by Bill Singer
Significant New SEC Ruling: Compliance Officer Slammed Over Emails and Instant Messages
July 19, 2010
vFinance Investments, Inc. ("vFinance" or the "Firm"), a Financial Industry Regulatory Authority, Inc. (FINRA) member firm and a registered broker-dealer, and Richard Campanella, the Firm's former chief compliance officer and later president (together with vFinance, "Respondents"), appealed a Securities and Exchange Commission (SEC) administrative law judge's (ALJ's) Initial Decision that found that vFinance willfully violated Section 17(a) of the Securities Exchange Act of 1934 and Exchange Act Rules 17a-4(b)(4) and 17a-4(j), by failing to preserve and promptly produce electronic communications regarding its trading in the securities of Lexington Resources, Inc. ("Lexington"), and that Campanella willfully aided and abetted and was a cause of these violations.
The ALJ ordered Respondents to cease and desist, censured Campanella, and fined the Firm $100,000 and Campanella $30,000.
vFinance
vFinance was based in Florida with approximately 120 registered representatives and about twenty-five branch offices.
Campanella
From 2003 to July 2006, Campanella was the Firm's chief compliance officer and was responsible for the Firm's preservation of business correspondence.
RR Thompson, Flemington, NJ Branch Manager
Independent Contractor Nicholas P. Thompson, a vFinance registered representative from June 2002 through August 2006, was the manager of the Firm's Flemington, New Jersey branch office, which typically included only one other registered representative, Thompson's father. Thompson's trading activities were supervised from the Boca Raton office by William Groeneveld, then vFinance's Head Trader. The Firm was entitled to 15% of the gross retail commissions generated by his branch office.
Thompson was a respondent in the SEC proceeding, charged with aiding and abetting the Firm's primary violations. He settled the Commission case against him without admitting or denying the charges. In the Matter of vFinance Invs., Inc., Exchange Act Rel. No. 58403 (Aug. 21, 2008), 93 SEC Docket 8905, 8910 (imposing cease-and-desist order, $30,000 civil penalty, and associational bar with a right to reapply after five years). http://www.sec.gov/litigation/admin/2008/34-58403.pdf
Electronic Communication Policy
vFinance's policy prohibited personnel from using non-Firm e-mail accounts for business purposes because the Firm could not readily access or preserve such messages. Campanella was responsible for ensuring compliance with this policy. Branch office managers also signed a questionnaire during annual audits of the branches affirming that branch associated persons used only vFinance's email system when electronically communicating with the public. Campanella also had responsibility for assuring that instant messages ("IMs") were saved in compliance with Firm policies. Campanella approved revised written policies requiring representatives to either disable IM programs on their computers or to keep paper copies of their IMs.
Instant Messaging Concerns
During a December 2003 audit of the Flemington branch, vFinance discovered that Thompson was communicating with Firm traders using IMs that were saved on his computer (firm policy required IMs be saved in hard copy form). Campanella approved this exception for Thomson. During the December 2003 audit, Thompson also signed the branch office manager questionnaire representing that he used only vFinance e-mail for public communications.
Blast.net Email #1 and #2 and #3: January 2004 and February 2004 and March 2004
In January 2004, Campanella received a business-related e-mail message from Thompson that originated from a "blast.net" e-mail account - which was not an authorized vFinance e-mail address. Campanella ordered Thompson to stop using the non-vFinance email address; however, on February 3, Thompson again e-mailed Campanella from the blast.net account. Campanella ordered Thompson to stop using the blast.net address or he would impose a fine for the next infraction. However, even after receiving a third blast.net e-mail from Thompson regarding Firm business on March 8, 2004,Campanella did not discipline Thompson; nor is there evidence that Campanella monitored Thompson's subsequent use of the blast.net e-mail account.
NASD's Lexington Query
Thompson was a market maker in Lexington Resources, Inc. and represented retail clients trading in Lexington, including Liechtenstein-based Hypo-Alpe-Adria Bank ("Hypo"). Lexington was his most actively traded stock, generating him $274,334 in commissions and 578 trades between October 2003 and December 2005.
