More On Legal & Compliancefrom The Advisor's Professional Library
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
- Client Commission Practices and Soft Dollars RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.
Among recent enforcement actions were a $1 million fine and $353,000 in restitution ordered by FINRA against StateTrust Investments over excessive markups and markdowns in fraudulent corporate bond transactions; charges against a China-based company and its CEO by the SEC for misleading investors about its financial condition; SEC charges against a medical device company for misleading shareholders about the FDA’s opinion of its product; and an amicus brief filed by the SEC in a case concerning market manipulation and misrepresentation.
FINRA Fines StateTrust Investments $1 Million, Orders Restitution
StateTrust Investments, Inc. was fined $1.045 million by FINRA and ordered to pay restitution of $353,000, plus interest, to customers who were affected by excessive markups and markdowns in fraudulent corporate bond transactions. In addition, the agency also sanctioned the firm’s head trader, Jose Luis Turnes, suspending him for six months and fining him $75,000.
The agency had already taken action against Jeffrey Cimbal, StateTrust's chief compliance officer, who in April was fined $20,000 and suspended for five months in a principal capacity for failing to supervise Turnes.
FINRA found that the firm charged excessive markups or markdowns to customers in a total of 563 transactions. In 227 of those transactions, the markups and markdowns were greater than 5%, and in 85 of those instances, StateTrust acted through Turnes to charge excessive markups and markdowns that deviated 8% to more than 23% from the prevailing market price.
In each of those 85 instances, when StateTrust bought bonds from customers, it did so at prices that were 8% or more below the prevailing market price and then sold them to its bank or insurance affiliate at a markup. When it bought bonds from its bank or insurance affiliate, it sold them to customers at a markup 8% or more above the prevailing market rate.
During that period, Turnes was also the chairman and largest indirect shareholder of the bank and insurance affiliates.
StateTrust, Turnes and Cimbal neither admitted nor denied the charges but have consented to the entry of FINRA's findings.
SEC Charges China MediaExpress With Fraud
Investigation by the SEC’s cross-border working group has resulted in the agency filing charges against China MediaExpress, a company that is publicly traded in the U.S. but which purports to operate a television advertising network on intercity and airport express buses in China. The company is charged with misleading investors about its financial condition by inflating its cash balances by millions of dollars.
China MediaExpress became a publicly traded company in October 2009. According to the SEC, it then began to materially overstate its cash balances in both press releases and SEC filings, with the company’s chairman and CEO, Zheng Cheng, signing off on the public filings and attesting to their accuracy.
In its 2009 annual report, for example, which was filed on March 31, 2010, it claimed to have $57 million in cash when its cash balance was actually $141,000. In November that year, it issued a press release claiming a cash balance of $170 million at the end of Q3 of its fiscal year when the actual figure was $10 million. The company also falsely claimed two multinational corporations as clients.
The misrepresentations sent the company’s stock price soaring; it tripled to more than $20 per share. At the same time, the company received $53 million from a hedge fund for a sale of the company’s stock to that fund.
Zheng had agreements in place to receive stock if the company met net income targets, so he had plenty of incentive to falsify the figures. In fact, he netted around $6 million in company stock (2009 value) when the company met its net income targets for FY 2009.
After the company’s external auditor resigned, citing suspicion of fraud, and an internal investigation was launched, Zheng tried to pay $1.5 million to a senior accountant assigned to the case to “assist with the investigation.”
The SEC is seeking financial penalties, permanent injunctions, disgorgement, and an officer and director bar against Zheng.
SEC Charges Medical Device Company and Founder With Fraud
Imaging3 of Burbank,Calif., and its founder and chief executive, Dean Janes, were charged by the SEC with fraud for misleading investors about how the FDA regarded its medical device.
The company was denied clearance to market its proprietary scanner, which provides three-dimensional images for use in medical diagnosis, not once but three separate times: the first in 2008, the second early in 2010, and the third later in 2010. At the time the FDA expressed concerns about device safety and image quality, but in a conference call with investors held in November 2010, Janes dismissed FDA concerns as “not substantive” and chiefly “administrative.”
It took the company more than another two years—till early 2013—to get around to releasing the full text of the FDA’s denial letter.
The SEC seeks a court order to bar Imaging3 and Janes from future violations of federal securities laws, require them to pay civil monetary penalties, and bar Janes from serving as a public company officer or director.
SEC Files Amicus Brief on Market Manipulation/Misrepresentation
The SEC has filed an amicus brief in a case in which it says an appeals court has incorrectly raised the bar for plaintiffs charging market manipulation.
The case of Fezzani v. Bear, Stearns & Co. (2d Cir. May 7, 2013) was heard by the U.S. Court of Appeals for the Second Circuit. The plaintiffs, who lost money in a boiler room scheme operated by A.R. Baron in the mid-1990s, charged that Isaac Dweck, a confederate of A.R. Baron, entered into illegitimate “parking” transactions with Baron as part of this scheme.
A panel majority decided to dismiss the plaintiffs’ claims, saying that the plaintiffs didn’t just have to prove that Dweck engaged in market manipulation, but also that he misrepresented the price of securities and market activity.
The plaintiffs have requested a rehearing, and the SEC has filed its brief in support of that request, citing Supreme Court precedent and a number of other cases. It also cites Judge Raymond Lohier’s dissent that states that the existing decision, according to the dissenting judge, will “unnecessarily” provide “extra shelter for stock manipulation under the federal security laws.” It also expressed concern that the existing decision could affect its own ability to pursue cases.
Check out SEC Enforcement: Morgan Keegan Fund Directors Settle Over Botched Valuations on AdvisorOne.