More On Legal & Compliancefrom The Advisor's Professional Library
- Registration Requirements for Investment Advisor Representatives (IARs) When individuals launch an advisory firm, they must avoid marketing themselves or the firm as investment advisors before they are properly approved and registered. Otherwise, they are subject to severe penalties.
- 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.
Among recent actions taken by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) were charges against a former hedge fund advisory firm and two of its executives for fraud and numerous actions on reporting failures, unsuitable investments and supervisory failures.
Former billion-dollar hedge fund advisory firm, execs charged
The SEC charged a former $1 billion hedge fund advisory firm and two executives with scheming to overvalue assets under management and exaggerate the reported returns of hedge funds they managed so that they could hide losses and increase investor fees.
The case, the seventh to do so, arose from the SEC’s Aberrational Performance Inquiry, an initiative by the Enforcement Division’s Asset Management Unit that uses proprietary risk analytics to identify hedge funds with suspicious returns. Performance flagged as inconsistent with a fund’s investment strategy or other benchmarks forms a basis for further investigation and scrutiny, the SEC says.
The SEC alleged that New Jersey-based Yorkville Advisors LLC, its founder and president Mark Angelo, and chief financial officer Edward Schinik lured pension funds and other investors to invest in their hedge funds by falsely portraying Yorkville as a firm that managed a highly collateralized investment portfolio and employed a robust valuation procedure. They misrepresented the safety and liquidity of the funds’ investments, and charged excessive fees to the funds based on the investments’ fraudulently inflated values.
According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, Yorkville, Angelo, and Schinik defrauded investors in the YA Global Investments (U.S.) LP and YA Offshore Global Investments Ltd hedge funds.
The SEC alleges that Yorkville and the two executives failed to adhere to Yorkville’s stated valuation policies and ignored negative information about certain investments by the funds. In addition, they kept the adverse information about the investments from Yorkville’s auditor, so that the firm could continue to carry some of its largest investments at inflated values. They also misled investors about the funds’ liquidity, underlying collateral, and Yorkville’s use of a third-party valuation firm.
The SEC alleges that by fraudulently making Yorkville’s funds more attractive to potential investors, Angelo and Schinik enticed more than $280 million in investments from pension funds and funds of funds. This enabled Yorkville to charge the funds at least $10 million in excess fees based on the inflated values of Yorkville’s assets under management.
FINRA Sanctions Citigroup Global Markets on Reporting, Other Failures
Citigroup Global Markets was censured, fined $900,000, and required to pay $32,355.82, plus interest, in restitution to customers on FINRA findings that it failed to report the correct contra-party’s identifier for transactions in TRACE-eligible securities to FINRA's Trade Reporting and Compliance Engine (TRACE). The firm neither admitted nor denied the findings in consenting to the sanctions, and FINRA considered, among other things, the remedial efforts the firm had taken to enhance its supervisory procedures and systems.
FINRA found that the firm failed to report transactions in TRACE-eligible securities to TRACE within 15 minutes of the execution time, failed to report the correct trade execution time for transactions in TRACE-eligible securities to TRACE, failed to show the correct execution time on the memoranda of brokerage orders, and reported transactions in TRACE-eligible securities that it was not required to report.
Findings also included numerous other reporting failures, as well as a determination that in transactions for or with a customer, the firm failed to use reasonable diligence to ascertain the best interdealer market and failed to buy or sell in such market so that the resultant price to its customer was as favorable as possible under prevailing market conditions. Moreover, FINRA found that in some transactions, the firm sold (or bought) corporate bonds to (or from) customers and failed to sell (or buy) such bonds at a price that was fair, taking into consideration all relevant circumstances, including market conditions with respect to each bond at the time of the transaction, the expense involved and that the firm was entitled to a profit.
Merrill Lynch, Pierce, Fenner & Smith Incorporated was censured and fined $450,000 by FINRA over supervisory control system failures. Without admitting or denying the findings, the firm consented to the entry of findings that its supervisory control system failed to include a policy or procedure requiring a review to detect or prevent multiple transmittals of funds from multiple customers going to the same third-party accounts.
The findings stated that the firm’s system failed to include exception reports that would have identified multiple customer wires going to the same third-party account. Consequently, the firm failed to detect that a registered representative had initiated fund transfers totaling approximately $887,931 out of customer accounts to bank accounts he apparently controlled. The registered representative has been barred from association with any FINRA member in any capacity and the firm has repaid each of the affected customers.
Merrill Lynch Fined, Censured over Unsuitable Recommendations
FINRA censured Merrill Lynch, Pierce, Fenner & Smith and fined the firm $400,000, which includes the disgorgement of commissions received of $47,190.03, as well as requiring it to pay $130,718, plus interest, in restitution to customers. Without admitting or denying the findings, the firm consented to the entry of findings that, through a registered representative, it recommended that customers engage in a pattern of unsuitable short-term closed-end fund (CEF) and unit investment trust (UIT) trading.
