September 1, 2017
As with most lawsuits, any given defendant or respondent may or may not be guilty; and in a recent Securities and Exchange Commission administrative proceeding, that question is still an open one. At this stage in the regulatory case, the Respondent is presumed innocent unless and until proven guilty beyond a preponderance of the evidence. Also at this stage in the regulatory case, the federal regulator and Respondent are engaged in the gamesmanship by which all such legal battles begin. In response to the SEC's allegations, the Respondent offered his defenses, but the SEC Division of Enforcement is troubled by at least one affirmative defense and has protested to the Administrative Law Judge handling the matter. What develops is an interesting glimpse behind the scenes.
Case In Point
On June 23, 2016, the Securities and Exchange Commission filed In the Matter of William Tirrell, Respondent (Order Instituting Administrative and Cease-And-Desist Proceedings; '34 Act Rel. No. 78142; Invest. Adv. Act Rel. No. 4434; Invest. Co. Act Rel. No. 32159; Admin. Proc. Rul. Rel. No. 3-17313; / June 23, 2016). As asserted in the Order Instituting Proceedings ("OIP"), Respondent Tirrell was an associated person of broker-dealer/investment adviser Merrill Lynch, Pierce, Fenner & Smith, Inc. ("MLPF&S"), which was acquired in 2009 by Bank of America. From 2004 until April 2016, Tirrell purportedly was the Financial and Operational Principal and the Head of the Regulatory Reporting Department for MLPF&S. As set forth in the "Summary" section of the OIP:
From 2009 to 2012, Tirrell aided and abetted and caused unprecedented violations of Sections 15(c)(3) and 17(a)(1) of the Exchange Act and Rules 15c3-3, 17a-5(a), and 17a-5(d) thereunder by Merrill Lynch, Pierce, Fenner & Smith, Inc. ("MLPF&S") and its wholly-owned subsidiary, Merrill Lynch Professional Clearing Corp. ("MLPro" and, together with MLPF&S, "ML").
During this period, ML willfully violated Section 15(c)(3) of the Exchange Act and Rule 15c3-3 thereunder. Known as the Customer Protection Rule ("Rule"), Rule 15c3-3 requires broker-dealers to safeguard the cash of their customers so that customer assets can be quickly returned if the firm fails. ML violated the Rule by failing to deposit a sufficient amount of cash in a customer reserve account it was required to maintain pursuant to Rule 15c3-3(e), thereby placing billions of dollars of ML customers' money at risk. ML underfunded its reserve account by billions of dollars through the use of trades, known internally as Leveraged Conversion Trades ("Trades"), that improperly used ML customer assets to finance its own activities.
Tirrell was MLPF&S's Head of Regulatory Reporting, which is the department responsible for, among other things, ensuring ML protects its customers by complying with Rule 15c3-3. Tirrell was also MLPF&S's designated Financial and Operational Principal ("FinOp"), assuming specific and primary responsibilities for the firm's compliance with the Rule. In these capacities, Tirrell and his subordinates calculated the customer reserve requirement each week. Tirrell knowingly reduced the amount ML reserved by billions of dollars as a result of the Trades despite knowing that regulators had significant unanswered questions about changes being made to the Trades, changes that Tirrell both approved of and failed to address with those regulators. In addition, he failed to accurately disclose the purpose of the Trades to regulators and repeatedly ignored requests from regulators for information that, if provided, would have put an abrupt end to the Trades. In so doing, Tirrell was reckless and negligent.
Tirrell likewise was reckless and negligent in aiding and abetting and causing ML's violations of Section 17(a)(1) of the Exchange Act and Rule 17a-5(a) thereunder as well as MLPF&S's violation of Rule 17a-5(d) thereunder, which the firm violated by submitting required Financial and Operational Combined Uniform Single ("FOCUS") Reports and required annual financial reports that consistently provided inaccurate information about ML's reserve formula, and omitted required information on the Leveraged Conversion Trades.
Among the 18 affirmative defenses that Respondent Tirrell asserted in his Answer, he included that:
The claims alleged in the OIP are barred, in whole or in part, because Mr. Tirrell relied in good faith upon the judgment of professionals, including ML's and Bank of America's in-house counsel, outside counsel, compliance and accounting professionals, and legal consultants as to matters that he reasonably believed were within such persons' professional or expert competence.
