Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.
One Financial Center,
Boston, MA 02111
Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.
One Financial Center,
Boston, MA 02111
§ 1.1 Introduction
The volumes of final judicial and enforcement actions decreased somewhat in 2020 due to disruptions associated with the global coronavirus pandemic. As in previous years, a significant amount of financial institutions’ enforcement litigation that established important precedents was settled, due in part to the difficulties associated with disputing cases brought by one’s regulator. Still, there were some very important cases, including enforcement actions imposing record monetary penalties. Key themes of 2020’s financial institutions’ litigation include cases arising in alleged failures by all types of financial institutions to address suspicious activities by institutional and retail customers. We summarize instances in which a banking official, broker-dealers, a futures commission merchant, and a cryptocurrency money transmitter all allegedly failed to detect and report suspicious activity and agreed to significant fines. Another case holds an institutional broker-dealer responsible for providing direct market access to other broker-dealers that operated alternative trading systems and allegedly conducted a wide range of market manipulation schemes. We also discuss the continuation in 2020 of sales practice-related cases centering on special investor protection issues for more complex retail investment products like variable annuities and unit investment trusts. We hope you find this summary of key cases on financial institutions’ legal and regulatory requirements helpful and welcome any feedback.
§ 1.2 Banking Institutions
In the Matter of Michael LaFontaine, 2020-01, U.S. Department of the Treasury Financial Crimes Enforcement Network (Feb. 26, 2020)
Michael LaFontaine, the former Chief Operational Risk Officer at U.S. Bank National Association (“U.S. Bank”), accepted a fine from the Financial Crime Enforcement Network (“FinCEN”) in the amount of $450,000 in connection with his role in anti-money laundering (“AML”) violations committed by U.S. Bank. FinCEN found that, while Mr. LaFontaine was in charge of U.S. Bank’s AML compliance function, the bank improperly capped the number of alerts generated by its automated transaction monitoring system and failed to adequately staff the Bank Secrecy Act (“BSA”) compliance function. This matter is of interest because FinCEN placed weight on the fact that a separate institution, Wachovia Bank, had previously been fined by FinCEN for similar conduct, and Mr. LaFontaine “should have known based on his position the relevance of the Wachovia action to U.S. Bank’s practices or conducted further diligence to make an appropriate determination.” In essence, individuals responsible for AML compliance must be aware of regulatory actions generally in the industry. Further, the targeting of the individual executive starkly reminds the industry that AML suspicious activity monitoring parameters must be set based on actual AML risks, not arbitrary volume limits, and that suspicious transaction volumes, not desired resource expenditure levels, must dictate the amount of suspicious activity monitoring and investigation a financial institution conducts. Mr. LaFontaine admitted to all facts in consenting to the $450,000 penalty.
In the Matter of TD Bank, N.A. (“TD Bank”), CFPB Administrative Proceeding No. 2020-BCFP-0007 (August 20, 2020)
TD Bank consented to an order by the CFPB relating to the marketing and sale of its optional overdraft service, without admitting or denying the findings. According to the CFPB, TD Bank’s general practice was not to present new customers with a written overdraft notice until the end of the account-opening process, and without having provided written disclosures. The overdraft service forms were pre-filled by TD Bank, and CFPB viewed these practices as amounting to an “opt-out” procedure as opposed to the “opt-in” procedure for overdraft services as mandated by Regulation E, and were deceptive acts or practices. According to the CFPB, TD Bank’s practices also violated the Electronic Fund Transfer Act (“EFTA”) and Regulation E by charging consumers overdraft fees for ATM and one-time debit card transactions without obtaining their affirmative consent. TD Bank agreed to pay restitution in the amount of $97,000,000 and a civil monetary penalty in the amount of $25,000,000.
