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Regulation and Compliance > Federal Regulation > SEC

SEC, FINRA Enforcement Roundup: Allianz, TheStreet Charged

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Among recent enforcement actions taken by the SEC were charges against Allianz for violations of the Foreign Corrupt Practices Act that resulted in penalties of more than $12.3 million; against a Connecticut-based advisor for telling clients it was investing in the same collateralized debt obligations it recommended for them; against TheStreet Inc. and three executives for accounting fraud; against a Toronto-based brokerage firm and two executives for allowing layering; and against two investment advisory firms and two portfolio managers in the collapse of a mutual fund.

FINRA, meanwhile, imposed censures and fines for a Toronto firm that inappropriately shared transaction-based commissions with non-FINRA entities, and censures and fines for a Chicago-based firm after it was found to be an introducing broker-dealer established to facilitate U.S. market access for a single large entity and it had failed to design or implement an anti-money-laundering program to track possible violations.

Allianz SE Agrees to Pay Penalty of $12.3 million-plus on FCPA Violations

The SEC charged German-based insurance and asset management company Allianz SE with violating the books and records and internal controls provisions of the FCPA for improper payments to government officials in Indonesia during a seven-year period.

In its investigation, the SEC found 295 insurance contracts on large government projects that were obtained or retained by improper payments of $650,626 by Allianz’s subsidiary in Indonesia to employees of state-owned entities. Allianz made more than $5.3 million in profits as a result of the improper payments.

According to the SEC’s order instituting settled administrative proceedings against Allianz, the misconduct occurred from 2001 to 2008 while the company’s shares and bonds were registered with the SEC and traded on the New York Stock Exchange. Two complaints brought the misconduct to Allianz’s attention. The first complaint, submitted in 2005, reported unsupported payments to agents, and a subsequent audit of accounting records at Allianz’s subsidiary in Indonesia uncovered that managers were using “special purpose accounts” to make illegal payments to government officials in order to secure business in Indonesia. Despite the audit, the payments continued.

According to the SEC’s order, the second complaint was made to Allianz’s external auditor in 2009. Allianz failed to properly account for certain payments in its books and records. The improper payments were disguised in invoices as an “overriding commission” for an agent that was not associated with the government insurance contract. In other instances, the improper payments were structured as an overpayment by the government insurance contract holder, who was later “reimbursed” for the overpayment. Excess funds were then paid to foreign officials who were responsible for procuring the government insurance contracts. Allianz lacked sufficient internal controls to detect and prevent the wrongful payments and improper accounting.

Without admitting or denying the findings, Allianz agreed to cease and desist from further violations and pay disgorgement of $5,315,649, prejudgment interest of $1,765,125, and a penalty of $5,315,649 for a total of $12,396,423.

Connecticut Advisor Charged for ‘Skin in the Game’ Lies to Clients

Connecticut-based Aladdin Capital Management was charged by the SEC with falsely telling clients to whom it recommended two different CDOs that it had “skin in the game” and was investing in the CDOs along with them.

The SEC’s investigation found that Aladdin Capital Management’s co-investment representation was a key feature and selling point for its Multiple Asset Securitized Tranche advisory program involving CDOs and collateralized loan obligations.

For example, Aladdin Capital Management asked in one marketing piece, “Why is an investor better off just investing in Aladdin sponsored CLOs and CDOs?” It then emphasized that the “most powerful response I can give to your question is that Aladdin co-invests alongside MAST investors in every program. Putting meaningful ‘skin in the game’ as we do means our financial interests are aligned with those of our MAST investors.”

Aladdin Capital Management in fact made no such investments in either CDO, and its affiliated broker-dealer Aladdin Capital collected placement fees from the CDO underwriters.

According to the SEC’s order against one of the firms’ former executives, Joseph Schlim, he was significantly involved in the MAST program on a day-to-day basis. He made sales calls to potential clients and negotiated with CDO and CLO underwriters about the amount of equity in those securities that Aladdin Capital could place with customers or purchase for itself. Schlim also negotiated the placement fees to be received by Aladdin Capital for securing MAST investments in equity tranches of each CDO or CLO.

The SEC found that Schlim knew that Aladdin used the co-investment representation as a significant marketing feature in its pitches to clients, but he failed to take any action to ensure that such representations were accurate when they were made. As the CFO of Aladdin, Schlim was responsible for reserving funds for Aladdin to co-invest alongside its MAST clients, yet he failed to ensure that funds were reserved or allocated for any co-investments alongside clients in either CDO.

Aladdin Capital Management and Schlim agreed to cease-and-desist orders without admitting or denying the SEC’s allegations. The Aladdin entities agreed to jointly pay $900,000 in disgorgement, $268,831 in prejudgment interest, and a $450,000 penalty. Schlim agreed to pay a $50,000 penalty to settle charges against him for his role in the misrepresentations.

TheStreet Inc. Charged by SEC with Accounting Fraud

The SEC charged digital financial media company TheStreet Inc. and three executives for their roles in an accounting fraud that artificially inflated company revenues and misstated operating income to investors.