On May 12, 2004, NASD contacted Campanella to request vFinance's Lexington trading. On June 24, 2004, vFinance's Head Trader William Groeneveld, e-mailed Thompson about his Lexington trades (copying Campanella), cautioning Thompson that NASD rules regarding market manipulation were "becoming an issue." Groeneveld had discovered that vFinance had been responsible for 69% of Lexington trading for the first four months of 2004, and that the share price had steadily increased from $4 to almost $7 from March to June 2004. Thompson agreed to limit his customers' Lexington purchase orders, and within the next five days, the share price fell from $7.50 to $3.50. Groeneveld subsequently e-mailed Campanella that Lexington's pricing pattern raised red flags because Lexington had only $40,000 in revenue, the stock price increase was orderly, and there were numerous times when Thompson was both the inside bid and offer.
In September 2004 Campanella responded to Groeneveld that he had looked at the trades and do not see any issues , but that the Head Trader should go with his gut, and stop Thompson from trading the stock; or the Head Trader should handle the trading for a few weeks, and then make a decision to stop trading the stock altogether. Thompson continued to trade Lexington.
November 2004 Audit
In November 2004, during an unannounced audit of Thompson's office in November 2004, neither Campanella nor anyone else at vFinance alerted the compliance auditor to Thompson's use of the blast.net account. The compliance auditor was not trained in detecting non-vFinance e-mail. He checked Thompson's desktop screen for an icon of a non-Firm e-mail account but did not find one. He did not make further checks for e-mail programs. This auditor directed Thompson to continue to maintain the electronic file of IMs and his contemporaneous notes of conversations with clients. Thompson once again affirmed that he used only the vFinance system to e-mail the public.
SEC Division of Enforcement Seeks Documents
By letter dated July 18, 2005, the SEC's Division of Enforcement contacted Campanella to request, among other things, all paper and electronic materials related to Lexington trading from October 1, 2003 to July 18, 2005 (the "Initial Covered Period"), including any memoranda, correspondence, phone logs, and notes and recordings of conversations. Campanella assigned responsibility for the correspondence records to Thompson.
On July 22, 2005, Thompson told Campanella that he had nothing to send to Campanella but asked that all correspondence between himself and Groenveld be produced to the SEC. Campanella informed the SEC that Thompson did not have any responsive correspondence, phone logs, notes or recordings of any conversations.
The Division contacted Campanella on August 17 and 18, 2005, seeking confirmation that vFinance had searched Thompson's phone records, and requested access to all desktop and laptop computers used by Mr. Thompson during the Initial Covered Period for purposes of making forensic images of the hard drives. The Division also sought Thompson's appearance for testimony.
On August 19, Head Trader Groeneveld ordered Thompson to produce phone records and Hypo contact information, ordering Thompson not to accept any orders from Hypo until we get this information compiled. On August 22, Groeneveld e-mailed Thompson that the Firm would recommend that he seek independent counsel for any questions that he may have regarding his personal property. Thompson retained counsel and subsequently asked for a copy of the Firm's complete record production to the Division and for the return of phone records he had previously produced. Thompson complained to Groeneveld, copying Campanella, that he could not respond without these materials, and asserted that his vFinance e-mails were captured in Boca Raton and were not his responsibility to retain. Groeneveld replied to Thompson (with a copy to Campanella) that the Firm captures all emails except those from a personal account such as blast.net. Groeneveld suggested that the choice to retain such non-Firm emails was Thompson's, although the RR was required to retain emails from any personal account. vFinance produced Thompson's phone records and Hypo contact information on September 12, 2005, but failed to confirm that it had searched Thompson's phone records as the Division had requested. Although the record does not suggest that Thompson had produced additional e-mails or IMs, Campanella relaxed the Hypo trading prohibition that day, authorizing Thompson to start trading but only for purchases.
