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.
- Using Solicitors to Attract Clients Rule 206(4)-3 under the Investment Advisors Act establishes requirements governing cash payments to solicitors. The rule permits payment of cash referral fees to individuals and companies recommending clients to an RIA, but requires four conditions are first satisfied.
Among actions taken by FINRA recently were censure and $500,000 in fines against Merrill Lynch for failing to file required reports, and a joint action with the SEC and the exchanges against Hold Brothers. Also, the SEC brought charges against Tyco International over more than $10.5 million in illicit profits connected to fake commissions and other payments to foreign officials, as well as acting on a number of other cases, including one of insider trading that reached Brazil.
Merrill Lynch Fined $500,000 Over Failure to File Reports
FINRA announced that it has censured and fined Merrill Lynch, Pierce, Fenner & Smith Inc. $500,000 for supervisory failures that allowed widespread deficiencies in filing hundreds of required reports, including customer complaints, arbitration claims, and related U4 and U5 filings, and for its failure to file the required reports. In concluding the settlement, Merrill neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
The violations, undetected for several years, may have hampered investors' ability to assess some brokers’ backgrounds via BrokerCheck. They also may have compromised firms’ hiring background checks, reduced the ability of securities regulators to review brokers' transfer applications and hindered FINRA from promptly investigating certain disclosure items.
FINRA’s rules specify that when a securities firm hires a broker, it must ensure that broker’s U4 is updated and kept current. The firm must also record updates involving that broker, such as regulatory actions, customer complaints, settlements and felony charges, and convictions. Firms must also notify FINRA within 30 days of termination of a registered person’s association with them by filing a U5, and must notify FINRA within 30 days if a U5 is found to be incomplete or inaccurate.
However, according to FINRA’s findings, that was not the case at Merrill. Instead, from 2007 to 2011, Merrill Lynch failed to file or timely file more than 650 required reports, including customer complaints and customer settlements. From 2005 to 2011, Merrill Lynch failed to report or timely report customer complaints, and related Forms U4 and Forms U5 between 23% and 63% of the time.
Findings also state that Merrill Lynch failed to adequately train and supervise personnel responsible for customer complaint tracking and reporting, and did not have systems in place to identify the high volume of customer complaints that were not being acknowledged or reported as required. That meant Merrill Lynch failed to acknowledge nearly 300 customer complaints in a timely manner.
Merrill Lynch failed to file or timely file approximately 300 non-NASD/FINRA arbitrations and criminal and civil complaints that it received for approximately three years. From July 2007 to June 2009, and again from October 2009 to February 2010, Merrill Lynch failed to make these filings 100% of the time. From 2007 through 2010, Merrill Lynch failed to file related Forms U4 and U5 between 28% and 79% of the time.
Hold Brothers Fined Over $5.9 Million on Multiple Charges
FINRA, along with NYSE Arca Inc., The NASDAQ Stock Market LLC, NASDAQ OMX BX, Inc., and BATS Exchange Inc., announced that they have censured and fined Hold Brothers On-Line Investment Services, LLC $3.4 million for manipulative trading activities, anti-money laundering (AML), and other violations. Hold Brothers neither admitted nor denied the charges, but consented to the entry of FINRA's findings to conclude the settlement.
In a related case, the SEC also announced a settlement with Hold Brothers, fining the firm more than $2.5 million and including bars for three senior managers associated with the firm.
Hold Brothers, headquartered in New York, is a self-clearing broker-dealer that primarily operates as a day-trading firm by facilitating direct market access to customers and to its proprietary traders. From Jan. 1, 2009 through Dec. 31, 2011, Hold Brothers' largest account, Demostrate LLC, and an affiliate, Trade Alpha, were day-trading firms wholly owned and funded by Hold Brothers' principals.
Demostrate and Trade Alpha engaged traders and trading groups in various foreign countries, primarily China, to trade its capital. FINRA found that Demostrate and Trade Alpha were controlled by, or under common control with, Hold Brothers.
Demostrate and Trade Alpha used sponsored access relationships with Hold Brothers to connect to U.S. securities exchanges to manipulate the prices of multiple securities. FINRA uncovered hundreds of instances where the foreign day traders used spoofing and layering activities to make the trading algorithms of unwitting market participants provide the traders with favorable execution pricing not otherwise available to them without the day traders' illicit activities.
