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New York State Ethics Commission
Alfred E. Smith State Office Bldg.
80 South Swan Street, 11th Floor, Suite 1147
Albany, NY 12210


Advisory Opinion No. 03-8:

Whether a former Attorney General’s Office [ ] may assist a client in an investigation by the Securities Exchange Commission involving similar issues that are currently being investigated by the Attorney General’s Office, and whether his involvement in the early stages of the Attorney General’s investigation rose to the level of direct concern and personal participation or active consideration of a transaction so as to trigger application of the lifetime bar.


INTRODUCTION

[The former State employee] was employed with the New York State Attorney General’s Office (“AG”) as [ ] of the Investment Protection and Securities Bureau from [date] through [date], when he left to join [a securities firm] on [date] as a [senior officer].  In his new post, he will report to [the firm’s] chief legal officer.  He now seeks guidance on the application of the post-employment restrictions to his current position and its impact on his ability to participate in an on-going and broadening probe into the trading practices of mutual funds.  Currently, the AG, the Commonwealth of Massachusetts, the National Association of Securities Dealers (“NASD”), the Securities Exchange Commission (“SEC”), and other jurisdictions are investigating facts and circumstances surrounding the sale of mutual funds at [the firm].1 

BACKGROUND

[The former State employee] was a central figure in the AG’s investigation of alleged conflicts of interest in the use of corporate research at [a different securities firm], which began in mid-2001, and which led to sweeping reform starting in April 2002 when ten Wall Street securities firms, including [the firm where he now is employed], entered into a settlement with state and federal regulators, in which they agreed to pay a $1.4 billion penalty and separate analytic research from investment banking.  The Global Resolution was not signed by [the firm] until [date].2  [The firm] has complied with its terms, and [the former State employee] asserts that he had no significant dealings with [the firm] for the remainder of his employment with the AG’s Office.

The AG’s Investigation Into The Trading Practices of Mutual Funds

During the late Spring of 2003, the AG began a general inquiry into conflicts of interest in the mutual fund industry.  Soon thereafter, the AG received information concerning two particular practices:

“late trading”, which involves purchasing mutual fund shares at the 4 p.m. price after the market has closed, and “market timing,” which is an investment technique involving short-term, “in and out” trading of mutual fund shares, which has a detrimental effect on the long-term shareholders for whom mutual funds are designed.3  Late trading is prohibited by the Martin Act (see, General Business Law, Article 23-A), and SEC regulations. 4   The investigation quickly focused on the activities of, and the relationship between, a hedge fund named Canary Capital Partners, LLC (“Canary”) and a mutual fund run by Bank of America.  [The former State employee] states that “almost all” of his supervisory involvement was related to these parties and their trading conduct.   

On July 18, 2003, Assistant Attorneys General (“AAG”) [ ] and [ ] prepared a subpoena duces tecum signed by [ ] to [the firm] concerning two of its brokers: [  ]  and [ ].5  The subpoena asks for material concerning time trading and late trading practices at [the firm].  The subpoena does not relate to Canary or Bank of America.  [The former State employee] maintains that he was unaware of the subpoena nor its substance.

Five days later, on July 23, 2003, [the former State employee] met with the General Counsel for [the firm] and discussed the terms of his potential employment. Shortly thereafter,  in  consultation  with AG counsel  [ ], [the former State employee] recused himself from any work or information concerning [the firm].  The AG erected a “complete wall,” according to [the former State employee], and, consequently, he never learned of any new information concerning [the firm] in the mutual fund investigation.  [The former State employee] states that during this time frame he was still unaware of the [ ] subpoena.

On or about July 31, 2003, negotiations between [the firm] and [the former State employee] reached a point where [the former State employee] recused himself from all securities-related matters.  [The former State employee] has since learned that, on August 21, 2003, Assistant Attorney General [ ] sent a second, broader subpoena to [the firm] seeking information concerning late trading and time trading of mutual funds beyond the two previously mentioned brokers.  [The former State employee] believes similar subpoenas were sent to other Wall Street firms; he had no involvement in this portion of the investigation. Two days later, [the former State employee] ended employment with the AG’s Office.

[The firm] responded to the July 18, 2003 subpoena on August 20th, after [the former State employee] was recused from [the firm] and all other securities matters, but prior to [the former State employee] having left the AG’s Office.  One of AAG’s working on the investigation believes he received a phone call from an attorney representing one of the brokers, indicating that a timing agreement asked for in the July 18th subpoena had never been executed.  Other than this call, the AG believes that there were no other communications prior to July 23, 2003.

