The SEC ordered a large asset manager to pay over $34 Million in disgorgement and interest to settle charges that it bribed foreign officials to obtain investment mandates. The firm also agreed to pay a $32 Million criminal fine and execute a non-prosecution agreement with the Department of Justice. The SEC alleges that employees at the asset manager knew that payments made by a foreign subsidiary to a solicitor were used to bribe foreign officials with power to direct investments by sovereign wealth funds. The SEC accuses the firm for violating the internal control provisions of the Foreign Corrupt Practices Act and for having insufficient internal accounting controls.
OUR TAKE: Compli-pros must implement enhanced procedures when their firms seek to attract foreign government clients. Procedures should include vetting of solicitors and due diligence into payments.
A large asset manager agreed to pay over $97 Million in disgorgement, fines and interest for over-relying and marketing faulty quantitative models and other portfolio management missteps. The SEC maintains that the respondents rolled out registered funds and separate accounts based on un-tested quantitative models created by an inexperienced research analysist. When the models failed to work as described to the Board and investors, the respondents discontinued their use without explanation or disclosure. The SEC also accuses the firm of declaring dividends without proper disclosure of the percentage attributable to return of capital and for using third party performance data without verification. The SEC charges violations of the anti-fraud rules, the compliance rule, and Section 15(c) of the Investment Company Act for lying to the funds’ Board.
OUR TAKE: This case reads like a cautionary tale for large firms trying to quickly roll out a product. It appears that the portfolio management, marketing, legal, operations, and legal functions worked in silos, and, as a result, failed to properly vet or describe the products. We recommend that firms create a cross-functional product assessment team that can ask the hard questions before launching a product.
Compliance deficiencies led to the demise of a private fund manager because of failures to enforce a consistent redemption policy, deliver audited financial statements, and file accurate Form ADVs. According to the SEC, the firm allowed certain clients and insiders the ability to redeem before the stated 90-day redemption policy. The firm also failed to deliver audited financials as required by the custody rule. The SEC also cites the firm for filing inaccurate Form ADVs, including claiming SEC registration eligibility even though the firm had less than $100 Million in assets under management. The SEC attributes the failures to the firm’s deficient compliance program which used a template manual and did not require annual compliance reviews.
OUR TAKE: Failure to implement an adequate compliance program can have real-world implications for the viability of your firm. A tight compliance program will support a more coherent operating environment that will prevent sloppy business practices that will lose clients and attract regulators.
FINRA fined a global online broker $5.5 Million for allowing naked short selling in violation of Regulation SHO despite red flags raised by FINRA as well as its own compliance and internal audit departments. FINRA maintains that, over a three-year period, the BD did not timely close out fail-to-deliver positions, unlawfully routed short sale orders, and did not issue required client pre-borrow notices. The firm’s Compliance Technology Department had advised senior management to fix systems that failed to account for segregation deficits. The firm’s Internal Audit Department also highlighted deficiencies. FINRA noted red flags in three consecutive examinations.
OUR TAKE: The regulators will react swiftly and harshly to a registrant that knows about compliance problems but appears to flout the requirements by failing to take remedial action. When assessing compliance programs, senior executives should first ask whether the firm has addressed previously-identified deficiencies.
A large investment adviser affiliated with a global bank agreed to pay $8.9 Million in disgorgement, fines and interest for allowing affiliated investment banking relationships to influence the selection of a portfolio manager recommended to retail clients. The adviser’s due diligence team had recommended the termination of a third party money manager because of personnel changes. According to the SEC, senior executives, seeking an investment banking mandate with the third party, lobbied and influenced the due diligence group to delay the termination until after the awarding of the mandate. The SEC faults the respondent for allowing this conflict of interest to influence its fiduciary obligations to recommend investment products in the best interest of its retail clients.
OUR TAKE: Compli-pros face an enormous challenges in large, global institutions to ferret out multi-lateral business relationships and ensure that the firm adequately observes its fiduciary obligations.
The SEC fined and censured an investment adviser for insufficient supervision and compliance procedures, which allowed one of its investment advisers to cherry-pick trades for the benefit of favored accounts. The adviser used an omnibus brokerage account to allocate profitable trades to favored accounts to the detriment of other accounts, notwithstanding the firm’s policies and procedures and Form ADV that indicated that it would allocate trades fairly and equitably. The SEC acknowledges that the firm did conduct daily reviews of the trading but focused on suitability and concentrations, rather than trade allocation.
OUR TAKE: Failure to prevent wrongdoing creates a burden and inference that your compliance policies and procedures do not measure up. In this case, the SEC did not offer insight into how the firm should conduct allocation testing or whether such testing would have stopped the misconduct. Instead, the SEC argues that the cherry-picking itself proves that the firm failed to implement reasonable policies and procedures. This is why firms need to implement testing and monitoring and not just write a nice policy.
The SEC fined a large broker-dealer $5.75 Million for failing to allocate sufficient resources to its valuation control function, thereby allowing rogue traders to inflate securities valuations and positions. The firm eliminated 15 valuation control positions as part of a global efficiency initiative, which, according to the SEC, left the control function understaffed and under-trained to adequately implement the firm’s valuation supervision policies. One manager complained internally that four staff members were tasked with verifying prices for more than 20 trading desks that held over $200 Billion in Level 2 and 3 securities. The SEC alleges violations of the books and records and supervision rules.
OUR TAKE: Having a valuation control function is not the same as having an effective valuation control function. Global firms must consider metrics before gutting compliance and supervisory functions that could ultimately allow bad actors to put the firm at risk. Firm leaders should think of compliance and supervision as the defense to protect assets and the firm’s reputation. And, defense wins championships.
The SEC fined a large BD/IA $4.5 Million for overly relying on flawed compliance technologies that failed to prevent 5 registered representatives from stealing over $1 Million from clients over a 4-year period. One of the systems, which was designed to compare disbursement addresses against controlled addresses, contained a technical error that resulted in a failure to generate the necessary red flags for further investigation. The other system, a transaction-monitoring tool, had a design limitation that required an exact word-for-word address match, thereby failing to identify suspicious addresses. Complementary manual supervision and monitoring also failed to uncover the conduct. The SEC charges the firm with failures to supervise and to implement reasonable policies and procedures.
OUR TAKE: We love compliance regtech as a tool to leverage compli-pros’ efforts to uncover wrongdoing. However, over-reliance on technology without professional judgment and intervention will lead to a false sense of compliance security. An automatic hammer will not build a house without the architects and the builders.
The SEC fined a wrap sponsor and ordered it to enhance its policies and procedures in connection with failures to evaluate and disclose trading away practices by third party portfolio managers. The SEC, which reviewed the firm’s practices back to 2008, asserts that 40% of the portfolio managers stepped-out trades to non-participating brokers, resulting in additional costs to the wrap client. The SEC faults the sponsor for neglecting to (i) provide historical trading away information about the portfolio managers to participating advisers so that they could conduct adequate suitability reviews and (ii) disclose the costs of trading away practices. The SEC charges violations of the compliance rule (206(4)-7) for failing to adopt reasonable policies and procedures.
OUR TAKE: We have warned that the SEC does not like wrap programs. If your firm insists on operating a wrap program, we would recommend a strict policy against trading away with a non-participating broker-dealer, unless the portfolio manager can document the execution benefits on a trade-by-trade basis. Of course, the wrap sponsor must disclose the trading away information as soon as possible to participating RIAs and wrap clients.