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.
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
The Financial Industry Regulatory Authority and the Securities and Exchange Commission recently took action against a number of firms for everything from fraud to supervisory failure that in some cases cost the firms dearly.
FINRA Fines Guggenheim Securities $800,000, Sanctions Two Traders
FINRA announced that it has fined Guggenheim Securities, LLC of New York $800,000 for failing to supervise two collateralized debt obligation traders who engaged in activities to hide a trading loss. FINRA also sanctioned the two traders; Alexander Rekeda, the former head of Guggenheim's CDO desk, was suspended for one year and fined $50,000, and Timothy Day, a trader on Guggenheim's CDO desk, was suspended for four months and fined $20,000.
In October 2008, according to FINRA, as the result of a failed trade, Guggenheim's CDO desk acquired a €5,000,000 ($6.469 million) junk-rated tranche of a collateralized loan obligation. After unsuccessful attempts by Guggenheim's CDO desk to sell the position, Rekeda and Day persuaded a hedge fund customer to purchase the CLO for $950,000 more than it had previously agreed to pay by falsely presenting the CLO as part of a package of securities a third party offered for sale.
FINRA found that the traders tried to hide the trading loss on the CLO position by providing the customer with order tickets that increased the price for the CLO position and decreased the price of the other positions that were part of the transaction. When the customer inquired about the pricing adjustments, Day, at Rekeda's direction, lied and said a third-party seller of the CLO position had already settled the trade at a higher price and requested the customer pay the higher price.
The customer agreed to overpay for the CLO and in return, Day and Rekeda agreed to compensate the customer through other transactions, including pricing adjustments on six other CLO trades, a waiver of fees the customer owed in connection with resecuritization transactions, and a cash payment to the customer. The records created to document the transactions did not indicate any connection to the overpayment for the CLO.
FINRA found Guggenheim failed to conduct adequate review of the CDO desk's trades, documentation concerning transactions by traders on the desk, and the traders' email communications. Guggenheim, Rekeda, and Day neither admitted nor denied the charges, but concluded the settlement by consenting to the entry of FINRA's findings. As part of the settlement, Guggenheim must retain an independent consultant to review and make recommendations concerning the adequacy of its supervisory procedures.
FINRA Fines, Censures BrokersXpress on Reporting Failures
BrokersXpress LLC was censured by FINRA and fined $60,000, and without admission or denial, consented to the sanctions and entry of findings that, for nearly two years, it effected municipal securities transactions on a riskless principal or agency basis, and failed to submit required reports to the Municipal Securities Rulemaking Board for both the trades it effected with other dealers and the trades it effected with its customers.
According to the findings, the firm failed to properly submit some reports of trades it effected with customers, in that some were submitted to the MSRB that reflected that the trades were effected by the firm’s affiliated dealer, when the firm itself effected the trades. Also, some reports of trades were not submitted at all. Many that were submitted to the MSRB were inaccurate or deficient. The firm also improperly reported corporate bond trades to the MSRB. Of the 257 transactions the firm effected during this period, confirmations sent to customers for 121 of them were inaccurate because they stated that the bonds were “traded flat” or were in default, when the bonds were not in default. Other failures were also part of the findings.
BrokersXpress had been acquired by Charles Schwab & Co. as part of OptionsXpress Holdings, which it acquired in 2011. However, in May of this year Schwab announced that it would be closing BrokersXpress, saying that it “was difficult to integrate because BrokersXpress does not meet our core business needs.” Spokesman Susan Forman said at the time that the company would provide the requisite 90-day notification process for affiliated advisors and clients.
A Schwab spokesperson told AdvisorOne on Oct. 12 that "BrokersXpress is no longer operational" and that the BD's "last day of trading and supporting advisors/end clients was September 4, 2012."
Parent OptionsXpress had previously been hit with two SEC actions, the first for an alleged abusive naked short-selling scheme and the second involving its trading arm, OX Trading LLC, which was charged with continuing to trade after delisting from the Chicago Board Options Exchange and deregistering with the SEC, apparently to avoid an audit. Forman had said in May that closure of BrokersXpress had nothing to do with either case.
United Planners Censured, Fined over Supervisory Failure on VAs
United Planners Financial Services of America, based in Scottsdale, Ariz., and its principal, Douglas Hall of Phoenix, were censured and fined by FINRA over supervisory failures on variable annuity sales.
Without admitting or denying the findings, Hall and his firm consented to sanctions that included a $200,000 fine for the firm and a $15,000 fine for Hall after FINRA found that that the firm failed to have in place a supervisory system for compliance over VA transactions of field Office of Supervisory Jurisdiction supervisors. The firm permitted these supervisors to self-approve their own VA sales, and the post-transaction review system, also inadequate, delegated to a principal the responsibility for reviewing and approving VA sales, without providing guidance, procedures and tools or auditing.
Also, the firm neither evaluated nor trained properly the person who was assigned to the home-office OSJ supervisor position. Procedures that were defined, for a weekly review of the blotter, for, among other things, suitability and switching, and a compliance department audit of all OSJ locations, were not carried out adequately. Hall was responsible for monitoring compliance, and failed to do so.
Edward Jones & Co. Fined, Censured Over Customer Account
Edward Jones & Co., L.P. was censured and fined $95,000 and consented, without admitting or denying the findings, to entry of FINRA findings that it failed to adequately review activity in a customer account that resulted in lost funds.
