SEC Alert! Statement Second Commission Statement Relating to Certain Administrative Adjudications.

An update on how certain databases were not configured to restrict access by staff from our Division of Enforcement to memoranda drafted by staff from the Adjudication Group.

Source: https://www.sec.gov/news/statement/second-commission-statement-relating-certain-administrative-adjudications

On April 5, 2022, the Commission issued a Statement Relating to Certain Administrative Adjudications (the “April 5 Statement”) describing a control deficiency related to the separation of enforcement and adjudicatory functions within the agency’s system for administrative adjudication. As the April 5 Statement explained, for a period of time, certain databases maintained by our Office of the Secretary (“OS”) were not configured to restrict access by staff from our Division of Enforcement (“Enforcement”) to memoranda drafted by staff from the Adjudication Group (“Adjudication”) in our Office of the General Counsel (“OGC”). As a result, in a number of adjudicatory matters, administrative support staff from Enforcement responsible for maintaining Enforcement’s case files accessed Adjudication memoranda via OS’s databases. In many instances, those administrative staff also emailed Adjudication memoranda to other administrative staff for potential upload to Enforcement databases; once uploaded, the memoranda became accessible more broadly to Enforcement staff.

When it was discovered that Enforcement staff had access to Adjudication memoranda, the Commissioners were notified, as was the Commission’s Office of Inspector General. As the April 5 Statement explained, the Chair immediately directed the implementation of remedial measures, including enhanced access controls, to ensure that Enforcement staff would no longer be able to access these memoranda in the OS databases or through the Enforcement databases to which they may have been uploaded. The Chair also initiated a comprehensive internal review to assess the scope and potential impact of the control deficiency. This review has been conducted by experienced investigative staff from the Division of Examinations under the supervision of the Commission’s General Counsel (the “review team”). As noted in the April 5 Statement, the review team has been supported by Berkeley Research Group, LLC, a consulting firm retained by OGC that includes a team of experienced investigators and forensic analysts.

The April 5 Statement disclosed the review team’s findings regarding two matters arising from administrative adjudicatory proceedings as to which challenges were pending in the federal courts. In the April 5 Statement, the Commission also committed to releasing information about additional affected matters. We are now releasing the below statement from the review team, which provides additional information about the two matters discussed in the April 5 Statement, as well as findings regarding additional adjudicatory matters that are currently pending before us. Those matters include 28 matters as to which one or more Adjudication memoranda specific to a particular matter were accessed by Enforcement administrative staff, as well as 61 additional matters in which one or more Adjudication memoranda broadly applicable to numerous pending matters were accessed by Enforcement administrative staff.

We deeply regret that the agency’s internal systems lacked sufficient safeguards surrounding access to Adjudication memoranda, and we are continuing our work to ensure that, going forward, work product from the Adjudication staff is appropriately safeguarded. We take this lapse in controls very seriously and are committed to both informing the public about the scope of this issue and preventing any similar lapses in the future.

The information presented below is based on the work of the review team. We will release additional findings from the review team as appropriate.

Review Team Findings

Summary of Review and Findings

The review team has interviewed more than 250 current and former staff members, including individuals from Enforcement, OS, and OGC. The review team has collected and considered documents from Enforcement, OS, and OGC, including over 500,000 pages of emails and attachments. The team has also reviewed hundreds of case files in Enforcement’s case management database (the “Enforcement Centralized Database”), including the electronic case files of each of the matters discussed below. Working with Berkeley Research Group, the review team has analyzed over 25 million rows of data from access logs for various systems.

Part A and Exhibit 1 provide additional information regarding Cochran and Jarkesy,the two matters addressed in the Commission’s April 5 Statement.

In addition to those two matters, the review team identified additional matters that are currently pending before the Commission in which Enforcement administrative staff accessed one or more Adjudication memoranda that either: (1) pertained specifically to that matter (or in some instances to another matter but were maintained in the same Enforcement case file); or (2) were not specific to any individual adjudicatory matter but rather described procedural actions that Adjudication staff recommended that the Commission take in many (or all) pending adjudicatory proceedings. For ease of reference, the first set of memoranda is referred to as “case-specific memoranda,” and the matters they address are referred to as the “Affected Matters.” As discussed below, the review team identified 28 Affected Matters. The second set of memoranda—those addressing more generally applicable procedural actions—is referred to as “Omnibus Memoranda.” The review team determined that Enforcement administrative staff accessed eight Omnibus Memoranda and that there are 61 additional currently pending matters encompassed by one or more of those memoranda.