But We're Not Relying On Withheld Documents
In correspondence from Tirrell's legal counsel to the SEC's Division of Enforcement (the "Division"), it was stated that [Ed: footnote omitted]:
"Tirrell does not intend to rely" in presenting this defense "on documents that have been withheld by Bank of America or any other party as privileged. Mr. Tirrell does not hold, and is not asserting, a personal privilege over any documents."
Stepping back from the fray, let's see just what's going on here. Tirrell seems to be asserting an affirmative defense that he was justified in relying upon the "judgment of professionals," among which are various lawyers working at in-house and outside capacities for his former employers. Those professionals may well have engaged in conversations or correspondence that could fall under the privilege of confidential attorney-client communications, which are often precluded from use against the party asserting the confidentiality. In an interesting ploy or strategy, Tirrell proclaims that he will not rely on any documents withheld pursuant to a claimed privilege. Moreover, Tirrell declines to assert his personal privilege over "any" documents.
The Procedural Chess Game
From my perspective as a veteran securities lawyer, Tirrell's positions are, to say the least, provocative. The chess moves in my mind are that Tirrell want to defend his alleged misconduct, in part, by claiming that he was justified in his actions because he relied in good faith on "the judgment of professionals." I take note that he is not necessarily saying that he is relying upon a professional's advice but, in contradistinction, a professional's judgment: It will be interesting to see if that distinction is developed further.
If Tirrell moves that chess piece of asserting a good-faith-reliance defense, the Division would likely argue that the Respondent is hypocritically asserting it because the very evidence by which to corroborate or refute such a defense is barred from presentation as evidence based upon the attorney-client privilege.
In response to that gambit, we are left to ruminate whether a lawyer working in-house for a former employer or retained by that former employer on an outside basis has an attorney-client relationship with Tirrell or whether such an arrangement only flows between the employer and the lawyer/law firms. As such, is there even a privilege for Tirrell to assert? If there is, does the client to whom any duty of confidentiality is owed also have a right to refuse to release any documents that might violate their separate privilege?
So . . . do you move the Bishop or the Rook? What are we to make of Tirrell's concession that he will not assert a personal privilege over any document? Is that a complete waiver of any purported attorney-client confidentiality as to such documents? If the waiver is absolute, then doesn't that meant that Tirrell is not going to hide behind such a privilege while asserting his good-faith-reliance defense?
Motion In Limine Notwithstanding Respondent Tirrell's clear concession that he will not assert a personal privilege over any documents, the Division moved to preclude Tirrell from asserting his reliance defense. In the Matter of William Tirrell, Respondent (Order Denying Division's Motion In Limine; Admin. Proc. Rul. Rel. No. 4588; Admin. Proc. File No. 3-17313 / February 6, 2017). As explained in the Order Denying Division's Motion In Limine, the Division asserts that after receiving counsel's letter:
[I]t contacted Bank of America and learned that the latter would rely on privilege and instruct any inside or outside counsel not to answer any questions about any legal advice given to Bank of America personnel regarding the allegations in the OIP. Mot. at 3. The Division asserts that Tirrell is improperly attempting to assert an advice-of-counsel defense "while shielding such advice and any communications relating thereto from disclosure." Id. at 4. Noting that Tirrell cannot establish the elements of an advice-of-counsel defense, id., and relying on United States v. Wells Fargo Bank, N.A., 132 F. Supp. 3d 558 (S.D.N.Y. 2015), it argues I should bar Tirrell's reliance defense, id. at 6-7.2
Footnote 2: The court in Wells Fargo held that a litigant cannot rely on an "advice-of-counsel defense that requires disclosure of his employer's privileged communications where the employer will not waive the privilege." 132 F. Supp. 3d at 561, 566.
Another interesting wrinkle: Bank of America will assert its privilege and not permit its various counsel to "answer any questions about any legal advice given to Bank of America personnel regarding the allegations . . ." Perhaps Tirrell's offer not to personally claim any privilege isn't as sincere as it appears; however, the monkey wrench at issue was not tossed into the regulatory process by him but by his former employer, which was not named as a Respondent in the administrative proceeding.
All of which prompts us to consider the cited USA v. Wells Fargo Bank case.
