More On Legal & Compliancefrom The Advisor's Professional Library
- The Few and the Proud: Chief Compliance Officers CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations. When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.
- 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.
Recent enforcement actions taken by the Securities and Exchange Commission (SEC) include charges against a California man who tipped off a hedge fund manager with inside information; three men in a $27.5 million investment fraud case; a China-based company over fraud via phony sales that inflated revenues; a PR executive who took advantage of knowledge of a client’s firm to engage in insider trading; a financial guru and radio personality who misled investors about an investing plan; and an advisor who failed to disclose revenue sharing agreements.
Radio Financial Guru Charged Over Misleading Information
The SEC charged Ray Lucia Sr., a nationally syndicated radio personality and financial advice author, for spreading misleading information about his “Buckets of Money” strategy at a series of investment seminars that he and his company hosted for potential clients.
The SEC’s Division of Enforcement alleges that Lucia claimed that the wealth management strategy he promoted at the seminars had been empirically “backtested” over actual bear-market periods. Lucia, who lives in the San Diego area, and his company, formerly named Raymond J. Lucia Cos. (RJL), allegedly presented a lengthy slideshow at the seminars indicating that extensive backtesting proved that the Buckets of Money strategy would provide inflation-adjusted income to retirees while protecting and even increasing their retirement savings. However, Lucia and RJL performed scant, if any, actual backtesting of the Buckets of Money strategy.
Hedge Fund Tipster Charged
The SEC charged Hyung Lim of Los Altos, Calif., with illegally tipping a hedge fund manager with inside information about Nvidia Corp.’s quarterly earnings that he learned from his friend who worked at the company. In a parallel action, the U.S. Attorney for the Southern District of New York announced criminal charges against Lim. The SEC’s own investigation is ongoing.
According to the SEC’s complaint filed in federal court in Manhattan, Lim passed information to Danny Kuo, a hedge fund manager, who illegally traded on the information and passed it on to multibillion-dollar hedge fund advisory firms Diamondback Capital Management and Level Global Investors.
Kuo and the hedge funds made nearly $16 million trading in Nvidia securities based on Lim’s inside information. They were charged earlier in the year by the SEC.
The SEC alleges that Lim and Kuo met at poker parties organized by a mutual friend, and that during at least 2009 and 2010, Lim’s Nvidia friend regularly provided him with detailed information about the contents of Nvidia’s upcoming quarterly earnings announcements. Lim’s source provided him with not only one tip but a whole series; they grew more accurate and reliable as Nvidia finalized its financial results for a given quarter and prepared to report them publicly.
Lim’s Nvidia friend usually told Lim the nonpublic information in phone conversations; within one minute of ending a conversation, Lim would be on the phone to Kuo to pass along the latest data.
In compensation for the tips, Kuo wired $5,000 to a Las Vegas casino to pay a debt for Lim, and later Kuo made two $5,000 cash payments to Lim. Kuo also provided Lim with nonpublic information about a pending corporate acquisition, which Lim used to make more than $11,000 in trading profits.
In the seminars, held to solicit advisory clients who would pay for Lucia and RJL’s advisory services, the Buckets of Money strategy was promoted—as it also was on Lucia’s radio show and on his personal and company websites. However, Lucia and RJL have admitted during the SEC’s investigation that the only testing they actually performed were some calculations that Lucia made in the late 1990s—copies of which no longer exist—and two two-page spreadsheets.
According to the SEC’s order instituting administrative proceedings against Lucia and RJL, not only did the so-called “backtests” use a 3% inflation rate, lower than actual historical inflation and designed to make the strategy more favorable, they failed to account for the negative effects of the advisory fees. In addition, the backtesting didn’t allocate in the manner advocated by the Buckets of Money strategy.
The Division of Enforcement is seeking financial penalties and other remedial action in the proceedings.
Advisor Charged Over Undisclosed Revenue Sharing
Two Portland, Ore.-based investment advisory firms, Focus Point Solutions and The H Group, and their owner, Christopher Keil Hicks, were the target of a settled administrative proceeding over the failure to disclose a revenue-sharing agreement and other potential conflicts of interest to clients. Without admitting or denying the SEC’s charges, Hicks, Focus Point and The H Group agreed to pay a combined $1.1 million to settle the case.
The SEC’s investigation found violations in three areas of Hicks’ advisory business. Most notably, Focus Point did not disclose to customers that it was receiving revenue-sharing payments from a brokerage firm that managed a particular category of mutual funds being recommended to Focus Point clients.
Focus Point had an incentive to recommend these funds to clients over other investment opportunities, since it received a percentage of every dollar its clients invested in them, bringing in additional revenue.
According to the SEC’s order, there were two additional ways Hicks and his firms failed to disclose conflicts of interest while seeking approval to have Focus Point added as the subadviser to a mutual fund called the Generations Multi-Strategy Fund.
First, while seeking required approval from the fund’s trustees, Focus Point misrepresented that it would receive no payments other than fees paid under the subadvisory contract. The trustees did not know that the fund’s primary adviser had a separate payment arrangement with Focus Point, which it was required to disclose to them but did not.
Second, Focus Point’s request to be retained as subadviser to Generations also required the approval of Generations’ shareholders, the vast majority of whom were clients of The H Group. Thus, The H Group had a potential conflict of interest as a related entity to Focus Point, which stood to reap additional fees from the mutual fund that The H Group recommended to many of its clients.