On September 3, 2003, the AG’s Office filed its complaint against Canary, based on charges that it had engaged in illegal trading with several large mutual fund companies and entered into a $40 million settlement.6  The AG’s press release indicated that it had obtained evidence of widespread illegal trading schemes, such as late trading and market timing, which cost mutual fund shareholders billions of dollars annually, that its investigation of the mutual fund industry was on-going, and that the full extent of the fraud was not yet known.

The next day, on September 4, 2003, the SEC sent [the firm] and many other Wall Street firms two subpoenas, one of which concerns time trading and late trading.  The SEC’s subpoenas are broader in scope than those issued by the AG and seek information concerning the handling of customer orders and the redemption practices of mutual fund shares.  [The former State employee] has reviewed the subpoenas and views them as significantly broader and more industry-wide than either of the AG’s subpoenas.  [The former State employee] states that the SEC was not informed of the AG’s activities and the Canary case.

Finally, on September 10 and 11, 2003, the SEC sent two additional subpoenas to [the firm]: the first deals with “timing” issues and mutual funds in the broadest sense, as well as the violation and redemption of mutual fund shares, and the second “is examining practices by investment companies” concerning their overseas pricing of foreign funds and portfolios of securities.

The Massachusetts Investigation 

On Thursday, July 10, 2003, the Director for the Massachusetts Security Division, [‘the Director”], telephoned [the former State employee] inviting him and Attorney General Eliot Spitzer to attend a news conference on the following Monday at which the Massachusetts Secretary of State, William F. Galvin (“Galvin”) would announce a complaint against [the firm].  The complaint concerned [the firm’s] response to a regulatory inquiry that Massachusetts viewed as either incomplete or false, and arose in the context of an investigation concerning whether [the firm] had improperly held sales contests to boost sales of its mutual funds, whether brokers received better commissions for selling one product over another and the adequacy of the disclosures in this area. [The director] wanted Mr. Spitzer to attend the press conference and lend his support.

Over the weekend, [the former State employee] and Mr. Spitzer read the complaint that would be filed on Monday and [the former State employee] helped prepare Mr. Spitzer over the weekend (Attachment A).  At the time, [the former State employee] understood that he was receiving no confidential information about the Massachusetts investigation of [the firm].  Mr. Spitzer’s reason for attending was to warn the public that similar State probes could be prohibited if controversial legislation in Congress, which would bar State regulators from investigating similar practices, were to become law.7

Mr. Spitzer and [the former State employee] attended the press conference held on July 14, 2003.   [The former State employee] states that he simply observed the conference and attended a brief pre-press conference meeting between Galvin, [the Director], and Mr. Spitzer.  On August 11, 2003, after [the former State employee] had recused from all [matter regarding the firm] and securities matters, Massachusetts filed its second action against [the firm], concerning the alleged sales practices and sales contest violations.8  [The former State employee] states that he never received any confidential information from Massachusetts beyond what was eventually disclosed either in the original complaint concerning [the firm’s] alleged false filing to regulators or in the subsequent August 11th complaint.

[The former State employee] and the AG’s Office state that their office neither separately nor jointly conducted any investigation into this matter, nor the issues in general, notwithstanding a press release issued by Massachusetts and the AG’s Office at that time, that a joint investigation was being conducted.  [The firm] has asked [the former State employee] to work on the Massachusetts action and on an SEC investigation into similar issues.  According to [the former State employee], the SEC probe is not primarily concerned with sales contests but encompasses issues with respect to the sale of mutual funds beyond that covered by the Massachusetts complaint.  The SEC investigation predates the Massachusetts investigation, which began in March, 2003.

Secretary Galvin has objected to [the former State employee’s] participation in the Massachusetts action and [the former State employee] has agreed not to appear before Massachusetts in connection with that case.  In addition, since then, other jurisdictions have commenced investigations into similar issues involving the issue of sales contests. 

SPECIFIC QUESTIONS PRESENTED

[The former State employee] asks (1) whether he may work on [the firm’s] response to the SEC subpoenas that followed after the AG announced the Canary settlement in early September, (2) whether he may work on the response to the SEC subpoenas relating to the Massachusetts investigation, (3) whether he may work on the investigations concerning sales contests from jurisdictions other than New York, and (4) whether he may provide advice to [the firm] in the context of the company’s business plan relating to mutual fund sales.

