Compliance Officer Found Liable for Failing to Preserve Data

A recent ruling of the Securities and Exchange Commission (“SEC”) should serve as a yet another reminder of the importance of adequately preserving electronically stored data.

On July 2, 2010, the SEC ruled that vFinance Investments Inc., a Florida based broker dealer, violated securities laws by failing to preserve and produce electronic communications requested by the SEC as required by Section 17(a) of the Securities Exchange Act of 1934. In re vFinance Investments Inc., SEC, Admin. Proc. File No. 3-12918, 7/2/10.


In addition, as another example of the growing trend of blaming corporate executives for e-discovery failures, the SEC held that the firm’s former chief compliance officer, Richard Campanella, was liable for willfully aiding and abetting vFinance’s violations. The SEC sustained an administrative law judge’s decision censuring the Campanella and assessing penalties of $100,000 and $30,000 against the firm and Campanella, respectively. The SEC also barred Campanella from the industry for two years.


The penalties stemmed from vFinance’s failure to preserve and produce electronic communications of a branch manager at one of the firm’s offices. In July of 2005, the Enforcement Division of the SEC contacted Campanella to alert him regarding a forthcoming document request regarding Lexington Resources, Inc. -- the branch manager acted as a market maker for its stock. Although it was obvious to Campanella that the branch manager would not produce the requested documents, he waited almost six months after the division’s request to threaten to fire the branch manager for not doing so. In spite of the manager’s noncompliance, Campanella never followed through on the termination threat, giving the branch manager time to destroy the documents sought by the Enforcement Division. In addition, while Campanella was aware that the branch manager was sending and receiving email relating to Lexington Resources from a personal email account, he never implemented a system to preserve such email.  Because Campanella failed to act when he had a duty to do so, the SEC found him liable for aiding and abetting vFinance’s violations.  


Campanella was found liable for aiding and abetting vFinance’s violations even though he did not have actual knowledge that his failure to act constituted a violation. At oral argument before the SEC, Campanella’s counsel argued that in order to ensure certainty in the law, the standard for aiding and abetting in SEC administrative actions should be the same as in federal district courts, where actual knowledge is required. The SEC disagreed, holding that “recklessness is sufficient to establish aiding and abetting liability, and here we find Campanella’s conduct was variously knowing and extremely reckless.” 


There are two important implications here:  (1) corporate executives are not immune from e-discovery sanctions by virtue of being a few corporate steps removed from the process; and (2) the standard for liability in SEC actions is lower than in district courts -- recklessness rather than actual knowledge.


Beach Reading from the SEC

The Enforcement Manual, or "Red Book," of the SEC (that's right: the SEC) was released to the general public this October and it is the perfect read if you're being investigated by the SEC or know someone who will be.  It contains simply a wealth of helpful information on what the SEC wants in terms of electronic production.  Although there are a number of relevant sections, two of the particularly helpful being sections, "Form of Production," and, "Format for Electronic Production of Documents to the SEC," both of which provide some guidance for those responding to an SEC subpoena. Now, in addition to the two standard responses to SEC subpoenas of (1) sending everything in every possible format, including scans of  napkins with humorously-shaped and possibly discoverable stains and (2) sending nothing and hoping no one notices, the subpoenaed have a third option: send materials in precisely the formats that the SEC wants.

For those of you anxious to sink your teeth into the delicious prose of the Security and Exchange Commission, the complete manual is available here. (You will be relieved to know that the most recent SEC offering is without the tacked on romantic subplot that made Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date such a disappointment.)