Spoofing manipulates markets by placing one or more non-bona fide orders, usually inside the existing National Best Bid or Offer (NBBO), to trigger one or more market participants to join or improve the NBBO. Once that occurs, the non-bona fide order is canceled and an order is entered instead on the opposite side of the market.
Layering is the placement of multiple non-bona fide limit orders on one side of the market at various price levels at or away from the NBBO to create the appearance of a change in supply and demand levels to artificially move the price of the security. An order is then executed on the opposite side of the market at the artificially created price, and the non-bona fide orders are immediately canceled.
FINRA also found thousands of instances where Demostrate or Trade Alpha traders engaged in prearranged trades and wash sales.
Hold Brothers also failed to establish and maintain a supervisory system and written procedures reasonably designed to supervise the firm's trading activities. FINRA found that numerous "red flags" indicating suspicious trading were neither detected nor investigated, including broad categories of significant suspicious trading that involving patterns of spoofing, layering, prearranged trading and wash trading.
FINRA also found Hold Brothers' AML policies, procedures and internal controls inadequate; they failed to detect suspicious transactions and did not trigger reporting of the suspicious transactions as required by the Bank Secrecy Act.
Hold Brothers also failed to tailor its AML program to its business, as required. Between 2009 and 2011, the firm averaged about 400,000 trades per day, approximately 90% of which was placed through the Demostrate account. Despite this high volume, Hold Brothers' AML procedures only provided for manual monitoring to detect suspicious trading activity in the accounts.
FINRA also found numerous instances when Hold Brothers' compliance department determined that Trade Alpha or Demostrate traders had engaged in suspicious or manipulative trading. These instances were not escalated to the firm's AML compliance officer and the firm never considered filing a suspicious activity report relating to the activity.
As part of the disciplinary action, FINRA and the exchanges also ordered Hold Brothers to retain an independent consultant to conduct a comprehensive review of the adequacy of the firm's policies, systems and procedures, and training related to AML, trading, day trading, compliance with SEC Rule 15c3-5, and the use of foreign traders.
Tyco Charged on Illicit Payments, Settles for over $26 Million
The SEC has charged Tyco International Ltd. with violating the Foreign Corrupt Practices Act (FCPA) when subsidiaries arranged illicit payments to foreign officials in more than a dozen countries.
Tyco agreed to pay a total of more than $26 million to settle the SEC’s charges and to resolve criminal proceedings announced by the U.S. Department of Justice. In the parallel criminal proceedings, the Justice Department entered into a non-prosecution agreement with Tyco in which the company will pay a penalty of approximately $13.68 million.
According to SEC allegations, subsidiaries of the Swiss-based global manufacturer used payments of fake “commissions” or third-party agents to funnel money improperly to obtain lucrative contracts. Overall, Tyco illicitly brought in more than $10.5 million as a result.
The SEC alleges that Tyco subsidiaries operated 12 illicit payment schemes globally, beginning before 2006 and continuing until 2009. The most profitable scheme was in Germany, where agents of a Tyco subsidiary paid third parties to secure contracts or avoid penalties or fines in several countries. These payments were falsely recorded as “commissions” in Tyco’s books and records when they were in fact bribes to pay off government customers. Tyco’s resulting benefit was more than $4.6 million.
According to the SEC’s complaint, Tyco’s China subsidiary signed a contract with the Chinese Ministry of Public Security for $770,000, but reportedly paid approximately $3,700, which it recorded as a “commission,” to the “site project team” of a state-owned corporation to get the contract.
Tyco’s French subsidiary recorded payments to individuals from 2005 to 2009 for “business introduction services.” However, one of those individuals was a security officer at a government-owned mining company in Mauritania, and many of the earlier payments were deposited in the official’s personal bank account in France. In Thailand, Tyco’s subsidiary had a contract to install a CCTV system in the Thai Parliament House in 2006, and paid more than $50,000 to a Thai entity that acted as a consultant. The invoice for the payment refers to “renovation work,” but Tyco is unable to ascertain what, if any, work was actually done.
