A large mutual fund company agreed to pay a $1 Million fine and reimburse clients another $1.095 Million for failing to stop a portfolio manager from engaging in unlawful cross-trades. The SEC also fined and barred the portfolio manager. The SEC alleges that the portfolio manager interpositioned a friendly broker to execute cross-trades between clients in a scheme that benefited buying clients over selling clients. Such cross-trades – which were not conducted at the bid-ask spread and which paid commissions – violated the Investment Company Act’s affiliated transactions rules and did not comply with the Rule 17a-7 safe harbor. The SEC faults the firm and its compliance function for failing to further investigate responses from the portfolio management team that uniformly contended that the questioned trades were not prearranged. The SEC also criticizes the compliance function for failing to properly monitor trading practices and for neglecting to train employees.
OUR TAKE: Compliance testing and monitoring does not stop when a questioned employee (with an incentive to engage in violative transactions) denies wrongdoing. While this may avoid personal responsibility in the corporate blame game, it will not satisfy the regulators or fulfill a compli-pro’s obligations to implement reasonable policies and procedures.