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SEC Fines Dual-Hat CEO/FINOP for Incorrect Net Capital Calculations

The SEC censured and fined a broker-dealer and its dual-hatted CEO/FINOP for failing to properly calculate and report its required net capital.  The firm executed transactions with foreign banks which would have required a $250,000 minimum net capital rather than the reported $5000 minimum net capital.  The firm also failed to properly accrue for legal liabilities.  The CEO, a certified public accountant, also served as the firm’s financial and operations principal.  As part of the settlement, the firm agreed to hire a FINOP acceptable to the Commission.

OUR TAKE: Firms should not “dual-hat” C-suite executives to serve in regulatory roles such as FINOP or Chief Compliance Officer.  The dual-hat model exposes senior executives to significant regulatory risk and shortchanges the required functions.  If you can’t afford a full-time person, engage a third party firm that offers these services.


IA/BD Failed to Supervise Its CEO/CCO

The SEC fined and censured an IA/BD for failing to supervise its CEO/CCO who was ultimately criminally convicted of stealing from clients.  The CEO/CCO used the firm’s consolidated reporting system, which allowed manual inputs of outside investments, as a way to mislead clients about false investments that he siphoned off into his own account.  The SEC faults the firm for failing to implement reasonable policies and procedures to review the consolidated reports, which, according to the SEC, would have quickly uncovered the obvious scheme.  The SEC charges violations of the antifraud rules and the compliance rule (206(4)-7), which requires firms to adopt and implement reasonable compliance policies procedures to prevent violations of the securities laws.

OUR TAKE: It’s never good when the CEO (or any other revenue-producing individual) also serves as the CCO.  Such a structure virtually ensures a lack of proper supervision.  Firms must ensure that the CCO, whether inside or outsourced, has significant independence from management and the revenue-producing function.  The SEC has brought several enforcement actions against dual-hatted CCOs, who also serve in a management capacity.


Dual-Hatted CCO and Under-Resourced Compliance Function Result in Fine/Censure for BD

The SEC fined and censured a broker-dealer because its under-resourced compliance function failed to implement adequate employee and information monitoring procedures.  The firm’s Chief Compliance Office, who also served as a relationship manager, was initially appointed despite a lack of compliance experience.  He pleaded for more compliance resources, including the use of a third party compliance consultant, to monitor the firm’s 45+ registered representatives, but the CEO refused because the firm “needed to generate more revenue before it could spend more money on compliance.”  As a result, the broker-dealer failed to review employee securities trading, review a sufficient number of emails, and monitor information barriers.

OUR TAKE: Registered advisers and broker-dealers should retain a fully-committed CCO – either through hiring or by retaining a third party compliance firm – that has significant compliance experience.  Dual-hatting an unqualified internal employee will not satisfy the regulators.  Also, firms must adequately resource the compliance function.  Based on previous benchmarking studies, most SEC-regulated entities spend between 7%-20% of total operating costs on compliance, with a minimum of 5% of revenues.