More On Legal & Compliancefrom The Advisor's Professional Library
- The Few and the Proud: Chief Compliance Officers CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations. When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.
- Dealings With Qualified Clients and Accredited Investors Depending upon an RIAs business model and investment strategies, it may be important to identify “qualified clients” and “accredited investors.” The Dodd-Frank Act authorized the SEC to change which clients are defined by those terms.
Among recent enforcement actions taken by the SEC and FINRA were charges against a father and son, along with their Chicago-area advisory firm, for making undeclared trades and then cherry-picking the profitable ones for their own accounts, while assigning the unprofitable ones to clients; charges against the city of South Miami for defrauding investors on the tax-exempt status of municipal bonds; and censure and a hefty fine over misleading brochures.
Father and Son Charged by SEC for Cherry-Picking Trades
Father and son Charles J. Dushek and Charles S. Dushek, and their advisory firm, Lisle, Ill.-based Capital Management Associates (CMA), were charged with defrauding clients by cherry-picking stock trades so that the profitable ones went into the Dusheks’ accounts while the losing trades went into client accounts. The scheme brought the Dusheks almost $2 million in illicit profits, which they spent on luxury homes, vehicles and vacations.
The Dusheks, says the SEC, were particularly successful in achieving positive returns—but only in their own accounts, since they waited anywhere from a day to several days to declare whether any given trade out of more than 13,500, for more than $350 million in securities purchases, turned a profit. If so, the Dusheks usually assigned the profitable trade to their own accounts; if not, the trade was usually consigned to the account of an unwitting client.
They kept up this charade for 17 consecutive quarters, not keeping any written records of trades in client funds or personal funds so that they could assign the successful trades to themselves and the losers to their clients, many of whom were senior citizens. They were so diligent about it that one of Dushek Sr.’s personal accounts gained some 25,000% from 2008–2011. His clients, on the other hand, mostly lost money.
Even though Dushek Sr. had no other source of income but the trades and his Social Security checks, he spent lavishly on his 6,500-square-foot luxury home, which boasted separate equestrian facilities, and on other goodies: a Mercedes Benz SL550 and other luxury vehicles, membership in a luxury vacation resort and vacations abroad. Dushek Jr. devoted his own illicit profits to payments for a boat slip and vacations to ski resorts and to Hawaii.
Even their brochures were deceptive, claiming that reports of the firm’s proprietary trading activities were submitted to an associate for review, when there were no such reports and no review.
The Dusheks and their firm are charged with fraud, and the SEC seeks the return of ill-gotten gains with interest and additional penalties.
SEC Charges City of South Miami with Defrauding Investors
The city of South Miami, Fla., was charged by the SEC with defrauding investors concerning the tax-exempt financing eligibility of a mixed-use retail and parking structure being built in its downtown commercial district.
Originally, the city sought the financing to develop a public parking garage. To do this, it borrowed about $12 million in two pooled conduit bond offerings through the Florida Municipal Loan Council (FMLC).
However, over time the project turned into a mixed-use retail and public parking structure to be developed by a for-profit developer. The initial lease agreement with the developer specified that the city would be responsible for all construction costs except the retail portion and would retain full control over operation and maintenance of the garage segment as well as all parking revenues.
Limiting the developer’s part in the arrangement was critical to qualifying for tax-exempt financing. IRS regulations specify that the project qualified for tax-exempt financing only if its use by the for-profit developer was kept to a minimum.
South Miami approved the financing for construction of the tax-exempt portion of the project and went ahead with the first of its two FMLC bond offerings in 2002. But when bond counsel got a copy of the city’s lease agreement with the developer, a potential tax issue was flagged because of the mixed public-retail nature of the project. Bond counsel told the city’s then-finance director and city officials in subsequent conference calls that no funds from the bond offering could be used to finance the retail portion of the structure.
South Miami never told the FMLC, bond counsel, or any third parties about the project changes, and the documents it prepared for the second bond offerings thus contained material misrepresentations and omissions about the changed lease and the use of the proceeds from the offering.
The city kept saying in annual certifications from 2003 to 2009 that it was in compliance with the terms of the loan agreement and that no material changes had occurred to affect the bonds’ tax-exempt status. But in July of 2010, the city filed a material event notice with the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access (EMMA) system that acknowledged the change and threat to the status of the bonds.
South Miami agreed to settle the SEC’s charges and to retain an independent third-party consultant to oversee its policies, procedures, and internal controls for municipal bond disclosures.
Separately, the city settled with the IRS by paying $260,345 and defeasing a portion of the two prior bond offerings at a cost of $1.16 million. Because of the city’s settlement and payments, bondholders were not financially harmed and are not required to include any interest from the bonds in their gross incomes.
FINRA Censures, Fines Firms on Misleading Brochures
Hartford Investment Financial Services and Hartford Life Distributors, now known as Forethought Distributors, were censured and fined $100,000, jointly and severally, by FINRA. The agency found that a mutual fund brochure Hartford Life prepared and distributed, and which was approved by Hartford Investment, the chief investment advisor to the fund, made statements regarding the fund that were unwarranted and misleading in light of changing conditions in the bank loan market.
Specifically, the brochure claimed that the fund was appropriate for bond investors concerned about the price stability of their investments, provided the potential for greater price stability compared with other fixed-income investments, and was appropriate for investors seeking some degree of capital preservation. However, market conditions during the period in which the brochure was prepared and distributed made these claims inaccurate.
The brochure was also approved at least twice, without changes to those claims, after Hartford Investment became aware of their inaccuracy; about 2,450 copies of the brochure were distributed with the inaccurate claims.
Also, even though the board of the mutual fund was advised of concerns about the bank loan market and the fund, none of Hartford Investment’s employees responsible for approving the fund’s advertising materials were present at the meetings during which these concerns were presented.
Both firms’ WSPs also had no means by which they could make sure that those responsible for drafting or reviewing advertising materials would be informed of material facts concerning relevant conditions in the bank loan market or the mutual fund’s performance.
The firms neither admitted nor denied the findings, but consented to the sanctions.
Read SEC, FINRA Enforcement Roundup: Husband and Wife Divert Funds to Buy Home on AdvisorOne.