of the settlement, Novartis made factual admissions about its relationships and interactions with specialty pharmacies in connection with distribution of the two drugs and accepted responsibility for those admissions. Per the press release, this is the third settlement in this lawsuit—in January 2014 and April 2015 two specialty pharmacies agreed to pay a total of $75 million to resolve federal and state claims against them based on the same allegations. Together with the settlement announced on November 20, 2015, the federal and state governments will recover a total of $465 million from this lawsuit. The case was initiated by a qui tam whistleblower (no award announced) and the government first intervened in 2013.

Non-healthcare FCA resolutions:

  • January 6, 2016—URS E & C Holdings, Inc. agreed to pay $9 Million to resolve FCA allegations: URS E & C Holdings, Inc., the successor in interest to global design and construction company Washington Group International, Inc. (WGI), agreed to pay $9 million to settle allegations (neither admitted nor denied) that WGI submitted false claims in connection with United States Agency for International Development contracts. No qui tam case reported.
  • December 21, 2015—Two Texas-based import companies agreed to pay $15 million to resolve FCA charges in connection with evasion of customs duties: The settlement resolved allegations (neither admitted nor denied) that University Furnishings L.P. and its general partner Freedom Furniture Group, Inc. made false statements and misclassifications to avoid paying duties on wooden bedroom furniture (for student housing) imported from China. Qui tam whistleblower to receive award of $2.25 million.
  • December 9, 2015—Bollinger Shipyards agreed to pay $8.5 million to settle an FCA lawsuit filed against it in the Eastern District of Louisiana: The complaint made allegations (neither admitted nor denied) that Bollinger violated the FCA by misrepresenting the longitudinal strength of patrol boats it delivered to the Coast Guard that resulted in the boats failing once put into service. No qui tam case reported.
  • December 2, 2015—Franklin American Mortgage Company agreed to pay $70 million to resolve allegations that it violated the FCA in connection with mortgage lending insured by the Federal Housing Administration (FHA): As part of the settlement, the Tennessee-based company admitted to knowingly originating and underwriting mortgage loans insured by the FHA that did not meet applicable requirements from 2006 through 2012. No qui tam case reported.
  • November 20, 2015—University of Florida agreed to pay $19.875 million to resolve FCA allegations: The settlement resolved allegations (neither admitted nor denied) that the University improperly charged the U.S. Department of Health and Human Services for salary and administrative costs on hundreds of federal grants. No qui tam case reported.
  • November 2, 2015—NetCracker Technology Corp. agreed to pay $11.4 million and Computer Sciences Corp. agreed to pay $1.35 million to settle FCA allegations that they used individuals without security clearances on Defense Information Systems Agency (DISA) contracts: The settlement resolved allegations (neither admitted nor denied) that from 2008 through 2013, Massachusetts-based telecom software and services company NetCracker Technology Corp. used employees without required security clearances to perform work on DISA contracts, resulting in Virginia-based technology services company Computer Sciences Corp. submitting false claims for payment to DISA. Qui tam whistleblower to receive award of $2.6 million.

See here to read the DOJ's 12/3/15 press release titled "Justice Department Recovers Over $3.5 Billion From False Claims Act Cases in Fiscal Year 2015."

See here to read the Writ of Certiorari filed on 6/30/15 in Universal Health Services, Inc. (Petitioner) v. United States and Commonwealth of Massachusetts ex rel. Julio Escobar and Carmen Correa (Respondents).

See here to read the D.C. Circuit's 11/24/15 opinion in United States of America ex rel. Robert R. Purcell v. MWI Corporation.

