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Author: Todd Cipperman

BD and Principal Punished for Failing to Observe Information Barriers (Again)

A broker-dealer and its principal were censured and fined for failing to observe information barriers intended to safeguard material nonpublic information contained in research reports.  According to the SEC, notwithstanding the BD’s written supervisory procedures, (i) the principal and other employees engaged in active personal trading without pre-approval, (ii) the firm failed to observe information barriers between research and sales, (iii) employees disseminated material information such as price targets to existing and prospective customers, and (iv) the firm failed to prevent trading ahead of research reports or decisions to commence coverage.  FINRA had previously cited the firm about similar issues.  The SEC alleges violations of Section 15(g) of the Exchange Act, which requires broker-dealers to establish and enforce policies and procedures to prevent the misuse of material nonpublic information.

OUR TAKE: The SEC will bring an enforcement action based on issues raised by other regulators (e.g. FINRA) but not adequately remediated.  The regulators will throw the book at recidivists.  (see e.g. In re Morgan Stanley).


Investment Adviser Sentenced to 2 Years in Prison for Cherry-Picking Trades

An investment adviser was sentenced to 2 years in prison plus another 2 years of supervised release for engaging in an illegal cherry-picking scheme that favored his personal accounts over his clients.  He was also ordered to pay $1.3 Million in restitution.  The SEC charged that the adviser used omnibus accounts and allocated trades at the end of the trading day.  The SEC has not yet imposed civil penalties, which will likely include a significant financial penalty and an industry bar.

OUR TAKE: When we reported this case back in January, we noted that the SEC included 10b-5 charges to allow for criminal prosecution.   Apparently, this strategy was successful as the defendant faces 2 years behind bars.


CFP Board Proposes Fiduciary Standard

The CFP Board has proposed a broad fiduciary standard in its new Code of Ethics and Standards of Conduct.  The proposed fiduciary standard requires a CFP professional to exercise a duty of loyalty, which requires placing the client’s interests above those of the CFP or his/her firm, avoiding or fully disclosing conflicts of interest, and acting without regard to personal or firm financial interests.   The new Code requires disclosure of all conflicts of interest such that a client can provide informed consent.    Comments on the proposed Code are due on August 21.

OUR TAKE: Whether or not the DoL or the SEC moves ahead with a fiduciary standard, the CFP Code would apply a best interest standard to many of the high-end planners carrying the CFP designation.  The fiduciary genie appears to be out of the lamp.


Form ADV FAQs Impact Cross-Border Investment Managers

The SEC’s Division of Investment Management has released additional Form ADV FAQs that affect cross-border investment managers.  The staff advises that non-U.S. investment funds, including UCITs or their equivalent, should be classified as “pooled investment vehicles” when describing assets.  Also, a non-resident GP or managing agent of a relying adviser must file Form ADV-NR.  The FAQs also broadly define “borrowings” for purposes of whether an adviser engages in borrowing transactions on behalf of clients, explain social media disclosure, and clarify that the new Form supersedes SEC no-action relief with respect to relying advisers.

OUR TAKE: The SEC continues to take an extra-territorial regulatory approach to any cross-border adviser that must register in the U.S.


Former CCO Fined and Barred for Life for Circumventing SEC Order

 The SEC fined and permanently barred a former broker-dealer chief compliance officer for violating a prior 5-year bar by consulting with the BD on FINOP matters including financial statements and FOCUS filings.  The SEC accuses the respondent from executing a consulting agreement on the day after he resigned to comply with the prior bar.  According to the SEC, the respondent “continued to run the day-to-day operations” for the next 3 years and maintained a BD email account.

OUR TAKE: There is a special place in the basement of the SEC Enforcement Division with wall photos of recidivists.  The SEC staff will show no quarter to those that violate enforcement settlements.


Clearing Broker Charged with Failing to File SARs

 The SEC instituted enforcement proceedings against a clearing broker for failing to file required Suspicious Activity Reports as required by the Bank Secrecy Act.  Although the broker-dealer had appropriate Written Supervisory Procedures, the firm failed in practice to implement its compliance program.  The firm filed nearly 2000 SARs that omitted necessary descriptive information, failed to file follow-up SARs with respect to another 1900 transactions, and did not file 250 SARs within the required time frames.  The SEC claims that the deficient SARs “facilitated illicit actors’ evasion of scrutiny by U.S. regulators and law enforcement.”