In the Matter of Citibank (“Citi”), National Association, OCC Case AA-EC-2020-65 (October 2, 2020)
Without admitting or denying the allegations, Citi settled an Office of the Comptroller of the Currency (“OCC”) enforcement action alleging that it failed to implement and maintain an enterprise-wide risk management and compliance risk management program, internal controls, or a data governance program commensurate with the Bank’s size, complexity, and risk profile. The OCC found Citi violated 12 C.F.R. Part 30, Appendix D, “OCC Guidelines Establishing Heightened Standards for Certain Large Insured National Banks, Insured Federal Savings Associations, and Insured Federal Branches,” and conducted unsafe or unsound practices with respect to the Bank’s enterprise-wide risk management and compliance risk management program. Deficiencies the OCC found included: (a) failure to establish effective front-line units and independent risk management; (b) failure to establish an effective risk governance framework; (c) failure of the Bank’s enterprise-wide risk management policies, standards, and frameworks to adequately identify, measure, monitor, and control risks; and (d) failure of compensation and performance management programs to incentivize effective risk management. The OCC further found Citi lacked clearly defined roles and responsibilities, resulting in noncompliance with multiple laws and regulations and unsafe or unsound practices with respect to the Bank’s data quality and data governance, including risk data aggregation and management and regulatory reporting. The OCC alleged that these enterprise risk management failures contributed to separate violations of: the Fair Housing Act, 42 U.S.C. § 3601—19, and its implementing regulation, 24 C.F.R. Part 100; the holding period for other real estate owned, 12 U.S.C. § 29 and 12 C.F.R. § 34.82; and the Flood Disaster Protection Act, as amended, 42 U.S.C. § 4012a(f), and its implementing regulations, specifically 12 C.F.R. § 22.7(a). The OCC noted Citi has begun taking corrective action and has committed to taking all necessary and appropriate steps to remedy the deficiencies identified by the OCC. Citi agreed to pay a civil monetary penalty of $400,000,000. The case is an important example of how federal banking regulators will aggregate various risk, control, and governance issues to impose large fines under the stricter enterprise risk management requirements specifically imposed on large institutions by the Dodd-Frank Wall Street Reform and Consumer Protection Act and related guidance issued by federal banking regulators.
§ 1.3 Securities Institutions
In the Matter of Department of Enforcement vs. Wilson-Davis & Co., Inc., James C. Snow, and Byron B. Barkley, FINRA Case No. 2012032731802 (Dec. 19, 2019)
The National Adjudicatory Council affirmed the Decision of a FINRA Hearing Panel finding that the Respondents (1) engaged in short selling in violation of Regulation SHO of the Securities Exchange Act of 1934 (“Reg SHO”), (2) failed to supervise registered representatives generally, including failure to supervise instant message communications, and (3) failed to establish and implement AML policies and procedures and conduct adequate AML training. These findings also triggered violations of NASD Rule 3010 and FINRA Rule 2010. Mr. Snow and Mr. Barkley were two of the three principals of Wilson-Davis. According to FINRA, the short sales were designed to carry out a speculative trading strategy, and not as “bona fide market making activities.” FINRA also found that the written supervisory procedures “did not provide procedures, processes, tests, or guidance that would permit an evaluation by supervisors at the firm of whether the particular facts of a short sale transaction established that a sale was made in connection with bona-fide market making activity … [and that] the firm did not even have procedures for locating or borrowing securities for its short sales because the firm considered all trading to be bona-fide market making.” Wilson-Davis was fined $350,000 and ordered to disgorge $51,624 plus prejudgment interest for the violations of Reg SHO. The firm was fined an additional $750,000 and directed to retain an independent consultant for its failures to supervise and implement adequate AML procedures. Mr. Snow was fined $77,000 and suspended for one year as a principal and supervisor (including three months in all capacities) for AML violations. Mr. Barkley was fined $52,000 and suspended for one year as a principal and supervisor (including three months in all capacities) for short sale violations.