For more on this subject, read the (1) DOJ's press release dated 1/8/15 titled "Former Owner of Bostwick Laboratories Agrees to Pay Up to $3.75 Million to Resolve Allegations of Unnecessary Testing and Illegal Remuneration to Physicians"; (2) DOJ's 12/18/15 press release titled "21st Century Oncology to Pay $19.75 Million to Settle Alleged False Claims for Unnecessary Laboratory Tests"; (3) DOJ's 12/18/15 press release titled "32 Hospitals to Pay U.S. More Than $28 Million to Resolve False Claims Act Allegations Related to Kyphoplasty Billing"; (4) DOJ's 12/18/15 press release titled "Splint Supplier and Its President to Pay Over $10 Million to Resolve False Claims Act Allegations"; (5) DOJ's 11/20/15 press release titled "Manhattan U.S. Attorney Announces $370 Million Civil Fraud Settlement Against Novartis Pharmaceuticals For Kickback Scheme Involving High-Priced Prescription Drugs, Along With $20 Million Forfeiture Of Proceeds From The Scheme"; (6) DOJ's 1/6/16 press release titled "URS E & C Holdings, Inc. Agrees to Pay $9 Million to Resolve False Claims Act Allegations"; (7) DOJ's 12/21/15 press release titled "Texas-Based Importers Agree to Pay $15 Million to Settle False Claims Act Suit for Alleged Evasion of Customs Duties"; (8) DOJ's 12/9/15 press release titled "Bollinger Shipyards Agrees to Settle False Claims Act Suit"; (9) DOJ's 12/2/15 press release titled "Franklin American Mortgage Company Agrees to Pay $70 Million to Resolve Alleged False Claims Act Liability Arising From Federal Housing Administration-Insured Mortgage Lending"; (10) DOJ's 11/20/15 press release titled "University of Florida Agrees to Pay $19.875 Million to Settle False Claims Act Allegations"; and (11) DOJ's 11/2/15 press release titled "Netcracker Technology Corp. and Computer Sciences Corp. Agree to Settle Civil False Claims Act Allegations."

Securities Fraud—What Do RMBSs, EB-5s and Political Intelligence Have in Common?

Why it matters: A few interesting and diverse securities fraud matters from late 2015—one from the Second Circuit, two from the SEC—caught our eye. Read on for a recap.

Detailed discussion: The last two months of 2015 saw the announcement of three interesting and diverse matters from the world of securities fraud jurisprudence and enforcement that we found worthy of note. We recap them here:

  • December 8, 2015—The Second Circuit in U.S. v. Litvak reversed the securities fraud conviction of a defendant broker-dealer on evidentiary grounds: Defendant Jesse Litvak (Litvak), a registered broker-dealer with Jeffries & Co. (Jeffries), was indicted in January 2013 for securities fraud and other charges. The indictment alleged that Litvak made fraudulent misrepresentations to "purchasing counterparties" in order to "covertly reap excess profit for Jeffries in the course of transacting residential mortgage-backed securities (RMBS)." These included misrepresentations as to the costs to Jeffries of acquiring the RMBS and the price at which Jeffries had negotiated to resell them. In March 2014, after a 14-day jury trial, Litvak was convicted of securities fraud and sentenced to two years in prison. On appeal to the Second Circuit, the court considered four of Litvak's many challenges to his conviction, but the challenge that proved successful and led the court to vacate the conviction and remand the case for a new trial was evidentiary, having to do with whether the district court erred when it excluded portions of two experts' testimony proffered by Litvak at trial. The Second Circuit found that the district court exceeded its allowable discretion by excluding the experts' testimony in numerous instances, the two most relevant of which are:

    1. Exclusion of expert evidence that went to "materiality": The first of Litvak's experts was excluded from testifying "about the process investment managers use to evaluate a security, and the irrelevance of the broker-dealer's acquisition price to that process [which] was directly probative of whether Mr. Litvak's misstatements would have been material to a reasonable investor." The Second Circuit found that the district court exceeded its allowable discretion by excluding this testimony because it "would have been highly probative of materiality, the central issue in the case" and could have "educated the jury…about the highly-specialized field of RMBS trading." The court found that "a jury could reasonably have found that misrepresentations by a dealer as to the price paid for certain RMBS would be immaterial to a counterparty that relies not on a 'market' price or the price at which prior trades took place, but instead on its own sophisticated valuation methods and computer model." The court held that the district court's error in excluding this testimony was "not harmless" and thus a reversal of Litvak's conviction was warranted.