FINRA found that that the customer’s account was the subject of heightened scrutiny by the firm because, among other things, international wire activity was detected in the account; the activity involved wires of more than a million dollars and the account became subject to a grand jury subpoena and an investigation by law enforcement.
Despite heightened scrutiny on the account, a branch office assistant was able to convert $167,249 from that customer’s account by using forged letters of authorization to effect wire transfers out of the account without permission or authority. The improper transfers, with the exception of two, were each for less than $10,000 and occurred several times per month.
FINRA also found that the funds were wired to an outside bank account belonging to the assistant’s relative, who was not associated with the customer or his accounts. Despite the heightened scrutiny, inquiries by law enforcement and the size and frequency of the wire activity to a third-party account, the firm failed to perform an adequate account activity review and failed to respond to red flags that would have alerted it to the misconduct. FINRA found that the firm promptly reimbursed the customer for the losses.
Firms Censured, Fined Over Subprime Loans in Income Mutual Fund
Fidelity Brokerage Services, LLC and Fidelity Investments Institutional Services Co., Inc., both of Smithfield, R.I., were censured and fined $375,000, jointly and severally, by FINRA. Without admission or denial, both firms consented to the sanctions and to the entry of findings related to a mutual fund determined to be unsuitable for conservative investors seeking to preserve capital.
According to FINRA’s findings, the firms marketed, sold and/or wholesaled shares in an income mutual fund and, in connection with that, created advertising, training and/or wholesaling materials for that fund that were provided to public customers, retail sales firms, used internally or used for institutional purposes within the selling intermediaries. The fund, however, included securities backed by, among other things, subprime mortgages and credit card and auto loan receivables.
After the subprime crisis began, the fund’s net asset value started to fall, and it was obvious that it was no longer suitable for investors trying to preserve capital. However, instead of doing a timely update of their sales materials to reflect the fund’s change in suitability, and to accurately depict how the fund was affected by the subprime crisis, or ceasing to distribute them, the firms continued to use materials that were unbalanced to begin with and contained unqualified promises of positive future performance. The materials were misleading, contained unwarranted statements and failed to provide a sound basis by which to evaluate the fund’s nature, holdings and risks.
FINRA found that not only did Fidelity Investments continue to distribute certain of these materials to selling intermediaries, but procedures the firms had in place to review and approve sales materials were not reasonably designed to achieve and monitor compliance with applicable laws, regulations and rules.
RBC Capital Markets Censured, Fined for Account Reconciliation Failures
FINRA censured and fined RBC Capital Markets, LLC $250,000 for violations resulting from difficulties in reconciling accounts after a merger. Without admitting or denying the findings, RBC consented to the sanctions and to the entry of findings that it failed to successfully resolve problems stemming from a merger combining the institutional firm with its affiliated retail firm, and a back-office system conversion.
According to the findings, after the merger and conversion, the firm experienced difficulties in reconciling its accounts. This resulted in customer reserve, net capital, recordkeeping and supervisory violations. The firm failed to prepare an accurate customer reserve formula, made a late deposit to its customer reserve account resulting in an eight-minute hindsight deficiency of approximately $317 million, and made some late withdrawals from customer reserve and proprietary accounts of introducing brokers (PAIB accounts).
The firm also failed to take net capital charges of approximately $366 million for aged debits in some accounts. This amount reduced the firm’s excess net capital from approximately $627 million to $260 million, but did not result in a deficiency. FINRA found that in connection with the customer reserve and net capital violations, there were numerous other inaccuracies and failures.
SEC Charges Hedge Fund Managers With Defrauding Investors
The SEC announced that it has separately charged a pair of hedge fund managers and their firms with lying to investors about how they were handling the money invested in their respective hedge funds.
In one case, the SEC alleges that San Francisco-based hedge fund manager Hausmann-Alain Banet and his firm Lion Capital Management stole more than a half-million dollars from a retired schoolteacher who thought she was investing her retirement savings in Banet’s hedge fund. In the other case, the SEC charged Chicago-based hedge fund managers Norman Goldstein and Laurie Gatherum and their firm GEI Financial Services with fraudulently siphoning at least $147,000 in excessive fees and capital withdrawals from a hedge fund they managed.
According to the SEC’s complaint filed against Banet and Lion Capital Management in federal court in San Francisco, Banet led the teacher to believe that his hedge fund would invest in the stock market using a long/short equity investing strategy. Instead, Banet used the teacher’s investment of $550,000 to pay his own personal and business expenses, including his home mortgage, office rent, and staff salaries. He also provided phony account statements showing nonexistent investment gains and listing an independent administrator that performed no actual work for the fund.
In a parallel action, the U.S. Attorney’s Office for the Northern District of California also announced criminal charges against Banet.
According to the SEC’s complaint against Goldstein, Gatherum, and GEI Financial Services filed in federal court in Chicago, investors in the hedge fund were not told that its adviser removed various performance hurdles when calculating fees. Furthermore, inappropriate capital withdrawals were made from the fund. Goldstein, Gatherum, and their firm disclosed to advisory clients that Illinois regulators had stripped Goldstein of his securities registrations in 2011, barring him from providing investment advisory services in the state. Goldstein nevertheless continued to make all investment decisions on behalf of clients, and he and Gatherum caused GEI Financial Services to violate compliance rules applicable to SEC-registered investment advisers.