APPLICABLE STATUTES

The statutory language setting forth the two year bar is found in Public Officers Law §73(8)(a)(i), which provides as follows:

No person who has served as a state officer or employee shall within a period of two years after the termination of such service or employment appear or practice before such state agency or receive compensation for any services rendered by such former officer or employee on behalf of any person, firm, corporation, or association in relation to any case, proceeding or application or other matter before such agency.

The lifetime bar found in Public Officers Law §73(8)(a)(ii) states, in relevant part, that:

No person who has served as a state officer or employee shall after the termination of such service or employment appear, practice, communicate or otherwise render services before any state agency or receive compensation for any such services rendered by such former officer or employee on behalf of any person, firm, corporation or other entity in relation to any case, proceeding, application or transaction with respect to which such person was directly concerned and in which he or she personally participated during the period of his or her service or employment, or which was under his or her active consideration.

The above restrictions set the ground rules for what individuals may do with the knowledge, experience and contacts gained from public service after they leave their employment with a State agency.  The two-year bar prohibits former State officers and employees from appearing, practicing or rendering services for compensation in relation to any case, proceeding, application or other matter before their former agency for two years following their separation from State service.  A second provision, known as the “lifetime bar,” prohibits former State officers and employees from appearing, practicing, communicating or rendering services before any State agency for compensation, and rendering services for compensation in relation to any case, proceeding or transaction with respect to which they were directly concerned and in which they personally participated during the period of their State service, or which was under their active consideration during that period. 

DISCUSSION

The Two Year Bar

Since he is subject to the restrictions of the two year bar, [the former State employee] may not appear or practice before the AG or render compensated services in relation to a matter before the AG. [The former State employee] has asserted to the Commission that he does not intend to appear, practice or render services for compensation before the AG during his two-year period, which will effectively run through August 23, 2005.

In essence, the restrictions of the two-year bar mean that [the former State employee] may not participate, passively or otherwise, in any meetings, discussions, telephone calls, or be the recipient of documents, pertaining to the AG’s investigation of [the firm].  In addition, he may not review documents or testimony, or review or provide input into submissions that are relevant to any AG investigation.  While there may be situations in which counsel for [the firm] may wish to discuss the response to both the AG and the SEC subpoenas or the investigation in general, or request his presence in meetings where both investigations are discussed, [the former State employee] is cautioned to recuse himself from any participation in the AG’s portion of the investigation.9

In Advisory Opinion No. 99-03, the Commission noted the difficulty in providing guidance to a former employee of the Banking Department (“Department”) when she proposed to work for a consulting firm retained by a bank to conduct an investigation which had been ordered by the Federal Reserve Bank (“FRB”).  The bank was also regulated by the Department, and the FRB was authorized, but not required, to share information with the Department regarding the investigation.  Whether she would render services in a matter before the Department was not “foreseeable” because the former employee could not possibly know what the investigation would reveal as it progressed.

The Commission went on to hold that should the investigation come before the Department she would be required, at that time, to withdraw from the matter.

Investigations, by their very nature, make it impossible to know what information will be uncovered and revealed, and who may be involved, either as a witness or a subject of the inquiry.  In this case, the AG and the SEC are now probing the very same issues and activities involving [the firm’s] trading practices and its selling of mutual funds.  The issues are sufficiently similar so that the likelihood exists that the AG and the SEC will at least coexist, and may logically combine forces in a collaborative effort.10  If actionable conduct is discovered, past practice suggests a settlement with federal and state regulators similar to the one reached with the Wall Street firms in the investment banking research cases in 2002.  Under the circumstances, [the former State employee] would not be permitted to participate in any aspect of the matter that is before the AG or that is jointly before the AG and the SEC, or the AG and some other jurisdictions, such as Massachusetts .  Furthermore, he would be required to withdraw from a matter at the time he becomes aware that the AG is involved in the matter.

The Lifetime Bar

For the Commission to determine whether the lifetime bar prohibits [the former State employee] from representing [the firm] in the on-going investigations which involve the trading practices of mutual funds and sales contests, two issues must be addressed: (1) whether [the former State employee’s] activities while in State service were such that he personally participated in and was directly concerned with, or actively considered, either of the investigations, and, if they were, (2) whether the investigation is the same “case, proceeding, application or transaction” as the investigation [the former State employee] worked on while with the AG.