    2. Exclusion of evidence that went to "good faith"—the "standard operating procedure" defense: The second of Litvak's experts was excluded from testifying about "the widespread use of similar negotiation tactics [to those of Litvak] at Jeffries" which would have "shown that others at Jeffries engaged in the same conduct and that it was approved by supervisors and by Jeffries' compliance department." The second expert's testimony would have gone to the issue of Litvak's good faith by introducing evidence that, during the relevant time period, Litvak's conduct was "business as usual" and that "supervisors at Jeffries…regularly approved of conduct identical to that with which Litvak was charged." The Second Circuit found that the district court "exceeded its allowable discretion in concluding that this testimony was not relevant under the low threshold set forth by Federal Rule of Evidence 401… in determining whether Litvak 'held an honest belief that his actions were proper and not in furtherance of any unlawful activity.' " As a reversal of Litvak's conviction had already been found to be warranted earlier in the opinion, the court felt no need to reach a decision as to the harmlessness of this error.
  • December 7, 2015—SEC charged attorneys and law firms in numerous states with acting as unregistered brokers by offering EB-5 investments to immigration clients: The SEC announced a series of enforcement actions against attorneys across the United States who were charged with offering EB-5 investments—sold via a program created by the Immigration Act of 1990 to stimulate foreign investments—while not registered to act as brokers in violation of the Securities Exchange Act of 1934. The press release highlights one case filed in the Central District of California where the SEC alleged that a New York-based immigration attorney and his firm acted as unregistered brokers by selling EB-5 investments to more than 100 investors and also defrauded clients by failing to disclose that they received commissions on the investments in breach of fiduciary and legal duties. The SEC announced that it had settled administrative proceedings for similar charges (which were neither admitted to nor denied) against numerous attorneys and firms in Texas, Florida, New Jersey and California. Enforcement Director Andrew Ceresney stated that "[i]ndividuals and entities performing certain services and receiving commissions must be registered to legally operate as securities brokers if they're raising money for EB-5 projects…[t]he lawyers in these cases allegedly received commissions for selling, recommending, and facilitating EB-5 investments, and they are being held accountable for disregarding the relevant securities laws and regulations."
  • November 24, 2015—SEC charged political intelligence firm Marwood Group Research LLC with compliance failures in violation of the securities laws: The SEC announced that Marwood Group Research LLC (Marwood), a regulatory and legislative policy firm (a.k.a. a "political intelligence" firm) and registered broker-dealer/investment advisor, agreed to pay a $375,000 penalty and admit wrongdoing for failing to properly inform its in-house compliance officers about instances when analysts obtained potentially material nonpublic information from government employees in violation of its written policies and procedures. According to the SEC's order, Marwood's admitted misconduct occurred in 2010 when Marwood analysts obtained from government employees information about policy issues and pending regulatory approvals at the Centers for Medicare & Medicaid Services and the Food and Drug Administration. The information was obtained by the analysts in the usual course of Marwood's business as part of the firm's "research notes" service to "provide hedge funds and other clients with regulatory updates and analysis about potential timing and developments for future government actions or rulemaking decisions." The facts show that Marwood encouraged its analysts to "maintain relationships" with the government employees, which the SEC found to be a violation as government employees "often are familiar with confidential matters at their agencies" and thus "such interactions increased the likelihood that Marwood Group employees could acquire material nonpublic information in the course of their work." The facts show that Marwood's written policies and procedures in place at the time "expressly prohibited the acquisition and dissemination of material nonpublic information and required employees to bring it to the attention of the compliance department if they encountered anything confidential." The SEC found that "[d]espite the red flags," the analysts failed to run the confidential information they received from the government employees by the compliance department "so it could be properly vetted for any material nonpublic information ripe for insider trading" and instead drafted and distributed the research notes directly to the firm's clients "who could have used any material nonpublic information to inform securities trading decisions." As the result, the SEC's order finds that Marwood violated Section 15(g) of the Securities and Exchange Act of 1934 and Section 204A of the Investment Advisers Act of 1940.

See here to read the Second Circuit's 12/8/15 opinion in U.S. v. Litvak.

See here to read the SEC's 12/7/15 press release titled "SEC: Lawyers Offered EB-5 Investments as Unregistered Brokers."