This case-a civil fraud case brought by the United States against Defendants Wells Fargo Bank, N.A. ("Wells Fargo" or the "Bank") and Kurt Lofrano (together with the Bank, "Defendants") -- presents an issue of first impression within the Second Circuit: whether, or under what circumstances, an employee may pursue an advice-of-counsel defense where doing so requires disclosure of privileged communications and his employer owns the privilege and refuses to waive it. In a prior opinion, the Court held that Lofrano's mere declaration of his intention to assert an advice-of-counsel defense -- without more -- does not impliedly waive the Bank's privilege. See United States v. Wells Fargo Bank N.A., No. 12-CV-7527 (JMF), 2015 WL 3999074 (S.D.N.Y. June 30, 2015) ("Wells Fargo I "). The Court indicated, however, that Wells Fargo might waive the privilege by failing to object to Lofrano's reliance on privileged communications or that, in any event, Lofrano's "right to present a defense could conceivably overcome Wells Fargo's right to maintain its privilege." Id. at *3.
Wells Fargo now moves for a protective order precluding Lofrano from disclosing any privileged communications (Docket No. 274) -- thereby confirming that it does object and squarely presenting the question of whether Lofrano's right to present the advice-of-counsel defense is sufficient to overcome the Bank's privilege. For the reasons stated below, the Court concludes -- in light of binding Supreme Court precedent -- that it does not and that Lofrano may not assert an advice-of-counsel defense over Wells Fargo's objection. The Court recognizes that that result is arguably harsh in this particular case, as it may well deprive Lofrano of his best defense to liability for tens of millions of dollars. It is, however, the price that must be paid for society's commitment to the values underlying the attorney-client privilege. Additionally, upon closer analysis, the result may be less harsh than first appears because, in the absence of a robust commitment to the privilege, the communications at issue may never have been made -- or Lofrano might not have been made privy to them. Moreover, in many cases, companies in Wells Fargo's position may choose to either waive the privilege or, if they choose not to do so for broader institutional reasons, indemnify their employees and pay the price themselves.
United States v. Wells Fargo Bank, N.A., 132 F.Supp.3d 558, 559 (S.D.N.Y. 2015)
What Advice of "Counsel"?
In light of his assertion that he would not be relying on any communications with counsel to rebut the Division's claims, Tirrell was baffled by the Division's position. Maybe we truly do need to focus on the precision of language used in the affirmative defense: a good-faith reliance on the "judgment" of others and not on the "advice of counsel." Tirrell explained that he was aware that, in addition to his own involvement with the leveraged conversion trade at issue:
[O]ther "professionals from various disciplines" reviewed aspects of the trade. Id. at 7. Tirrell argues that he "relied on" those other professionals and certain "external advisers to do their jobs and determine whether the trade was appropriate based on their areas of expertise." Id. He thus asserts that he "relied on those professionals to carry out their responsibilities appropriately and reasonably took comfort from knowing that Merrill Lynch thoroughly reviewed the . . . trade." Id. at 9. And he says that he "relied on the business unit to accurately and fully describe the structure and purpose of the . . .Trade as part of his assessment of" it. Id. at 10.
Not a mention of reliance upon any legal "advice." Instead, Tirrell references his:
Despite Tirrell's clarifications, the Division views his affirmative defense as one that is trying to have its cake and eat it too; namely, Respondent is depicted as trying to:
- reliance upon experts carrying out their responsibilities,
- taking comfort in ongoing reviews, and
- trusting that the relevant business unit had properly described the structure/purpose of the disputed trade.
[E]xploit Bank of America's assertion of the attorney-client privilege while "arguing that the presence of these attorneys and other professionals and their communications exonerate him." Reply at 7. The Division argues that Tirrell is actually trying to present an advice-of-counsel defense without meeting the requirements of the defense. Id. Finally, the Division argues that Tirrell's defense prejudices the Division because it cannot "examin[e] [the] communications that bear upon the defense." Id. at 10.
As I had previously mused, Tirrell seems to be arguing that his good-faith reliance was not necessarily on advice provided to him by counsel, whether directly or indirectly through an employer. As I believe the defense may be setting up, Tirrell is suggesting that he didn't call the fire department because no sprinklers went off, no alarms sounded, he didn't smell smoke, and he didn't see any flames. If, in fact, a fire had started on his watch, he would argue that some or all of the aforementioned developments would have come to his attention; however, in the absence of such notice, he was justified in relying upon circumstances as confirming that all was normal. In more exacting industry terms, if no supervisor warned Tirrell of any issue, if no manager brought something to his attention, if the Compliance Department didn't contact him with concerns, and if the General Counsel's office never chimed in, what the hell did the SEC expect him to do?
