More On Legal & Compliancefrom The Advisor's Professional Library
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
The Securities and Exchange Commission (SEC) on Thursday “charged three AXA Rosenberg entities with securities fraud for concealing a significant error in the computer code of the quantitative investment model that they use to manage client assets. The error caused $217 million in investor losses,” according to an SEC announcement.
Separately on Thursday, the SEC charged TD Ameritrade Inc. for failing to reasonably supervise its representatives, some of whom misled customers when selling shares of the Reserve Yield Plus Fund.
The three companies, AXA Rosenberg Group LLC (ARG), AXA Rosenberg Investment Management LLC (ARIM), and Barr Rosenberg Research Center LLC (BRRC) will pay a $25 million penalty to the SEC, and an additional $217 million to investors. The firms use quantitative models to manage portfolios for clients. The SEC also “charged BRRC with failing to adopt and implement compliance policies and procedures to ensure that the model would work as intended.”
Bruce Karpati, co-chief, Asset Management Unit, SEC Division of Enforcement, told AdvisorOne that the $217 million that the three companies agreed to pay to investors will go to “those who were harmed.” The error, he said, affected “600 funds.”
The SEC found said in its announcement that “senior management at BRRC and ARG learned in June 2009 of a material error in the model's code that disabled one of the key components for managing risk. Instead of disclosing and fixing the error immediately, a senior ARG and BRRC official directed others to keep quiet about the error and declined to fix the error at that time.”
The SEC added in its release that, “the error, which was introduced into the model in April 2007, was eventually fixed for all portfolios. However, knowledge of the error was kept from ARG's Global CEO until November 2009. ARG then conducted an internal investigation and disclosed the error to SEC examination staff in late March 2010 after being informed of an impending SEC examination of ARIM and BRRC. ARG disclosed the error to clients on April 15.”
"To protect trade secrets, quantitative investment managers often isolate their complex computer models from the firm's compliance and risk management functions and leave oversight to a few sophisticated programmers," Robert Khuzami, director of the SEC's Division of Enforcement, stated in the SEC release. "The secretive structure and lack of oversight of quantitative investment models, as this case demonstrates, cannot be used to conceal errors and betray investors."
AXA Rosenberg manages $30 billion as of December 2010, according to its corporate release. “A comprehensive, objective and detailed analysis of the coding error’s impact has been performed by Cornerstone Research, and its results have been incorporated into the SEC settlement. Compensation payments to adversely affected clients as calculated by Cornerstone will be made,” the AXA Rosenberg release stated.”
“We deeply regret that the coding error adversely impacted many of our clients,” Dominique Carrel-Billiard, chairman of the board of AXA Rosenberg stated in the company’s announcement. “The exhaustive review that we undertook of this matter reflects our commitment to regaining our client’s confidence and restoring trust.”
AXA Rosenberg did not respond by press time to AdvisorOne’s phone and emailed requests for comment; if they respond later, we will update this article.
TD Ameritrade Also Settles With SEC
According to the announcement on Thursday by the SEC, the regulator charged TD Ameritrade Inc. for "failing to reasonably supervise its registered representatives, some of whom misled customers when selling shares of the Reserve Yield Plus Fund, a mutual fund that "broke the buck" in September 2008,”
The SEC’s release said “a number of the representatives violated the securities laws when they mischaracterized the fund as a money market fund, as safe as cash, or as an investment with guaranteed liquidity.”
TD Ameritrade Inc. settled the charges with the SEC by agreeing to “distribute approximately $10 million to eligible customers who continue to hold shares of the fund.”
"It is critical that customers get accurate information about investment products, and broker-dealers must provide the training and supervision that enables their representatives to deliver this important guidance," Julie Lutz, associate director of
the SEC's Denver Regional Office, stated in the SEC release.
The fund that “broke the buck,” was the Reserve Yield Plus Fund, which was not managed by TD Ameritrade, and which “sought to provide higher returns than a money market fund while seeking to maintain a net asset value (NAV) of $1.00. The fund's NAV fell to 97 cents on Sept. 16, 2008, after the Reserve wrote down the fund's investments in commercial paper issued by Lehman Brothers Holdings Inc,” the SEC said in its announcement.
“Without admitting or denying the SEC's allegations, TD Ameritrade consented to the SEC's order, which censures the firm,” the SEC noted in its announcement.
In its own notice on the firm’s web site, TD Ameritrade stated that it had “agreed to make a payment of $0.012 per share to eligible clients who invested in the Reserve Yield Plus Fund through the firm,” within 30 days.
TD Ameritrade spokesperson Kristen Petrick responded to the SEC by saying “This agreement with the SEC allows us to move forward and provide clients with additional compensation in this difficult situation. TD Ameritrade was not fined as a result of the SEC investigation.”