See here the SEC's 11/24/15 press release titled "SEC Charges Political Intelligence Firm."

DFS and FinCen—The Rise of the New Enforcers

Why it matters: The New York State Department of Financial Services—or DFS—was created in 2011 from two previously separate state agencies to regulate banks and other financial institutions subject to New York insurance, banking and financial services laws. The Financial Crimes Enforcement Network—or FinCen—is part of the U.S. Department of Treasury and was created in the early 1990s as a collector and repository of financial intelligence with added regulatory and enforcement capabilities. FinCen's mission is to "follow the money" in its attempts to stem criminal financial activity. In recent years, the DFS and FinCen have increased their respective profiles in the area of enforcement, joining the DOJ and SEC as primary financial crimes enforcement agencies. A recap of both agencies' activities from late-2015 foreshadows a trend for 2016 and beyond. Read on for the details.

Detailed discussion: Reviewing the regulatory and enforcement activities from the final months of 2015 of the New York State Department of Financial Services (DFS) and the Financial Crimes Enforcement Network (FinCEN) underscores that these two agencies are becoming serious enforcement agencies in their own right, a trend that we expect will continue and even increase in 2016. Here's the breakdown:

DFS: The DFS was created in October 2011 by Governor Andrew Cuomo and the New York legislature by combining the New York State Insurance Department and the New York State Banking Department. New York and international banks with New York branches, as well as other financial service entities, such as check cashers and investment houses with a New York nexus, fall under the regulatory authority of the DFS. As New York is an international banking center, DFS's reach is therefore potentially very broad, in particular as to foreign banks with a New York presence. The DFS website states that the mission of the DFS is to "reform the regulation of financial services in New York to keep pace with the rapid and dynamic evolution of these industries, to guard against financial crises and to protect consumers and markets from fraud." Over the nearly five years since its creation and in keeping with its stated mission, the DFS has increasingly flexed its muscles in the financial crimes regulatory and enforcement arena. Illustrative of this are the actions DFS took in November and December of 2015, where the agency proposed new strict regulations regarding antiterrorism, anti-money laundering (AML) and cyber security requirements for the institutions under its authority and announced high-profile enforcement actions that it undertook on its own, independent of the DOJ or SEC:

DFS proposed rules/regulations:

  • December 1, 2015—Proposed rule that would require N.Y.-regulated financial institutions to comply with enhanced antiterrorism and AML requirements, including annual certification filings for chief compliance officers subjecting them to potential criminal liability for noncompliance: On behalf of the DFS, on December 1, 2015, Governor Cuomo announced proposed new antiterrorism and AML regulations applicable to N.Y.-regulated institutions that include a requirement, modeled on a similar provision in the Sarbanes-Oxley Act of 2002, that chief compliance officers certify that their institutions have sufficient systems in place to "detect, weed out, and prevent illicit transactions." In the press release, Governor Cuomo underscored the need for such regulations, stating that "[g]lobal terrorist networks simply cannot thrive without moving significant amounts of money throughout the world. At a time of heightened global security concerns, it is especially vital that banks and regulators do everything they can to stop that flow of illicit funds." The "key requirements" proposed to be imposed on "regulated institutions" include (1) the maintenance of a "Transaction Monitoring Program" for the purpose of "monitoring transactions after their execution for potential BSA/AML violations and Suspicious Activity Reporting"; (2) the maintenance of a "Watch List Filtering Program" for the purpose of "interdicting transactions, before their execution, that are prohibited by applicable sanctions, including OFAC and other sanctions lists, politically exposed persons lists, and internal watch lists"; and (3) the annual certification by the regulated institution's chief compliance officer, to be filed with the DFS, that the institution is in compliance with the regulation's requirements. In this last regard, the language of the proposed rule provides that "[a] Certifying Senior Officer who files an incorrect or false Annual Certification also may be subject to criminal penalties for such filing." The DFS instituted a 45-day comment period with respect to the proposed rule.
  • November 9, 2015—"Potential" new cyber security regulation requirements "aimed at increasing cyber security defenses within the financial sector": In a memo to the Financial and Banking Information Infrastructure Committee (FBIIC), Acting Superintendent of Financial Services Anthony J. Albanese states that DFS "considers cyber security to be among the most critical issues facing the financial world today—and one that poses a particular challenge to regulatory agencies." The agency's hope is that the memo to fellow financial agency regulators would "help spark additional dialogue, collaboration, and, ultimately, regulatory convergence among our agencies on new, strong cyber security standards for financial institutions." The memo states that, to this end, it is inviting feedback from FBIIC members on "key regulatory proposals" currently being considered by DFS for the institutions under its authority, including the requirements that "covered entities" (1) adopt, implement and maintain (i) written cyber security policies and procedures covering the areas set forth in the memo, (ii) policies and procedures ensuring the security of sensitive data accessible to third-party service providers and (iii) written procedures, guidelines and standards "reasonably designed" to ensure security of all applications utilized by the entity; (2) adopt procedures to implement multifactor authentication for access to both internal and external systems; (3) designate a Chief Information Security Officer (CISO) who would be responsible for (i) overseeing, implementing and enforcing the entities' cyber security policies; (ii) filing board-reviewed annual reports with the DFS assessing the strength of the cyber security program and the cyber security risks to the entity; and (iii) reviewing on an annual basis the entities' application security procedures; (4) employ personnel "adequate" to manage the entities' cyber security risks and provide mandatory ongoing training so that such personnel is able to "stay abreast" of changing cyber security threats; (5) conduct annual "penetration testing" and quarterly "vulnerability assessments" and maintain an "audit trail system"; and (6) immediately notify the DFS of any cyber security incident that has a "reasonable likelihood" of materially affecting the normal operation of the entity.