Robinhood Financial, LLC (“Robinhood”), AWC No. 2017056224001, FINRA (December 20, 2019)
Without admitting or denying the findings, Robinhood agreed to a settlement of an enforcement action alleging violations of FINRA Rule 5310 (“Best Execution”) relating to equity orders, and related supervisory failures. For a period of more than a year, Robinhood routed non-directed equity orders to four separate broker-dealers, each of whom paid back Robinhood for the order flow. Best Execution requires that firms use reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. This obligation can be satisfied by either reviewing order-by-order, or conducting what is known as “a regular and rigorous review.” According to FINRA, Robinhood failed to do either, and did not have written supervisory procedures for Best Execution outside of merely reciting the regulatory requirements. The result was hundreds of thousands of orders a month falling outside of a compliant review process. In addition to accepting a censure and retaining an independent consultant, the firm paid a fine in the amount of $1,250,000.
Credit Suisse Securities (USA) LLC (“Credit Suisse”), AWC No. 2012034734501, FINRA (December 23, 2019)
Without admitting or denying the findings, Credit Suisse agreed to a settlement of an enforcement action alleging violations of Exchange Act Rule 15c3-5 (the “Market Access Rule”). Over a four-year period, Credit Suisse offered clients direct market access (“DMA”) to a number of exchanges and alternative trading systems (“ATSs”), generating in excess of $300 million in revenue. In addition to accepting a censure and retaining an independent consultant, the firm paid a fine in the amount of $1,250,000. FINRA alleged that, despite this large revenue figure, Credit Suisse failed to implement reasonable supervisory procedures to detect manipulative activity by its DMA clients. This failure resulted in more than 50,000 alerts at FINRA and multiple exchanges for potential manipulation, including spoofing, layering, wash sales, and pre-arranged trading that Credit Suisse allegedly allowed to continue unabated. In addition to a censure, Credit Suisse agreed to update its supervisory policies and procedures with respect to DMA clients, and pay a fine of $6,500,000.
Prudential Investment Management Services LLC (“PIMS”), AWC No. 2015047966801, FINRA (January 2, 2020)
Without admitting or denying the findings, PIMS settled an enforcement action with FINRA relating to the allegedly inaccurate information it provided with respect to group variable annuities (“Group VAs”). According to FINRA, PIMS provided inaccurate expense ratio and historical performance information to employer sponsors and employee participants over a period of seven years, in violation of FINRA’s advertising content rules. Additionally, for a period of 15 years, PIMS allegedly provided performance data for money market funds available as investment options in retirement plans without providing the seven-day yield information required by SEC Rule 482. The result of this failure was that plan participants using the communications did not have up-to-date yield information when making investment decisions, as required by the Rule. In addition to a censure, PIMS agreed to retain an independent consultant and pay a fine of $1,000,000.
Virtu Americas LLC (“Virtu”), AWC No. 2015045441001, FINRA (February 2, 2020)
Without admitting or denying the findings, Virtu agreed to settle an enforcement action relating to its trading of over-the-counter (“OTC”) securities. According to FINRA, Virtu failed to immediately execute, route, or display 156 customer limit orders in OTC securities in violation of FINRA Rule 6460 and to timely report nearly 500 transactions in Trade Reporting and Compliance Engine (“TRACE”)-Eligible Securities in violation of FINRA Rule 6730. Virtu also allegedly violated FINRA Rule 6437 (the “Locked/Crossed Rule”) by failing to implement policies designed to avoid displaying locking or crossing quotations in any OTC Equity Security. Virtu agreed to a censure and a fine of $250,000. This fine included $100,000 for the Locked/Crossed Rule violations and $40,000 for TRACE-related violations.
In the Matter of the Application of Newport Coast Securities, Inc. (“Newport”), SEC Admin. Proc. File No. 3-185555 (April 3, 2020)
The SEC upheld a FINRA decision (1) expelling Newport from FINRA membership; (2) imposing a $403,000 fine; and (3) ordering payment of more than $900,000 in restitution and costs. FINRA imposed these sanctions upon a finding that Newport’s registered representatives engaged in a five-year pattern of excessive trading, churning, and qualitatively unsuitable recommendations. According to FINRA, Newport abdicated its responsibility to supervise those representatives. Newport did not contest liability or the fines assessed. Rather, Newport argued that the proceedings were constitutionally and procedurally defective and that the order of expulsion was excessive and oppressive. Specifically, Newport argued that the expulsion was punitive because the firm was no longer doing business, was an undue burden on competition, and was disproportionate to the claimed supervisory failures. The SEC disagreed, finding that “Newport abused its customers’ trust and confidence by excessively trading and churning their accounts and by making qualitatively unsuitable recommendations. These were not isolated incidents; rather, they were repeated, years-long securities law violations committed against more than twenty customers by multiple representatives and across multiple offices.” The SEC also found that there was no evidence of any procedural or constitutional abnormalities and that FINRA did not single out Newport unfairly. The SEC sustained FINRA’s findings of violations and imposition of sanctions in their entirety.
