More On Legal & Compliancefrom The Advisor's Professional Library
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
- Differences Between State and SEC Regulation of Investment Advisors States may impose licensing or registration requirements on IARs doing business in their jurisdiction, even if the IAR works for an SEC-registered firm. States may investigate and prosecute fraud by any IAR in their jurisdiction, even if the individual works for an SEC-registered firm.
Recent enforcement actions by the SEC and FINRA ensnared a former Hall of Fame college football coach charged in an $80 million Ponzi scheme and a Wells Fargo vice president for failing to disclose the risks of mortgage-backed securities.
Other actions included charges of fraud amid an emergency asset freeze to halt a $15.7 million Ponzi scheme originating in Colorado; and the barring of a firm, its CEO and CFO over findings that it misstated its financial records and for engaging in securities transactions when it was below its required net capital.
Hall of Fame Football Coach Charged in $80 Million Ponzi Scheme
Jim Donnan, a College Football Hall of Fame inductee who guided teams at Marshall University and the University of Georgia and later became a television commentator, was charged by the SEC, together with his business partner Gregory Crabtree in an $80 million Ponzi scheme.
The SEC said the two allegedly conducted the fraud through a West Virginia-based company called GLC Limited, which, according to Donnan and Crabtree, was in the wholesale liquidation business and earning substantial profits by buying leftover merchandise from major retailers and reselling those discontinued, damaged or returned products to discount retailers.
Promising returns ranging from 50% to 380%, the two only used about $12 million of the money they received to actually purchase merchandise, much of which was simply abandoned in warehouses in West Virginia and Ohio. The rest was either used to pay off earlier investors or stolen by the pair for their own purposes.
According to the SEC’s complaint filed in federal court in Atlanta, the scheme began in August 2007 and collapsed in October 2010. Donnan recruited most of his investors by approaching contacts he made as a sports commentator and as a coach and then capitalizing on the relationships. For instance, he told one former player, “Your daddy is going to take care of you” … “if you weren’t my son, I wouldn’t be doing this for you.” The player later invested $800,000. In a conference call to discuss the action, William P. Hicks, associate director of the SEC’s Atlanta regional office, said that losses to individual investors ranged from about $4 million down to a few thousand dollars.
While Donnan allegedly told his investors that he was investing right along with them, by the time his scheme fell apart, he’d managed to divert more than $7 million to his own ends; Crabtree had allegedly taken about $1.08 million.
Risk Disclosure Failure Costs Wells Fargo $6.5 Million
Wells Fargo’s brokerage firm and a former vice president, Shawn McMurtry, were charged by the SEC with selling investments tied to mortgage-backed securities without fully understanding their complexity or disclosing the risks to investors with generally conservative investment objectives.
Both consented to the SEC’s order without admitting or denying the findings, and the firm agreed to pay more than $6.5 million to settle the charges; the money will be placed into a Fair Fund for the benefit of harmed investors. McMurtry agreed to be suspended from the securities industry for six months and to pay a $25,000 penalty.
According to the SEC’s order instituting settled administrative proceedings against Minneapolis-based Wells Fargo Brokerage Services (now Wells Fargo Securities), the firm improperly sold asset-backed commercial paper (ABCP) structured with high-risk mortgage-backed securities and collateralized debt obligations (CDOs) to municipalities, nonprofit institutions and other customers without performing adequate research, instead relying on credit ratings.
A number of customers purchased SIV-issued ABCP as a result of Wells Fargo’s recommendations, and many of them ultimately suffered substantial losses after three SIV-issued ABCP programs defaulted in 2007.
McMurtry was charged for his improper sale of SIV-issued ABCP, the SEC said; he exercised discretionary authority in violation of Wells Fargo’s internal policy and selected the particular issuer of paper for one longstanding municipal customer. McMurtry did not obtain sufficient information about the investment and relied almost entirely upon its credit rating.
The SEC’s order finds that Wells Fargo has taken a number of remedial measures since 2007 to ensure that its registered representatives have adequate information about the nature and risk of the securities they recommend and that relevant information about those securities will be fully disclosed to customers.
$15.7 Million Ponzi Scheme Halted in Colorado, Assets Frozen
The SEC announced fraud charges and an emergency asset freeze against a Denver-based company, Bridge Premium Finance, and two Colorado residents, Michael J. Turnock of Denver and William P. Sullivan II of Highlands Ranch, Colo., for carrying out a $15.7 million Ponzi scheme that harmed more than 120 investors nationwide.
The SEC alleged that Turnock and Sullivan sold promissory notes to investors through Bridge Premium Finance, which purports to be in the business of insurance premium financing. They promised investors annual returns of up to 12%, and represented that investor funds would be used to make short-term loans to small businesses to enable them to pay their up-front commercial insurance premiums. The pair assured investors that the firm’s business was performing well and that investor funds were “100% protected” through various forms of collateral on the underlying loans.
However, according to the SEC’s complaint filed in federal court in Denver, Bridge Premium has been paying investor returns with funds from other investors since 2002. It has not been profitable in any year since at least 1998, and has lost more than $3 million during the past five years. In May 2012, after more than a decade of Ponzi payments and operational losses, Bridge Premium owed investors more than $6.2 million, yet its insurance premium loan portfolio totaled less than $250,000 and its assets totaled less than $500,000.
The court granted the SEC’s request for a temporary restraining order to freeze the assets that Bridge Premium, Turnock and Sullivan derived from the scheme.
FINRA Bars Firm, CEO, CFO on Records, Capital Deficiencies
FINRA announced that it has expelled WJB Capital Group for misstating its financial records and for engaging in securities transactions while it was below its required net capital. FINRA also barred the firm's CEO, Craig Rothfeld, from the securities industry, and barred the firm's CFO, Gregory Maleski, from acting in a principal capacity.
According to FINRA findings, from 2009, when WJB Capital began to experience financial difficulties, through 2011, Rothfeld and Maleski misstated WJB's financial position on the firm's balance sheet. In one example, Rothfeld and Maleski converted $9.8 million in compensation previously paid to 28 employees into forgivable loans. As a result, the firm also failed to provide for the appropriate payment of taxes. Had WJB appropriately recorded these loans and tax obligations, its balance sheet would have reflected substantial losses in addition to those that it was already experiencing.
Rothfeld and Maleski also misclassified some items as allowable for net capital purposes, which meant that on occasion in 2011, WJB engaged in securities transactions when it was below its minimum required net capital. For example, the firm improperly included receivables related to "non-deal road-shows" when they were not allowable assets under the net capital rule.
As a result of the misclassification of these receivables, WJB misstated its FOCUS report and net capital calculations by at least $1 million on a monthly basis for approximately two years, FINRA said. The firm also misclassified a $1.5 million loan it received from its clearing firm as an allowable asset for net capital. Rothfeld, Maleski and WJB also failed to reasonably supervise the firm's financial and accounting functions.
WJB, Rothfeld and Maleski neither admitted nor denied the charges, but consented to the entry of FINRA’s findings in settling the case.
Check out SEC, FINRA Enforcement Roundup from Aug. 2 at AdvisorOne.