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Adviser Ignored Compliance Consultant’s Supervision Recommendations

 

The SEC censured and fined an investment adviser for failing to supervise one of its employees who engaged in an unauthorized cherry-picking scheme.  Although the adviser had procedures requiring preclearance of personal trades, the SEC asserts that the firm failed to implement the preclearance procedures even after a third party consulting firm notified the firm of its failures to implement.  As part of the settlement, the adviser will deliver the order to each of the affected clients.

When you hire a compliance consultant, you should not ignore their recommendations.  The SEC will likely assert that you have displayed an unwillingness to implement a legitimate compliance program. 

Withdrawing BD Registration Doesn’t Stop the SEC from Prosecuting for Failure to Supervise

 

The SEC fined a broker-dealer and its CEO for failure to supervise even though the firm withdrew its registration.  A broker at the firm pleaded guilty to providing inflated quotes to an investment manager as a quid pro quo for receiving future trading business.  The SEC alleges that the CEO knew that the trader provided quotes but failed to adopt and implement reasonable procedures to supervise the trader and his provision of price quotes to third parties.  The BD withdrew from registration, but an SEC Enforcement official warned, “Deregistering with the Commission in the midst of an enforcement investigation will not enable such firms to evade liability.”

Just because you abandon your car before the police can stop you doesn’t mean that you can’t get arrested.  It appears that the respondent’s efforts to avoid prosecution by withdrawing may have exacerbated their SEC problems by making them look more guilty. 

BD Pays $26.4 Million for Failing to Conduct Targeted Email Reviews

 

A large broker-dealer agreed to pay $26.4 Million in client reimbursements and fines for failing to supervise traders that lied to customers about CMBS and RMBS transactions over a multi-year period.  The SEC asserts that the traders misled customers about bond prices, bids/offers, compensation, and ownership in very opaque secondary trading markets.  The SEC alleges that targeted reviews of electronic correspondence would have uncovered the illegal activity, thereby constituting a failure to supervise in violation of Section 15(b)(4)(E) of the Exchange Act.  As part of the remediation, the firm has implemented additional procedures for targeted reviews of communications relating to transactions that fall within certain risk-based parameters.

The most interesting legal point is that the SEC argues that the failure to implement compliance policies and procedures that would have uncovered wrongdoing can serve as a predicate for a failure to supervise charge.  In the past, the regulators generally separated the compliance program from the supervisory obligations.  Does this mean that a compli-pro can be charged with aiding and abetting his/her firm’s failure to supervise if the compliance monitoring program fails to detect wrongdoing?

Private Equity CEO Failed to Supervise CFO/CCO


A private equity firm, the firm’s CEO, and its CFO/CCO were each censured and fined for overcharging the fund, engaging in improper insider loans, and violating the custody rule.
According to the SEC, the CFO/CCO failed to properly allocate management fee offsets for certain deemed contributions, thereby overcharging the fund by about $1.4 Million. The CFO/CCO also arranged improper loans between the fund and the management company and overcharged for organizational expenses. The SEC also charges the firm with failing to deliver audited financial statements within the required 120-day period, in part because one of its auditors withdrew from the engagement. The SEC faults the CEO for failing to properly supervise the CFO/CCO as required by Section 203(e)(6) of the Advisers Act. The SEC alleges violations of the Advisers Act’s antifraud rule (206(4)-8) and the compliance rule (206(4)-7).

Senior leaders will not escape accountability by claiming reliance on subordinates. Also, private equity firms can’t use the funds they manage as their firm piggy banks. They need to implement policies and procedures about the withdrawal and use of funds.

Firm’s Procedures Did Not Guide Management on How to Respond to Red Flags

A large broker-dealer was fined and censured for failing to act against a longtime broker charged with participating in pump-and-dump transactions.  The SEC faults the firm for ignoring red flags including emails outlining the illegal activity, FINRA arbitrations, and customer complaints.  One supervisor explained that he did not act more aggressively because the broker worked at the firm for 30 years and her business partner was a partial owner of the firm. The SEC asserts that the firm’s supervisory system “lacked any reasonable coherent structure to provide guidance to supervisors and other staff for investigating possible facilitation of market manipulation.”  The SEC also maintains that the firm “lacked reasonable procedures regarding the investigation and handling of red flags.”

Reasonable policies and procedures must do more than simply restate the law and the firm’s commitment to comply with the law.  The compliance manual or WSPs must specifically describe HOW a firm will prevent and address regulatory misconduct. 

Bad Broker Costs Large RIA/BD $3.6 Million for Compliance and Supervisory Failures

The SEC fined a large broker-dealer/investment adviser $3.6 Million because its inadequate compliance and supervisory program failed to stop a broker from stealing from clients.  The broker, currently facing criminal charges, exploited a weakness in the firm’s control systems that allowed third party disbursements up to $100,000 per day based on representations that the broker received oral instructions.  According to the SEC, the broker misappropriated $7 Million from four advisory accounts.  Although the firm did have policies and procedures that included ad hoc manual supervisory reviews, the firm did not require authorization letters, call back clients to verify instructions, or record calls.