The SEC alleges that in Turkey, Tyco’s subsidiary retained a New York City-based sales agent who made illicit payments involving the sale of microwave equipment in September 2006 to an entity controlled by the Turkish government. Employees at Tyco’s subsidiary knew the agent was paying foreign government customers to obtain orders. One internal email stated, “Hell, everyone knows you have to bribe somebody to do business in Turkey. Nevertheless, I’ll play it dumb if [the sales agent] should call.” Tyco brought in $44,513 as a result.
In determining the settlement, the SEC said it had considered Tyco’s extensive efforts to identify and remediate its wrongdoing.
SEC Freezes Assets in Burger King Stock Insider Trading by Brazilian
In a continuing investigation, the SEC has obtained an emergency court order to freeze the assets of a stockbroker and Brazilian citizen, Waldyr Da Silva Prado Neto, who, while working in the U.S., used nonpublic information from a customer to engage in insider trading ahead of Burger King’s announcement that it was being acquired by a New York private equity firm.
The SEC obtained the asset freeze in U.S. District Court for the Southern District of New York to prevent Prado from transferring his assets outside of U.S. jurisdiction. Prado recently abandoned his most current job at Morgan Stanley Smith Barney, put his Miami home up for sale and began transferring all of his assets out of the country.
The SEC alleges that Prado, who was working for Wells Fargo in Miami, learned about the impending acquisition from a brokerage customer who invested at least $50 million in a fund managed by private equity firm 3G Capital Partners Ltd. and used to acquire Burger King in 2010.
According to the SEC’s complaint, Prado was the representative on the account used by the customer to transfer his investment to 3G Capital. The customer had been with Prado for more than 10 years and often shared his confidential financial information, with the understanding that it was to remain confidential.
Prado had repeated contact with the customer by phone and email as well as in person in Brazil from May 17 to Sept. 1, 2010, the period during which Prado traded Burger King securities. Prado misused the confidential information to illegally trade in Burger King stock for $175,000 in illicit profits, and tipped others living in Brazil and elsewhere who also traded on the nonpublic information.
The SEC alleges that Prado began his illegal trading while on a business trip to Brazil, during which he sent an e-mail to a friend that—translated from Portuguese—read, “I’m in Brazil with information that cannot be sent by email. You can’t miss it….” On the phone that night, Prado told his friend he heard 3G Capital was going to take Burger King private. The friend, a hedge fund manager in Miami, warned Prado that he should not trade on this information and should not encourage any of his customers to trade either.
According to the SEC’s complaint, Prado went on to tip at least four of his customers who eventually traded in Burger King stock based on nonpublic information about the impending acquisition.
For example, just minutes after Prado sent the May 17 email to his friend in Miami, he sent another to one of those customers which, again translated from Portuguese, read, “… if you are around call me at the hotel … I have some info … You have to hear this.” A 10-minute phone conversation followed, and the customer purchased out-of-the-money Burger King call options during the next two days.
In August 2010, Prado was on another business trip to Brazil, and the same customer sent Prado an email which translated to, “[i]s the sandwich deal going to happen?” Prado replied, “Vai sim,” which means, “Yes it’s going to happen.” He continued, “[e]verything is 100% under control. I was embarrassed to ask about timing. The last ‘vol’ got in the way.” Following these emails, the customer—identified as Tippee A in the SEC’s complaint—made additional purchases in Burger King call options. The customer’s total insider trading profits amounted to more than $1.68 million.
SEC Charges Three with Insider Trading
H. Thomas Davis, Jr., a former member of the board of directors at a North Carolina-based insurance company, has been charged by the SEC, along with two others, with illegally tipping inside information about an impending merger.
The SEC alleges that Davis, who has a home in Wilmington, N.C., breached his fiduciary duty to Mercer Insurance Group and its shareholders when he shared confidential details about the company’s negotiations to be acquired by United Fire. Davis tipped his friend and business associate Mark W. Baggett with the nonpublic information, and Baggett later tipped his golfing partner Kenneth F. Wrangell. Baggett and Wrangell, who both live in Wilmington, made more than $83,000 in illicit profits when they traded on that confidential information illegally.
When contacted by SEC investigators about his suspicious trading, Wrangell promptly offered significant cooperation. He provided truthful details acknowledging his own trading and entered into a cooperation agreement that resulted in direct evidence being quickly developed against Baggett and Davis. This cooperation enabled the SEC to swiftly reach settlements with all three individuals to recover ill-gotten monetary gains.
