More On Legal & Compliancefrom The Advisor's Professional Library
- Recent Changes in the Regulatory Landscape 2011 marked a major shift in the regulatory environment, as the SEC adopted rules for implementing the Dodd-Frank Act. Many changes to Investment Advisers Act were authorized by Title IV of the Dodd-Frank Act.
- 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.
In recent SEC enforcement actions, a hedge fund advisory firm and its owner were charged with misuse of investor funds; a court order was filed against Harvey, Ill., to halt a bond offering; two former brokers were charged with insider trading; and three former bank executives were charged in an accounting scheme.
Court Stops Muni Bond Sale in Chicago Suburb on Fraud Concerns
The Chicago suburb of Harvey and its comptroller, Joseph Letke, were the targets of a temporary restraining order requested by the SEC as the agency sought to stop a bond offering that the city has been marketing to potential investors, alleging the city has been misusing bond proceeds.
According to the agency, for the past several years, the city and Letke have been diverting bond proceeds for improper and undisclosed uses. The purported purpose of prior bond offerings was to fund the development and construction of a Holiday Inn hotel in Harvey. However, Harvey officials quietly diverted at least $1.7 million of bond proceeds from these offerings to pay the city’s operational costs such as its payroll, and Letke received approximately $269,000 in undisclosed payments derived from bond proceeds.
Harvey’s bond offerings in 2008, 2009 and 2010 were limited obligations bonds that were to be repaid from dedicated tax revenue streams such as Harvey’s hotel-motel tax, sales tax, or incremental tax from the Tax Increment Financing District that the city created for the development and construction of the Holiday Inn project.
However, with Harvey and Letke diverting offering proceeds, the hotel redevelopment project turned into a fiasco for both investors and city residents. The SEC cited news reports that say the proposed Holiday Inn hotel and conference center is just a shell, with holes in the façade, a gutted interior, dangling wires and exposed studs.
While investigating Harvey’s past bond offerings to investors, the SEC learned that the city intended to offer more limited obligation bonds before the end of June. The draft offering documents for these new bonds make materially misleading statements about their purpose and risks, while hiding the fact that past bond proceeds have been misused.
In response to the agency’s request, Judge Rebecca Pallmeyer at an emergency hearing issued the temporary restraining order. Additionally, the court order prohibits Letke from incurring any extraordinary expenses beyond reasonable and customary personal and business expenses. An additional hearing is scheduled, and the investigation is ongoing.
Florida Hedge Fund Advisory Firm, Owner Charged With Misuse of Funds
The SEC has filed charges against West Palm Beach, Fla.-based Weston Capital Asset Management LLC and its founder and president, Albert Hallac, for shifting money from one investment to another without informing investors. Instead, investors were told via fabricated account statements that their investments were doing as well as, or even better, than ever. The firm’s former general counsel, Keith Wellner, helped in the scheme.
In early 2011, Weston Capital managed more than a dozen unregistered hedge funds with combined total assets of approximately $230 million. One of the funds, Wimbledon Fund SPC, was segregated into five separate classes of investment portfolios. The Class TT Segregated Portfolio was required to invest all of its investor money in a diversified multibillion-dollar hedge fund called Tewksbury Investment Fund Ltd., which invested in short-term, low-risk interest-bearing accounts and U.S. Treasury bills.
However, Hallac and the firm, according to the agency, redeemed TT Portfolio’s entire investment in the Tewksbury hedge fund — more than $17 million — and transferred the money to a consulting and investment firm known as Swartz IP Services Group Inc.
Not only did they hide the move from investors and violate the hedge fund’s strategy, but $750,000 of the money eventually found its way into Hallac’s pockets — as well as those of his son and Wellner. In addition, Weston Capital and Hallac also used $3.5 million of that money to pay down part of a loan from another fund managed by the firm.
Weston Capital and Hallac also solicited and received investments for the TT Portfolio during this time while knowing the funds would not be invested in Tewksbury. As soon as Swartz IP received the money transfers, it disbursed the funds primarily to a special purpose entity created to support and finance varying medically related business ventures.
