SEC ALJ Issues Breathtaking Dismissal Of Compliance Professional Case

This is an update of an October 16, 2014, BrokeAndBroker.com Blog: "Wells Fargo Compliance Consultant Charged By SEC In Altered Inside Information Review."  This update features a Securities and Exchange Commission Administrative Law Judge's Initial Decision involving allegations that a veteran compliance person tasked with performing insider trading reviews had altered her logs and records to present the appearance of her having engaged in a more thorough analysis than was the case. In assessing the various factors in this matter, the ALJ offered this observation:

The evidence showed that Wolf, a seasoned compliance consultant who had been in the securities industry for over thirty years and held four securities licenses, was well trained and aware of the importance of keeping scrupulously accurate records for Wells Fargo, a regulated entity. Although Wolf's $61,000 salary is not indicative of a high-level employee, in practice Wolf exercised a key compliance function, having sole responsibility for conducting insider trading reviews and discretion on whether to escalate such reviews or not. Thus, Wells Fargo relied on Wolf to serve as the gatekeeper for detecting insider trading, a crucial role within the compliance department.

14. Waldyr Da Silva Prado Neto ("Prado") was a registered representative and associated person of Wells Fargo Advisors in a branch office in Miami. In September 2012, the Commission charged Prado with trading the securities of Burger King on the basis of material, nonpublic information concerning the September 2, 2010 announcement that 3G Capital Partners Ltd. ("3G Capital"), a private equity firm, would acquire Burger King and take it private (the "Announcement").1 The Commission alleged that Prado, who held Series 7 and 65 registrations and while an employee of Wells Fargo Advisors, misappropriated information about the acquisition from one of his brokerage customers who invested in the private equity fund 3G Capital used to acquire Burger King. The Commission alleged that Prado traded Burger King securities through his personal Wells Fargo Advisors brokerage account and that Prado tipped several of his other brokerage customers, including at least three tippees who traded Burger King securities through their Wells Fargo Advisors accounts. The Commission alleged that Prado and his tippees reaped profits of over $2 million in total from their Burger King trades, which included trading through Wells Fargo Advisors and another firm.

1 SEC v. Waldyr Da Silva Prado Neto, Civil Action No. 12-CIV- 7094 (SDNY Sept. 20, 2012); Litigation Release No. 22486 (Sept. 21, 2012). Prado was permanently enjoined from committing future violations on January 7, 2014. Litigation Release No. 22905 (Jan. 14, 2014). Based on the court's entry of the permanent injunction, follow-on administrative proceedings were instituted against Prado. Exchange Act Release No. 71379 (Jan. 23, 2014). The Initial Decision barring Prado was issued on May 20, 2014. Initial Decision Release No. 600 (May 20, 2014). The Initial Decision became final on July 1, 2014. Exchange Act Release No. 72513 (July 1, July 1, 2014. Exchange Act Release No. 72513 (July 1, 2014). Prado was also criminally charged with conspiracy to commit securities fraud, securities fraud, and fraud in connection with a tender offer in USA v. Waldyr Prado, et al., SDNY Case No. 13MAG2201 (Sept. 13, 2013).

11. In early 2009, Wolf drafted Wells Fargo Advisors' policies and procedures governing how she was to conduct look back reviews. In doing so, Wolf was aware of the risk that Wells Fargo Advisors personnel could obtain material nonpublic information from the firm's customers and advisory clients and she understood that conducting effective look back reviews was an important part of Wells Fargo Advisors satisfying its regulatory obligations. Between 2009 through at least March 2013, Wolf was the sole compliance officer at Wells Fargo Advisors responsible for conducting look back reviews. During that period, Wolf conducted look back reviews and closed the vast majority of them with "no findings.

15. Beginning on September 2, 2010, Wolf conducted a look back review of trading in Burger King securities at Wells Fargo Advisors before the Announcement by Prado and three of his customers. Wolf determined that:

a. Prado and his customers represented the top four positions in Burger King securities firm-wide;

b. Prado and his customers bought Burger King securities within 10 days before the Announcement, including on the same days;

c. The profits by Prado and his customers each exceeded the $5,000 threshold specified in the look back review procedures;

d. Both Prado and Burger King were located in Miami; and

e. Prado, his customers, and the company acquiring Burger King were all Brazilian.

4. In particular, Wolf added to the document a statement that rumors about an acquisition had been circulating for several weeks before the acquisition announcement. If Wolf had reviewed news articles during her review substantiating that statement, Wells Fargo Advisers' policies and procedures required Wolf to print and include them in her file. The file did not contain any news articles at all.

6. Wolf provided inconsistent information about the document when she was questioned during the Commission's investigation about her review of the trading. In her initial testimony, Wolf said she created the document in September 2010 when she performed the look back review. She also unequivocally denied altering the document after September 2010. In later investigative testimony, however, Wolf testified that she had altered the document after September 2010.

24. After the termination of her employment, the Commission staff took Wolf's testimony a second time, where she was confronted with the additional documents and metadata produced by Wells Fargo to the Commission. In the face of that additional evidence, Wolf finally admitted that she performed additional work on Burger King in 2012, although no one had asked her to. She also admitted she added the two sentences to the log entry after September 7 2010, but claimed she did not know when she added them. Finally, she admitted that her initial testimony before the Commission, where she had denied altering her records of look back review, was not true and correct.

