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Fund Manager Failed to Register as Broker-Dealer

A former fund manager was barred from the industry and faces possible fines and disgorgement for misrepresenting fees and commissions and for selling the fund without registering.  His partner previously settled with the SEC by agreeing to pay over $1.2 Million.  According to the SEC, the defendant hid the nature of the compensation received for selling the fund, which constituted transaction-based compensation requiring broker-dealer registration.  The SEC also charged the adviser with failing to register his firm as an investment adviser and with securities fraud. 

Fund managers that engage in selling efforts must register as broker-dealers unless they can take advantage of the issuer exemption (Rule 3a4-1), which prohibits the receipt of specific transaction-based compensation. 

FINRA Proposes Excluding RIAs from OBA Supervision

FINRA has proposed a new outside business activities supervision rule that would exclude independent investment advisers.  Under the proposal, third party investment advisers would need to receive informed consent for their activities, but the BD would not have supervisory obligations.  The BD could impose certain requirements based on a required risk assessment of conflicts of interest and customer confusion.  The proposal also limits BD obligations to supervise non-investment related activities.

OUR TAKE: That sound you heard yesterday was the Greek chorus of cheers from investment advisers who have had to pay their broker-dealers a percentage of their advisory fees for required supervision.  We expect the larger independent broker-dealers will lobby heavily against this proposal as it cuts off a lucrative revenue source.  The proposal would help smaller regional firms that want to recruit reps but don’t have the currently-required supervisory resources.  We expect much debate.

http://www.finra.org/industry/notices/18-08

SEC Takes Action against Head of Regulatory Reporting

The SEC issued a cease and desist order against the Head of Regulatory Reporting of a large investment bank for causing violations of the firm’s customer protection rule.  As previously reported, the firm agreed to pay $415 Million to settle the charges.  The SEC faults the respondent, who also served as the Financial and Operational Principal, with misleading regulators about the true purpose of certain synthetic transactions intended to reduce the amount held in the firm’s reserve account.  The SEC cites FINRA’s handbook which prohibits any window dressing designed to reduce the reserve formula.

OUR TAKE: It is noteworthy that the Head of Regulatory Reporting was the only individual specifically charged by the SEC in this action even though the firm paid a staggering settlement.  Regulatory officers, including CCOs and FINOPs, continue to be targeted by the regulators.

 

Broker-Dealer Responsible for Trading Desk’s Unlawful Trading Practices

An interdealer broker agreed to pay $2.5 Million in disgorgement for failing to disclose markups and markdowns on securities traded for clients.  According to the SEC, the broker-dealer’s Cash Equity Desk marketed its services as agency only, charging commissions between 1 and 3 cents per share.  However, the SEC alleges that during periods of market volatility, the Cash Equity Desk charged additional markups and markdowns on trades without telling clients and then misleading them about actual purchase/sale prices.  The conduct also violated its compliance policies.  The SEC faults the entire firm for the unlawful misconduct because the employees were “acting within the scope of their authority.”

OUR TAKE: Firms encountering bad conduct by a small number of employees will have a hard time making the “rogue employee” defense.  The SEC has increasingly taken a more strict liability approach whereby the firm is liable for all actions of all employees.

https://www.sec.gov/litigation/admin/2017/34-80332.pdf

Large BD to Pay $15 Million for Failing to Properly Train Reps

training

A large broker-dealer agreed to pay over $15 Million in disgorgement and fines for failing to adequately train its reps about the risks of structured notes sold to retail investors.  The SEC maintains that its rep training did not include sufficient information about volatility and breach risk such that the reps could satisfy their reasonable basis suitability obligations.  Over a 3-year period, the firm sold over $500 Million (notional amount) in the subject structured notes to more than 8,000 retail customers.  The SEC charges the firm with failure to supervise.

OUR TAKE: What is interesting about this case is that the SEC holds the firm accountable for failure to properly train the reps, rather than pointing the finger at the compliance department or the reps themselves.  This continues the trend of holding organizations and senior executives accountable for compliance failures.  Also, firms have a high regulatory burden when selling complex financial products to retail investors.

http://www.sec.gov/litigation/admin/2016/34-78958.pdf

Large BD Failed to Remedy Mini-Flash Crashes

Failed to Remedy Flash Crash

A large broker-dealer agreed to pay $12.5 Million to settle charges that it violated the market access rule (15c3-5).  The SEC charges that senior executives had discretion to set pre-trade controls at levels that allowed significant erroneous orders to reach the exchanges.  In several cases over a 3-year period, erroneous orders caused mini-flash crashes in the affected security.  Despite these events, which should have been red flags, the SEC faults the respondent for taking no action to address the market access until contacted by SEC staff.

OUR TAKE: This is the type of breakdown that can easily occur at large firms where compliance is left to individual business units, and no designated person has overall responsibility to monitor trading practices.

https://www.sec.gov/litigation/admin/2016/34-78929.pdf