Why it matters: What do fraudulent FX transactions, front running, overcharging for exchange and clearing fees, blue sheet violations, hoots and squawks and the Customer Protection Rule have in common? They all figured prominently in recent white collar enforcement actions, many having to do with compliance failures. We recap it for you here.
Detailed discussion: Read on for a recap of recent white collar enforcement actions that caught our eye.
Fraudulent foreign exchange (FX) transactions:
- “Hidden Mark-Ups”: On July 26, 2016, the DOJ announced that Massachusetts-based State Street Bank and Trust Company (State Street) agreed to pay an aggregate of $382.4 million (comprised of a $155 million civil penalty to the DOJ, $167.4 million in disgorgement and penalties to the SEC and at least $60 million to ERISA plan clients in an agreement with the Department of Labor) to settle allegations that it deceived its custody clients when providing them with indirect foreign currency exchange (FX) services in violation of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). As part of the settlement with the DOJ, State Street admitted that, contrary to its representations to its custody clients, its State Street Global Markets division did not price FX transactions at prevailing interbank market rates and that the prices were instead largely driven by “hidden mark-ups designed to maximize State Street’s profits.” The DOJ said that its investigation arose from filings made pursuant to the whistleblower provisions of FIRREA. The DOJ also said that State Street will pay an additional $147.6 million to resolve private class action lawsuits filed by the bank’s customers alleging similar misconduct.
Compliance failures: The Financial Industry Regulatory Authority (FINRA), the SEC and the Commodities Futures Trading Commission (CFTC) all cracked down on alleged compliance shortcomings this summer, including two separate fines imposed by FINRA on Deutsche Bank Securities, Inc. for indiscreet “hoots and squawks” and “blue sheet” violations. The SEC also separately imposed a fine against Citigroup Global Markets for “blue sheet” violations, making it two fines imposed within weeks of each other for a relatively infrequently prosecuted compliance failure. Read on for a recap.
- “Inadequate supervision of internal communications”: On August 8, 2016, the Financial Industry Regulatory Authority (FINRA) announced that it had fined Deutsche Bank Securities Inc. (DBS) $12.5 million for “significant supervisory failures” related to research and trading-related information it disseminated to its employees, called “hoots” or “squawks,” over internal speakers commonly known as “squawk boxes.” According to FINRA’s findings, which were neither admitted to or denied by DBS, DBS failed to establish adequate supervision over registered representatives’ access to hoots or their communications with customers regarding hoots despite multiple red flags regarding the potential dissemination of material nonpublic and confidential price-sensitive information. In addition to paying the fine, FINRA said that DBS also agreed as part of the settlement to provide a written certification that it had adopted and implemented supervisory systems and written procedures concerning hoots that are “reasonably designed to achieve compliance with FINRA rules and federal securities laws.”
- “Supervision failures over fee processing”: On August 8, 2016, the CFTC announced that Barclays Capital, Inc. (Barclays) agreed to pay an $800,000 civil penalty for failing to “diligently supervise” the processing by its employees of exchange and clearing fees it charged customers for trading and clearing Chicago Mercantile Exchange products from 2011 to 2015. This failure to supervise included the failure by Barclays to “implement and maintain” adequate software systems, policies, and employee training procedures for reconciling invoices from exchange clearinghouses with the amounts of fees actually charged to its customers. According to the CFTC, such failures led to “instances in which Barclays overcharged some customers in an aggregate amount of approximately $1.1 million.” The CFTC said that Barclays promptly took remedial steps when it discovered the problem in 2012, including refunding adversely affected customers, and cooperated with the CFTC’s investigation. The CFTC pointed out that this was only the second action it has brought involving “a clearing firm’s supervisory failures over fee processing” (the CFTC brought the first such action in 2014).
“Blue sheet” violations:
- On July 12, 2016, the SEC announced that Citigroup Global Markets agreed to pay a $7 million penalty and admit wrongdoing to settle charges that a computer coding error caused the firm to provide the agency with incomplete “blue sheet” information about trades it executed. The SEC said that the coding error occurred in the software that Citigroup used from 1999 to 2014 to process SEC requests for blue sheet data, including the time of trades, types of trades, volume traded, prices, and other customer-identifying information, which resulted in the omission of 26,810 securities transactions from its responses to more than 2,300 blue sheet requests. After discovering the coding error, the SEC found that Citigroup failed to report the incident to the SEC or take any steps to produce the omitted data until nine months later.
- On June 29, 2016, FINRA announced that it had imposed a separate fine of $6 million against DBS for failing to provide complete and accurate trade data in “blue sheets” submitted to FINRA and the SEC. According to FINRA’s findings, which were neither admitted to nor denied by DBS, from approximately 2008 through 2015 DBS experienced “significant failures” with its systems used to compile and produce blue sheet data, causing DBS to submit thousands of blue sheets to regulators that misreported or omitted critical information on over one million trades. In addition, FINRA found that a significant number of DBS’s blue sheet submissions did not meet regulatory deadlines. As part of the settlement, DBS agreed to retain an independent consultant to “improve its policies, systems and procedures related to blue sheet submissions.”
Violation of Customer Protection Rule: On June 23, 2016, the SEC announced that Merrill Lynch agreed to pay $415 million (consisting of $57 million in disgorgement and a $358 million penalty) and admit to wrongdoing to settle charges that it “misused customer cash to generate profits for the firm and failed to safeguard customer securities from the claims of its creditors” in violation of the SEC’s Customer Protection Rule. The SEC said that Merrill Lynch, which admitted to wrongdoing as part of the settlement, violated the SEC’s Customer Protection Rule from 2009 to 2012 by (a) misusing customer cash that “rightfully should have been deposited in a reserve account,” freeing up billions of dollars per week that Merrill Lynch used to finance its own trading activities and (b) failing to adhere to requirements that “fully-paid for customer securities be held in lien-free accounts and shielded from claims by third parties should a firm collapse.” The SEC said that, in conjunction with this settlement, it had established a two-part initiative designed to uncover additional abuses of the Customer Protection Rule: “The first encourages broker-dealers to proactively report potential violations of the rule to the SEC and provides for cooperation credit and favorable settlement terms in any enforcement recommendations arising from self-reporting. Second, the Enforcement Division, in coordination with the Division of Trading and Markets and the Office of Compliance Inspections and Examinations, will conduct risk-based examinations of certain broker-dealers to assess their compliance with the Customer Protection Rule.”
See here to read the DOJ’s 7/26/16 press release entitled “State Street Bank to Pay $382 Million to Settle Allegations of Fraudulent Foreign Currency Exchange Practices.”
See here to read FINRA’s 8/8/16 press release entitled “FINRA Fines Deutsche Bank Securities Inc. $12.5 Million for Inadequate Supervision of Internal Communications.”
See here to read the CFTC’s 8/4/16 press release entitled “CFTC Orders Barclays Capital, Inc. to Pay $800,000 for Supervision Failures.”
See here to read the SEC’s 7/12/16 press release entitled “SEC: Citigroup Provided Incomplete Blue Sheet Data for 15 Years.”
See here to read FINRA’s 6/29/16 press release entitled “FINRA Fines Deutsche Bank Securities Inc. $6 Million for Submitting Inaccurate and Late Blue Sheet Data.”
See here to read the SEC’s 6/23/16 press release entitled “Merrill Lynch to Pay $415 Million for Misusing Customer Cash and Putting Customer Securities at Risk.”