Without admitting or denying the allegations, Weston Capital, Hallac and Wellner agreed to settle the SEC’s charges along with Hallac’s son Jeffrey Hallac, who is named as a relief defendant in the SEC’s complaint for the purposes of recovering ill-gotten gains in his possession. Wellner and Jeffrey Hallac each agreed to pay $120,000 in disgorgement. The court will determine monetary sanctions for Weston Capital and Hallac at a later date.
Two More Former Brokers Charged in Insider Trading Case
Former brokers Benjamin Durant III and Daryl Payton were charged by the SEC with illegally trading on a tip about the $1.2 billion acquisition of SPSS Inc. in 2009 by IBM Corp. The tip came from Thomas Conradt, a friend and fellow broker in the New York office of a Connecticut-based broker-dealer. The SEC’s complaint seeks return of alleged ill-gotten trading gains of approximately $300,000, with interest, financial penalties and permanent injunctions.
In a parallel action, the U.S. Attorney’s Office for the Southern District of New York has announced criminal charges against Durant and Payton.
The SEC previously charged that Conradt and David Weishaus, another fellow broker and tippee, traded on confidential information that Conradt received from his roommate, Trent Martin, a research analyst who misappropriated it from an attorney working on the transaction. Martin, Conradt and Weishaus settled with the SEC and pleaded guilty last year to related criminal charges in the matter.
According to the agency, in a private meeting with Martin, his attorney friend revealed nonpublic information about the acquisition, including the names of the companies and the anticipated transaction price. The lawyer expected Martin to keep the information in confidence and refrain from trading on it but instead, Martin traded and tipped Conradt, who traded and tipped Durant and Payton, among others.
The investigation is continuing.
Former Bank Execs Charged in Accounting Scheme
Thomas Neely Jr., Jeffrey Kuehr and Michael Willoughby, former senior managers of Regions Bank, have been charged by the SEC with intentionally misclassifying loans that should have been recorded as impaired for accounting purposes. As a result, the bank’s publicly traded holding company overstated its income and earnings per share in its financial reporting.
According to the agency,the scheme took place while Neely was head of Regions Bank’s risk analytics group in 2009. Along with Kuehr, the bank’s head of special assets, and Willoughby, chief credit officer, Neely took intentional steps to circumvent internal accounting controls and improperly classify $168 million in commercial loans as performing so Regions could avoid recording a higher allowance for loan and lease losses.
Regions Bank tracked and recorded its nonperforming loans (NPLs) for internal performance metrics and regular financial reporting. NPLs typically were placed on nonaccrual status payment of all contractual principal and interest was 90 days past due or otherwise in doubt. Once a loan entered nonaccrual status, uncollected interest accrued during that current year was reversed and the bank’s interest income would be reduced.
Nonaccrual status also served as a trigger for Regions Bank to consider whether the loan was impaired and to determine an allowance for loan and lease losses in accordance with U.S. Generally Accepted Accounting Principles (GAAP).
Neely had other ideas, however. When personnel within the bank’s special asset department started proceedings for approximately $168 million in NPLs to enter nonaccrual status during Q1 of 2009, Neely arbitrarily and without supporting documentation required the loans to remain in accrual status. That meant that Regions’ financial statements for the quarter ended March 31, 2009, were materially misstated and not in conformity with GAAP. Neely and Willoughby knowingly provided understated NPL data for the quarter to the CFO and other senior executives during a meeting in late March.
Without admitting or denying the findings, Kuehr and Willoughby agreed to settle the SEC’s charges; they will pay penalties of $70,000 each, plus be prohibited from serving as officers or directors of public companies for five years. The agency will take Neely’s charges to court.
The SEC also entered into a deferred prosecution agreement with Regions Financial Corp., which substantially cooperated with the agency’s investigation and undertook extensive remedial actions. Regions will pay a total of $51 million to resolve parallel actions by the SEC, Federal Reserve Board and Alabama Department of Banking.
Check out Raking It In: What FINRA's Top Execs Earn on ThinkAdvisor.