OUR TAKE: A motivated miscreant will find the weaknesses in your compliance and supervisory system.  To avoid this type of theft, a firm should prohibit any third party money movement without the review of a supervisor or compli-pro.

 

BD/RIA Knew about Flipping Transactions but Failed to Stop Them

A large bank-affiliated broker-dealer/adviser agreed to pay over $5.1 Million in disgorgement, interest and penalties for failing to stop its brokers from churning/flipping high-commission market-linked investment products.  The SEC alleges that the respondent knew that its brokers engaged in flipping transactions as far back as 2005 but took inadequate measures to stop the misconduct.  For several years, the firm relied on supervisor pre-approval but failed to provide supervisors adequate guidance or training, resulting in routine approvals.  The firm finally stopped the unlawful activity by implementing a centralized electronic supervisory pre-approval process.

OUR TAKE: The regulators will not give credit for “voodoo compliance” whereby a firm superficially creates a compliance infrastructure, but the designated policies and procedures fail to stop unlawful conduct.  Ad hoc supervisory reviews rarely serve as adequate tools to check brokers with a significant financial incentive.

 

Large BD Pays $5.3 Million to Settle Fail-to-Supervise Charges

A large broker-dealer agreed to pay over $5.3 Million in remediation, disgorgement, fines, and interest to settle charges that it failed to properly supervise the traders and salespeople working on its non-agency CMBS desk.  Additionally, the head of the CMBS desk was fired, fined, and suspended from the industry for failing to supervise.  The SEC alleges that the CMBS desk regularly misrepresented terms and parties on the other side of secondary market CMBS transactions.  Although the firm had policies and procedures and conducted training, the SEC faults the firm for not conducting “specialized training regarding the opaque CMBS secondary market” and for weak surveillance that “used generic price deviation thresholds in its trade surveillance to flag potentially suspicious trades instead of ones tailored to specific types of securities.”

OUR TAKE: This case is an example of what we call “compliance voodoo” i.e. the appearance of a compliance program that does not actually discover or stop wrongdoing.  Sure, the firm had policies and procedure prohibiting making misrepresentations.  Sure, the firm provided compliance training.   Yet, the compliance and surveillance team completely missed the ongoing scheme of misrepresentations on the CMBS desk.

 

BD to Pay $28 Million Despite FINRA Safe Harbor

A large broker-dealer agreed to pay over $28 Million in restitution, fines, interest, and disgorgement for failing to properly supervise two brokers that the SEC alleges made misrepresentations about prices and profits in connection with secondary market trading of non-agency RMBS occurring nearly 5 years ago.  The SEC asserts that the two brokers misled customers about purchase/sale prices and market activity and charged excessive markups.  The SEC faults the firm for failing to implement a system to monitor customer communications.  This compliance breakdown constituted a failure to supervise because “the failure to have compliance procedures directed at [an underlying securities law violation] can be evidence of a failure reasonably to supervise.”  Also, the SEC further faulted the firm for charging excessive markups even though such markups were within FINRA’s 5% safe harbor policy because “Regardless of the applicability of the five percent guidance, the FINRA was explicit in stating that ‘[a] broker-dealer may also be liable for excessive mark-ups under the anti-fraud provisions of the Securities Act and the [Exchange] Act.’”  The two brokers were also fined and suspended.

OUR TAKE: The SEC breaks new legal ground in two ways: (1) explicitly linking underlying securities law violations by registered representatives as a predicate to a failure to supervise charge and (2) charging a firm even though it complied with a stated FINRA safe harbor.   What does this mean?  The SEC continues to move to a strict liability standard such that any violation by an employee constitutes a failure to supervise.  Also, broker-dealers must be wary about relying on stated FINRA safe harbors.

 https://www.sec.gov/litigation/admin/2017/34-80560.pdf

Hedge Fund Firm and Senior Manager Failed to Supervise Analyst Convicted of Insider Trading

failure-to-supervise

A hedge fund firm agreed to pay nearly $9 Million in disgorgement, interest and penalties and a senior research analyst was fined and barred from the industry for failing to reasonably supervise an analyst convicted of insider trading.  The SEC alleges that the firm and the supervisor ignored red flags including receiving confidential information that preceded public announcements, allowing the analyst to work out of his home, and the absence of any documentary support for recommendations.  Moreover, the supervisor violated the firm’s policies by failing to report the red flags to the firm’s Chief Compliance Officer for further investigation and testing.  The SEC asserts that the firm should have implemented heightened supervision including requiring reporting conversations with employees of public companies, requiring heightened information, and tracking recommendations.

OUR TAKE: The SEC properly placed responsibility on the firm and its line management (and not the CCO) for failing to supervise and report concerns to the CCO for further investigation.  Management should have accountability for regulatory compliance, while the compliance department owns the drafting and testing of procedures and advising management on regulatory issues.

https://www.sec.gov/litigation/admin/2016/ia-4550.pdf