Financial Services Litigation & Investigation Monitor : Financial Services Lawyer & Attorney : Perkins Coie Law Firm : Government Investigations, Class Actions

The SEC and Financial Industry Regulatory Authority (FINRA) filed separate lawsuits alleging that 16 brokers from the now defunct Brookstreet Securities Crop. fraudulently mislead investors that derivatives based on mortgage-backed securities were safe and conservative investments.  In its complaint, the SEC alleges that 10 Brookstreet brokers failed to inform customers about the risks associated with investing in collateralized mortgage obligations.  The brokers portrayed collateralized mortgage obligations as secure investments to more than 750 customers, which ultimately cost those investors more than $36 million in losses, but earned the brokers $18 million in commission and salaries, according to SEC allegations.  The SEC is seeking civil penalties and repayment of ill-gotten gains.

FINRA filed a companion complaint against six other former Brookstreet brokers.  According to a FINRA press release,  from June 2004 through May 2007, the brokers sold collateralized mortgage obligations to customers when the brokers themselves lacked a basic understanding of these complex and illiquid securities.

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In the wake of the subprime crisis and mortgage meltdown, on May 20, 2009, President Obama signed The Fraud Enforcement and Recovery Act ("FERA").  Among other provisions, the new law provides federal law enforcement with additional resources to combat mortgage and financial fraud, and authorizes federal prosecutors to prosecute anyone who fraudulently obtains funds under the American Recovery and Reinvestment Act or Troubled Asset Relief Program. 

The law also creates a "9/11"-style commission comprised of outside experts with authorty to review the causes of the economic crisis and recommend changes. The "Financial Crisis Inquiry Commission" will have subpoena power to bring in individuals for investigation and questioning.  FERA grants the Commission authority to refer evidence of wrongdoing to the U.S. attorney general and state attorneys general.

Further information about FERA is available in an article ("Obama Signs Fraud Enforcement and Recover Act in Effort to Combat Mortgage and Financial Fraud") published by Perkins Coie attorney Joel Levin.

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Following a Securities and Exchange Commission Office of Inspector General investigation which "revealed suspicious activity, appearances of improprieties, and evidence of possible trading on nonpublic information, and/or potential insider trading on the part of SEC Enforcement attorneys," the SEC has imposed new internal rules governing securities transactions for all SEC employees.

Under the new SEC rules, staff will be prohibited from trading in the securities of companies under SEC investigation, regardless of whether the employee has personal knowledge of the investigation.   Employees will also be required to preclear all securities transactions with supervisory staff prior to trading and certify that they do not possess non-public information about the company being traded.  Finally, all SEC staff must authorize their brokers to provide the Commission with copies of trade confirmation statements, so that ethics officials can monitor compliance with the new rules.

Whether the SEC has adequate infrastructure to monitor staff trading, in addition to its preexisting oversight duties, remains to be seen.  While the Commission currently lacks surveillance systems to monitor staff trading, the new rules call for an agency-wide computer system that will assist officials in preclearing and tracking all employee trades.  Chairman Schapiro has also directed the consolidation of compliance and reporting responsibilities within the SEC's Ethics Office, and has authorized the hiring of a new chief compliance officer.

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The Securities Exchange Commission has proposed new rules to increase the oversight of investment advisors who retain custody of client assets. The proposed measures come in the wake of what many have termed as a lack of SEC regulation and enforcement that enabled ponzi schemes and other investment fraud to thrive in recent years.

The SEC’s newly proposed regulations include yearly “surprise” audits performed by independent public accountants in order to verify the sanctity of client assets under an investment advisor’s custody. Advisers would be required to disclose the identity of the independent public accountant that performs its surprise audit in public SEC filings, and amend these filings to reflect changes in accountants.  In addition, when an adviser or an affiliate directly holds client assets, a custody control review would have to be conducted by a PCAOB-registered and inspected accountant.

The proposed amendments would further require all other custodians holding client assets to directly deliver custodial statements directly to the clients, rather than through investment advisers.  These additional safeguards are meant to deter advisers from preparing false account statements, and increase the likelihood that clients discover any discrepancies between the custodial statements and statements from their investment advisors.

The public comment period on these proposed rule amendments will be open for 60 days after their publication in the Federal Register. The full text of the proposed rule amendments have yet to be published.

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The Los Angeles Times reported on May 14, 2009 that SEC investigators had recommended the filing of civil fraud charges against former Countrywide chief executive Angelo Mozillo.  According to the article written by E. Scott Reckard and William Heisel, persons familiar with the matter report that SEC staff are seeking approval to file fraud charges that include insider trading and failing to disclose to shareholders the company's risks associated with its sub-prime mortgage business.  The article states that Mozillo's attorneys were provided with a "Wells" letter weeks ago, and the matter is now before the SEC's five commissioners to approve or reject the investigator's recommendation. 
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On May 6, the House of Representatives voted overwhelmingly to pass, with amendments, a Senate bill to improve enforcement of securities fraud, financial institutions fraud and mortgage fraud.  The bill also addresses fraud related to federal assistance and relief programs.  According to a summary of the bill posted on the CCH Financial Crisis News Center, the Fraud Enforcement and Recovery Act of 2009 ("FERA")  expands the scope of securities fraud provisions and extends the prohibition against defrauding the federal government to the TARP program and to the stimulus bill.  Among other elements of the bill, FERA implements significant improvements to fraud and money laundering statutes to strengthen the government's ability to combat the increase in fraud activities within the financial services sector.

A key element of the bill is an expanded budget for the U.S. Department of Justice to investigate and prosecute financial fraud.  Specifically, the bill authorizes appropriations to the Attorney General for FY2010-FY2011 for investigations, prosecutions, and civil and administrative proceedings involving federal assistance programs and financial institutions.  The bill requires that the DOJ use an appropriate percentage of such funds to investigate mortgage fraud.  Similar additional appropriations are authorized for the U.S. Postal Service, the Inspector General for the Department of Housing and Urban Development (HUD), the U.S. Secret Service, and the Securities and Exchange Commission (SEC):
 

The bill also proposes the creation of a "9/11" style commission called the "Financial Markets Inquiry Commission," which would undertake a bipartisan examination of the mortgage crises and other issues that led to the current financial crisis.  Senate co-sponsors of the amendment to create the Commission, Senators Johnny Isakson (R-GA) and Kent Conrad (D-ND), issued a release stating that “the only way to get an objective evaluation of where mistakes were made is to create an independent commission of experts to ask what went right, what went wrong and what could we have done to prevent this. We need a forensic audit of the laws of the United States as it relates to the financial markets and our economy.”

The bill now returns to the Senate, where the Senate can agree to the House amendments or ask for a conference to compromise on the differences in the two bills.   Assuming agreement, the bill will move to the president for consideration.

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