More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- RIAs and Customer Identification Just as RIAs owe a duty to diligently protect their clients privacy and guard against theft, firms also play a vital role in customer identification. Although RIAs are not subject to an anti-money laundering rule, securities regulators expect advisors to address these issues in their policies and procedures.
The SEC recently filed charges against four traders for bribing a Venezuelan official with millions, against the gatekeepers of two mutual fund trusts for inaccurate or misleading fund disclosures, and against the city of Harrisburg, Pa., for securities fraud.
Harrisburg, Pa., Charged with Securities Fraud
The SEC charged the city of Harrisburg, Pa., with securities fraud for making misleading public statements when its financial condition was deteriorating and financial information available to municipal bond investors was either incomplete or outdated. It is the first time that a municipality has been charged by the SEC for misleading statements made outside of its securities disclosure documents.
The statements were made in the city’s budget report, annual and midyear financial statements, and a State of the City address—all of which implied that the city was in considerably better financial shape than was actually the case.
Harrisburg, which is nearly bankrupt, is under state receivership thanks in the main to about $260 million in debt that it had guaranteed for upgrades and repairs to a municipal resource recovery facility owned by The Harrisburg Authority. As of March 15, Harrisburg has missed approximately $13.9 million in general obligation debt service payments.
Harrisburg failed to comply with requirements to provide investors with ongoing financial information and audited financial statements. These investors held bonds totaling hundreds of millions of dollars—all of which were either issued or guaranteed by the city. The lack of accurate information available from conventional city sources from 2009 to 2011 compelled investors to seek information elsewhere. However, precious little accurate data was available from other public sources, and some of what was available was seriously in error—such as the 2009 budget misstating Harrisburg’s credit as being rated “Aaa” by Moody’s, when Moody’s had already downgraded Harrisburg’s general obligation credit rating to Baa1 by December 2008.
Information on the city’s website in addition to the budget, such as the 2009 State of the City address and 2009 midyear fiscal report, also either misstated or failed to disclose similarly critical information aboutHarrisburg’s financial condition and credit ratings.
Harrisburg has neither admitted nor denied the SEC’s findings, but the SEC has issued an order for the city to cease and desist the violations. The agency has taken into account the city’s cooperation and the actions it has taken to avoid future violations in framing its settlement.
The SEC has also issued a report addressing disclosure obligations of public officials, as well as their potential liability under federal securities laws for public statements made in the secondary market for municipal securities.
Huge Kickback Scheme Nets Venezuelan Official Millions; Traders Charged
The SEC charged four traders tied to a New York City brokerage for their part in a kickback scheme in which they paid millions of dollars to an important Venezuelan finance official in an attempt to win the bond trading business of a state-owned Venezuelan bank.
Tomas Alberto Clarke Bethancourt, executive vice president of broker-dealer Direct Access Partners (DAP); along with a Panamanian resident, Iuri Rodolfo Bethancourt; and a husband and wife, Jose Alejandro Hurtado and Haydee Leticia Pabon, residents of Miami, all played a part in a massive setup in which the global markets group at DAP executed fixed income trades for customers in foreign sovereign debt, the SEC said.
DAP Global, according to the SEC, generated more than $66 million in revenue for DAP from transaction fees—markups and markdowns—on riskless principal trade executions in Venezuelan sovereign or state-sponsored bonds for Banco de Desarrollo Económico y Social de Venezuela (BANDES). They then channeled some of this revenue illegally to María de los Ángeles González de Hernandez, BANDES’ vice president of finance, who authorized the fraudulent trades.
The scheme ran from October 2008 until at least June 2010. BANDES, a new customer of DAP won through Hurtado’s connections, stayed with the firm when González was wooed by kickbacks to keep the bank’s business with DAP regardless of what it was charged in the complex transactions that resulted in the illegal profits. Ironically, Clarke and Hurtado also deceived González about the amount of DAP’s fees, cheating her out of some of her ill-gotten gains to keep a greater share of the illicit profits for themselves.
The SEC has charged Clarke, Bethancourt, Hurtado and Pabon with fraud, and seeks final judgments that would require them to return ill-gotten gains with interest and pay financial penalties. Its investigation is continuing.
The U.S. Attorney’s Office for the Southern District of New York has also announced criminal charges against González, Clarke and Hurtado.
Gatekeepers for Two Trusts Charged for Inaccurate Disclosures
Gatekeepers for the Northern Lights Fund Trust and the Northern Lights Variable Trust were charged for making inaccurate disclosures regarding the factors they considered when approving or renewing investment advisory contracts on behalf of shareholders.
An SEC examination found that some shareholder reports for the two trusts either misrepresented material information considered by trustees or omitted material information altogether with regard to how trustees weighed some factors in making decisions on behalf of the funds and their shareholders.
The five trustees named in the SEC enforcement action are Michael Miola of Arizona, Lester M. Bryan of Utah, Anthony J. Hertl of Florida, Gary W. Lanzen of Nevada and Mark H. Taylor of Ohio. They and the trusts’ chief compliance officer, Northern Lights Compliance Services (NLCS), were responsible for causing violations of the SEC’s compliance rule, and the trusts’ fund administrator Gemini Fund Services (GFS) caused violations of the Investment Company Act recordkeeping and reporting provisions.
In trustee meetings considering 113 advisory and 32 subadvisory contracts during what’s known as the 15(c) process, some boilerplate disclosures included by GFS were found by the SEC to hold untrue or misleading information, such as stating that the trustees had considered peer group information about the advisory fee when the trustees had never been provided with any such information. Another such “disclosure” claimed that the fund’s advisory fee was not materially higher than its peer group range, when in fact the fee was nearly double the peer group’s mean fee or even higher.
In addition, certain mutual fund series did not follow their policies and procedures for the trustees’ approval of the investment advisors’ compliance programs. Instead of the trustees actually evaluating approve the compliance program of each series’ investment advisor, they instead reviewed a brief written statement prepared by NLCS saying that the advisors’ compliance manuals were “sufficient and in use” and a verbal representation by NLCS that such manuals were adequate.
The trustees, GFS and NLCS neither admitted nor denied the SEC’s findings, but GFS and NLCS each agreed to pay $50,000 penalties; in addition, the firms and trustees agreed to bring in an independent compliance consultant to address the violations found by the SEC.