As noted above, the post-employment restriction is intended to prevent former State officers and employees from utilizing their “insider” knowledge of specific projects for their own benefit or that of a client.  Questions involving applications of the lifetime bar must be made on a case-by-case basis (see, Advisory Opinion No. 90-22).

In Advisory Opinion No. 93-13, the Commission held that decisive to a finding of whether a former employee personally participated in and was directly concerned with, or actively considered a transaction, is whether the former employee had some official State role in effecting the outcome of the transaction.  In that case, the Commission held that while the employee was “interested” in the outcome, his interest did not rise to the level of direct concern to invoke the lifetime bar. 

In Advisory Opinion No. 95-41, a former AAG sought to represent a party in a civil proceeding that was related to a criminal matter in which the attorney had a supervisory role.  The former AAG sought to represent a defendant in a civil suit brought by the City of Utica , alleging that the defendants were liable for costs it incurred due to the release of hazardous substances at a site.  Certain individuals were indicted in State court for criminal violations of the State’s environmental laws, which were prosecuted by the AG’s Office.  As a State employee, the former AAG’s involvement was limited to the review of the indictments for form.  The former AAG did not have any substantive input into the decisions to initiate the investigation or to seek the indictments.  The Commission held that the former employee’s limited involvement in the criminal matter while he served in the AG’s Office was not such that he personally participated in and was directly concerned with the matter, or that he had it under his active consideration.

[The former State employee’s] Participation in the AG’s Investigation into Mutual Fund Trading Practices

In the instant case, [the former State employee] had overall supervisory responsibilities concerning the mutual fund investigation at the time the July 18, 2003 subpoena was issued to [the firm] primarily concerning two of its brokers, although he did not sign the subpoena nor know of its existence until later.  At the time [the firm] made its initial response to the subpoena on August 20, 2003, and by the time that the AG issued its second, broader subpoena to [the firm], [the former State employee] had recused from all [of the firm’s matters] and securities-related matters. Based on the foregoing, the Commission finds that while [the former State employee’s] role as supervisor may have otherwise triggered the lifetime bar, given the brief period of time between the issuance of the July 18, 2003 subpoena and his recusal from [the firm’s] matters, the Commission concludes that the lifetime bar does not apply to the instant circumstances.

In Advisory Opinion No. 92-20, the Commission held that for an agency head, transactions handled by senior staff are imputed to him or her.  However, in that opinion, the Commission said that it “was aware of the hazard of imputing all actions of staff to the supervisor for purposes of determining whether there has been a violation of the ethics law.”  In the instant case, the Commission is aware that during the period in question, the AG’s Office was issuing scores of subpoenas to the securities industry, and to impute the narrower and broader [the firm] subpoenas to [the former State employee] at a time when he asserts having had no knowledge of the subpoenas, or, by the time he had been recused from all [the firm] and securities-related matters, would be inconsistent with the Commission’s historical application of the lifetime bar.

Even if the Commission were to conclude that the lifetime bar applies because [the former State employee] was the supervisor at the time the first subpoenas were issued, the Commission would be reluctant to conclude that the SEC investigation is the “same transaction” because the Commission notes that the SEC began its investigation after the AG publicly announced its settlement with Canary identifying the improper trading techniques now under scrutiny by the SEC.  Thus, given the independent nature of the SEC investigation and the five day period of time in which [the former State employee] had a supervisory role in the investigation (from July 18, 2003, when his subordinates issued the subpoena to [the firm] and July 23, 2003, when he recused from [the firm’s] matters), the Commission finds that it would be unwarranted to invoke the lifetime bar to these specific set of facts. 

[The former State employee’s] participation in the Massachusetts investigation involving whether [the firm] has improperly held “sales contests” to sell mutual funds

[The former State employee] attended the July 14, 2003 press conference announcing a complaint against [the firm] concerning an incomplete or false response relating to an inquiry relating to sales contests.  The AG’s Office did not conduct an investigation into this issue, but maintains that it attended the press conference solely to alert investors and the public about legislation in Congress that would preempt State action into similar cases.  At the time Massachusetts filed a second complaint against [the firm] alleging improper sales contests, [the former State employee] had recused from [the firm] matters.  Neither he nor the AG’s Office investigated these matters prior to his departure. While the SEC investigation predated the Massachusetts investigation, [the former State employee] had no substantive knowledge of the SEC investigation.

