The SEC has filed a lawsuit against a lawyer that operated an investment adviser that allegedly defrauded former NFL players and misled them about the credentials of one of the principals. The lawyer represented the players in class action concussion litigation against the NFL and then solicited them to invest in private funds that purportedly invested primarily in securities. However, the SEC asserts that the fund primarily served to advance settlement payments to other clients in the litigation. Also, the SEC charges that the respondents failed to disclose that the lawyer’s investment partner had a long regulatory and criminal history that included an industry bar and jail time. Disclosure documents described the partner as an adviser and consultant when in fact he managed the funds and shared profits with the lawyer. Item 9 of Form ADV requires disclosure of disciplinary information for any current employee, officer, partner, or “any person performing similar functions.”
The SEC views Item 9 disciplinary disclosures as critical to Form ADV because it provides potential clients with a window on an adviser’s reputation. A person with a regulatory history can’t avoid disclosure simply by becoming a “consultant” when the actual duties and financials show otherwise.
FINRA has proposed a new rule that would require broker-dealers with a large number of disciplinary events to set aside segregated funds to pay future penalties or arbitration awards. Proposed Rule 4111 (Restricted Firm Obligations) would score each firm against its peers based on registered person and member firm adjudicated events and expulsions. Based on FINRA’s grid, the firm would be required to deposit funds in a segregated account until the firm takes action to remedy the situation, thereby allowing a reduction in the amount deposited. FINRA seeks to address the small number of firms that attract brokers with significant disciplinary records but have not appropriately responded to FINRA’s previous efforts to require heightened supervision or enhance sanctions.
On the positive side, requiring what amounts to a net capital penalty should get the attention of senior leaders at these problem firms. On the other hand, FINRA needs to be careful that such a firm doesn’t make a cold calculation to hire a bad broker if the broker’s production offsets the additional financial obligation.
The SEC fined a broker-dealer $1.25 Million for failing to take sufficient disciplinary action against brokers that shared commissions in violation of firm policy. The SEC asserts that the one broker, who ultimately became a supervisor, assigned accounts to junior traders in exchange for off-the-book kickbacks paid by personal checks. The transactions violated the firm’s policies and procedures and books and records requirements. Upon discovering the arrangement 13 years after it began as a result of a FINRA investigation, the firm responded by issuing a memo condemning the activity and offering the participants the opportunity to resign. The SEC faults the firm for failing to discipline the wrongdoers.
OUR TAKE: Having policies and procedures, but taking no significant action against those who violate them, eviscerates their purpose. This compliance voodoo – the mere appearance of a compliance program – will draw the ire of the regulators.