The SEC alleges that TheStreet Inc., which operates the website, filed false financial reports throughout 2008 by reporting revenue from fraudulent transactions at a subsidiary it had acquired the previous year.

The SEC says the co-presidents of the subsidiary, Gregg Alwine and David Barnett, entered into sham transactions with friendly counterparties that had little or no economic substance. They also fabricated and backdated contracts and other documents to facilitate the fraudulent accounting. Barnett is additionally charged with misleading TheStreet’s auditor to believe that the subsidiary had performed services to earn revenue on a specific transaction when in fact it did not perform the services. The SEC also alleges that TheStreet’s former chief financial officer, Eric Ashman, caused the company to report revenue before it had been earned.

According to the SEC’s complaints filed in federal court in Manhattan, the subsidiary acquired by TheStreet specializes in online promotions such as sweepstakes. After the acquisition, TheStreet failed to implement a system of internal controls at the subsidiary, which enabled the accounting fraud.

The SEC alleges that through the actions of Ashman, Alwine, and Barnett, TheStreet improperly recognized revenue based on sham transactions. It also is alleged to have used the percentage-of-completion method of revenue recognition without meeting fundamental prerequisites to do so, including reliably estimating and documenting progress toward the completion of relevant contracts. In addition, it prematurely recognized revenue when the subsidiary had not performed actual work and therefore had not really earned the revenue.

According to the SEC’s complaint, when the subsidiary’s financial results were consolidated with TheStreet’s financial results for financial reporting purposes, the improper revenue on the subsidiary’s books resulted in material misstatements in the company’s quarterly and annual reports for fiscal year 2008. On Feb. 8, 2010, TheStreet restated its 2008 Form 10-K and disclosed a number of improprieties related to revenue recognition at its subsidiary, including transactions that lacked economic substance, internal control deficiencies, and improper accounting for certain contracts.

Ashman agreed to pay a $125,000 penalty and reimburse TheStreet $34,240.40 under the clawback provision of the Sarbanes-Oxley Act, and he will be barred from acting as a director or officer of a public company for three years. Barnett and Alwine agreed to pay penalties of $130,000 and $120,000, respectively, and to be barred from serving as officers or directors of a public company for 10 years. Without admitting or denying the allegations, the three executives and TheStreet agreed to be permanently enjoined from future violations of the federal securities laws.

SEC Charges Toronto Firm, Execs With Allowing Layering

A Toronto-based brokerage firm, Biremis, saw its license revoked and its two co-founders, Peter Beck and Charles Kim, permanently banned from the U.S. securities industry; all were charged with allowing layering.

In layering, a trader places orders with no intention of having them executed but rather to trick others into buying or selling a stock at an artificial price driven by the orders, which the trader later cancels. The SEC’s investigation found that Biremis–whose worldwide day trading business enabled up to 5,000 traders on as many 200 trading floors in 30 countries to gain access to U.S. markets–failed to address repeated instances of layering by many of the overseas day traders using its system. Beck and Kim ignored repeated red flags indicating that overseas traders were engaging in layering manipulations. Biremis served as the broker-dealer for an affiliated Canadian day trading firm, Swift Trade Inc.

The SEC’s order found that many of the Biremis-affiliated overseas day traders engaged in repeated instances of layering from January 2007 to mid-2010. Beck and Kim learned from numerous sources, including three U.S. broker-dealers and a Biremis employee, that layering was occurring, yet they failed to take any steps to prevent it. For example, in spring 2008, representatives of one U.S. broker-dealer warned Beck and Kim that certain overseas traders were “gaming” U.S. stocks by altering those stocks’ bid and offer prices in order to buy or sell the stock at the altered price. Beck and Kim failed to act on this information.

According to the SEC’s order, Biremis also failed to retain virtually all of its instant messages related to its broker-dealer business, and failed to file any suspicious activity reports related to the manipulative trading.

In addition to the license revocation and bans on Beck and Kim, the two executives agreed to pay penalties of $250,000 each. Biremis, Beck, and Kim neither admitted nor denied the findings contained in the SEC’s order.

Advisory Firms, Investment Managers Charged by SEC in Fund Collapse

Claymore Advisors and Fiduciary Asset Management, as well as two investment managers, were charged by the SEC in the collapse of a Midwest-based closed-end mutual fund.

According to the SEC’s investigation, the Fiduciary/Claymore Dynamic Equity Fund attempted two strategies to enhance returns: writing out-of-the money put options and shorting variance swaps. This exposed HCE to additional undisclosed risks and caused the fund to lose more than $45 million–approximately 45% of its net assets–in September and October 2008. The fund liquidated in 2009.

Fund advisor and administrator Claymore Advisors, located in Lisle, Ill., and the subadvisor responsible for managing HCE’s portfolio, St. Louis-based FAMCO, as well as the portfolio managers responsible for managing the fund, were charged for their roles in the failure to adequately inform investors about the fund’s risky derivative strategies that contributed to its collapse during the financial crisis.