All three have neither admitted nor denied the allegations, and their settlements are still subject to court approval.
The SEC’s complaints against Davis and Wrangell were filed in U.S. District Court for the Eastern District of North Carolina, and the complaint against Baggett was filed in U.S. District Court for the Northern District of Georgia.
According to the complaints, Davis was privy to Mercer’s negotiations in the latter part of 2010 to be acquired by United Fire. In October and November, Davis tipped Baggett with nonpublic information about the impending merger, enabling Baggett to stockpile 4,426 shares of Mercer as they moved toward the acquisition date. Baggett also tipped Wrangell with advance details about the merger, and Wrangell subsequently purchased 4,500 shares of Mercer stock.
After the markets closed on Nov. 30, Mercer and United Fire publicly announced the merger agreement. Mercer stock rose nearly 50% the next day, and Baggett and Wrangell immediately sold their holdings for illicit profits of $41,584.45 and $42,521.55, respectively.
In settling the SEC’s charges, Davis agreed to be jointly and severally liable for disgorgement of Baggett’s insider trading profits of $41,584.45 plus prejudgment interest, as well as to pay a penalty of $41,584.45. Davis also agreed to be barred from serving as an officer or director of a publicly traded company. Baggett agreed to pay disgorgement and a penalty in amounts that will be determined by the court.
Wrangell agreed to fully disgorge his ill-gotten gains of $42,521.55 plus prejudgment interest. Due to his extensive cooperation, the additional penalty that Wrangell is required to pay on top of that disgorgement amount has been reduced to $11,380.39.
Bank Executives Charged With Understating Millions in Losses
Three former bank executives in Nebraska have been charged by the SEC with participating in a scheme to understate millions of dollars in losses and mislead investors and federal regulators at the height of the financial crisis. One of the executives and his son also are charged with insider trading.
The SEC alleges that Gilbert G. Lundstrom, CEO and chairman of the board at Lincoln, Neb.-based TierOne Bank, along with President and COO James A. Laphen and Chief Credit Officer Don A. Langford, played a role in TierOne understating its loan-related losses as well as losses on real estate repossessed by the bank.
TierOne had expanded into riskier types of lending in Las Vegas and other high-growth geographic areas in Arizona and Florida, and was experiencing a significant rise in high-risk problem loans. TierOne’s primary banking regulator, the Office of Thrift Supervision (OTS), directed TierOne to maintain higher capital ratios because of this. To appear to comply, Lundstrom, Laphen and Langford disregarded information showing that the collateral securing certain TierOne loans and real estate repossessed by the bank was overvalued due to the bank’s reliance on stale and inadequately discounted appraisals. The losses were understated by millions of dollars in multiple SEC filings.
According to the SEC’s complaints filed in U.S. District Court for Nebraska, TierOne’s losses did not become publicly known until late 2009, after OTS told TierOne to get new appraisals for its impaired loans. TierOne then disclosed loan losses of more than $130 million that would have made the bank miss required capital ratios as far back as Q4 2008, had they been booked properly. After the losses became known, TierOne’s stock price dropped more than 70%, and the bank filed for bankruptcy shortly after it was shut down by OTS in June 2010.
Regarding insider trading, the SEC alleges that Gilbert Lundstrom tipped his son in 2009 with confidential details about a proposed asset sale between TierOne and Great Western Bank. Based on this, Trevor Lundstrom bought nearly 210,000 TierOne shares between June and September 2009 in anticipation of the asset sale. Following a Sept. 4 public announcement about the transaction, Lundstrom sold his TierOne holdings for $225,921 in illicit profits.
Gilbert Lundstrom, who lives in Lincoln, agreed to pay a $500,921 penalty and Laphen, who resides in Omaha, agreed to pay a $225,000 penalty. They also consented to permanent officer and director bars. Trevor Lundstrom, who lives in Birmingham, Ala., settled his insider trading charges without admitting or denying the SEC’s allegations. He agreed to pay disgorgement of $225,921 plus prejudgment interest and a $225,921 penalty. The settlements are subject to court approval. Langford, who lives in Gibsonia, Pa., has not settled the charges, and the SEC’s case continues against him.