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.
- Conducting Due Diligence of Sub-Advisors and Third-Party Advisors Engaging in due-diligence of sub-advisors isnt just a recommended best practice it is part of the fiduciary obligation to a client. An RIA should be extremely reluctant to enter a relationship with a sub-advisor who claims the firms strategy is proprietary.
Recent enforcement actions by the SEC and DOL included fines of $127.5 million for a securities firm over false CDO credit ratings and $14.5 million for two short-selling brothers, deferred prosecution for a nonprofit that runs an Amish fund and an order for restoration of more than $500,000 in pension funds.
Phony CDO Credit Ratings Cost Firm $127.5 Million
Mizuho Securities USA, the U.S. investment banking subsidiary of Japan-based Mizuho Financial Group, was charged by the SEC along with three former employees with misleading investors in a collateralized debt obligation (CDO) by using “dummy assets” to inflate the deal’s credit ratings. The SEC also charged the firm that served as the deal’s collateral manager and the person who was its portfolio manager.
According to the SEC, Mizuho made approximately $10 million in structuring and marketing fees. The firm has agreed to pay $127.5 million in disgorgement and penalties to settle the charges; the others charged, Alexander Rekeda, Xavier Capdepon, Gwen Snorteland, Delaware Asset Advisers (DAA) and Wei (Alex) Wei, have also agreed to settle.
The SEC alleged that Mizuho structured and marketed Delphinus CDO 2007-1, a CDO backed by subprime bonds at a time when the housing market was foundering. The deal was contingent on Mizuho obtaining credit ratings it used to market the notes to investors, but Delphinus couldn’t pass muster at Standard & Poor's, which had just set new criteria to protect CDO investors from ratings downgrades.
When Mizuho employees realized this, they made up a portfolio filled with dummy assets totaling millions of dollars that they submitted to the ratings agency instead of Delphinus’s actual portfolio of collateral. Delphinus was rated based on that fake portfolio, and Mizuho closed the transaction and sold the notes, giving investors the ratings based on the fake. In 2008, Delphinus defaulted; in 2010 it was liquidated. Mizuho experienced substantial losses from this.
Brothers Sell Short, Fined $14.5 Million
Options traders Jeffrey Wolfson and Robert Wolfson, charged by the SEC earlier in the year with short selling, have agreed to pay $14.5 million to settle the charges.
The Wolfson brothers, according to the SEC, engaged in naked short selling by failing to locate shares involved in short sales and failing to close out the resulting failures to deliver; they made approximately $9.5 million in illegal profits.
Jeffrey Wolfson, who lives in the Chicago area, conducted illegal naked short sales while working as a broker-dealer himself and later as the principal trader at a Chicago-based brokerage firm that is no longer in business. Robert Wolfson, who lives in Massachusetts, conducted illegal naked short sales while trading in an account at New York-based broker-dealer Golden Anchor Trading II LLC, which also was charged by the SEC and agreed to the settlement.
Without admitting or denying the findings, the brothers and Golden Anchor settled, with Jeffrey Wolfson required to pay $13.425 million, which includes a $2.5 million penalty in addition to disgorgement and prejudgment interest. Robert Wolfson and Golden Anchor are required to collectively pay $1.1 million in disgorgement, prejudgment interest and penalties.
In addition, Jeffrey Wolfson is suspended from working in the securities industry for 12 months, and Robert Wolfson is suspended for 4 months. Golden Anchor has been censured, and along with the Wolfsons is subject to a cease and desist order from committing or causing violations of the short sale rules they violated.
SEC Agrees to Deferred Prosecution for Amish Fund Nonprofit
Although the nonprofit Amish Helping Fund (AHF) violated securities laws, it took immediate steps to rectify the situation when notified of its violations by the SEC. As a result, the agency announced a deferred prosecution agreement with the fund.
AHF, a nonprofit that offers securities to fund mortgage and construction loans to young Amish families in Ohio, was formed in 1995 by a group of Amish elders interested in furthering the Amish way of life. AHF funds its loans by selling securities in the form of investment contracts. However, the SEC alleged that AHF’s offering memorandum, drafted in 1995, was not updated for 15 years and thus contained material misrepresentations about the fund and the securities being offered.
AHF currently has nearly 3,500 investors, more than 1,200 borrowers, and approximately $125 million in mortgage receivables. SEC staff found no evidence of a foreclosure during the nonprofit’s history. Also, despite AHF having violated federal securities laws by disseminating a stale offering memorandum, the SEC found no evidence that AHF investors suffered any undue harm or investment losses as a result of these misrepresentations.
As soon as the SEC notified AHF of its violations, the nonprofit immediately updated and corrected its offering memorandum and provided existing investors with a corrected copy of it; further, it offered all existing investors the right of rescission, retained an independent certified public accountant to perform ongoing audits and registered its securities offerings with the Ohio Division of Securities and consented to a cease-and-desist order with the agency.
Because of this, the SEC has entered into a deferred prosecution agreement and will not file an enforcement action against AHF provided it adheres to the provisions of the agreement.
As a result of a lawsuit filed by the U.S. Department of Labor that followed an investigation by its Employee Benefits Security Administration, a federal judge has ordered the president of Columbus-based Clark Graphics, Mary Clark, to restore $505,551.46 to the company’s two employee retirement plans. Additionally, Marcia Dowdell, the president of Pension Retirement Planning who served as administrator for the plans, has been ordered to restore funds to both plans.
The lawsuit alleged insufficient oversight and mishandling of plan assets resulting in multiple violations of the Employee Retirement Income Security Act, specifically, that Clark Graphics’ owners, Mary Clark, James Clark and Stephen Clark, failed in their fiduciary responsibilities as plan trustees by neglecting to monitor the actions of the plans’ administrator.
They also failed to review and reconcile the plans’ trust account statements, review participant distribution calculations and require the administrator to issue participant statements. Finally, Dowdell failed to maintain accurate records for participants in both plans; consequently, some participants have not received the correct retirement benefits.
Not only must funds be restored, but the Clarks are permanently enjoined from serving as fiduciaries and Dowdell is enjoined from serving as a fiduciary or service provider to any ERISA-covered plan in the future.