The Friday List: Top 10 CCO Liability Cases
Today, I offer the “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues. The Friday Lists are an expanded “Our Take” on a particular subject, offering my unique (and sometimes controversial) perspective on an industry topic.
The New York City Bar Association recently issued a framework for Chief Compliance Officer liability. The lawyers’ group recommended that the SEC only charge a CCO that has exhibited a “wholesale failure” in carrying out his/her compliance responsibilities. The NYC Bar recommends limiting liability to situations where (i) the CCO did not make a good faith effort, (ii) the failure related to a fundamental aspect of the compliance program; (iii) the CCO repeatedly fails to remedy the breach after notice and an opportunity to cure; (iv) the legal obligations were unambiguous; and (v) there were aggravating factors such as intentional misconduct or extreme disregard. The Report would also allow for cases where the CCO actively participated in the fraud or misconduct by adding value to the wrongdoing or engaged in a pattern of obstructing the SEC. We have long advocated for a more protective standard that only holds CCOs liable if s/he participated in the wrongdoing, actively covered it up, or directly and personally benefited. Most industry players, although they may disagree on the liability standard, do agree that we need clearer guidance. Currently, CCOs must look to a series of enforcement cases to read the liability tea leaves. To assist, I list below the 10 most significant CCO liability cases so that CCOs can understand the parameters of their potential personal liabilities.
Top 10 CCO Liability Cases
- Approving misleading marketing materials. A CCO was found negligent in approving marketing materials that the SEC argued furthered an underlying Ponzi scheme. The SEC did not determine that the CCO knew about the underlying fraud, although the regulator asserted that he ignored several red flags.
- Neglecting required board reporting. The SEC censured and fined a Chief Compliance Officer for failing to report to the fund board a portfolio manager’s personal investments in which his fund also invested. The SEC asserted that the CCO knew about the activity and allowed it to continue in violation of the firm’s policies.
- Failing to stop AML. As part of his settlement with FinCEN and the U.S. Attorney, the Chief Compliance Officer of a money transmitter agreed to pay a $250,000 penalty and accept a 3-year bar from serving in a compliance function after admitting that he failed to stop potential money laundering despite significant red flags.
- Signing incorrect certifications. The SEC censured and fined the Chief Compliance Officer of a broker-dealer for signing certifications that she knew, or should have known, were inaccurate, thereby enabling her firm to engage in unlawful securities lending transactions. The SEC argued that the CCO knew the firm did not comply with the applicable underlying agreements that were the subject of the certifications.
- Aiding/Abetting misleading disclosure. The SEC accused a compliance officer of ignoring misstatements in offering documents and client communications. The SEC charged the compliance officer with securities fraud and aiding and abetting his employer’s violations by “adding an aura of legitimacy” to an oil and gas offering fraud.
- Failing to verify AUM. The SEC accused a Chief Compliance Officer of failing to verify assets under management that he reported on Form ADV. SEC faults the CCO for filing a Form ADV based on AUM obtained from the Chief Investment Officer whom the CCO “knew had little to no involvement with the Registrants’ investment advisory accounts.” According to the SEC, the CCO failed to “personally review” the adviser’s records to verify AUM and the number of advisory accounts.
- Unqualified for the role. A federal court found that a Chief Compliance Officer violated the Advisers Act’s compliance rule because he was unfit for the role he undertook. The court determined that the CCO acted recklessly by assuming the compliance position despite his “complete lack of qualifications for that job.” The court also found that the CCO aided and abetted his firm’s other regulatory violations including commingling of client assets, inflating valuations, and misappropriating assets.
- Allowing overbilling. A Chief Compliance Officer was barred from the industry and faced criminal sentencing for wire fraud for his role in overbilling clients over $11 Million over a 10-year period. Overbilling practices included double billing clients, charging the wrong fee, charging a management fee instead of a performance fee, failing to prorate fees, and billing for services not performed. The CCO admitted that he knew there was a high probability that the CEO was defrauding clients, but the CCO deliberately avoided learning the truth.
- Not conducting trading reviews. The Chief Compliance Officer of a dual registrant was fined and barred from the industry for failing to conduct trading reviews as required by the policies and procedures. The CCO tried to cover her failures by delivering altered reports to the examination and enforcements staffs. Under oath, she admitted that she changed dates and created false handwritten notes.
- Not conducting email reviews. The SEC upheld FINRA’s findings of CCO liability because the CCO abdicated his obligation to review emails and failed to follow up on red flags relating to payments to a disqualified individual.