Based on the foregoing, the Commission finds that [the former State employee’s] limited involvement at the Massachusetts press conference did not rise to the level of having direct concern, personal participation or active consideration in relation to the investigation concerning sales contests.11

Although the timing of [the former State employee’s] departure from the AG’s Office, on the verge of a broadening investigation into [the firm’s] trading practices merits attention, evidence that [the former State employee] had insider information that could benefit his current employer in the SEC investigation into similar and other issues is to the contrary.

Notwithstanding the above, [the former State employee] is reminded that the lifetime bar would preclude him from having any involvement on behalf of [the firm] or any other entity with regard to [the firm’s] settlement with the AG over its research practices (the 2002 Global Resolution) as well as the AG’s complaint and settlement with Canary as they are transactions which [the former State employee] actively considered, personally participated or was directly concerned.  Given his prominent position at the AG’s Office, there may be additional transactions for which [the former State employee] faces a lifetime bar prohibition and he is encouraged to contact the Commission for further guidance.

CONCLUSION

Pursuant to the two-year bar, [the former State employee] may render services in connection with SEC investigations of [the firm], as long as the investigation is not a matter that comes  before the AG; should the investigation come before the AG, he must withdraw from the matter that is before the AG or from matters that are jointly before the AG, the SEC or any other jurisdiction.  The lifetime bar does not preclude him from working on the SEC subpoenas involving time trading and market timing, and the SEC subpoenas and investigations from other jurisdictions on [the firm’s] sales practices.

He may advise [the firm] on their sales practices as long as in doing so he does not appear, practice or renders services for compensation in any matter before the AG for the remainder of his two-year bar and does not render assistance with regard to the 2002 Global Resolution for which he is lifetime barred.

This opinion, unless and until amended or revoked, is binding on the Commission in any subsequent proceeding concerning the person who requested it and who acted in good faith, unless material facts were omitted or misstated by the person in the request for opinion or related supporting documentation.

 
All Concur:
Paul Shechtman, Chair
Robert J. Giuffra, Jr.
Lynn Millane, Members

Dated: October 16 , 2003


End notes

1. On [date], [the firm] agreed to pay $2 million to settle allegations by NASD of improper sales practices in which its brokers were encouraged to use prohibited contests to favor the sale of [the firm’s] mutual funds.

2. Under the terms of its agreement with the AG, [the firm] adopted all of the terms and provisions of the Global Resolution, paid a fine of $50 million and contributed $75 million to an independent research fund.

3. The technique of timing is designed to exploit market inefficiencies when the net asset value (“NAV”) price of the mutual fund shares, which is set at the 4 p.m. market close, does not reflect the current market value of the stocks held by the mutual fund.  When a “market timer” buys mutual funds at the stale NAV price, it realizes a profit when it sells those shares the next trading day or thereafter.  That profit dilutes the value of the shares held by the long-term investors. 

4. The AG is given very broad powers to enforce the provisions of the Martin Act by means of investigation, civil actions, and criminal prosecutions. (McKinney’s General Business Law §352.)

5. [The former State employee] was [ ] of the Investment Protection Bureau; [ ] was Deputy [ ] and [ ] and [ ], among others, were AAGs in that unit. 

6. The settlement agreement included two Canary-related entities and Edward J. Stern, the managing principal.  Canary obtained special trading opportunities with leading mutual fund families, including Bank of America’s Nations Funds, Banc One, Janus and Strong, pursuant to undisclosed agreements that involved substantial benefits for the fund management companies.

7. At the time, there was legislation before a key committee in the United States House of Representatives which would have, effectively, pre-empted State action.

8. The Commission notes that the Massachusetts complaint alleges the sales contest in question occurred within [the firm’s] Northeast region.  An exhibit to the complaint suggests several branches in New York State (Fairport, Rochester, New York City) may have some role in the matter under investigation.  The AG would not confirm or deny whether an investigation has commenced subsequent to [the former State employee’s] departure.

9. As distinctions between the two investigations may be difficult to discern, [the former State employee] is encouraged to contact the Commission for further guidance in specific situations. 

10. For example, on October 2, 2003, the AG’s Office and the SEC issued a press release announcing criminal charges and civil charges against a former executive and senior trader with the Hedge Fund firm, Millennium Partners, L.P., and promising to work together aggressively to pursue abusive trading practices.

11. Should the AG begin an investigation with sales contests, the two-year bar would preclude [the former State employee] from having any role in the AG’s inquiry on behalf of [the firm].

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