More On Legal & Compliancefrom The Advisor's Professional Library
- Disaster Recovery Plans and Succession Planning RIAs owe a fiduciary duty to clients to prepare for disasters and other contingencies. If an RIA does not have a disaster recovery plan, clients financial well-being may be jeopardized. RIAs should also engage in succession planning, ensuring a smooth transaction if an owner or principal leaves.
- Dealings With Qualified Clients and Accredited Investors Depending upon an RIAs business model and investment strategies, it may be important to identify “qualified clients” and “accredited investors.” The Dodd-Frank Act authorized the SEC to change which clients are defined by those terms.
Recent enforcement actions taken by FINRA and the SEC include an alleged $60 million investment fund run like a Ponzi scheme by a California advisor; a fine and crackdown on VA sales by Cadaret, Grant; a fine on suitability requirements for Morgan Stanley; and charges against two south Florida individuals who fed a Ponzi scheme to the tune of over $157 million.
The Securities and Exchange Commission charged an investment advisor in Scotts Valley, Calif., on May 24 with running a $60 million investment fund like a Ponzi scheme and defrauding investors by touting imaginary trading profits instead of reporting the actual trading losses he incurred.
The SEC alleges that John A. Geringer, who managed the GLR Growth Fund, used false and misleading marketing materials to lure investors into believing that the fund was earning double-digit annual returns by investing 75% of its assets in investments tied to major stock indices. In reality, Geringer’s trading generated consistent losses and he eventually stopped trading entirely. To mask his fraud, Geringer paid millions of dollars in “returns” to investors largely by using money received from newer investors. He also sent investors periodic account statements showing fictitious growth in their investments.
“Geringer painted the picture of a successful fund weathering America’s financial crisis through a diversified, conservative investment strategy,” said Marc Fagel, director of the SEC’s San Francisco Regional Office, in a statement. “The reality, however, was the complete opposite. Geringer lost millions of dollars in the market, tied up remaining investor funds in a pair of illiquid private companies, and lied about it in phony account statements.”
According to the SEC’s complaint filed in federal court in San Jose, Calif., Geringer raised more than $60 million since 2005, mostly from investors in the Santa Cruz area. Geringer used fraudulent marketing materials claiming that the fund had between 17% and 25% annual returns in every year of the fund’s operation through investments tied to well-known stock indices like the S&P 500, NASDAQ and Dow Jones. Although the fund was started in 2003, marketing materials claimed 25% returns in 2001 and 2002 — before the fund even existed.
The marketing materials also falsely indicated a nearly 24% return in 2008 from investing mainly in publicly traded securities, options and commodities, while the S&P 500 Index lost 38.5%.
Unsuitable VA Sales
Broker-dealer Cadaret, Grant was fined $200,000 and censured by FINRA, and will be required to rebate living customers for sales of variable annuities (VAs) that were identified as unsuitable.
At the heart of the matter were elderly customers who were sold VAs recommended to them with enhanced death benefit riders that were of limited value because of their age. The recommendations, said FINRA, indicated that the representative “did not understand or appreciate the significance of an age restriction or the reduced benefit of the rider when sold to a person close in age to the cutoff.”
The registered representative who recommended them already had several complaints on her U4 prior to joining Cadaret, Grant—some of which related to VA sales—and she was the subject of additional customer complaints after joining; this was reflected in amended U4s filed by the company.
Despite this, however, according to FINRA, she was neither subjected to heightened supervision nor her VA transactions reviewed by supervisors. She had been the subject of a FINRA Wells Notice for unsuitable VA sales at her prior firm, and Cadaret, Grant was advised of this; however, the notification did not result in additional supervisory measures. Some of the unsuitable recommendations occurred after the firm received the Wells Notice.
While the sales were subjected to review by the rep’s supervisor and also to a second level by the firm’s VA department, FINRA found that procedures and systems were inadequate to prevent inappropriate sales.
In addition, FINRA found that the rep, her supervisor and another colleague were using personal e-mails for business-related correspondence, and the firm knew or should have known about them but failed to retain those e-mails.
The firm submitted a Letter of Acceptance, Waiver and Consent in which it agreed to the fine and censure, as well as the rebate to customers, without admitting or denying findings. It also agreed to undertake a comprehensive review of its policies and procedures concerning suitability of VAs, and provide the results to FINRA within 90 days of its notice of acceptance.
Morgan Stanley Hit on Suitability
Suitability was an issue for Morgan Stanley as well, with the firm fined $600,000 by FINRA over findings that it did not have a firm-wide structured product-specific suitability policy. Instead, it had an overall suitability guideline that directed supervisors to consider concentration when reviewing all securities purchases.
In previous settlements with customers over unsuitable recommendations and their purchases of structured products based on those recommendations, the firm had already paid approximately $329,000.
Morgan Stanley issued selling memoranda specific to each of its proprietary structured product offerings, with some of those memoranda including a 10% concentration guideline for the specific issue, and a minimum net worth concentration of $100,000. However, despite that, structured products were sold at concentrated levels and to customers who failed to meet minimum net worth requirements.
The findings also included that the firm failed to create reasonable systems or procedures to notify supervisors whether structured product purchases complied with the firm’s internal guidelines, and that it placed the responsibility with branch supervisors to ensure, among other things, that structured product purchase recommendations financial advisors made were suitable.
Daily transaction reports failed to identify structured product purchases as such, and did not reflect any supervisory action regarding such transactions. FINRA also determined in a sampling of structured product purchases that in addition to the concentration and net worth issues, recommendations were found that were unsuitable based on customers’ financial situation and investment objectives.
Morgan Stanley submitted a Letter of Acceptance, Waiver and Consent in which it was censured and fined $600,000. Without admitting or denying the findings, the firm consented to the sanctions and to the entry of findings that it did not have a firm-wide structured product-specific suitability policy.
SEC Goes After Alleged Ponzi Schemers
In an SEC action, George Levin and Frank Preve of the Ft.Lauderdale area were charged in an ongoing investigation with raising more than $157 million from 173 investors in less than two years in a Ponzi scheme. In its complaint, the SEC seeks disgorgement of ill-gotten gains, financial penalties, and permanent injunctive relief against Levin and Preve to enjoin them from future violations of the federal securities laws.
In the complaint, filed in federal court in Miami, the SEC alleged that Levin and Preve issued short-term promissory notes from Levin’s company, Banyon 1030-32 LLC, and interests in a private investment fund they operated. Beginning in 2007, they used investor funds to purchase discounted legal settlements from former Florida attorney Scott Rothstein through his prominent law firm Rothstein Rosenfeldt and Adler PA. In 2009, looking for more money from investors, Levin and Preve formed a private investment fund called Banyon Income Fund LP that invested exclusively in Rothstein’s settlements.
However, the settlements Rothstein sold were not real and the supposed plaintiffs and defendants did not exist. Instead, Rothstein used the money he received from Levin and Preve in classic Ponzi scheme fashion to make payments due other investors and support his lavish lifestyle.
In fact, by the time the Banyon Income Fund offering began in May 2009, Rothstein had already ceased making payments on a majority of the prior settlements Levin and his entities had purchased. Rothstein’s Ponzi scheme collapsed in October 2009, and he is currently serving a 50-year prison sentence.
Read about more scams busted up at the SEC & FINRA Enforcement Roundup page at AdvisorOne.