The ALJ Rules
In tackling the dispute before him, SEC Administrative Law Judge ("ALJ") Grimes explained that [Ed: footnote omitted]:
As Tirrell argues, the Division's argument that he cannot establish the elements of advice-of-counsel defense misses the point. He "is not making that argument." Opp'n at 10. Tirrell has specifically disclaimed reliance on any communication or advice from counsel. Id. at 2-3. Indeed, he argues that he did not rely on what lawyers and other professionals advised or told him; rather he relied on the fact lawyers and other professionals approved or did not object -- apparently based on their professional judgment -- to the leveraged conversion trade as it related to their fields of expertise. Id. at 9-10.
Whatever the strength or relevance of Tirrell's proposed defense might be, matters that I am not currently in a position to determine, the defense does not depend on advice Tirrell received from counsel. Given Tirrell's express waiver, however, he will not be permitted to rely on the assertion that he took action or refrained from taking action based on advice, from counsel or any other professional, that his action or inaction would be lawful. If Tirrell testifies during the hearing that he relied on a previously undisclosed communication with any counsel or professional or previously undisclosed advice from any counsel or professional, I will entertain an appropriate motion from the Division regarding that testimony.
ALJ Grimes and I seem to have arrived at a common conclusion; namely, that Tirrell's defense is not asserting a reliance on "advice of counsel" but on ongoing circumstances. Until and unless the hearing starts and Tirrell contradicts that assumption, the case moves forward with his proposed affirmative defense of good-faith-reliance intact.
Bill Singer's Comment
Permit me one rant. I want to make it clear, very clear, how outrageous I find the Division's language in the OIP where it is stated in the "Summary" that [Ed: highlighting provided]:
From 2009 to 2012, Tirrell aided and abetted and caused unprecedented violations of . . .
The use of the adjective "unprecedented" is inappropriate and in light of the fact that Tirrell has refused to settle the pending charges, such language comes off as jarringly petulant. To its credit and as should always be the case, the Division has set out a very compelling case against Tirrell. As is his right, the Respondent will be given an opportunity to respond with equally compelling defenses. All of that being said, I don't think characterizing violations as "unprecedented" is something that should appear in any OIP. It is the silliness of press releases and does not belong in a formal regulatory complaint.
To better understand my objection, do an online search and tell me how many OIPs you find that include the phrase "unprecedented violations." If, in fact, you find any such OIPs, eliminate from those results all OIPs that at the time of their filing were accompanied by the settlement of the Respondent(s).
In response to the OIP's assertion that Tirrell's alleged violations were "unprecedented," I must ask why the term "unprecedented" does not regularly find its way into OIPs naming large financial institutions which are charged with multi-million dollar frauds.
Show me the body of work where an unsettled OIP describes a violation as "unprecedented."
Tell me who at the SEC gets to decide when a given set of facts is deemed "unprecedented."
Direct my attention to the SEC Rule of Practice that defines when a violation rises to the status of "unprecedented."
Far too much regulation is asymmetric with unfair advantage attaching to regulators who decide when to file charges and frequently conduct their prosecutions before captive, in-house forums. The costs for defending the innocent are just as steep as those for the guilty. The professional damage caused merely by the presentation of allegations may destroy a career, even if the respondent/defendant prevails. As such, there should be no place in an SEC OIP for the language of press releases. An OIP is a sobering moment in the life of any Respondent. The Division should respect the seriousness of the consequences of its filing charges. An OIP is not permission for the Division to land a kidney punch or a low blow. As Sgt. Joe Friday so aptly lamented: "Just the facts ma'am."