DFS enforcement actions:

  • December 17, 2015—Enforcement action against the only U.S. branch of Pakistan's largest bank, Habib Bank Limited, for "significant breakdowns" in the branch's AML compliance: The DFS announced that the AML compliance issues were identified during the most recent examination of Habib Bank Limited's New York branch (Bank and Branch, respectively) by the DFS and the Federal Reserve Bank of New York. Under the Order signed by the Bank and Branch, without the prior written approval of the DFS and FRB, the Bank and/or the Branch are restricted from increasing the aggregate dollar value of the Branch's U.S. dollar clearing activities above the aggregate dollar value balance as of the date of the Order or accepting any new foreign correspondent accounts or new customer accounts at the Branch for U.S. dollar clearing. In addition, the Bank and the Branch are required to retain an independent and qualified third party acceptable to the DFS and FRB to review the Branch's AML compliance procedures as well as its procedures involving the OFAC and other sanctions lists and, in both cases, provide a written report of findings, conclusions and recommendations to DFS.
  • November 18, 2015—Enforcement action against New York branch of Barclays Bank PLC resulting in the payment of an additional $150 million penalty and termination of senior employee in connection with alleged misconduct involving its automated, electronic foreign exchange (FX) trading "Last Look" program: The DFS announced that, together with a previous May 2015 enforcement action against the New York branch of Barclays Bank PLC (Branch and Bank, respectively) also related to manipulation in the spot FX trading market, the overall penalty the Bank has paid to the DFS pursuant to the FX enforcement actions is $635 million. In the Consent Order, the Bank and Branch admitted to using the Last Look system to automatically reject client orders that would be unprofitable for the Bank due to subsequent price swings during milliseconds-long latency (hold) periods and to misleading clients as to the reason for the rejected trades. In addition to paying the additional $150 million penalty, the Bank also agreed to terminate its Global Head of Electronic Fixed Income, Currencies, and Commodities Automated Flow Trading.

