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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. 

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. 

SEC Withdraws Letters that Allowed Advisers to Rely on Proxy Voting Firms

 The SEC has withdrawn two no-action letters that allowed an investment adviser to rely on third-party proxy voting services so long as the adviser had policies in place to ensure independence.  The SEC withdrew the letters because it wants to open debate about the regulation of proxy voting services at its upcoming Roundtable on the Proxy Process in November.  The SEC wants to consider whether investment advisers are “relying on proxy advisory firms for information aggregation and voting recommendations to a greater extent than they should, and whether the extent of reliance on these firms is in the best interests of investment advisers and their clients, including funds and fund shareholders.”  The SEC withdrew the Egan-Jones Proxy Services (5/27/04) and Institutional Shareholder Services (9/15/04) no-action letters.

OUR TAKE:  The Egan-Jones and ISS letters provided a de facto safe harbor for advisers to rely on third party voting services.  Their withdrawal and upcoming roundtable open the door to additional requirements on advisers to supervise proxy voting.

 

FINRA Requires Heightened Supervision over Bad Brokers

FINRA has outlined recommended heightened supervisory procedures for brokers with a history of past misconduct. FINRA suggests that firms should (i) designate a principal with supervision responsibility; (ii) provide specific training to the bad broker; (iii) require written acknowledgements; and (iv) conduct periodic reviews of the plan’s effectiveness.  FINRA also describes certain characteristics of an effective heightened supervisory plan: physical proximity of the supervisor to the broker, ongoing contacts and reviews, frequent monitoring, and expediting customer complaints.   FINRA has also proposed rules that would subject member firms that hire bad brokers to additional FINRA monitoring and reporting.

OUR TAKE: FINRA wants to make it difficult on firms that hire brokers with a disciplinary record by imposing additional regulatory, monitoring and reporting requirements.

http://www.finra.org/industry/notices/18-15

http://www.finra.org/sites/default/files/Regulatory-Notice-18-16.pdf