SEC Officials Emphasize Compliance's Importance, Accountability

Two top officials with the Securities and Exchange Commission stressed the importance of an effective compliance department in remarks during the Compliance Week 2014 conference in Washington, D.C. last week. They also suggested that the SEC won't hesitate to pursue companies and executives for compliance lapses where they have failed to act appropriately to stop fraud.

Those officials had some tough words for compliance officers, reminding them that they could be under investigation even if they didn't directly take part in a fraud. Commissioner Kara Stein, during her remarks, stressed that the SEC will pursue compliance officers themselves if they are “assisting fraud, ignoring red flags, not asking tough questions, and not demanding answers.” 

SEC Enforcement Director Andrew Ceresney also said the SEC will pursue companies more readily for compliance failures, during a keynote speech, and that charges could hit individual executives. “We continue to bring actions against legal and compliance officers when appropriate, particularly when individuals have actively participated in wrongful conduct,” he said.

Stein hinted that the SEC may issue more guidance on exactly what the SEC expects from CCOs. “We owe it to you to remove some of this uncertainty so that you can fully unleash your power,” she said. “One way to do this is for the Commission to provide guidance that sets clear expectations on what it means to act appropriately. And, when those expectations are met, a CCO can have comfort that he or she will not face liability.”

Such guidance could contain basic obligations, standards for escalating issues, and best practices if the CCO receives an unsatisfactory response. “There are no easy answers here, but we must make the effort to bring guidance and clarity to you on these issues,” Stein said.

Ceresney offered some ideas of his own that companies can use to determine if the compliance program is being elevated to the proper level of importance. “Companies that have done well in avoiding significant regulatory issues typically have prioritized legal and compliance issues and developed a strong culture of compliance across their business lines,” he said.

Ceresney added that companies can predict a lot about the likelihood of an enforcement action by asking a few simple questions about the role of its legal and compliance officers. These questions include:

Are legal and compliance personnel included in critical meetings?

Are their views sought and followed?

Do legal and compliance officers report to the CEO and have significant visibility to the board?

Are legal and compliance departments viewed as important partners in the business, and not simply as support functions or a cost center?

“Far too often, the answer to these questions is ‘no,'” Ceresney said. This is a problem, because the absence of legal and compliance involvement can lead to compliance lapses, which can lead to enforcement actions, he said.

“Our philosophy is that if you have engaged and are operating in good-faith trying to alleviate the situation, I can't conceive that we would be bringing an enforcement action against you.”

—Andrew Ceresney,

Enforcement Director,

SEC

“We've Got Your Back”

The SEC officials made it clear that they weren't interested in making compliance officers who are acting in good faith the targets of more enforcement actions or driving individuals from the profession by heaping liability on them. “It is clear to me that the vast majority of CCOs are working hard and getting good results,” Stein said. She described compliance as a bedrock of good financial markets and stressed that the intent of the SEC is to empower compliance officers to do their job. In fact, recent enforcement actions levied against CCOs should encourage—rather than discourage—other CCOs “to continue to be vigilant and assertive,” she asserted.

Ceresney voiced a similar sentiment. “You should not hesitate to provide advice to help remediate when problems arise,” he said, adding that compliance officers should not be concerned that, by doing their jobs, they will somehow be exposed to liability.

“Our philosophy is that if you have engaged and are operating in good-faith trying to alleviate the situation, I can't conceive that we would be bringing an enforcement action against you,” Ceresney said. “At the end of the day, legal and compliance officers that perform their responsibilities diligently, in good faith, and in compliance with the law are our partners and need not fear an enforcement action,” he added.

Furthermore, Stein stressed that the Commission will “have your back when others try to prevent you from doing your job.”

SEC Commissioner Kara Stein said the Commission will, “have your back when others try to prevent you from doing your job.”

She cited, for example, the case where the SEC sanctioned Carl Johns, a former portfolio manager at investment firm Boulder Investment Advisers, last August for forging documents and misleading the firm's chief compliance officer to conceal his failure to report personal trades. In that case, an SEC investigation found that Johns failed to report several hundred securities trades in his personal accounts as required under the federal securities laws and the code of ethics at BIA.

Carrots and Sticks

Stein posed a question to the audience: “How can the Commission help you make prevention more effective?” While support and guidance is important for the SEC to offer compliance officers, there must also be “sticks” to go with those “carrots,” she said.

In recent months, the SEC has issued record-setting fines for, among other matters, mis-stating financial results and lacking effective internal controls. Yet even the heftiest of fines often amounts to a fraction of a firm's quarterly net income.

“If our actions become nothing more than a footnote in the litigation reserve section of a firm's financial statements, or a brief media storm that can be easily weathered before it is back to business as usual, have we been effective?” Stein asked. “Or is it more effective to hold individuals to account?  The people who could have, and should have, prevented the harm? This may help empower each of you in making the case to your clients and your firms that they should heed your advice.” She praised the SEC's enforcement staff for bringing “tough and important cases” that help send that message.

Ceresney elaborated on those efforts in his speech. “We had more trials in the first half of this fiscal year than we had during all of the last fiscal year,” he said. “This renewed focus does not mean we will win every case,” he said. “What it does mean is that defendants know we will not hesitate to go to trial, and that when we are in court, defendants will face skilled, tireless advocates who will present as strong a case as possible on our behalf.”  

When Are CCOs Management?

Additional insight into when compliance officers might find themselves facing personal liability comes from a series of frequently asked questions released by the Securities and Exchange Commission's Division of Trading and Markets last year. Selections from that guidance include:

The Commission has brought failure to supervise actions against broker-dealer legal or compliance personnel only in limited circumstances in which these individuals have been delegated, or have assumed, supervisory responsibility for particular activities or situations, and therefore have “the requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue.”

Once a person has supervisory obligations, he or she must reasonably supervise with a view to preventing violations of the federal securities laws, the Commodity Exchange Act, the rules or regulations under those statutes, or the rules of the Municipal Securities Rulemaking Board. That person must reasonably discharge those obligations or know that others are taking appropriate action. It is not reasonable for a person with supervisory obligations to be a mere bystander to events that occurred, or to ignore wrongdoing or “red flags” or other suggestions of irregularity.

Source: SEC.

Trials can't happen without an investigation, and so the SEC is also devoting greater resources to specialized task forces, such as its new Financial Reporting and Auditing Task Force. “The importance of pursuing financial fraud cannot be over-stated,” Ceresney said. “Comprehensive, accurate, and reliable financial reporting is the bedrock upon which our markets are based, because false financial information saps investor confidence and erodes the integrity of the markets.”    

The Task Force's mandate is to “incubate financial reporting cases by finding promising investigations,” said Ceresney. “It brings together an experienced group of attorneys and accountants who are developing state-of-the-art techniques for identifying and uncovering accounting fraud.” 

Just as compliance officers are sweating personal liability amid these crackdowns, corporate counsel must also be wary. “One gatekeeper that often is absent from the list of cases I see every week are the lawyers,” Stein said. “When lawyers provide bad advice or effectively assist in a fraud, sometimes their involvement is used as a shield against liability for both themselves, and for others,” she said. “Are we treating lawyers differently from other gatekeepers, such as accountants? I think we should carefully review the role that lawyers play in our markets, with a view toward how they can better help deter misconduct and prevent fraud.”