Bates Research - 03-26-20

Enforcement Warnings in the Age of the Coronavirus

As regulators struggle to adjust to the stress that the coronavirus pandemic is placing on the markets, fraudsters are viewing it as an opportunity. That is one clear and consistent warning emanating from federal enforcement agencies over the past month. Last week, Bates described early compliance guidance, regulatory assistance and relief offered by various financial agencies to address some of the difficulties that firms are having, like, for example, fulfilling their reporting and recordkeeping obligations under newly activated business contingency plans. This week we take a look at the latest enforcement warnings and guidance from financial regulators, who are sounding alarms over the added threats that exist in the current volatile environment.

FinCEN Says File your SARs!

On March 16, 2020, the Financial Crimes Enforcement Network (FinCEN) warned financial firms to be alert to malicious or fraudulent transactions. FinCEN requested that institutions affected by the pandemic notify them “as soon as practicable” about any potential delay in filing suspicious activity reports (SARs) as required under the Bank Secrecy Act (BSA). Increasingly, regulatory enforcement strategies rely on these filings (see e.g., Bates’ recent article on senior financial exploitation), and FinCEN is emphasizing the importance of continued compliance and the filing of these reports.

Look Out for Scams

Since the outbreak of the pandemic, FinCEN has noted emerging trends related to imposter scams (impersonations of government officials to steal personal financial information), investment scams (promotions of companies claiming the ability to detect, prevent or cure the virus), and product scams (fraudulent marketing that make false health claims concerning unapproved products). These have yet to result in enforcement actions, but that may only be a matter of time. In any case, tracking these trends requires regulatory reliance on SARs reports which makes continued filings imperative.   

Likening the coronavirus to a natural disaster, FinCEN recommends financial institutions review its 2017 Advisory, which describes other types of potential fraud that FinCEN has reason to believe will possibly occur in the days ahead (i.e. benefits and charities fraud and cyber-related fraud).  FinCEN also notes that it received reports of potential insider trading – a subject highlighted by the widely reported news that two U.S. Senators sold millions of dollars of stock holdings shortly after private government briefings and just prior to the recent market downturn.

SEC on Heightened Alert for Insider Trading

The subject of trading on inside information has been top of mind for the Co-Directors of the SEC’s Division of Enforcement. In a statement issued on March 23, 2020, Stephanie Avakian and Steven Peikin reminded market participants of the importance of following corporate controls to ensure market integrity. Specifically, they noted the significant COVID-19 relief the Commission provided to firms, which allowed for certain delayed submission of earnings reports and certain required SEC disclosure filings. (For more on this SEC March 4, 2020 compliance relief, see here). The Co-Directors warned that this scenario can lead to more people having access to “material nonpublic information” and emphasized the importance of complying with “obligations to keep this information confidential.” This includes maintaining “disclosure controls and procedures, insider trading prohibitions, codes of ethics, and Regulation FD [Fair Disclosure] and selective disclosure prohibitions,” which protect against the “improper dissemination and use of material nonpublic information.” The Co-Directors made clear that these warnings applied to all registrants including broker-dealers and investment advisers. The expressed concern about more insiders holding material non-public information for longer periods of time should be a warning to firms that the SEC will be looking even closer at the effectiveness of existing controls. 

Other Federal Agency Messages

Consistent with the Co-Directors’ statement and FinCEN’s release, other SEC Offices have communicated additional messages that impact enforcement and institutional concerns. For example, the Office of Compliance Inspections and Examinations (OCIE) announced that a firm’s “reliance on [the SEC’s COVID-19] regulatory relief will not be a risk factor utilized in determining whether OCIE commences an examination.” This assurance shows that OCIE will not use these temporary measures to add to a firm’s compliance stress.

As early as February 4, 2020, the SEC Office of Investor Education and Advocacy (OIEA) warned investors about fraud involving claims that a company’s products or services will be used to help stop the coronavirus outbreak. The OIEA also raised issues around “so-called research reports” that make predictions that contain a specific stock target price and “pump and dump” schemes that involve microcap stocks. While these are familiar scams that firms were already alerted to in the OIEA’s Examination Priorities Report (see previous coverage), firms should take note of the enhanced attention the SEC is paying to them given the extreme circumstances afforded fraudsters in the current environment.

Similarly, in an advisory issued on March 18, 2020, the CFTC Office of Customer Education and Outreach (OCEO) warned against fraudsters seeking to profit from coronavirus-related market volatility. The Office urged investors to protect themselves “by learning to recognize common mental biases” and common fraud tactics including (i) promises of oversized returns, (ii) pressure to act “before market conditions change,” (iii) phony credentials, (iv) bogus testimonials, and (v) scams that involve some free gift in exchange for private information.

Conclusion

Financial regulators do not yet know what the new normal will look like.  They warn that bad actors are probing new opportunities created by the volatility and the fear in the markets brought on by the COVID-19. Enforcement officials are also trying to adapt to the temporary loosening of certain compliance reporting and disclosure obligations provided to help market participants cope with their contingent capabilities. As the SEC Co-Directors make clear, relaxing compliance for some of these requirements may create new opportunities for mischief and fraud – particularly as they relate to potential for dissemination of material non-public information. On both counts, regulator guidance emphasizes vigilance and communication. But the landscape is changing quickly. Bates will keep you apprised.

 

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