FinCEN: The Financial Crimes Enforcement Network (FinCen) is a bureau of the U.S. Department of Treasury that was first established by order of the Treasury Secretary in 1990 as a collector and repository of financial information through which information sharing with law enforcement agencies and regulators was coordinated. In 1994, its purview was broadened to include both regulatory and, via its merger with the Treasury Department's Office of Financial Enforcement, enforcement responsibilities for violations of the Bank Secrecy Act (BSA). FinCen's stated mission on its website is to "safeguard the financial system from illicit use and combat money laundering and promote national security through the collection, analysis, and dissemination of financial intelligence and strategic use of financial authorities." In 2015, FinCEN significantly raised its enforcement profile in the area of AML violations and failures under the BSA, including a $20 million assessment against Oppenheimer & Co. in January, a $75 million assessment against King Mail & Wireless in June and an $8 million assessment against Caesars Palace in September. In December 2015, FinCen forayed into new territory and announced two "first ever" enforcement actions against a precious metals dealer and a "card club," respectively, both deemed to be "financial institutions" under the BSA and thus subject to FinCen regulation:

  • December 30, 2015—Enforcement action announced against precious metals dealer: In its "first action against a dealer in precious metals, precious stones, or jewels," FinCEN announced that Los Angeles-based B.A.K. Precious Metals, Inc., its sole owner and its designated compliance officer admitted to violations of the AML laws of the BSA and were assessed a $200,000 civil penalty. B.A.K. and the individuals were further required to hire an external auditor and report back to FinCen on an annual basis through 2020 regarding their institution and implementation of a comprehensive AML program.
  • December 17, 2015—Enforcement action against a "card club" gaming business: FinCEN announced its "first settlement with and assessment against a 'card club' gaming establishment." Emeryville, California-based Oaks Card Club admitted that it "willfully violated" the AML and suspicious activity reporting requirements of the BSA and agreed to pay a $650,000 fine. Among other things, FinCEN found that the card club relied on inaccurate and misleading AML policies to train its staff, including failing to give instruction as to when employees should file Suspicious Activity Reports as required by the BSA.

See here and here to read (1) the DFS's 12/1/15 press release titled "Governor Cuomo Announces Anti-Terrorism Regulation Requiring Senior Financial Executives to Certify Effectiveness of Anti-Money Laundering Systems" and (2) the proposed regulation titled "Part 504—Banking Division Transaction Monitoring and Filtering Program Requirements and Certifications."

See here to read the DFS's 11/9/15 memo to the Financial and Banking Information Infrastructure Committee titled "Potential New NYDFS Cyber Security Regulation Requirements."

See here to read the DFS's 12/17/15 press release titled "NYDFS Announces Enforcement Action Against Habib Bank Limited."

See here to read the DFS's 11/18/15 press release titled "NYDFS Announces Barclays to Pay Additional $150 Million Penalty, Terminate Employee for Automated, Electronic Foreign Exchange Trading Misconduct."

See here to read FinCEN's 12/30/15 press release titled "FinCEN Assesses Money Penalty against Precious Metals Dealer for Violations of Anti-Money Laundering Laws."

See here to read FinCen's 12/17/15 press release titled "FinCEN's First Card Club Enforcement Action Leads to $650k Settlement with California's Oaks Card Club."

Keeping an Eye Out—Updates and Briefly Noted

1. Enforcement recap:

a. 12/3/15—Attorney General Loretta Lynch announced DOJ collections for Fiscal Year 2015: Attorney General Lynch announced that the DOJ collected an overall $23.1 billion from civil and criminal enforcement actions and resolutions in the fiscal year ended 9/30/15.

b. 12/23/15—Ukrainian national extradited from Poland to face charges related to $10 million cyber money laundering operation: Viktor Chostak, 34, of Ukraine, along with three other individuals, was charged in a 25-count indictment with money laundering, transporting stolen property, aggravated identity theft and conspiracy to commit money laundering, computer fraud, transportation of stolen property and access device fraud.

c. 12/21/15—Former trader at Royal Bank of Scotland pleaded guilty in Connecticut district court to conspiracy to commit securities fraud: Adam Siegal waived his right to indictment and agreed to cooperate. Siegal admitted to conspiring to increase the bank's profits by lying to customers about the prices of securities.

d. 12/17/15—Reviled hedge fund manager and drug company CEO Martin Shkreli arrested for securities fraud: Shkreli, who as CEO of Turing Pharmaceuticals recently raised the cost of a life-saving pill from $13.50 to $750, was accused in an unrelated case of illegally taking stock from a biotech company he founded to pay off debts from other business transactions.