- SEC Hit By Wave Of Petitions For Removal of Post-Bartko Collateral Bars (BrokeAndBroker.com Blog, February 3, 2017)
- SEC Collateral Bars Set Aside In Dramatic Bartko Victory (BrokeAndBroker.com Blog, January 18, 2017)
- SEC ALJ Says Bandimere Notwithstanding. And So It Goes. And So It Goes (BrokeAndBroker.com Blog, January 16, 2017)
- UPDATE: In Face Of Split Circuits, SEC ALJ Rules Because We Say So (BrokeAndBroker.com Blog, January 10, 2017)
- SEC Opts For Intercircuit Nonacquiescence (BrokeAndBroker.com Blog, January 9, 2017)
- In Face Of Split Circuits, SEC ALJ Rules Because We Say So (BrokeAndBroker.com Blog, January 6, 2017)
- BREAKING NEWS: Federal Appeals Court Says Securities and Exchange Commission ALJs Unconstitutional (BrokeAndBroker.com Blog, December 28, 2016)
UPDATE: September 1, 2017
SEC Order Making Findings
1. From 2009 to 2012, Tirrell negligently caused violations of Section 15(c)(3) of the
Exchange Act and Rule 15c3-3 thereunder by Merrill Lynch, Pierce, Fenner & Smith, Inc.
("MLPF&S") and its wholly-owned subsidiary, Merrill Lynch Professional Clearing Corp.
("MLPro" and together with MLPF&S, "ML").
2. As stated in a previous settled and admitted order concerning ML, see In the
Matter of Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional
Clearing Corp., Admin. Proc. File No. 3-17312 (June 23, 2016), ML during this period willfully
violated Section 15(c)(3) of the Exchange Act and Rule 15c3-3 thereunder. Known as the
Customer Protection Rule ("Rule"), Rule 15c3-3 requires broker-dealers to safeguard the cash of
their customers so that customer assets can be quickly returned if the firm fails. ML violated the
Rule by failing to deposit a sufficient amount of cash in a customer reserve account it was
required to maintain pursuant to Rule 15c3-3(e), thereby placing billions of dollars of ML
customers' money at risk. ML underfunded its reserve account by billions of dollars through the
use of trades, known internally as Leveraged Conversion Trades ("Trades"), that improperly
used ML customer assets to finance its own activities.
3. Tirrell was MLPF&S's Head of Regulatory Reporting, which is the department
responsible for, among other things, ensuring ML protects its customers by complying with Rule
15c3-3. Tirrell was also MLPF&S's designated Financial and Operational Principal ("FinOp"),
assuming specific and primary responsibilities for the firm's compliance with the Rule. In these
capacities, Tirrell and his subordinates calculated the customer reserve requirement each week.
Tirrell caused ML to reduce the amount reserved by billions of dollars as a result of the Trades. He
did so while failing to respond to questions from regulators about changes being made to the
Trades of which he and others at ML gave approval. In addition, Tirrell should have known the
purpose of the trades was to finance firm inventory and should have conveyed that purpose to
regulators. In so doing, Tirrell was negligent.
SIDE BAR: Below find pertinent portions of the third and fourth paragraphs from the OIP's Summary. The highlighted red text shows the prior language in the OIP that varies from the subsequent assertions in the OMF.
Tirrell knowingly reduced the amount ML reserved by billions of dollars as a result of the Trades despite knowing that regulators had significant unanswered questions about changes being made to the Trades, changes that Tirrell both approved of and failed to address with those regulators. In addition, he failed to accurately disclose the purpose of the Trades to regulators and repeatedly ignored requests from regulators for information that, if provided, would have put an abrupt end to the Trades. In so doing, Tirrell was reckless and negligent.
Tirrell likewise was reckless and negligent in aiding and abetting and causing ML's violations . . .
Pursuant to the terms of the settlement, the SEC revised its allegations from asserting that Tirrell had "knowingly reduced" the reserves to his having "caused" the firm to do same. Further, the SEC revised its earlier allegations that Tirrell knew that regulators had "significant unanswered questions about changes being made" to his "failing to respond to questions." Moreover, the SEC revised its initial allegations that Tirrell had "failed to accurately disclose the purpose of the Trades to regulators and repeatedly ignored [their] requests" to he "should have known the purpose of the trades was to finance firm inventory and should have conveyed that purpose to regulators." Finally, the allegations that Tirrell's conduct was reckless and negligent in aiding and abetting and causing the firm's violations was revised to an allegation that he was negligent.
In accordance with the terms of the settlement as set forth in the OMF, the SEC deemed it appropriate and in the public interest to order Tirrell to cease and desist from future violations of the '34 Act.
Bill Singer's Snarky Comment
I would like to take the opportunity to note that nowhere in the OMF do I find the word "unprecedented."