OUR TAKE: The BSA is no joke.  Failure to file SARs can result in crippling fines (up to $25,000 per failed SAR) and land you in jail.  It should be Chapter 1 of a broker-dealer’s compliance program.


Supreme Court Limits SEC Disgorgement

The U.S. Supreme Court has ruled that the SEC cannot seek disgorgement with respect to ill-gotten gains received more than 5 years ago.   A unanimous Court held that disgorgement is a “penalty” under the statute of limitations because (i) the SEC brings public cases not intended to remedy individual harm and (ii) disgorgement is imposed for punitive and deterrent purposes.  The Court rejected the SEC’s argument that disgorgement is used for restitution because disgorgement orders often exceed the defendant’s gains.  The Court has previously held that SEC penalties are also subject to the 5-year statute of limitations.

OUR TAKE: The Supreme Court significantly constrains the SEC’s enforcement power to demand huge settlements based on multi-year violations.  The SEC will have to move more quickly to investigate and file.


Adviser Looted Trust Accounts and Over-Charged Clients

 The SEC barred an investment adviser from the industry and ordered him to pay over $1.7 Million in disgorgement in part for looting trust accounts for which he served as a trustee.  According to the SEC, the adviser sold trust assets and purported to replace those assets with lesser-valued securities in which he had a personal interest.  The SEC also accuses the adviser of over-charging management fees and making misrepresentations about conflicts of interest.

OUR TAKE: This type of misconduct is exactly why the SEC should move forward and require all advisers to obtain third party compliance reviews in an effort to weed out wrongdoers.  The custody rule (206(4)-2) deems an adviser to have custody where the adviser serves as the trustee of a trust, and requires an annual surprise examination to verify assets and prevent looting of the trust.  Unfortunately, an adviser that is willing to steal from clients probably doesn’t prioritize compliance.


SEC Chairman Commences Consideration of Uniform Fiduciary Rule

SEC Chairman Jay Clayton has solicited public comment concerning the standard of conduct applicable to retail advisers and broker-dealers.  The SEC seeks public input on such topics as the preferred standard of care, conflicts of interest, approaches to regulation, disclosure, technologies, and investor confusion.  Mr. Clayton asks, “If the Commission were to proceed with a disclosure-based approach to potential regulatory action, what should that be?  If the Commission were to proceed with a standards-of-conduct-based approach to potential regulatory action, what should that be?  Should the standards for investment advisers and broker-dealers be the same or different?  Why?”  Mr. Clayton notes that the SEC last solicited such information back in 2013 but that rapidly changing markets, participants, and regulations require updated information.  He welcomes coordination with the Department of Labor as it implements and re-considers the Fiduciary Rule.  The SEC has set up a webform and email box to receive comments.

OUR TAKE: The SEC should adopt a uniform fiduciary or best interest standard for all retail advisers and broker-dealers, and the DoL should incorporate that standard rather than create a separate regime solely for retirement products.  We hope that Mr. Clayton has begun the process to ending this internecine regulatory battle of agencies.


SEC Stays All ALJ Cases in Tenth Circuit

The SEC has stayed all administrative proceedings assigned to Administrative Law Judges if a decision could be appealed to the Tenth Circuit Court of Appeals (based in Denver) until time has expired to appeal to the Supreme Court.  The SEC’s decision follows a Tenth Circuit decision (Bandimere v. SEC) that SEC ALJs are not appointed consistent with the U.S. Constitution’s Appointments Clause.  The Tenth Circuit’s decision conflicts with other federal courts, which would provide grounds for the SEC to appeal the decision to the Supreme Court.

OUR TAKE: The SEC will only appeal to the Supreme Court if it thinks it will win because a loss would have significant consequences to previously-decided cases, other federal agencies, and the SEC’s operations.   Instead, the SEC may just change the way it appoints ALJs and avoid a further federal imbroglio.