SagePoint Financial, Inc. (“SagePoint”), AWC No. 2018056858101, FINRA (June 10, 2020)
Without admitting or denying the findings, SagePoint agreed to settle a FINRA enforcement action alleging failure to supervise its registered representatives’ recommendations to customers for early rollovers of Unit Investment Trusts (“UIT”), an area where both the SEC and FINRA have had increasing focus over the past few years. A UIT is a type of registered investment company offering a fixed (unmanaged) portfolio of securities having a definite life. The common maturity date of a UIT is between 15 and 24 months from initial offering, and at maturity, the investor will usually receive the proceeds of the value of the investment, accept a rollover of the investment into a new UIT, or receive an in-kind transfer of the UIT’s underlying portfolio securities. According to regulators, UITs are generally not suitable for short-term holds because of their fee structure. The early liquidation of a UIT accompanied by the rollover of investor positions into another UIT is particularly problematic for regulators due to the attendant sales charges generated for the broker. FINRA found that SagePoint executed more than $895 million in UIT transactions during a four-year period that generated more than $17.2 million in sales charges. This included $203.7 million in proceeds for early rollovers and $65.8 million in proceeds for trades where the UIT is rolled over to purchase a subsequent series in the same UIT (known as “series-to-series rollovers”). SagePoint agreed to a censure, a fine of $300,000 and restitution in the amount of $1,315,373.01.
In the Matter of Department of Enforcement vs. Sandlapper Securities, LLC, (“Sandlapper”) Trevor Lee Gordon, and Jack Charles Bixler, FINRA Case No. 2012032731802 (June 23, 2020)
The National Adjudicatory Council affirmed the Decision of a FINRA Hearing Panel finding that (1) the respondents defrauded investors; (2) Mr. Gordon and Mr. Bixler caused Sandlapper to be an unregistered broker-dealer; and (3) Sandlapper and Mr. Gordon failed to reasonably supervise investment sales. These findings amounted to willful violations of Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), Exchange Act Rule 10b-5, and FINRA Rules 2010 and 2020. The underlying scheme involved the purchase of fractional interests in saltwater disposal wells from a well operator, and reselling those interests to investors. Over a three-year period, more than $12 million was raised from 170 investors to fund this endeavor. According to FINRA, the sales of the fractional interests were fraudulent, and investors were overcharged by $8 million through excessive markups. Additionally, despite the fact that Mr. Gordon and Mr. Bixler claimed the investments were not securities, FINRA found otherwise. Therefore the failure to register Sandlapper as a broker-dealer was another violation. The NAC upheld the sanctions in their entirety, including expulsion of Sandlapper, a permanent bar for Mr. Gordon and Mr. Bixler, and restitution totaling $7.1 million.
Frederick Scott Levine, AWC No. 2018057247201, FINRA (July 21, 2020)
Without admitting or denying the findings, Mr. Levine agreed to settle a FINRA enforcement action alleging “an unsuitable pattern of short-term trading of [UITs] in customer accounts.” This enforcement action continues FINRA’s apparent interest in early rollovers of UITs (see Sagepoint case summary above), and shows that FINRA is targeting individuals as well as firms. According to FINRA, Mr. Levine recommended early rollovers to customers on approximately 950 occasions, 600 of which were series-to-series rollovers. FINRA found that these recommendations “caused his customers to incur unnecessary sales charges and were unsuitable in view of the frequency and cost of the transaction.” Mr. Levine agreed to a three-month suspension and a $5,000 fine.