Part B and Exhibit 2 provide the review team’s findings about the 28 Affected Matters, identifying the case-specific memoranda accessed by Enforcement staff that relate to each of those matters. Part B also notes the instances in which an Omnibus Memorandum was uploaded to one of the Enforcement case files for the Affected Matters.

Part C and Exhibit 3 provide additional information about the eight Omnibus Memoranda that were accessed, including the scope of the adjudicatory matters encompassed by each. Exhibit 4 identifies—as to Cochran, Jarkesy, and all of the Affected Matters—the Omnibus Memoranda that encompass each matter. Exhibit 5, in turn, identifies the 61 additional pending adjudicatory matters in which only an Omnibus Memorandum encompassing that matter was accessed by Enforcement staff—that is, those currently pending matters encompassed by an Omnibus Memorandum as to which the review team found no evidence that a case-specific Adjudication memorandum was also accessed by Enforcement staff.

In all instances, the review team found that the Enforcement administrative staff accessed the Adjudication memoranda as part of an effort to track and upload to the Enforcement Centralized Database all Enforcement memoranda recommending Commission action in enforcement proceedings. Consistent with this effort, the overwhelming majority of the memoranda accessed by the Enforcement administrative staff were memoranda to the Commission submitted by Enforcement staff. But because the OS databases were not configured to prevent Enforcement staff from accessing Adjudication memoranda—and the Enforcement administrative staff did not distinguish between Enforcement and Adjudication memoranda—those administrative staff included some Adjudication memoranda in their effort to continually upload relevant materials into the Enforcement Centralized Database.

As indicated in Part B and Exhibit 2, in each of the 28 Affected Matters, an Enforcement administrative staff member accessed one or more case-specific Adjudication memoranda and emailed many of those memoranda to other Enforcement administrative staff. The administrative staff member who initially accessed the memoranda generally did not distribute the documents to other administrative staff members until after the Commission had voted on the action recommended by the memoranda. The administrative staff members who received these memoranda via email then typically uploaded the memoranda into the Enforcement Centralized Database. As a result, some case-specific Adjudication memoranda became accessible in the Enforcement Centralized Database to all Enforcement staff, including individuals investigating and prosecuting the matters referenced in those memoranda. None of the administrative staff members had a practice of contacting Enforcement staff directly responsible for investigating and prosecuting the relevant matters. And the review team found no evidence that any Enforcement staff assigned to investigate and prosecute any of the Affected Matters accessed any case-specific Adjudication memoranda before the Commission approved the action recommended in those memoranda.

As indicated in Part C and Exhibit 3, one of the eight Omnibus Memoranda accessed by Enforcement administrative staff was uploaded to the Enforcement Centralized Database in the Enforcement case files for Cochran and four of the Affected Matters and thus became accessible to all Enforcement staff. The remaining Omnibus Memoranda were accessed by Enforcement administrative staff via the OS databases but were not uploaded to the Enforcement Centralized Database, emailed to, or otherwise accessed by, any other Enforcement staff.

Access to Adjudication Memoranda by Enforcement Staff in the New York Regional Office

Enforcement administrative staff in the Commission’s New York Regional Office (“NYRO”) maintained a practice of uploading Enforcement memoranda relating to matters handled by NYRO staff to a separate database created and maintained by NYRO Enforcement staff (the “NYRO database”). The NYRO database was intended to serve as a supplemental reference resource for Enforcement memoranda and ultimately contained over 250 Enforcement memoranda. When the NYRO Enforcement administrative staff received Adjudication memoranda via the process described above, they too did not distinguish between memoranda drafted by Enforcement staff and those drafted by Adjudication staff.

Between February 2019 and August 2020, NYRO administrative staff emailed several Adjudication memoranda to an Enforcement supervisor in NYRO (“Enforcement Supervisor”), an attorney responsible for overseeing the work of other Enforcement attorneys in NYRO. The administrative staff’s emails sought instruction whether the Adjudication memoranda should be uploaded to the NYRO database. This occurred with respect to Jarkesy, as well as three of the Affected Matters; where it occurred with respect to those matters, it is noted below and in Exhibit 1 or 2, as appropriate. In two such instances, the NYRO Enforcement staff uploaded the memoranda to the NYRO database at the direction of the Enforcement Supervisor.

The review team found no evidence that either NYRO administrative staff or the Enforcement Supervisor circulated any Adjudication memoranda to anyone else, including anyone directly involved in investigating and prosecuting the relevant matters. The review team also determined that, for each of the Adjudication memoranda sent to the Enforcement Supervisor, transmission occurred after the Commission had already approved the action recommended in the Adjudication memorandum. For the Adjudication memoranda uploaded to the NYRO database, the review team determined that no one other than administrative staff accessed those memoranda in the NYRO database.