B. Discussion

On the one hand, Wolf acted with scienter. Based on her professional experience, she must have known that it was improper to alter compliance records, and that her alteration would result in the Log and cover sheet being misleading. Wolf's failure to inform the Division during her initial testimony that the Log was a document routinely updated, her unequivocal testimony at that time that she had not altered the Log after 2010, and her admission to altering the Log only after she realized the Commission was focusing on it, demonstrate that Wolf must have understood the wrongfulness of her actions.

Moreover, although Wolf conceded at the hearing that falsification of records is wrong, that "there are things that [she] could have done better," and that she wished she had not closed her Burger King review with "no findings" in 2010, Wolf continues to maintain that she is not culpable because she "[did] not alter[] documents for purposes of misleading anyone or for purposes of falsifying documentation." Tr. 140, 282. While Wolf sincerely regrets the 20 consequences resulting from her alteration of the Log, and the profound effect it has had on her life, she does not recognize the wrongful nature of her misconduct.

On the other hand, Wolf's alteration of the Log was an isolated event. Although Wolf was not initially forthcoming about having altered the Log, and thereby prolonged the period that the truth was hidden, her violation was limited to the addition of the Two Sentences to the Log and cover sheet, and was thus neither a recurrent nor widespread offense. Nor does her hearing testimony transform her misconduct, which surely took no more than a few minutes to complete, into a recurrent infraction. Div. Br. at 38-39.

Wolf also provided assurances against future violations. Wolf credibly testified that she has no desire to ever work in the securities industry again, and that she does not believe she would even be able to because of the allegations in this proceeding. Since her termination by Wells Fargo, Wolf has been unable to find employment, and at age sixty-two, is functionally retired.

For these same reasons, Wolf is not, and is unlikely to ever be, in an occupation presenting opportunities for committing securities violations. The violation occurred in 2012, and was neither recent nor remote. She has no record of discipline, and although her salary between her violation in September 2012 and her termination in June 2013 could be considered unjust enrichment, the Division does not contend that it is. Div. Br. at 42-43.

Taken in isolation, these factors weigh in favor of at least some sanction. I find, though, that they are decisively outweighed by the remaining public interest factors: egregiousness, degree of harm, and deterrence.

I do not condone Wolf's misconduct, or her deceit in attempting to cover it up. As an experienced compliance professional, Wolf knew of the importance of ensuring the integrity of records, and nevertheless purposefully altered the Log after the fact to make it appear that her past review had been more thorough than it was. Wolf must have known there was a strong likelihood that her altered documents would end up in the hands of the Commission, which would be misled into thinking that the produced Log was the same as the Log that existed in 2010. She knew that it is wrong to mislead Commission staff while testifying under oath.

But overall, Wolf's violation was not egregious and it caused no proven harm to investors or the marketplace. Certainly it stands to reason that the Division expended unnecessary investigative resources as a result of Wolf's Log alteration and initial, misleading testimony. But the Division demonstrated no particular degree of unnecessary expenditures, beyond having to take Wolf's testimony twice, and it learned very quickly that the Log had been altered. Exs. 523, 524. Indeed, there is literally no evidence that Wolf's alteration of the Log materially impeded the Division's investigation of Prado. Wolf credibly testified that there were public reports in 2010, around the time of Prado's insider trading, that Burger King was a takeover target, even though she was unaware of them at the time. There is therefore no reason to believe that Wolf's conclusion of "no findings" would have been different had she not altered the Log, or that Wells Fargo would have otherwise detected Prado's misconduct. 21

Admittedly, books and records violations alone can be egregious, and "the sanction for a failure to produce documents or information" is "likely to be greater than, or at least comparable to, the potential sanction for any wrongdoing that might be uncovered" during the associated investigation. vFinance Invs., Inc., Exchange Act Release No. 62448, 2010 WL 2674858, at *15 (July 2, 2010). But other recent books and records violations found to have been egregious generally caused more serious, or more demonstrated, harm. In vFinance, for example, "Respondents' Exchange Act violations ultimately facilitated the destruction of the only version of certain records critical to a Commission fraud investigation." Id. In Phlo Corporation, Exchange Act Release No. 55562, 2007 WL 966943, at *12 (Mar. 30, 2007), the respondent "did not make any records available for examination for more than two months after a response to the October 31 document request letter was due, and even then, not all of the requested documents were made available." In Schield Mgmt. Co., 58 S.E.C. at 1219, the respondents "deliberately deleted e-mails, furnished the staff with several different, inconsistent versions of requested [documents] that were incomplete and inaccurate, and destroyed and withheld documents related to client and adviser PINs." In The Barr Financial Group, Inc., 56 S.E.C. 1243, 1262 (2003), the respondents' "untrue assertions" in Commission filings "misled investors regarding [Respondents'] qualifications and the willingness of others to trust respondents with their assets."