Morgan Stanley Smith Barney LLC (“MSSB”), AWC No. 2019063917801, FINRA (August 12, 2020)
Without admitting or denying the findings, MSSB agreed to a settlement of an enforcement action alleging failure to supervise a registered representative in recommending trades without a reasonable basis for doing so. During a period of five years, the registered representative engaged in a practice of recommending the purchase of corporate bonds or preferred securities, only to then recommend the sale of the same investments shortly thereafter. According to FINRA, this practice resulted in losses to the customers, while at the same time generating increased sales charges for the representative. MSSB’s automated system generated multiple alerts relating to this activity, and the compliance department conducted a review concluding that the representative’s recommendations were “generating high costs/commissions and the products/investment strategies were costing the clients more money than they are making the client.” Despite these facts, MSSB did not take action sufficient to address the representative’s practices, resulting in more than $900,000 in customer losses over the relevant period. MSSB consented to a censure, a fine of $175,000, and restitution in the amount of $774,574.08, plus interest. In a related action, the registered representative received a permanent bar from associating with any FINRA member firm. This matter reflects an ongoing trend of FINRA levying fines on firms for failure to supervise excessive short-term trading, not just in equities, but also as here in fixed income securities.
Jose A. Yniguez, AWC No. 2018060543701, FINRA (August 25, 2020)
Without admitting or denying the findings, Mr. Yniguez agreed to settle a FINRA enforcement action relating to failing to disclose an Outside Business Activity (“OBA”) and participating in a private securities transaction. The actual allegations here are not extensive relative to other enforcement actions: Mr. Yniguez only received $5,000 from his OBA, and the total investment of individuals he referred to the private securities transaction amounted to $99,000, while his undisclosed investment was $4,300 (Mr. Yniguez also received $1,600 in referral compensation). What is notable, however, is that while the fine and disgorgement totaled $14,000, the representative was suspended for 14 months – a considerable period of time in light of the allegations.
§ 1.4 Derivatives Institutions
United States Commodity Futures Trading Commission vs. Peter Szatmari, Civil Action No. 19-00544, United States District Court for the District of Hawaii (July 28, 2020)
The CFTC secured a default judgment against Peter Szatmari in the amount of $13,800,000 for fraudulently soliciting U.S. residents to open binary options trading accounts. Mr. Szatmari engaged in “affiliate marketing,” a form of performance-based marketing promoting third-party products or services, such as binary options trading. This activity is typically conducted by email or internet postings. According to the CFTC, Mr. Szatmari intentionally defrauded customers by sending marketing solicitations that “(1) misrepresented that trading binary options would generate guaranteed profits while minimizing or disclaiming any risks; (2) claimed trading software was tested and produced profits when software had not been tested; (3) used actors or fake personalities as real owners of the trading software; and (4) depicted fictitious trading results as real.” The Court found that Mr. Szatmari “intentionally committed fraud in connection with his binary options which qualify as a ‘swap’ under Section 1a(47)(A), 7 U.S.C. § 1a(47)(A).” The judgment includes $6,258,250 in restitution, $1,899,837 in disgorgement, and a civil monetary penalty of $5,700,000.
In the Matter of JPMorgan Chase & Co., JPMorgan Chase Bank, N.A., and J.P. Morgan Securities LLC (together, “JPMorgan”), CFTC Docket No. 20-69 (Sept. 29, 2020)
The CFTC settled charges against JPMorgan alleging manipulative and deceptive conduct and spoofing with respect to precious metals and U.S. Treasury futures over an eight-year period. This settlement is significant because JPMorgan agreed to a payment of $920,203,609, representing the largest amount of monetary relief ever imposed by the CFTC. According to the stipulated findings, “[JPMorgan] traders placed hundreds of thousands of orders to buy or sell futures contracts with the intent to cancel them before execution, intentionally sending false signals of supply or demand designed to deceive market participants into executing against other orders they wanted filled.” The CFTC noted JPMorgan’s cooperation in the early stages of the investigation was “unsatisfactory[,]” but that it was cooperative in the later stages of the investigation. According to the CFTC, JPMorgan benefitted from the scheme in the amount of $172,034,790, which was the total amount of disgorgement under the settlement. Restitution was in the amount of $311,737,008 and the civil monetary penalty was $436,431,811.