Outstanding Seriatim Reports

From at least 2015 through 2021, OS generally sent a weekly report to senior staff in Enforcement (including, at times, the Director, Deputy Director, and Chief Counsel) that provided the status of certain outstanding recommendations from Enforcement to the Commission. Referred to as the “Outstanding Seriatim Report,” this report listed all outstanding recommendations from Enforcement as to which the Commissioners intended to vote sequentially (in seriatim) without convening a meeting. The report briefly described the Enforcement staff’s recommendation and the status of the Commissioners’ votes on each recommendation. OS staff members generated the reports from one of the OS databases that did not adequately segregate Adjudication memoranda. While OS staff typically excluded information about Adjudication matters from the Outstanding Seriatim Reports, in some instances, limited information briefly describing Adjudication staff’s recommendations was inadvertently included in the reports.

Thirteen weekly Outstanding Seriatim Reports—one sent in February 2016 and twelve sent between June 2019 and July 2020—included Adjudication-specific information regarding one of the matters discussed below. Where this occurred, it is noted below and in Exhibit 1 or 2, as appropriate*.* The review team found that none of these Outstanding Seriatim Reports attached an Adjudication memorandum, nor did the review team find any evidence that the Outstanding Seriatim Reports were forwarded to any staff assigned to investigate and prosecute any of the matters.

A. Cochran and Jarkesy

As explained in the April 5 Statement, in both Cochran and Jarkesy, Enforcement administrative staff accessed one or more Adjudication memoranda and emailed those documents to other administrative staff who, in a number of instances, uploaded the memoranda to the Enforcement Centralized Database. As a result, certain Adjudication memoranda were accessible to all Enforcement staff, including attorneys investigating and prosecuting Cochran and Jarkesy.

David S. Hall, P.C. d/b/a The Hall Group CPAs, David S. Hall, CPA, Michelle L. Helterbran Cochran, CPA, and Susan A. Cisneros, Admin. Proc. 3-17228

The Commission issued an Order Instituting Proceedings (“OIP”) in this matter on April 26, 2016.[8] In March 2017, an administrative law judge (“ALJ”) issued an initial decision finding that respondents, auditors Michelle Helterbran Cochran and Susan Cisneros, had engaged in improper professional conduct in connection with their audits of publicly traded companies.[9] In June 2017, the Commission issued an order providing that the ALJ’s decision had become the final decision of the Commission.[10] Cochran sought Commission review of that decision, but while that review was pending, the matter was remanded and assigned to a new ALJ in light of the Supreme Court’s decision in Lucia v. SEC.[11] While the proceeding was pending before the new ALJ, Cochran filed a lawsuit in federal district court, seeking to enjoin the administrative proceeding.[12] The district court dismissed her complaint for lack of jurisdiction, and a panel of the U.S. Court of Appeals for the Fifth Circuit affirmed.[13] In December 2021, the en banc Fifth Circuit reversed the district court’s decision and remanded the case to the district court.[14] The Supreme Court subsequently granted the government’s petition for certiorari and, on April 14, 2023, affirmed the en banc court’s decision, holding that the district court has jurisdiction to hear Cochran’s complaint.[15] All deadlines in the administrative proceeding are postponed pending resolution of the litigation in federal court.[16]

As described in the Commission’s April 5 Statement (and further detailed in Exhibit 3), administrative staff in Enforcement accessed—and uploaded to the Cochran case file in the Enforcement Centralized Database—one Omnibus Memorandum, dated November 29, 2017, encompassing the Cochran matter. Enforcement administrative staff initially accessed the memorandum the day after the Commission issued its order on the issues presented in the Adjudication memorandum (hereinafter referred to as a “corresponding order”). The staff emailed the memorandum to other Enforcement administrative staff, who uploaded the document to the Cochran case file (as well as to several other case files, as indicated in Exhibit 3).

As described in the Commission’s April 5 Statement—and in submissions to the U.S. District Court for the Northern District of Texas[17] and the U.S. Supreme Court[18] by the Department of Justice (“DOJ”)—the review team found no evidence that Enforcement staff accessed any case-specific Adjudication memoranda relating to the Cochran matter, that any of the individuals assigned to investigate and prosecute the Cochran matter ever accessed or took any action influenced by the November 29, 2017 (or any other) Omnibus Memorandum, or that any of these individuals contacted or communicated with the Adjudication staff advising the Commission in its decision-making in this matter.[19]

2*. John Thomas Capital Mgmt. Grp. LLC d/b/a Patriot28 LLC, and George R. Jarkesy Jr.*, Admin. Proc. 3-15255