Blast.net Email #4: September 2005
On September 17, 2005, Campanella received a fourth blast.net e-mail from Thompson. Campanella responded by directing Thompson and an information technology vice president to coordinate the capture of the blast.net emails. Thompson explained to Campanella the the blast.net account was paid for through the end of the current month and would be closed thereafter, and he would only use vFinance's email address thereafter.
On September 22, 2005, compliance officer Jonathan Matthai ("Matthai") sent to the Division emails between Groeneveld and Thompson.
After Thompson complained that the restrictions that remained on his trading were causing his a significant decline in his business, Groeneveld replied on September 27th that the issue was now in the firm's Compliance Department's hands.
On September 28th, the firm's compliance auditor again audited Thompson's branch office but was not given a copy of the Division's request or directed to search for responsive documents. Even though Campanella had received another blast.net e-mail that same month, neither he nor anyone else at vFinance ever asked the compliance auditor to look at Thompson's blast.net account. During the audit, Thompson again represented that he used only vFinance e-mail to communicate with the public. Although his audit notes suggest that the IT department may have been receiving the IMs by September 2005, the compliance auditor's report encouraged Thompson to continue to maintain the electronic file of his IMs and to continue to document client conversations in writing.
Matthai's Explanations
In a November 10, 2005, letter to Campanella, (the Division's fifth letter to Campanella), the Staff expressed its frustration about not receiving all requested communications, particularly those between vFinance personnel and clients regarding Lexington. Also, the Division requested certification of vFinance's "thorough search" and production . Matthai responded on behalf of vFinance on November 18, 2005, and acknowledged the existence of Thompson's responsive personal email correspondence involving Lexington. Matthai noted that Thompson was an Independent Contractor and his computers were his personal property. Matthai further explained that Thompson's independent legal counsel had advised the RR to not allow access to his personal computers. However, Matthai added that Thompson represented to vFinanance that he would search his personal email correspondence involving Lexington and make it available to the Division on November 21, 2005. Finally, Matthai explained that it was the position of vFinance that Thompson should comply completely with all Division requests, but that his personal email and personal computers were outside the firm's control.
Campanella Turns Up the Heat
In light of still pending requests from the Division, on January 6, 2006, Campanella threatened Thompson with termination for failure to provide his computer and emails. On January 10, 2006, nearly six months after the Division's initial request, Thompson's counsel produced another 244 pages of Thompson's e-mails, stating that Thompson had now produced the complete set of the written communications between the parties that could be located. This production, like the October 2005 production, included extensive blast.net e-mails communicating with both clients and Firm personnel.
Electronic Shredding
Weeks later, Thompson gave the Commission access to his hard drive for imaging. This imaging revealed that, as of February 14, 2006, Thompson's vFinance e-mail inbox contained only twenty-five "live" messages, i.e., messages available without forensic recovery. Some of Thompson's messages were separately saved to an archive file on his hard drive. However, a forensic analysis found that Thompson began electronically searching for e-mail files related to Lexington about one week after the Firm disclaimed control over Thompson's personal email and personal computers. Approximately 1000 emails related to this matter appeared to have been deleted from the hard drive and then electronically "shredded," or made unrecoverable, in a multi-step process over a period of several months. In addition, approximately 850 of Thompson's e-mails between November 2005 and February 2006 were likely "double deleted" from Thompson's inbox and were only partially recoverable, even by forensic recovery.
Subpoena
The Division sent a document subpoena to vFinance on July 21, 2006, requesting the same communications as its July 2005 letter and extending the request to 2006. On August 4, 2006, Thompson resigned. Meanwhile, Campanella was promoted to Firm president and chief executive officer, but continued to coordinate the Firm's subpoena response.
On January 18, 2007, the Division wrote vFinance:
We understand that vFinance has never actually gone to Nick Thompson's office and searched for the documents requested by the staff. Instead, vFinance has relied on Mr. Thompson to respond to the staff's requests, despite the staff repeatedly informing vFinance that we had concerns about whether Mr. Thompson was making a good faith effort to search for and produce documents.