Therefore, The H Group’s proxy voting policy required the proxies to be voted by the investors themselves. Instead, The H Group itself voted its clients’ proxies in favor of the proposal to add Focus Point as a subadviser.
SEC Charges 3 in $27.5 Million Investment Fraud
The SEC charged an attorney and two others living in South Florida for their roles in a $27.5 million investment scheme that led investors to believe they were purchasing securities consisting of “presold” commodities contracts with a predetermined profit. The so-called profits, however, mostly came out of other investors’ funds.
After an asset freeze last year to stop the scheme, and the appointment by the court of a receiver over Commodities Online and Commodities Online Management, the SEC’s follow-up charges come against the founder and former president of the company, James C. Howard III, as well as the company’s vice president Louis N. Gallo III and outside counsel Michael R. Casey, who later became the president.
According to the SEC’s complaint filed in federal court in Miami, Commodities Online offered investors the chance to participate in its supposedly profitable brokering of physical commodities via presold contracts. Investors were sold participation units in unregistered private placement offerings, each supposedly tied to a commodities transaction in which Commodities Online had already secured a buyer and a seller of the commodity.
In reality, however, Commodities Online performed only a limited percentage of the commodities transactions and most of the “profits” came not from completed transactions but from other investors’ money. In the meantime, Gallo and Howard were moving millions of dollars into sham companies through which they then stole the funds. In one offering, for example, which brought in $2 million, Howard moved $1.45 million to another entity.
Howard also failed to disclose to prospective investors that he is a convicted felon. After his arrest in 2010 for an unrelated investment fraud, Casey replaced him as president of the company, and continued the deceptions.
The SEC also alleges that Gallo ran an in-house “boiler room” of telephone sales agents and a network of approximately 20 regional and international sales offices, and failed to disclose to investors that he previously pled guilty to federal bank fraud and other felonies and was serving a term of supervised release while employed at Commodities Online. Gallo also misled investors about Howard’s role at Commodities Online.
The SEC has charged Howard, Gallo and Casey with numerous offenses, and seeks disgorgement of ill-gotten gains plus prejudgment interest, financial penalties and permanent injunctions against the three. It also has named several relief defendants for the purposes of recovering investor money steered to those entities in the scheme: Sutton Capital, J&W Trading, American Financial Solutions and Minjo Corp. In a parallel action, the U.S. Attorney’s Office for the Southern District of Florida announced criminal charges against Howard, Gallo and Casey.
A China-based company, China Sky One Medical Inc. (CSKI), and its CEO, Yan-qing Liu, were charged by the SEC with fraud for recording fake sales of a weight-loss product to inflate revenues in the company’s financial statements by millions of dollars.
According to the SEC’s complaint, filed in U.S. District Court for the Central District of California, CSKI, which is based Harbin, China, became a public company in the U.S. via reverse merger in 2006; it trades over the counter. In its 2007 annual and quarterly reports, CSKI falsely stated that it had entered into a strategic distribution agreement with a Malaysian company, Takasima Industries, that would become the “exclusive” distributor of CSKI’s “slim patch” in Malaysia and generate $1 million per month in sales.
No such agreement was made; instead, CSKI created approximately $19.8 million in phony export sales to Malaysia that were recorded as revenue in its financial results for 2007 and 2008. CSKI falsely reported export sales to Malaysia of more than $12.2 million for 2007, which constituted 25% of its total revenues, and $7.5 million (8.2% of total revenues) in such sales for 2008. Nearly all CSKI’s reported sales to Malaysia via Takasima were bogus. Liu certified the overstated financial results, which appear in CSKI’s financial statements through 2010 and continue to impact the company’s retained earnings on its balance sheet.
The SEC’s complaint seeks financial penalties against CSKI and Liu as well as disgorgement of ill-gotten gains by Liu, who personally benefited from the overstated financial statements through the company’s 2008 private placement of securities.
The agency also seeks to have Liu reimburse CSKI for certain incentive-based compensation he received during the period affected by the fraud and to have him barred from acting as an officer or director of a public company. In addition to the court action, the SEC instituted administrative proceedings to determine whether to revoke or suspend registration of CSKI’s securities due to the company’s failure to file its annual report for 2011 or any quarterly reports for 2012.
PR CEO Charged in Insider Trading
Renee White Fraser, CEO of Fraser Communications, a Los Angeles-based public relations firm, was charged by the SEC with insider trading on nonpublic information she learned from a client that was about to acquire a bank in a deal assisted by the FDIC.
The SEC alleges that Fraser and her firm were contacted by Pasadena-based East West Bancorp (EWBC) on Oct. 14, 2009, for marketing and public relations support during its acquisition of San Francisco-based United Commercial Bank. EWBC shared material, nonpublic information about the upcoming transaction to allow Fraser and her employees to prepare marketing and public relations materials ahead of the acquisition, and formally engaged the firm on October 15.
According to the SEC’s complaint, filed in U.S. District Court for the Central District of California, Fraser bought 10,000 EWBC shares on Oct. 16. The acquisition was announced on Nov. 6, and on Nov. 10, the second trading day after the announcement, she sold 7,500 shares. The remaining 2,500 shares she sold on June 24, 2011, and from both transactions made a total profit of $43,868.
In settling the SEC’s charges without admitting or denying the allegations, Fraser agreed to pay $43,868 in disgorgement, $3,794.36 in prejudgment interest and a $43,868 penalty—more than double what she made in the transactions.