The SEC censured and fined an institutional manager for charging different commission rates to different clients even though the manager combined orders in block trades. The compliance policies and procedures required that the manager allocate execution costs on a pro rata basis when using block trading. However, certain client agreements (or instructions) imposed a cap on commission rates. The SEC alleges that the manager allocated commission rates up to the cap for the preferred clients and then allocated the remaining costs to the other clients, thereby causing them to incur more than their pro rata share. The SEC charges the manager with failing to follow its own procedures.
Large institutional clients often request special treatment either directly or through “most favored nation” clauses. Sales folks want to land these relationships and often agree to client requirements without consulting with the compliance team. As a result, last year’s clients loses out to this year’s prospect. A fiduciary should treat all its clients equitably.
The SEC fined a large broker-dealer $42 Million for masking trade execution venues over a 5-year period. The SEC asserts that the respondent routed orders to various undisclosed third party execution venues in an effort to increase order flow to those venues, avoid trading access fees, and give the impression that the firm was a more active trading center. The firm acknowledges that it masked trading venues by reconfiguring FIX messages, modifying TCA reports, and misleading clients. The SEC argues that the firm withheld material information because many large buy-side clients consider trading venue material to their execution strategies.
OUR TAKE: Although this case was brought as a failure to disclose material information, it is really a fiduciary duty case. The SEC does not allege that the customers suffered any harm i.e. that they paid higher commissions or received worse execution. Instead, the SEC faults the respondent for using its unique position to benefit itself (and its trading partners).
A large broker-dealer agreed to pay $1.575 Million to FINRA and several exchanges for failing to implement procedures to properly control market access. FINRA asserts that the firm’s weak procedures and controls allowed multiple instances of spoofing, wash trading, and access by unidentified traders. FINRA claims that the firm’s Written Supervisory Procedures did not adequately describe how supervisors and others should follow up on red flags. FINRA charges the firm with violations of the customer protection rule (15c3-5) and the supervision/compliance rule (3110). FINRA explains that the market access rule is “designed to ensure that broker-dealers appropriately control the risks associated with market access, so as not to jeopardize their own financial condition, that of other market participants, the integrity of trading on the securities markets, and the stability of the financial system.”
OUR TAKE: The market access rule is fairly specific about the supervisory and compliance requirements. Generalized WSPs and third party technology half-measures won’t satisfy the regulators or the exchanges. We call this “compliance voodoo”: the appearance of a compliance infrastructure without actually stopping (or even facilitating) the targeted wrongdoing.
The SEC has commenced enforcement proceedings against the portfolio manager of a registered fund for engaging in a matched trade scheme that allowed him to generate $1.95 Million in profits at the fund’s expense. The SEC alleges that the portfolio manager matched call options bought/sold from his personal brokerage account against matching options bought/sold by the fund in less liquid securities with relatively wide NBBO spreads. These trades benefitted his brokerage account when he immediately sold the call options to third parties at more favorable prices. The SEC maintains that the portfolio manager failed to disclose his personal brokerage account to his employer (for review under the Code of Ethics) and failed to disclose his employer to his broker-dealer. The SEC charges violations of Investment Company Act Section 17(j) and Rule 17j-1 (Code of Ethics) as well as securities fraud. The U.S. Attorney has filed a parallel criminal action.
OUR TAKE: The SEC will hold individuals liable for securities law violations they cause especially where they intentionally seek to evade compliance efforts by lying to their employers. It is unclear at this point whether his employer will also suffer an action for failing to detect his unlawful trading.