The Commission issued an OIP in this matter on March 22, 2013.[20] In October 2014, an ALJ issued an initial decision finding that respondents George R. Jarkesy Jr. and John Thomas Capital Management Group LLC, d/b/a Patriot28 LLC (“JTMG”), had violated the antifraud provisions of the federal securities laws.[21] Respondents appealed that decision to the Commission, and Enforcement cross-appealed the ALJ’s determination on sanctions. While the appeal was pending, the proceeding was remanded and reassigned to a different ALJ in light of Lucia, though respondents moved to vacate the remand order and proceed with their previously filed appeal on the existing record.[22] The Commission granted that request and, in September 2020, issued an opinion finding that respondents had violated the antifraud provisions and an order imposing a penalty, disgorgement on JTMG, and an industry and penny stock bar on Jarkesy.[23] Jarkesy filed a petition for review with the Fifth Circuit, which, in May 2022 vacated the Commission’s decision.[24] The Fifth Circuit denied the government’s petition for rehearing en banc. On March 8, 2023, the government filed a petition for a writ of certiorari, seeking the Supreme Court’s review of the Fifth Circuit’s decision.[25]

As described in the Commission’s April 5 Statement—and as DOJ notified the Fifth Circuit[26]—and as further detailed in Exhibit 1, an administrative staff member in Enforcement accessed nine case-specific Adjudication memoranda relating to the Jarkesy matter and emailed them to other administrative staff in Enforcement, who uploaded seven of them to the Jarkesy case file in the Enforcement Centralized Database. The review team found that administrative staff also emailed one of these Jarkesy-specific memoranda to the NYRO Enforcement Supervisor but that the memorandum was never uploaded to the NYRO database. In addition, in one instance, an Outstanding Seriatim Report circulated to senior Enforcement staff included a reference to one of the case-specific Adjudication memoranda relating to the Jarkesy matter.

The review team found no evidence that any of the individuals assigned to investigate and prosecute the Jarkesy matter ever accessed these Adjudication memoranda. The review team found no evidence that either the NYRO Enforcement Supervisor or any of the individuals assigned to investigate and prosecute the Jarkesy matter ever took any action influenced by these memoranda.[27] The review team also found no evidence that any of these individuals contacted or communicated with the Adjudication staff advising the Commission in its decision-making in this matter.[28]

B. Affected Matters

As noted above, there are 28 Affected Matters. In 20 of those matters, Enforcement administrative staff uploaded one or more case-specific Adjudication memoranda to a case file in the Enforcement Centralized Database.

As to all of the Affected Matters, the review team found no evidence—including through interviews with Enforcement staff—that access to Adjudication memoranda impacted any Enforcement filings or decision-making in those matters. In 23 of the Affected Matters, Enforcement made no filings between the date an Adjudication memorandum was initially accessed by a member of Enforcement’s administrative staff and the date the Commission voted to take action on the recommendation presented in the memorandum. In all of the remaining five Affected Matters—those in which an Enforcement filing was made during the time period between initial access and Commission approval—the Enforcement filing was unrelated to the subject matter of the recommendation in the Adjudication memorandum.[29]

C. Omnibus Memoranda

As noted above, and described in greater detail in Exhibit 3, Enforcement administrative staff accessed a total of eight Omnibus Memoranda recommending that the Commission take certain procedural actions in then-pending administrative adjudicatory proceedings.[135] Six of the memoranda involved recommendations following legal developments in litigation challenging the constitutionality of the Commission’s ALJs.[136] The remaining two involved recommendations by Adjudication staff related to the 2018-2019 federal government shutdown.

As indicated in Exhibit 3, one of the eight Omnibus Memoranda—the November 29, 2017 memorandum—was uploaded to the Enforcement Centralized Database. It was not uploaded to the NYRO database. The remaining seven were never emailed to, or otherwise accessed by, other Enforcement administrative staff; nor were they uploaded to either the Enforcement Centralized Database or the NYRO database. The review team found no evidence that the administrative staff member who accessed the Omnibus Memoranda contacted any Enforcement staff responsible for investigating and prosecuting the relevant matters about any of these memoranda.

Exhibit 4 identifies the particular Omnibus Memoranda that encompassed each matter described in Parts A and B (and listed in Exhibits 1 and 2). Exhibit 5 lists the additional currently pending adjudicatory matters in which the review team found that only an Omnibus Memorandum encompassing that matter was accessed (i.e., the review team found no evidence that a case-specific Adjudication memorandum was accessed relating to those matters). For each such matter, Exhibit 5 also indicates the particular Omnibus Memoranda that encompassed that matter.