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Broker/Custodian Failed to File SARs for Terminated Advisers


The SEC fined a large broker/custodian $500,000 for failing to file Suspicious Activity Reports for terminated advisers suspected of engaging in risky activity.  The firm would only file SARs when an individual employee referred the adviser to the Anti-Money Laundering Department. According to the SEC, the firm failed to supervise employees making such referrals, which resulted in inconsistent referrals based on a misunderstanding of regulatory requirements.  The firm failed to file SARs despite knowledge of potentially unlawful activity such as improperly shifting trade error losses to clients, charging questionable fees, and making false statements.  The SEC charges the broker/custodian with failing to file SARs with respect to activity that had “no business or apparent lawful purpose.”

OUR TAKE: The SEC is again using a broad reading of the Bank Secrecy Act and the SAR filing requirement to force broker/custodians to police all potential wrongdoing by advisers using their platforms.  The SEC does not contend that the misbehaving advisers were engaging in money laundering or that the broker/custodian in any way assisted such activity.  Nevertheless, the broker/custodian must file a SAR anytime it has reason to believe that any regulatory violation has occurred.  It is also noteworthy that the broker/custodian did not get much credit for ceasing business activities with the questionable advisers.

Broker/Custodian Should Have Filed SARs to Report Advisers Act Violations

A large custodian/clearing firm agreed to pay $2.8 Million to settle charges that it failed to file Suspicious Activity Reports about the conduct of dozens of terminated advisors that the SEC claims violated the Advisers Act.  The SEC asserts that the Bank Secrecy Act required the custodian/clearing firm to file SARs when it suspected that advisers using its platform engaged in questionable fund transfers, charged excessive management fees, operated a cherry-picking scheme, or logged in as the client.  According to the SEC, such unlawful activities fall within the SAR rules because they had no lawful business purpose or facilitated criminal activity.

OUR TAKE: The SEC is leveraging the Bank Secrecy Act, adopted to combat money laundering, to require broker/custodians to police advisers on their platforms for violations of the Advisers Act.  It’s a novel legal theory to further the regulator’s enforcement goal of requiring large securities markets participants to serve in a gatekeeping role for the industry

Lawyer Charged with Preparing Misleading Registration Statement

The SEC has sued a lawyer for aiding and abetting securities fraud by preparing a registration statement that failed to disclose that the principal was a convicted felon that controlled the issuer.  According to the SEC, the principal instructed the lawyer that he should not be named as an officer or director of the issuer because of his prior conviction.  Nevertheless, according to the SEC, the lawyer knew that the principal fully controlled the issuer and failed to include such disclosure in the Form S-1.  The SEC also charges that the lawyer knew or was severely reckless in not knowing that the three persons listed as officers and directors had not agreed to serve.

OUR TAKE: The SEC will hold gatekeepers, including lawyers, accountable for their bad clients.  This case goes further than prior enforcement cases by prosecuting a lawyer for reckless conduct rather than knowingly furthering a specific fraud.


Fund Administrator Liable for Miscalculating Fund NAV

The SEC fined and censured a fund administrator for causing a money market fund’s violations of the Investment Company Act.  The SEC asserts that the administrator used a flawed valuation methodology that resulted in violations of Rule 2a-7.  The fund was used as a vehicle to invest securities lending collateral for the benefit of affiliated mutual funds.  Because the fund failed Rule 2a-7, the investments by the registered funds violated the affiliated transaction rules.

OUR TAKE: As was the case with another recent case against a fund administrator, the SEC will broadly interpret the securities laws to hold non-registrant service providers accountable as gatekeepers of the securities markets.


Purported Lawyer Barred for Negligent Due Diligence

The SEC barred from the industry a purported lawyer that failed to investigate red flags arising in municipal bond offerings for which he served as underwriter’s counsel.  The sponsor of the offerings previously settled an SEC enforcement action pursuant to which he agreed to repay over $86 Million to investors because of misleading disclosures about compliance with municipal disclosure requirements.  The SEC faults the lawyer for engaging in a weak due diligence that failed to investigate disclosure red flags that were raised by several parties involved in the transaction.  Additionally, the respondent claimed to be a lawyer even though he was not actively admitted to the bar in any jurisdiction.  The SEC charges the respondent with fraud in the offer and sale of securities as well as causing the issuer’s legal violations.

OUR TAKE: The SEC will hold gatekeepers such as lawyers accountable for the bad acts of their clients.  This case expands gatekeeper liability by charging securities fraud even though the lawyer is not a registrant.


Fund Administrator Pays for Client’s Fraud

A fund administrator agreed to pay over $560,000 to settle charges that it caused its client’s violations of the Advisers Act’s antifraud provisions.  The client defrauded clients (and ultimately went to prison) for misappropriating client assets by creating fake loans in which the fund invested.  The fund’s custodian declined to book the fake loans because they lacked sufficient backup documentation.  Regardless, the administrator included the loans in the fund’s NAV even though, according to the SEC, it knew that the custodian excluded the loans.  The SEC faults the administrator for failing to further investigate, notify the board or shareholders, or exclude the loans from the NAV calculation.

OUR TAKE: Although it may be a legal stretch to assert that a fund administrator caused a fraudulent client’s illegal conduct, the SEC will hold securities markets gatekeepers accountable for their client’s behavior.  Service providers must conduct due diligence before accepting a client or risk being found guilty by association.


SEC Charges Lawyers for Clients’ Securities Fraud

The SEC charged two lawyers with securities fraud for providing legal opinions and other assistance to fraudulent blank check company schemes.  One of the lawyers also faces criminal charges brought by the U.S. Attorney’s Office.  The lawyers are accused of issuing due authorization and Rule 144 opinions, prerequisites to the public offering and sale of the shell companies, as well as other substantial assistance including moving assets through their lawyer trust accounts.  The Director of the SEC’s Miami Regional Office warned that “Lawyers are critical gatekeepers when it comes to protecting the integrity of our capital markets.”

OUR TAKE: Lawyers and other securities markets gatekeepers cannot plead ignorance when red flags indicate that they knew or should have known about their clients’ wrongdoing.  Firms must conduct significant due diligence both before accepting a client and during representation.  It is also noteworthy that the SEC charged the lawyers with securities fraud and not just aiding/abetting.


Lawyer Barred for Failing to Conduct Adequate Due Diligence

The SEC fined and barred an attorney from practicing before the Commission for failing to conduct proper due diligence as underwriter’s counsel for misleading municipal bond offerings.  According to the SEC, the lawyer prepared disclosure documents that contained erroneous statements that the issuer would comply, and had complied, with certain continuing disclosure obligations.  The SEC faults the lawyer for failing to conduct proper due diligence and relying solely on statements from the issuer.  The SEC also alleges that the lawyer ignored red flags that the disclosure was inaccurate.  The SEC separately prosecuted the issuer and the underwriter.

OUR TAKE: We have previously predicted that the SEC would target lawyers as a class of gatekeepers responsible for policing securities markets.  Counsel cannot ignore wrongdoing by claiming to have relied solely on client representations.