Here, by contrast, no documents were destroyed, Wolf timely produced all documents requested of her, Wolf's Log alteration was minimal and the cover sheet simply duplicated what was already in the file, and, most importantly, there is no evidence that Wolf's misconduct made any material difference to the investigation of Prado. Nor did her violation have any effect on investors or the marketplace. Wolf may have violated the law, but she did not do so egregiously.

The weightiest public interest consideration, however, is deterrence. To be sure, remedial sanctions "provide specific deterrence even where respondents may no longer work in the industry." Ralph Calabro, Exchange Act Release No. 75076, 2015 WL 3439152, at *46 (May 29, 2015). But Wolf has persuasively shown that she believes she has no realistic chance of ever working in the securities industry again, even without the imposition of remedial sanctions. On the facts of this case, the incremental specific deterrent effect of a sanction is vanishingly small.

As for general deterrence, there is, of course, a "need to deter . . . other persons." Ralph Calabro, 2015 WL 3439152, at *46 (citation omitted, ellipsis in original). On the facts of this case, however, I am satisfied that any remedial sanction, no matter how small, will not be an effective general deterrent. This is principally because of Wolf's status at Wells Fargo. She was low-ranking, relatively low-paid, supervised no one, and worked in a cubicle. Of all the individuals at Wells Fargo who contributed to its compliance failures, the only one charged individually was notably low-ranking. By sanctioning only Wolf -- who, to her credit, does not blame anyone else for her misconduct, but whose testimony suggests that at least St John and possibly Moya could have been charged with the same misconduc -- the rest of the securities industry could view this proceeding as proof that Wolf's violation was isolated and nonsystemic. That is, if Wolf is sanctioned, there is a likelihood that others in the industry will perceive Wolf as simply a bad apple, a low status worker who unilaterally caused Wells Fargo to violate the law, and will see no need to examine their own practices and corporate cultures. 22

In fact, this would be a misperception, as the settled proceeding against Wells Fargo amply demonstrates. Ex. 533. Wells Fargo clearly had much deeper and more systemic problems than one bad apple. See id. Wolf testified to two examples of this. First, she testified that St John knew that Wolf made retroactive Log entries in other instances, apparently with no objection. Tr. 430-31. Second, St John told Moya by email in September 2012 that she would review Wolf's insider trading reviews on a "daily basis going forward," as if that would be an improvement on existing practices. Ex. 368. According to Wolf, though, St John was already doing just that, and St John's email was, therefore, misleading at best. Tr. 312; Ex. 368. But overall, there is a likelihood that others in the securities industry will focus on the superficial aspects of this proceeding, rather than on the details of Wolf's misconduct in the context of Wells Fargo's overall practices. Thus, any sanction here will not only fail to have the desired general deterrent effect, but may actually be counterproductive.

There is one additional consideration: the fact that Wolf worked in compliance. Obviously, compliance professionals are subject to the securities laws like everyone else. But Wolf is correct to complain that in compliance, "the risk is much too high for the compensation." Tr. 439. In my experience, firms tend to compensate compliance personnel relatively poorly, especially compared to other associated persons possessing the supervisory securities licenses compliance personnel typically have, likely because their work does not generate profits directly. But because of their responsibilities, compliance personnel receive a great deal of attention in investigations, and every time a violation is detected there is, quite naturally, a tendency for investigators to inquire into the reasons that compliance did not detect the violation first, or prevent it from happening at all. The temptation to look to compliance for the "low hanging fruit," however, should be resisted. There is a real risk that excessive focus on violations by compliance personnel will discourage competent persons from going into compliance, and thereby undermine the purpose of compliance programs in general. That is, "we should strive to avoid the perverse incentives that will naturally flow from targeting compliance personnel who are willing to run into the fires that so often occur at regulated entities." Comm'r Daniel M. Gallagher, Statement on Recent SEC Settlements Charging Chief Compliance Officers With Violations of Investment Advisers Act Rule 206(4)-7 (June 18, 2015), available at http://www.sec.gov/news/statement/sec-cco-settlements-iaa-rule-206-4-7.html (last accessed July 7, 2015).

Again, I do not condone Wolf's misconduct. Neither the Division nor the Commission as a whole should tolerate falsified records or knowingly false testimony, and the Division was quite right to at least investigate Wolf. But now that the evidence has been fully aired, it is clear that sanctioning Wolf in any fashion would be overkill. Accordingly, no sanction will be imposed.

The Director's misconduct is the third instance during an eight year period in which a FINRA employee, or an employee of its predecessor, the National Association of Securities Dealers, Inc. ("NASD"), provided altered or misleading documents to the Commission. Although FINRA has endeavored to improve its procedures and training since document integrity issues came to light in May 2006 and December 2007, those efforts were not effective in preventing the Director's misconduct.

Item 36 of the document request letter asked for "Minutes of District staff meetings conducted between November 1, 2005 and the present." On August 7, 2008-hours before furnishing the Commission inspection staff with FINRA's response to Item 36-the Director caused the minutes for meetings that took place on August 28, 2006, September 22, 2006 and January 31, 2007 to be altered. Specifically, certain information was deleted or edited, while in other instances, entire passages were removed or changed. With respect to all three altered documents, the original author's signature was changed to the Director's.

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