Tag Archives: consent order

Auditing the Auditor: SEC Charges Firm With Inadequate Surprise Exams

On April 29, 2016, the SEC brought and settled charges that an accounting firm, Santos, Postal & Co. (“Santos”) and one of its principals, Joseph Scolaro (“Scolaro”), performed inadequate surprise exams of one of their investment advisor clients, SFX Financial (“SFX”), the president of which stole over $670k from SPX clients. Santos and Scolaro neither admitted nor denied the allegations in the SEC Order but consented to its entry and to disgorgement and penalties totaling over $55,000. Santos and SColaro agreed to be suspended from practicing before the SEC, which includes preparing financial reports and audits of public companies. Santos and Scolaro are permitted to apply for reinstatement after one and five years, respectively.

Because SFX was deemed to have custody of client assets under SEC Rule 206(4)-2 (the “Custody Rule”), SFX was required to hire an independent accountant (Santos) to perform surprise audits. The Custody Rule seeks to protect clients from asset misappropriation by investment advisors (e.g., Ponzi schemes). Accordingly, among other things, Santos was supposed to contact SFX’s clients to verify that they were aware of the contributions and withdrawals into and out of their accounts as reflected in SPX’s records. According to the SEC Order, Santos failed to actually contact clients about such transactions.

The SEC previously announced charges against SFX’s president Brian Ourand, who was later found by an administrative judge to have misappropriated funds from client accounts in violation of the Investment Advisers Act of 1940. Ourand was ordered to pay disgorgement of $671,367 plus prejudgment interest and a $300,000 penalty, and was barred from the industry. SFX and its CCO separately agreed to settlements.

The SEC’s Order relating to Santos and Scolaro can be found here:


SEC Sanctions $1B AUM Investment Adviser for Weak Compliance Culture

On June 23, 2015, the SEC censured an investment advisor and its two principals for rickety compliance policies and procedures.[1] Among other things, the SEC found that, due to systemic compliance failures, the advisor overcharged its high net worth clients for their investments in a mutual fund called the Appleseed Fund. The firm, Pekin Singer, offered shares in the Appleseed Fund under a sliding fee structure where clients who met a higher minimum investment paid a lower fee. Pekin Singer failed to timely advise its clients, most of whom met the higher minimum investment threshold, that they could convert to the lower costs shares, thereby improperly increasing the firm’s bottom line at the expense of customers.

Pekin Singer’s internal compliance issues ran deep. In 2009 and 2010, it failed to conduct required annual compliance program reviews and it chronically underfunded and underemphasized its compliance function. For example, the firm’s former CCO had limited compliance experience and was required to simultaneously serve as the CFO of the firm. Because of the multiple hats the he wore, the CCO was only able to devote 10% to 20% of his time to compliance issues.

Further, the CCO, aware of his limitations in the compliance area, sought to hire outside compliance help. After two years of lobbying, the firm hired an outside compliance consultant. The consultant’s review coincided with an OCIE examination by the SEC’s Chicago office. The examination and consultant’s review uncovered a number of compliance failures, including improper trading by an employee, which could have been prevented if the firm had enforced its code of ethics.

To its credit, Pekin Singer fully cooperated with the SEC and returned the excessive fees to its clients. It also hired a new CCO whose only job is compliance and hired an outside attorney to advise on securities law issues relating to mutual funds. Finally, the firm has continued and expanded its relationship with an outside compliance consultant who is charged with monitoring and advising on the firm’s annual compliance program reviews.

Bottom line: Advisory firms and their principals should not skimp on or de-prioritize compliance issues. While having robust compliance policies and controls in place can seem costly up front, the costs to the firm, both in terms of reputation and money, can be much more if OCIE finds deficiencies.

[1] http://www.sec.gov/litigation/admin/2015/ia-4126.pdf

Massachusetts Fines Citigroup $30 Million for Selectively Releasing Apple Research to SAC Capital and Others

On October 2, 2013, the Securities Division of the Massachusetts Secretary of State (“Securities Division”) entered into a consent order with Citigroup in which Citigroup admitted to the facts alleged in the Order, but neither admitted nor denied it violated any laws.[1]  Specifically, the Order states that Citigroup, through its former employee Kevin Chang, violated securities laws by passing unpublished analyst research about Apple to a handful of clients, including indicted hedge fund SAC Capital, giving those select clients the opportunity to trade in Apple stock before the information was widely disseminated.  Under the Order, Citigroup agreed to pay a $30 million fine and to implement a raft of internal review, training, reporting and other programs.  The money is to come out of Citigroup’s treasury without the possibility of insurance reimbursement.

Mr. Chang, a Taipei-based former Citigroup analyst, was responsible for coverage of technology companies and suppliers, including Hon Hai Precision Industry, a supplier to Apple.  The Order states that the day before Citigroup publicly released Mr. Chang’s research on iPhone orders, which forecasted a drastic reduction of orders, Mr. Chang provided certain select Citigroup customers with the unpublished research, permitting them to trade ahead of the public.  The next day, after the research was publicly disseminated, Apple’s share price fell 5.2%.

There are a few notable aspects to this matter that jump out.  First, this is the second time the Securities Division reprimanded Citigroup for selective disclosure of company research.  Last year, the Division fined Citigroup $2 million for the selective dissemination of an analyst’s research note on the Facebook IPO.[2]

Second, because Citigroup already had one strike against it, the Division was probably more emboldened to seek big concessions.  Apart from the $30 million fine, which cannot be paid using insurance, Citigroup agreed to certify annually for a three-year period that it has implemented a wide array of new training and internal review programs under the Order.  This includes reviewing and improving internal e-mail surveillance policies to make sure they are up to snuff and instituting new training programs for all publishing equity analysts.

Finally, even though the Order is heavily weighted in favor of the Division’s wish list, Citigroup was able to work in a couple of things to its own benefit.  As noted above, Citigroup neither admitted nor denied the conclusions of law.  Relatedly, the Division agreed that nothing in the Order is intended to disqualify Citigroup from relying on any state or federal exemptions, such as registration exemptions or safe harbor provisions.

Such concessions, however, may not be available to Citigroup should it have a “third strike” at the plate in Massachusetts in the future.