e. 12/16/15—N.Y. state court of appeals agreed to hear appeal of a lower court's ruling that Facebook lacks standing to challenge search warrants seeking information on 381 of its account holders: The N.Y. state court of appeals announced that it would hear the appeal in Matter of 381 Search Warrants Directed to Facebook v. New York County District Attorney's Office. Facebook is challenging search warrants issued by the Manhattan District Attorney in connection with a Social Security fraud investigation, and the lower court had ruled that Facebook lacks standing to challenge the warrants.

f. 12/1/15—SEC charged Bitcoin mining companies with conducting a Ponzi scheme to defraud investors: The SEC announced that it had filed a complaint in Connecticut district court against two digital Bitcoin "mining" companies, GAW Miners and ZenMiner, and their founder for allegedly perpetrating a fraud on investors by offering them the opportunity to buy shares in a digital Bitcoin "mining" operation via a Ponzi scheme.

g. 11/24/15—DOJ announced that five individuals, including two doctors, were charged in kickback schemes involving nearly $600 million in fraudulent claims by Southern California hospitals: The DOJ announced that, in a series of related cases spanning an eight-year period, the former CFO of a Long Beach, California, hospital, two orthopedic surgeons and two other individuals were charged in a "long-running" healthcare fraud scheme that illegally referred thousands of patients for spinal surgeries and generated nearly $600 million in fraudulent billings.

2. District courts in Tennessee and California extend the "where to whistle" split (update to our October 2015 newsletter article "Do You Have to Whistle to the SEC to Get Protection Under Dodd-Frank? The Second Circuit Says No, Splits With Fifth Circuit"):

a. 12/8/15—An E.D. Tennessee judge in Verble v. Morgan Stanley Smith Barney, LLC sided with the Fifth Circuit in Asadi and held that Dodd-Frank whistleblowers must "whistle" to the SEC in order to have standing to bring suit under the act.

b. 11/21/15—An N.D. California magistrate judge in Wadler v. Bio-Rad Laboratories denied Bio-Rad's motion for interlocutory appeal to the Ninth Circuit. Bio-Rad had sought the interlocutory appeal in response to the judge's ruling on 10/23/15 that the former general counsel whistleblower could proceed with his suit under Dodd-Frank even though he did not "whistle" to the SEC. The judge specifically cited to and rejected the Fifth Circuit's Asadi opinion in his ruling. The judge also ruled that the "context and broad purpose" of the Sarbanes-Oxley Act of 2002 supports the conclusion that a director may be held individually liable as an "agent" under that Act and thus the whistleblower could proceed with his claims for retaliatory termination against Bio-Rad's board.

c. Other SEC whistleblower news: On 12/11/15, an unnamed whistleblower—who "tipped" the SEC about alleged wrongdoing at a "well-known" corporation in 2011 and still has not yet heard back from the SEC about whether the tip qualifies for a monetary award—filed a "first of its kind" petition with the D.C. Circuit seeking to compel the SEC to make the award determination within 60 days.

3. Challenges to SEC ALJ administrative hearings (update to our April, June and October 2015 ongoing series of "Wherefore Art Thou Due Process" articles):

a. 12/2/15—Former SEC Commissioner Joseph Grundfest testified before the House Financial Services Subcommittee on Capital Markets that the SEC faces a "crisis of confidence" over its in-house administrative proceedings: Grundfest also testified that there were "fundamental issues of fairness" raised by the SEC's increasing use of its five administrative law judges, including for "serious" cases. Grundfest's testimony was given in connection with the "Due Process Restoration Act of 2015" introduced by subcommittee head U.S. Rep. Scott Garrett (R-NJ) on 10/22/15. The bill would give targets of SEC investigations the right to terminate any SEC ALJ proceeding and move the case to federal court; and, for those that choose to proceed with the SEC in-house proceeding, the government's burden of proof would be increased.

b. 11/5/15—Bebo v. SEC: The Seventh Circuit denied plaintiff Bebo's motion for rehearing en banc.

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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