Hell hath no fury like a regulator (allegedly) lied to. This week, the SEC brought civil charges, and the U.S. Attorney for the Southern District of New York brought criminal charges, against a broker-dealer and its founder for falsifying books and records to hide capital deficiencies from SEC examiners, as well as for violating net capital requirements. The cases are in litigation, so the following account is based on the government’s allegations.
The SEC’s enforcement action, brought as an administrative proceeding, alleges that the firm and its head attempted to disguise the firm’s extensive and repeated net capital insufficiencies. The respondents improperly off-loaded liabilities onto the books of an affiliated firm, and improperly treated non-marketable stock as an allowable asset. According to the SEC, the affiliated firm did not have sufficient resources to pay for the liabilities, which related to services actually performed for the firm. The SEC discounted an expense-sharing agreement between the firm and the affiliate as a sham.
More seriously, however, the principal tried to hide the broker-dealer’s true financial condition by providing the SEC examiners with “falsified documents” that sought to mask the extent of the firm’s liabilities. The CEO of the broker-dealer was thus charged criminally for his alleged obstruction of the SEC examination and for making false statements and false filings. The charges carry maximum prison sentences of 20 years and 5 years, respectively.
When announcing the SEC’s case, senior SEC officials pointed to “the SEC’s critical work in overseeing broker-dealers and other regulated entities” (Enforcement Director Andrew Ceresney), and the importance of the net capital rule in monitoring the financial health of brokerage firms (NY Regional Office Associate Director Amelia Cottrell). The U.S. Attorney and other criminal justice representatives likewise highlighted the defendants’ attempts to “blow smoke in the eyes of the SEC” by maintaining false books and records, and creating falsified documents in response to SEC requests.
Everybody knows that a regulated entity must maintain accurate books and records, and accurately report its financial condition. Everybody knows that a firm should not aggravate a situation by lying to examiners and falsifying documents. The lesson of these cases is that once a firm steps over the line and decides to attempt to deceive the regulators, it opens itself up to criminal prosecution. The Department of Justice is willing and able to support its civil partner and seek criminal sanctions for such conduct. Moreover, perhaps slightly less obvious but equally crucial, this case highlights the need for all firms and their personnel to be meticulous and vigilant about the accuracy of information provided to the SEC—lest an examination blossom into an enforcement action and explode into criminal charges.