More On Legal & Compliancefrom The Advisor's Professional Library
- 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.
- Anti-Fraud Provisions of the Investment Advisers Act RIAs and IARs should view themselves as fiduciaries at all times, whether they meet the legal definition or not. Deviating from the fiduciary standard of full disclosure while courting clients may cause the advisor significant problems.
The CFTC got an acknowledgment from JPMorgan of fault in the London Whale case, while the SEC won one high-profile case and lost another, even as it brought Knight Capital to book in its first case under the market access rule and shut down a pyramid scheme that targeted Asian-Americans.
Knight Capital Charged, Fined $12M in Market Access Debacle
Although it’s paying a $12 million fine and taking other actions to settle SEC charges, Knight Capital Americas is not one of the firms admitting to wrongdoing in its own case. The firm was charged with violating the agency’s market access rule in connection with the firm’s Aug. 1, 2012, trading incident that disrupted the markets.
Because of a 2005 action it took with regard to computer code, Knight Capital rendered a function of an automated equity router defective. Even though that function was not intended for use, the firm did not remove it from the router. That meant that in July 2012, when Knight was getting ready to participate in the NYSE’s new Retail Liquidity Program and incorrectly deployed new code in the same router, the problem was compounded.
As a result, certain orders eligible for the NYSE’s program triggered the defective function in Knight Capital’s router, which was then unable to recognize when orders had been filled. During the 45 minutes after the market opened on Aug. 1, Knight Capital’s router rapidly sent more than 4 million orders into the market when attempting to fill just 212 customer orders. The firm traded more than 397 million shares, acquired several billion dollars in unwanted positions, and eventually suffered a loss of more than $460 million.
To add insult to injury, an internal company system generated 97 automated emails to a group of personnel on August 1 that actually identified the problem and the router. While the messages weren’t designated as system alerts, they were triggered by the code deployment failure. Had the employees acted in time, they could have fixed the problem before the opening of the market that day.
Knight Capital was charged with numerous violations of the market access rule, as well as violations of Regulation SHO regarding the proper marking of short sale orders and locating of shares to borrow for short sales.
While the firm neither admitted nor denied the charges, it did agree to the fine, and to retaining an independent consultant to conduct a comprehensive review of the firm’s controls and procedures to ensure compliance with the market access rule.
This was the first enforcement action for the SEC under the market access rule. The rule was adopted in 2010 as Rule 15c3-5.
JPMorgan Admits Wrongdoing in $100 Million CFTC Settlement
The Commodities Futures Trading Commission has wrung an admission from JPMorgan that its employees behaved “recklessly” with derivatives in the London Whale case, even as it collected $100 million from the firm that has constantly been in the headlines of late.
According to David Meister, the CFTC’s head of enforcement, JPMorgan’s traders tried to shore up their position after trades went sour “by dumping a gargantuan, record-setting volume of swaps virtually all at once, recklessly ignoring the obvious dangers to legitimate pricing forces.”
The CTFC had launched a 17-month investigation into whether market manipulation was the result of the Whale’s trades, and pressed for JPMorgan to admit fault. The agency did have to threaten JPMorgan with a lawsuit, but the concession came at last — if not, perhaps, as complete as the CFTC might like.
Joe Evangelisti, a JPMorgan spokesman, said that the bank neither admitted nor denied the legal decision from the CFTC that the bank had violated laws, but instead was admitting to “certain facts set out in the order.”
Mark Cuban Walks in High-Profile Loss for SEC
Not all the SEC’s enforcement actions result in victory. Mark Cuban argued his case in court, against videotaped testimony by the SEC’s star witness, and was acquitted of insider trading.
Cuban had been charged by the SEC over the sale of stock he owned in a Canadian Internet company in 2004. According to the agency, Cuban sold his 6.3% stake in Mamma.com, now Copernic, for $7.9 million to avoid taking a loss of $750,000 that would have been caused by a dilution of his shares due to a private investment in public equity (PIPE). He was told about the PIPE during a phone conversation in June of 2004 with Guy Faure, former CEO of Montreal-based Mamma.com.
Faure said in videotaped testimony that Cuban remarked, “Now I’m screwed. I can’t sell,” after the former told him about plans for the PIPE. But Cuban, who testified at the trial in person, remembered things differently and said that news of the PIPE was already public and he had never promised not to reveal it or act on it.
Cuban’s lawyers also pointed to a trading spike in the stock that they said proved Cuban’s point that the PIPE was already public news. That led former SEC official Erik Sirri to testify that he believed the news was public before Cuban sold his shares.
The jury acquitted Cuban, with the forewoman saying that the case was not as strong as the SEC thought it was. Although Faure and former Mamma.com Chairman David Goldman both testified in absentia, Cuban’s lawyers won the day, resulting in a loss that SEC spokesman John Nester said “will not deter us from bringing and trying cases where we believe defendants have violated the federal securities laws.”
The SEC froze assets and charged the operators and promoters of a worldwide pyramid scheme that promises exponential, risk-free returns to investors in a venture that supposedly sells Internet-based children’s educational courses.
Five entities based in Hong Kong, Canada and the British Virgin Islands that collectively operate under business names “CKB” and “CKB168” are at the center of the scheme. At least 400 investors in New York, California and other U.S. areas with large Asian-American communities have been targeted via three CKB executives who live overseas and several promoters living in the U.S. The promoters have raised more than $20 million from U.S.investors, and millions of dollars more from investors in Canada, Taiwan, Hong Kong and other countries in Asia.
The SEC said that the scheme’s operators and promoters, capitalizing on the close ties in the Asian community, use Internet videos, promotional materials and seminars to make it look as if they have a real business. However, CKB has little or no real-world retail consumer sales and can’t deliver the promised extraordinary returns. Not only that, CKB apparently has no other source of revenue than money fleeced from new investors, and most of what it got has been paid out to accounts controlled by CKB executives and as commissions to promoters of the pyramid scheme.
Three CKB executives, Rayla Melchor Santos, a Philippine national; Hung Wai (“Howard”) Shern, a Canadian citizen and resident of Hong Kong; and Rui Ling (“Florence”) Leung, a Hong Kong national; have been charged.
Also charged were eight U.S. promoters: Daliang (David) Guo, a China native and a resident of Coram, N.Y.; Yao Lin, a resident of Fresh Meadows, N.Y.; Chih Hsuan (“Kiki”) Lin, a Taiwanese native and resident of Las Vegas; Wen Chen Hwang (“Wendy Lee”), a Taiwanese native and resident of Rowland Heights, Calif.; Toni Tong Chen, a resident of Hacienda Heights, Calif.; Cheongwha (“Heywood”) Chang, a Chinese native and the husband of Toni Tong Chen; Joan Congyi Ma, a resident of Arcadia, Calif.; and Heidi Mao Liu, a resident of Diamond Bar, Calif.
Potential investors were solicited through seminars and meetings across the country and promised huge returns. They were told that to get one of the educational courses the company supposedly offered, they had to invest in CKB. They were also pushed to recruit new investors, which was the only real way they would ever see a dime.
The SEC seeks disgorgement of ill-gotten gains, financial penalties, permanent injunctions and other relief.