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News February 8, 2010 Issue

More on Enforcement Developments at SEC Speaks

It may have been the "snowpocalypse" or "snowmaggedon" outside (depending on which papers you read), but the Practicing Law Institute bravely completed a significant portion of its SEC Speaks program late last week before calling it to permit panelists and participants alike to scramble for the exits.

As part of its compressed program, the Enforcement panel packed a wallop, including in its presentation the new specialized unit chiefs who had been scheduled to present a workshop at the dayís end.

You may have been wondering, now that all these specialized units have been established, what will the rest of the enforcement staff be doing?

Robert Kaplan, new co-chief of the Asset Management unit, addressed the point directly. "To be clear, we have no intention Ė and wouldnít be able to if we wanted to Ė to supplant the rest of the division in their active role in enforcement in this space," said Kaplan. The division has a "tremendous demonstrated history of bringing terrific, complicated cases" concerning misconduct in the asset management space. Recent high profile cases such as State Street and Evergreen, as well as last yearís fund-of-funds case against the Hennessey Group demonstrate that the staff has been "active on the asset management beat and will continue to do so."

The unitís first goal, he said, is to aggressively bring important cases in the asset management space. The Division has a solid pipeline of asset management cases, he said, and the staff has been actively meeting with colleagues both inside and outside the agency to develop subject area priorities and build an inventory of high impact investigations.

The second role of the unit is to serve as a resource and a focal point for the expertise available throughout the division. Kaplan, along with co-chief Bruce Karpati, will seek to create an infrastructure to help the division and develop a more specialized understanding of the industry. They anticipate imminently posting positions to hire individuals with extensive industry experience in mutual funds, hedge funds and private equity firms to assist the unit and the rest of the division to identify, investigate and prosecute asset management violations.

As for the unitís priorities, Kaplan mentioned the following non-exhaustive list: preferential disclosures to institutional investors and insiders, disparate treatment of commonly managed funds or accounts, whether informational, or in the form of preferential redemptions or trade allocations, and whether trades are being allocated pari pasu. Those general violations as a risk class are probably one of the most pressing issues in the asset management space, said Kaplan.

The co-chiefs also have concerns about co-investments on the private equity and hedge fund sides, to the extent that the fund adviser doesnít appropriately manage those conflicts of interest and especially when theyíre investing side-by-side with investors.

The unit will scrutinize investing contrary to disclosures in offering memoranda and prospectuses, and investing contrary to other representations made to investors. Representations about performance, risk profile, exposure of firmís performance redemption rates, and skin in the game, are all hot issues. "The issues weíre going to be looking at are going to be as diverse as the industry itself," he said.

Dan Hawke, director of the Philadelphia Regional Office and new chief of the Market Abuse unit, also described division-wide support and the identification of high-impact investigations. A primary focus of his unit will be to sustain and enhance the Divisionís efforts with respect to large-scale insider trading cases, and especially "organized" insider trading conducted by large institutional investors and the market professionals associated with them and their networks. "To learn from each of the cases that we are conducting, sort of the unique attributes of how people engage in this type of trading and to share that info with staff throughout the division including staff outside of the unit to improve the way that they do their investigations," is a primary goal, said Hawke.

The unit will also focus on hard to detect violations such as those occurring on a systemic or platform basis inside the regulated community. Best execution, internal controls cases, analyst research practices, abusive short selling, front running, collusive and manipulative trading practices and large cap market manipulation cases that involve large amounts of data and a fair amount of coordination among the people engaged in the violative activity each will be targeted.

"I expect the unit will work closely with the criminal authorities where appropriate," said Hawke. Hawke plans to use new and novel investigative approaches and deploying technology to analyze large amounts of data quickly before "surfacing" an investigation. The unit will seek to develop its own leads, and will not wait for SRO referrals or media reports or complaints or tips before we look for suspicious trading patterns. The unit will be hiring specialists "who know where the bodies are buried," and understand trading practices. "We will only bring highly specialized cases," said Hawke, "so when we knock on your door, weíre going to be very interested in learning from you about our area of interest."

Division of Enforcement director Robert Khuzami (who co-lead the conference with Investment Management director Buddy Donohue), described his view of the specialized units. "The reason for specialization is pretty simple. In complex markets and products and transactions, deep understanding and knowledge is good. Even deeper understanding and more knowledge is better." The SEC has a special obligation to act with respect to complex frauds, said Khuzami, because otherwise, there is no significant law enforcement presence in some of these areas. There has been and is a great deal of expertise in the Division of Enforcement, he said, and even a passing glance at the kind of cases that have been brought underscores that point.

The specialized units will also allow the staff to identify wrongdoing earlier on in the life cycle of a fraud or a scheme, and to act before investor money is lost. "That is the holy grail," said Khuzami, "for any enforcement program, criminal or civil, to stop it before the money is lost, rather than pick up the pieces and distribute what remains." And lastly, he observed, the focus and attention and a steady diet of investigations in the same kind of areas just leads to more efficient investigations and more efficient use of resources. As a result, the staff can cover more ground overall as a division.

Several of the Divisionís regional directors highlighted specific enforcement tools that will enhance investigations.

David Bergers, director of the Boston Regional Office, emphasized the divisionís newly delegated subpoena powers. "This change has been incredibly significant," he said, and the staff is now able to "get evidence that wouldnít have been there the very next day." Some folks may have been surprised to get a subpoena the day they found out the SEC is interested in a matter. "I think you can expect to see that continuing," said Berger.

New York regional director George Canellos offered some insight into efforts to coordinate among various regulators and criminal authorities in an investigation.

There is some element of competition present when you have regulators with similar statutes and overlapping jurisdiction, said Canellos. It puts the pressure on to stay current, cutting edge, and relevant. One of the challenges of law enforcement is in maintaining consistent national standards. It is no longer the case necessarily, he said, that the SEC sets the "governing standard of the land". The obligation therefore, is to be thorough, responsible, and to avoid duplicative efforts among regulators. Canellos noted that itís a big challenge for enforcement officials to act in ways to avoid imposing inconsistent burdens on the targets of an investigation. For example, SEC and federal grand jury procedures include confidentiality of investigation provisions, but not all state rules do.

Former SEC Chairman and panel commentator Harvey Pitt asked "Has any consideration been given to the interplay between the renewed emphasis on individual cooperation and cooperation with other regulators?" If somebody comes in and the staff believes thatís a person who might have very valuable information, will the staff agree or make arrangements to try to at least encourage comparable treatment of the same person with respect to other regulators?

Yes, said Canellos. One of the revisions of the divisionís "cooperation tools" is the revision of the standard proffer agreement. That agreement, which would accord an interviewee protections such as limited immunity to incentivize cooperation, contained a standard warning about "access requests." Pursuant to those requests, the SEC could share the information obtained with other regulators and criminal authorities. Those other enforcement officials could do whatever they wanted with the information, including using it directly against the interviewee. That didnít seem to make much sense, said Canellos. "Our new proffer agreement now provides that, unless weíre required by law, we will not provide information we obtain by proffer to any other regulators or law enforcement organizations unless they agree to abide by the same restrictions that would apply to us." The Enforcement Division is giving a great deal of attention to that, especially at the criminal level he said, because many cooperation tools only work in some cases when they are used in harmony with the federal criminal prosecutorsí own cooperation tools.

"Frankly, we expect defense counsel to demand that kind of coordination before they sign up," added Khuzami, "itís good law enforcement practice and a practical necessity."