According to the findings, most of the short-term transactions involved CEFs purchased at IPOs, with customer sales charges built into the offering price. Even though CEFs and UITs generally were intended as longer-term investments, the registered representative recommended some customers sell their entire positions as soon as two months after purchase. Many of the transactions involved switching, with the customer gaining little or no economic benefit from the exchange.
The firm, through the representative, made these recommendations to purchase and sell CEFs and UITs on a short-term basis without reasonable grounds to believe the recommendations were suitable for the customers, who as a result incurred unnecessary sales charges and suffered losses of approximately $360,000 while the firm and the representative earned gross commissions of more than $47,000. The representative also made unsuitable recommendations that customers open margin accounts and use margin to buy and sell securities. These customers paid in aggregate over $70,000 in margin interest.
FINRA found that the firm failed to detect that the representative was engaging in a pattern of unsuitable short-term trading of CEFs and UITs and unsuitable transactions on margin; it also failed to respond adequately to exception reports and information suggesting the representative’s pattern of unsuitable use of margin. The firm did not speak with any customers about the short-term trading or margin activity until they began to complain. In some cases, the firm relied upon the broker’s self-serving explanations for the transactions without conducting further investigation. FINRA also found additional supervisory failures.
Natixis Securities Americas LLC, formerly Natixis Bleichroeder LLC, was censured by FINRA, fined $300,000 and required to revise its written supervisory procedures (WSPs). Without admitting or denying the findings, the firm consented to the entry of findings that it had fail-to-deliver positions at a registered clearing agency in equity securities that resulted from short sales and long sales, and did not close the fail-to-deliver positions by purchasing securities of like kind and quantity within the time frame SEC rules prescribed.
The findings stated that the firm had fail-to-deliver positions at a registered clearing agency in equity securities that were attributable to market-making activities, and did not close out the positions with appropriate purchases within the time SEC rules prescribed. In instances involving equity securities, the firm accepted short sale orders from other persons, or effected short sales for its own accounts, without first borrowing the securities, or entering into a bona fide arrangement to borrow the securities, and it had fail-to-deliver positions at a registered clearing agency in such securities that had not been closed out in accordance with the provisions of SEC rules.
In addition, FINRA found numerous reporting errors in a range of categories, failures in order execution and the exercise of diligence in the area of pricing for its customers, as well as delivery failures. FINRA also found that the firm effected short sales in the publicly traded securities of financial firms that had been banned by SEC Emergency Order #34-58592. Finally, the findings also found failures in the firm’s supervisory system.
FINRA announced that it has expelled EKN Financial Services. of Melville, N.Y., for numerous compliance violations and for allowing its CEO, Anthony Ottimo, to act as a supervisor after being barred from acting in that capacity by the SEC in June 2008. FINRA barred Ottimo from the securities industry and barred the firm's former president, Thomas Giugliano, from acting in a principal capacity, suspended him from the securities industry for one year and fined him $150,000. EKN, through Ottimo and Giugliano, also violated numerous NASD/FINRA and SEC rules and federal securities laws, including antimoney laundering (AML) violations, net capital deficiencies and widespread reporting failures.
FINRA found that from 2008 through 2011, Ottimo acted in a supervisory role despite an SEC order barring him from doing so, and acted as CEO despite not being registered as a principal. During that time, EKN and Giugliano repeatedly misrepresented to FINRA that Ottimo was no longer acting as EKN's CEO, as a principal or as a supervisor. In 2011, EKN lied to FINRA examiners, reporting that since 2008, it had "never filled" the CEO position when, in fact, FINRA's investigation revealed that EKN's own documents indicated that from 2008 through 2011, Ottimo was listed as EKN's CEO and was operating in that capacity. As CEO, Ottimo supervised other EKN personnel, negotiated and executed agreements, controlled its finances, retained signatory authority over its bank accounts, and represented himself as EKN's CEO to its clearing firm and other third parties.
In addition, FINRA found that EKN, Ottimo and Giugliano, who was aware of EKN and Ottimo's regulatory violations, committed numerous anti-money-laundering violations, including failing to establish an adequate AML compliance program to detect and report suspicious activity. For instance, EKN customers attempted to inject several hundred million dollars of bogus bonds into the U.S.financial system, but the firm failed to detect "red flags" suggesting possible suspicious activity.
Moreover, EKN failed to meet minimum net capital requirements during certain periods from September 2008 to November 2010, and also prepared inaccurate net capital computations, failed to accurately report its net capital deficiencies to the SEC and FINRA, and failed to accurately record expenses and liabilities in its books and records. EKN also failed to report to FINRA, which would have made this information publicly available through FINRA BrokerCheck, that Ottimo and Giugliano each had hundreds of thousands of dollars in unsatisfied judgments and liens.
In settling this matter, EKN, Ottimo and Giugliano neither admitted nor denied the charges, but consented to the entry of FINRA's findings.