More On Legal & Compliancefrom The Advisor's Professional Library
- Use and Misuse of Social Media Social media is an inexpensive and effective way to communicate with established and prospective clients. Nevertheless, when RIAs utilize social media to promote their advisory practices, they risk compliance problems for their firms.
- Updating Form ADV and Form U4 When it comes to disclosure on Form ADV, RIAs should assume information would be material to investors. When in doubt, RIAs should disclose information rather than arguing later with securities regulators that it was not material.
“We have a different view of what it means to be entrusted with your future.”
Those ambiguous words posted on the homepage of a Houston brokerage, meant to assure wary investors, may have a quite opposite meaning if charges of self-dealing with millions in client funds, announced Tuesday by the Securities and Exchange Commission, are ultimately upheld.
The SEC announced administrative proceedings against two Houston investment advisor firms and four executives — Parallax Investments and its owner, John P. Bott II, and chief compliance officer, F. Robert Falkenberg; and against Tri-Star Advisors and its CEO, William T. Payne, and president, Jon C. Vaughan.
In a statement accompanying the two SEC orders, the commission says the two firms engineered “thousands of principal transactions through their affiliated brokerage firm without informing their clients.”
A principal transaction essentially means the investment professional is trading on his own behalf with the client. Because of the inherent conflict of interest, the advisor is required to disclose his financial interest in the transaction and obtain the client’s consent.
The SEC says that Parallax and Tri-Star fulfilled neither of these requirements before Parallax’s Bott initiated and executed at least 2,000 trades on behalf of uninformed clients, and Tri-Star supplied mortgage-backed bonds from its own inventory to the Parallax accounts. Tri-Star’s Payne and Vaughan reaped more than $2 million for the illicit trades, and Bott garnered nearly half the $1.9 million in sales credits for the transactions, the SEC charges.
Over the same 2009-2011 period, Tri-Star — from whose website the above quote is taken — performed the same hustle with its own clients, according to the SEC, with Payne and Vaughan receiving nearly half of $1.9 million in sales credits on these transactions.
While both firms are accused of violating the principal transaction and compliance provisions of the Investment Advisers Act of 1940, the SEC is also leveling a third charge against Parallax for violating the “custody rule” requiring firms to maintain certain standards when maintaining client funds or securities.
To custody client assets, a firm must either undergo a surprise annual SEC exam or it may elect a Public Company Accounting Oversight Board (PCAOB)-registered audit, delivering results to clients within 120 days after the fiscal year ends.
The SEC order charges Bott and Parallax’s chief compliance officer, F. Robert Falkenberg, with violating these rules. The firm did not obtain audits of its private fund Parallax Capital Partners LP after 2010, and the two executives knowingly retained an auditor not registered with PCAOB to perform its 2010 audit.
Attempts to reach both firms’ executives were met with a referral to the parties’ attorney,
Dona Szak, part of the legal team representing Tri-Star Advisors, told ThinkAdvisor that her client and Parallax, who she is not representing, “are completely separate businesses,” though “They have some of the same principals and some of the same personnel.”
However, this reporter’s phone call to Parallax rang through, automatically, to Tri-Star, seemingly indicating a strong affiliation between the two firms in terms of day-to-day activities.
Moreover, their websites show they are located at the same street address, though each lists a separate suite on the ninth floor.
In a State of Texas disclosure supplementing the firm’s Form ADV and found on Parallax’s website, Bott discloses a 40% ownership interest in Tri-Star.
The Houston-based attorney made a further distinction between her client, Tri-Star Advisors — an investment advisory firm — and another entity Tri-Star Financial, a broker-dealer, whom she says carried out the trades at the heart of the SEC action. Those two entities also share the same personalities at the heart of the SEC enforcement.
Asked about profits made on client accounts, Szak said: “There were trades handled through the broker-dealer and there would have been commissions through those trades. We received this action today and are investigating the allegations, so I’m not in a position to comment on the substantive allegations.”
She continued: “Tri-Star Advisors has worked with compliance personnel since its inception, so it’s fully compliant with the law and operates with the fullest degree of ethics. My client disputes the SEC allegations and we intend to vigorously defend them.”
Tri-Star’s website, the same one promising a different view of what it means to be entrusted, also leads on its home page and several other pages with a prominently displayed quote from the eminent American philosopher Ralph Waldo Emerson. It reads:
“Nothing astonishes men so much as common sense and plain dealing.”
In a statement released by Tri-Star’s legal team (after the initial publication of this article), the firm says it “has sought to make all necessary disclosures and to obtain all necessary consents from our clients for transactions in their accounts.”
Tri-Star Advisors adds that it “is disappointed by the SEC's meritless action and comments to the press. We have sought to work with the SEC to make sure our firm meets all standards of operation.”
The same statement also vigorously denies the connection to Parallax:
“The SEC has implied that Tri-Star Advisors is connected with Parallax Investments. This is not true. We have explained to the SEC numerous times that Parallax and Tri-Star Advisors are separate entities, yet they continue to make this erroneous statement.”
Check out SEC, FINRA Enforcement: Advisor to NFL, NBA Players Barred Amid Fraud Case on ThinkAdvisor.