More On Legal & Compliancefrom The Advisor's Professional Library
- The Need for Thorough and Effective Policies and Procedures Whethere an advisor is SEC or state-registered, RIAs must revise their policies and procedures to address significant compliance problems occurring during the year, changes in business arrangements, and regulatory developments.
- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
Among recent enforcement actions by the SEC were charges against 23 firms for short selling prior to stock offerings; against the operator of a Florida hospital for misleading investors about the hospital’s finances; against a self-styled money manager for defrauding investors; and against a hedge fund advisor for breach of fiduciary duty.
23 Firms Charged for Short Selling Stocks Prior to Offerings
The SEC has charged 23 firms with short selling stocks prior to a public offering of those stocks in which they subsequently participated. All but one of the 23 firms is settling the enforcement actions; the 22 will pay a total of $14.4 million in fines.
Rule 105 of Regulation M, which seeks to prevent anyone with an interest in the outcome of an equity offering from manipulating the price, has become a focus of SEC enforcement actions as the agency has sought to prevent the artificial depression of stock prices prior to an offering—most often a secondary offering.
Numerous hedge funds have run afoul of the rule in recent years, particularly since the SEC need not prove an intent to manipulate the market. Earlier enforcement actions have wrung settlements from such leaders in the hedge fund field as UBS’s O’Connor, Bain Capital’s Brookside Capital and Appaloosa Management.
The SEC’s Division of Enforcement is pursuing a litigated administrative proceeding against G-2 Trading LLC, and seeks full disgorgement of the trading profits, prejudgment interest, penalties, and other relief.
See the SEC statement for the 22 firms that have settled.
Fake Money Manager Charged With Bilking Investors
Frederick Scott, owner of New York-based investment advisory firm ACI Capital Group, was charged by the SEC with defrauding investors and grossly exaggerating the amount of assets he had under management.
Scott registered ACI Capital, apparently for the express purpose of stealing investor money. He then set out to woo small businesses and individual investors with too-good-to-be-true opportunities while boasting about that registration and the nonexistent $3.7 billion he supposedly had under management.
Scott took their money and ran—to pay for personal expenses that included private school tuition for his kids, department store purchases, air travel and hotels and thousands in dental bills. He never paid returns to his investors and never intended to, according to the SEC.
He was creative in how he got the money from investors. In an “advance fee” scheme, he promised investors that ACI would provide multimillion-dollar loans to people seeking bank financing. First, he told them, they’d have to provide an advance percentage of the loan amount to ACI; after they did that, he claimed, they’d get the remaining balance of the amount he’d promised to pay.
He also offered investors the “opportunity” to make a bridge loan to a third-party entity. According to his version of the deal, investors would pay one portion of the loan to the nonexistent borrower and ACI would provide the rest, and then later investors would get a good return on the money they’d “loaned.” But Scott stole this money, too.
Scott was also charged in a parallel criminal action by the U.S. Attorney’s Office for the Eastern District of New York, which announced that he had pleaded guilty. Among other things, he was charged with lying to SEC examiners.
Operator of Miami-Dade County’s Largest Hospital Charged
The operator of the Public Health Trust, which is the governing authority for Jackson Health System, Miami-Dade County’s largest hospital, has been charged with misleading investors about how badly its financial condition had deteriorated prior to an $83 million bond offering.
The SEC found in an investigation that both present and future revenues were misstated in the official statement accompanying the bond offering. While PHT projected a $56 million non-operating loss for its fiscal year ending Sept. 30, 2009, that figure was more than four times lower than what PHT finally reported at the end of the 2009 fiscal year.
The problem originated with breakdowns in a new billing system that inaccurately recorded revenue and patient accounts receivable. When it was discovered by outside auditors, it required a large accounting adjustment to the reported net income, and the PHT ultimately reported a non-operating loss of $244 million for fiscal year 2009.
But PHT had been aware of the billing problems, and despite the concerns of trustees and executive management, its budget department used stale cash collection numbers to generate the projection. That resulted in a materially misleading statement, since the PHT lacked a reasonable basis for its loss projection.
PHT also failed to properly account for an adverse arbitration award that required it to pay a third-party receivables company $3.9 million in cash, and transfer to the company $360 million face amount of existing accounts receivable and $250 million face amount of future accounts receivable. PHT misrepresented that its financial statements were prepared according to Generally Accepted Accounting Principles (GAAP), when in fact it had failed to perform an analysis to determine the value of the replacement accounts receivable awarded to the third-party company and thus determine how to report the award.
PHT has neither admitted nor denied the SEC’s findings, which resulted in a cease-and-desist order but not a financial penalty owing to PHT’s current financial condition. The SEC’s investigation is ongoing.
Hedge Fund Advisor Charged with Breach of Fiduciary Duty
Shadron Stastney, an advisor to a New York-based hedge fund, was charged by the SEC with breaching his fiduciary duty after he put together an undisclosed principal transaction in which he had a financial conflict of interest.
In late December 2007 and early January 2008, Stasney, a partner at the investment advisory firm Vicis Capital, arranged for a personal friend and outside business partner who had been hired by the firm as a managing director to sell a basket of illiquid securities to a client hedge fund. The friend was required to divest himself of the securities, which overlapped with securities in which the hedge fund, Vicis Capital Master Fund, also was invested.
Stasney never revealed to either the client hedge fund or any other partners and management at the firm that he himself had a personal stake in the sale of those securities. He traded as a principal when he authorized the client hedge fund to pay approximately $7.5 million for the securities, and then personally benefited from the sale, receiving a portion of the proceeds—something that, as principal, he was required not only to disclose but to seek client consent for.
After the hedge fund purchased the securities, Stasney’s friend wired Stastney’s share of more than $2 million of the sales proceeds to his personal savings account.
Without admitting or denying them, Stastney has agreed to pay more than $2.9 million to settle the SEC’s charges. That includes disgorgement of $2,033,710.46, prejudgment interest of $501,385.06, and a penalty of $375,000. He is also barred from association with any investment company, investment advisor, broker, dealer, municipal securities dealer, or transfer agent for at least 18 months. He will be permitted to finish winding down the fund under the oversight of an independent monitor payable at his own expense.