In the Matter of Interactive Brokers LLC (“Interactive Brokers”), SEC File No. 3-19907 (Aug. 10, 2020)
Interactive Brokers, AWC No. 2015047770301, FINRA (Aug. 10, 2020)
In the Matter of Interactive Brokers, CFTC Docket No. 20-25 (Aug. 10. 2020)
Interactive Brokers settled with three separate regulatory entities for a total of $38 million, without admitting or denying the findings. According to the SEC, Interactive Brokers failed to file at least 150 SARs in connection with the potential manipulation of microcap securities in its customers’ accounts, leading to $11,500,000 in fines. The same alleged activity constituted violations of AML rules resulting in $15,000,000 in fines payable to FINRA and $12,000,000 million to the CFTC. Some of the activity cited by the SEC that should have resulted in SARs filings included:
- Interactive Brokers’ customers deposited large blocks of microcap securities followed by sales of those securities and the rapid withdrawals of the proceeds from the customers’ accounts.
- Customer sales accounted for a significant portion of the daily trading volume in certain U.S. microcap securities issuers.
- Interactive Brokers failed to review at least 14 deposits of U.S. microcap securities where the security at issue had been the subject of an SEC trading suspension.
With respect to the AML violations, FINRA and the CFTC determined that:
- Interactive Brokers’ customers wired hundreds of millions of dollars, including to countries recognized as “high risk,” without being surveilled for money laundering concerns.
- Interactive Brokers lacked sufficient personnel and a reasonably designed case management system to investigate suspicious activity, despite being warned of such deficiencies by a compliance manager.
- Interactive Brokers failed to establish and implement policies, procedures, and internal controls reasonably designed to cause the reporting of suspicious transactions as required by the Bank Secrecy Act (“BSA”).
- Even where Interactive Brokers maintained written policies, it did not commit adequate resources to monitor, detect, escalate, and report suspicious activity in practice, commensurate with the size and scope of its business.
The FINRA and CFTC settlements carried with them the additional penalty that Interactive Brokers must retain an independent compliance consultant and disgorge $700,000 in profits. These matters highlight that AML compliance was singled out as a 2020 examination priority of both the SEC and FINRA.
§ 1.5 Money Services Businesses
In the Matter of Larry Dean Harmon d/b/a Helix, 2020-2, U.S. Department of the Treasury Financial Crimes Enforcement Network (Oct. 19, 2020)
In its authority pursuant to the Bank Secrecy Act (“BSA”), FinCEN assessed a civil monetary penalty against Larry Dean Harmon as the primary operator of Helix and as CEO and primary operator of Coin Ninja LLC (“Coin Ninja”) in the amount of $60,000,000. During the relevant time period, Mr. Harmon and Coin Ninja were doing business as “money transmitters” as defined by 31 C.F.R. § 1010.100(ff)(5) in their capacity as exchangers of convertible virtual currencies, accepting and transmitting bitcoin. Over the course of a five-year period, Harmon (1) failed to register as a money services business on behalf of himself and Coin Ninja; (2) failed to implement an effective AML program; and (3) failed to report certain suspicious activity. With respect to the unreported suspicious activity, FinCEN identified at least 2,464 instances in which Mr. Harmon failed to file a SAR for transactions involving Helix. Helix was also involved in $39,074,476.47 in bitcoin transactions with darknet and other illicit marketplace-associated addresses. FinCEN determined that a maximum penalty would have been $209,144,554, but ultimately settled on the $60,000,000 fine. The reasons for the reduced fine are not expressly detailed in the Order, but FinCEN noted that Helix agreed to two statute of limitations tolling agreements.