According to the SEC’s orders instituting settled and unsettled administrative proceedings, FAMCO managed HCE in a manner that was inconsistent with the fund’s registration statement. Through the portfolio managers, FAMCO made misleading statements about HCE’s performance, omitting discussion of contributions from the put-writing and variance swap strategies. FAMCO also made misleading statements about HCE’s exposure to downside risk. Investors in HCE lost $45,396,878 as a result of this riskier trading, and the fund lost $70 million altogether (72.4% of its net asset value) during this period of general market decline.

Without admitting or denying the charges, Claymore has established a distribution plan to fully reimburse shareholders for up to $45,396,878 in losses from these derivative transactions. Also without admitting or denying the charges, FAMCO has agreed to pay disgorgement of $644,951, prejudgment interest of $134,978, and a penalty of $1.3 million.

The SEC’s case continues against former FAMCO employees Mohammed Riad of Clayton, Mo., and Kevin Timothy Swanson of St. Louis, the co-portfolio managers who allegedly made misleading statements in HCE’s periodic reports about the two strategies’ contribution to HCE’s performance and about HCE’s exposure to downside risk.

Toronto Firm, Principal Fined, Censured by FINRA on Shared Commissions

Toronto-based Mercator Associates and Fabrizio David Lentini were fined and censured by FINRA over findings that that the firm, acting through Lentini, its head trader, improperly shared transaction-based commissions totaling approximately $4,277,740 with entities that were not FINRA member firms.

Without admitting or denying the allegations, the firm and Lentini consented to the sanctions, which included a fine of $150,000 for the firm and $75,000 for Lentini, and to the entry of findings that the firm, acting through Lentini, sent a series of wire transfers to the bank accounts of non-FINRA entities. The wire transfers were initiated when Lentini received a Letter of Authorization with wire instructions and amounts from the firm’s main customer. Lentini would then take steps to ensure that the requested funds were wired from the firm’s bank account according to the instructions reflected on the LOAs.

The wired funds were generated from trading in some or all of the firm accounts in the names of the non-FINRA entities. Lentini was the firm registered representative assigned to each of those accounts.

The findings also stated that the firm, acting through Lentini, charged excessive commissions that ranged from 5.02% to 31.25% on trades placed in accounts. Lentini was the firm registered representative assigned to those accounts and the firm trader responsible for the execution of the subject transactions. Each of the subject trades was part of the commission-sharing arrangement.

FINRA also found that the firm failed to establish and maintain a supervisory system and establish, maintain and enforce WSPs reasonably designed to achieve compliance with applicable securities laws and regulations; in fact, its supervisory system and WSPs failed entirely to address the commission-sharing arrangement and provide guidance or structure regarding the supervision of securities pricing and commissions.

Numerous other violations, including failure to implement portions of the firm’s AML Compliance Program, failure to obtain the identifying information its Customer Identification Program required about some of the customers that opened accounts with the firm, and to verify that information through documentary or nondocumentary methods, failure to maintain transmittal orders for wire transfers in excess of $3,000, including the name, address and account number of the recipient, and the identity of the recipient’s financial institution and failure to provide any AML training to its personnel for two years, were also found.

Title Securities Fined, Censured on AML Failures, More

Title Securities Inc. of Chicago was censured and fined $150,000 by FINRA on findings that the firm, an introducing broker-dealer established to facilitate direct market access to U.S. markets to a single particularly large customer, failed to implement AML policies, procedures and internal controls that adequately supervised the customer’s transactions.

The firm’s large customer, according to the findings, is a corporation in Cyprus that utilizes the services of an unregistered third-party trading organization to trade its capital. The customer account does a large volume of high frequency trading through the firm, averaging trades of as many as 3 billion shares per month.

The findings stated that the firm failed to develop and implement an AML program tailored to its business model, so its AML policies, procedures and internal controls could not reasonably be expected to monitor, detect and cause the reporting of suspicious or manipulative trading activity. The AML procedures also did not include red flags for the firm to monitor for in connection with suspicious trading activity.

The firm also did not make reasonable efforts to ensure that each trader was only issued one trader ID or to terminate inactive IDs, so traders were able to use multiple trader IDs to bypass the wash sale filters, to circumvent surveillance monitoring, to have access to higher trading limits through the use of multiple IDs and to potentially continue trading under a different trader ID.

FINRA also found that the firm received numerous inquiries from its clearing firm, as well as from FINRA, BATS, NYSE ARCA and NASDAQ concerning wash trading, odd lots and layering in the customer account. Despite being placed on repeated notice of potentially manipulative trading in the customer account, the firm failed to establish meaningful controls.

Without admitting or denying the findings, the firm consented to the fine, which will be paid jointly to FINRA, The NASDAQ Stock Market, BATS Exchange Inc. and NYSE ARCA Inc., and to the entry of the findings.


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