On January 31, 2007, vFinance agreed to provide all emails sent by or to Thompson using his vFinance.com email address, but did not address the blast.net messages. That day, the Firm's IT department completed its search of the vFinance.com e-mail in about six hours.
On February 5, 2007, vFinance produced Thompson's vFinance e-mails, but did not include attachments for messages before June 2005. Three days later, vFinance produced Thompson's August 2005 IMs showing extensive dialogue between Thompson and vFinance's traders regarding Firm business, but did not include Thompson's IMs for any of the Initial Covered Period.
Finally, in March 2007, almost eight months after the Division's subpoena, more than six months after Thompson's resignation, and approximately two months after the Division criticized the Firm's failure to search the office, Campanella searched the branch office for paper records. He found two boxes of responsive documents.
The SEC Sustains the ALJ
The SEC reviewed the ALJ's findings and affirmed them.
The SEC deemed Campanella's assignment of responsibility to Thompson to respond to the Division's request as questionable from the outset given Campanella's knowledge of the red flags surrounding Thompson's 2004 Lexington trading -- information indicative of a motive to withhold or obstruct production of relevant records. The SEC stated in the Decision:
The SEC believed that Respondents also knew of Thompson's repeated refusals to comply with Campanella's orders to stop using the blast.net account -- a pattern indicating Thompson's unwillingness to either act in accordance with recordkeeping requirements or to heed direct instructions from Campanella himself.
Thompson's July 2005 assertion that he did not have any responsive records was implausible on its face in light of his extensive Lexington trading generating him almost $275,000 in commissions during a twenty-six month period. .
At page 12 of the Decision
The SEC was equally upset about the Respondents assertions that they had engaged in good faith. Particularly irksome to the SEC was the Respondents' stance that they had to watch what they made independent contractors provide. Worse, the SEC was clearly troubled by the Respondents' encouragement of Thompson to seek independent counsel, a factor that was apparently exacerbated by the representation that the computers in the branch office were Thompson's "personal property."
The SEC admonished that it has long held that the designation of an independent contractor has no relevance for purposes of the securities laws. The SEC held that Respondents knew that Thompson was routinely using his blast.net account for Firm business, a fact more than sufficient to alert them to the possibility that the Firm was not capturing all of his business correspondence. Yet, because Respondents did not inform the compliance auditor about the blast.net account, his audits never focused on it. Further, Campanella's supposed stern warnings to Thompson about the use of the blast.net account was seens as a recognition that Thompson's was using blast.net messages for business correspondence. However, in spite of Thompson's refusal to heed Campanella's warnings, Campanella never imposed the threatened discipline on Thompson, nor implemented a system to preserve Thompson's business related blast.net messages.
The SEC found that the Firm also knew about, and Campanella expressly authorized, Thompson's storage of business-related IMs solely on his own computer beginning in 2003, although its own compliance policy required hard copy preservation. Moreover, electronic storage of these IMs violated the Exchange Act record retention requirements (in a non-rewritable, nonerasable format and available to the Commission at all times).
Whether Campanella willfully aided and abetted the Firm's violations rests on whether
- vFinance, in fact, committed the primary violations;
- Campanella substantially assisted the conduct constituting the primary violations; and
- Campanella provided that assistance with the requisite scienter.
The SEC notes that the scienter requirement is satisfied if Campanella knew of, or recklessly disregarded, the wrongdoing and his role in furthering it.
The SEC refused to accept that Campanella's role was merely a failure to act. Moreover,the SEC gave short shrift to the fact that Campanella did not assist in the destruction of documents - noting that such claims understated Campanella's role and misperceived the primary violations that Campanella aided and abetted, i.e., failure to preserve and produce Firm documents. Campanella's conduct was deemed, extremely reckless, and often knowing, particularly in light of his status as chief compliance officer.
In the Matter of vFinance Investments, Inc. and Richard Campanella (Opinion of the Commission, Securities Exchange Act of 1934 Rel No. 62449 / Admin. Proc. File No. 3012918 / July 2, 2010) at http://sec.gov/litigation/opinions/2010/34-62448.pdf