More On Legal & Compliancefrom The Advisor's Professional Library
- Regulatory Oversight of Investment Advisors Although the regulatory environment is in a state of flux, it is imperative that RIAs adhere to their compliance obligations. To ensure compliance, RIAs and IARs must fully understand what those obligations are.
- 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.
Even officials on the front lines of catching wrongdoing at broker-dealer and advisory firms can be guilty of wrongdoing themselves.
The law firm Sutherland found a bevy of violations during its annual look at Securities and Exchange Commission and Financial Industry Regulatory Authority disciplinary actions targeting chief compliance officers and in-house counsel for BDs and advisory firms.
From July through December 2012, Sutherland found that FINRA and the SEC brought disciplinary actions against CCOs and in-house counsel for a range of conduct, including failure to supervise; aiding, abetting and causing primary violations; anti-money-laundering (AML) deficiencies; making false representations to staff; FINRA Rule 8210 violations; and registration deficiencies.
Following are some of the notable violations Sutherland highlights in each area:
Simply having procedures is usually not enough. In general, firms must also enforce those procedures. In an October settlement, FINRA alleged that a CCO failed to enforce his firm’s procedures in connection with excessive trading in four customer accounts.
Specifically, FINRA alleged that the CCO failed to:
—Conduct quarterly reviews of customer accounts to detect excessive trading as required by his firm’s written supervisory procedures (WSPs);
—Contact customers whose turnover ratios exceeded six (a threshold set in the firm’s procedures), despite a requirement in the procedures that he should take “immediate steps to determine that such trading activity is acceptable to customers”; and
—Send an activity letter as required by the WSPs to account holders whose accounts had a turnover rate of greater than two or had more than eight trades in one month.
For these and other alleged failures, FINRA suspended the CCO for 30 days in a principal capacity and fined him $20,000.
Written supervisory procedures are not one-size-fits-all because BDs engage in different types of business. Consequently, it is important that procedures are tailored to the firms' business lines.
In a December complaint, FINRA alleged that a firm’s written supervisory procedures were inadequate with respect to the sale of unregistered securities. In 2009, the firm allowed a customer (a corporation engaged in stock promotion) to deposit nearly a billion shares of unregistered, nonexempt securities into firm accounts and then to liquidate the positions, resulting in significant commissions for the firm.
With respect to the firm’s WSPs, FINRA alleged that, while the firm had procedures related to the sale of unregistered securities, they “were not tailored to the securities liquidation business that [the firm] conducted.”
In an October settlement, FINRA alleged that a CCO “had supervisory responsibility” over the firm’s president and owner and that the CCO “was responsible for reviewing transactions at the firm, including trades and wire transmissions, for potentially suspicious activity and other irregularities.”
Between July 2008 and April 2009, the firm’s president had a client who controlled three accounts: two maintained by hedge funds and one maintained by the client’s wife. The client engaged in a scheme that involved reallocating profitable trades from the hedge funds’ accounts to his wife’s account and unprofitable trades in the other direction.
FINRA alleged that the following red flags ought to have made the CCO aware of what FINRA characterized as a “cherry-picking scheme”:
—The client’s wife’s account was funded with a deposit of approximately $350,000 with no additional funds being deposited into or credited to the account; between September 2008 and April 2009, approximately $5.8 million was wired out of the account in nine wires, with one of those wires being for approximately $1.63 million; and
—From July 2008 to April 2009, approximately 86% of the trades in the account were profitable.
FINRA has disciplined several AML compliance officers (AMLCOs) in connection with their firms’ deficient AML compliance programs. Some of the AML-related disciplinary actions related to alleged failures to follow up on red flags indicating suspicious activity.
For instance, in an August settlement, FINRA disciplined a CCO (who was also the firm’s AMLCO) for his firm’s alleged failure to develop and implement a written AML program reasonably designed to ensure the firm’s compliance with the Bank Secrecy Act. Specifically, FINRA determined that the firm,“acting through” the CCO, failed to “monitor, detect and investigate suspicious transactions and determine whether to file a suspicious activity report in the face of multiple ‘red flags’ involving at least five customers and numerous accounts.”
False Representations to SEC Staff
In a July settlement, the SEC disciplined the CCO of an investment advisor for allegedly making false and misleading entries in numerous documents to make it appear that he performed compliance reviews of IA operations.
The SEC’s order stated that the CCO’s “false and misleading statements made it appear to regulators and the firm’s advisory clients that [the firm] actually had a CCO who performed required compliance functions, when in reality Respondent did nothing of the sort.” Among the documents the CCO allegedly falsified were the firm’s Form ADV, as well as annual reports related to compliance reviews.
Suspension From Practicing Before the Commission
The SEC can prohibit attorneys from practicing before it. In a November order, the SEC reviewed an appeal filed by a general counsel of an IA (who was also the CCO) who had been temporarily suspended from practicing before the commission after a federal district court found she had engaged in insider trading.
The general counsel appealed the suspension on a number of grounds, including arguing that the suspension was a “penalty” and that the federal district court had declined to assess a penalty against her. The SEC denied the request to lift the temporary suspension, but ordered a hearing before an administrative law judge. This litigation is ongoing.
In September 2012, another attorney with an IA was barred from practicing before the commission for antifraud violations.
Read last year's report, Playing With Fire: CCOs and Lawyers Who Got Burned by Regulators, on AdvisorOne.