Tag Archives: federal securities laws

Whistleblower Rejects $8.25 Million SEC Award

On August 19, 2016, Eric Ben-Artzi, a former Deutsche Bank risk officer, stated he would not accept his portion of a $16.5 million whistleblower award from the SEC because the executives he contends were responsible for overvaluing certain portfolios at the bank were not being personally held accountable in the bank’s settlement with the SEC.  Ben-Artzi had provided information to the SEC, which led to a $55 million fine and settlement in 2015.

Ben-Artzi’s main criticism of the settlement and whistleblower award is that Deutsche Bank shareholders and rank-and-file employees bear the cost of paying such penalties.  He also accused the SEC of having too many connections to the bank through the “revolving door” between government and the industry.  Ben-Artzi noted that his ex-wife and attorneys may have claims on portions of the award.  He also stated that he would accept his portion if he was sure it came out of the pockets of the executives who he claims caused violations of the securities laws.

Here’s a Bloomberg article on the subject:

http://www.bloomberg.com/news/articles/2016-08-19/deutsche-bank-whistle-blower-spurns-8-million-reward-from-sec

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SEC to Increase Focus on Advisor Fee Disclosures

The SEC’s investor advocate, Rick Fleming, has told Congress that one of the SEC’s focuses in the coming budgetary year (starting October 2016) will be the quality of advisor and broker dealer fee disclosures. The SEC is concerned that such disclosures (referencing things like advisory, trailer, administrative, “regulatory,” and custodial fees) are confusing to retail investors who don’t know industry parlance. Broker dealers are likely to be paying extra attention to the quality of their disclosures, not only because of this initiative but because the “best interests” standard under the DOL’s fiduciary rule will take effect in April 2017.  For further discussion, please see the link below.

http://www.investmentnews.com/article/20160701/FREE/160709997/sec-investor-advocate-fleming-targets-fees-charged-by-advisers

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:

https://www.sec.gov/litigation/admin/2016/34-77745.pdf

SEC: Ski Resort Operators Abused Immigrant Investor Program (EB-5)

The SEC recently announced it would pursue fraud charges and freeze the assets of the Jay Peak, Inc. Vermont ski resort. The SEC alleges that Ariel Quiros, of Miami, and William Stenger, of Vermont, conducted an illegal Ponzi-like scheme in connection with the funds raised for the resort. The total amount of money in question with these activities is $350 million, a large portion of which was raised through the EB-5 Immigrant Investor Program, a program designed to incentivize foreign investment by promising a fast track to a green card.

According to the SEC, Quiros and Stenger diverted money from the ski resort project to other projects in an attempt to finance them. In addition, an alleged $50 million was spent on Quiros’s personal expenses, such as his personal income taxes and a luxury condominium. There appears to be little money left to fund the ski resort renovations.

Further, the actions of Quiros and Stenger could put many investors’ funds and immigration petitions in jeopardy. In order to get their green card the investors need to fund at least 10 new jobs, which may not happen here.

Given these charges, it is unclear whether investors who were considering committing capital to U.S. projects under EB-5 will still do so. It is also unclear as to whether this is a continuing problem or isolated incident.

Here’s the link to the SEC news release.  https://www.sec.gov/news/pressrelease/2016-69.html

 

It’s Here! DOL Issues Final Fiduciary Rule

The long awaited and much contested DOL Rule imposing a fiduciary duty on brokers providing advice to retirement accounts is now final. Though it provides a significant runway for implementation (at least a year), the Rule is already changing business models from small brokerages right up to the biggest wirehouses.

The Big Change

Under current rules, brokers, for the most part, operate under a standard that only requires advice to clients to be suitable, but not necessarily in the client’s bests interests. Investment advisers, by contrast, are always operating under a best interests fiduciary duty standard.

The DOL, with strong support from the White House, has moved to plug this gap by using its powers to issue a best interests standard for ALL advisers providing advice over retirement plans. (Such plans are defined as 401(k)s and other employer-sponsored plans, IRAs and other tax-deferred accounts, such as health savings accounts.) The Rule is supposed to provide increased protection for retail investors, who the DOL says are more likely to use brokers on commission than their more expensive counterpart – investment advisers paid as a percentage of assets under management.

While it was already the case that brokers providing repeated investment advice (e.g., asset allocation and rebalancing advice) for a fee had a fiduciary duty, the new DOL Rule broadens the definition to include even one-time investment consultations or recommendations. Rollover recommendations also would be considered fiduciary advice.

Potential Impact 

The potential impact on brokerage houses and their representatives is immense.  For one thing, investors who bring suit or arbitrations against their representatives will have a broader claim basis – representatives could be personally liable for losses caused by a breach of the best interests duty. 

Fiduciaries also are subject to potentially large excise taxes for engaging in prohibited transactions, unless they qualify for an exemption. ERISA currently prohibits fiduciaries from completing transactions that involve conflicts of interest unless they disclose the conflicts and operate under the oversight of an independent fiduciary.

Commissions/Annuities Still Ok

The Rule permits brokers to charge commissions provided they comply with the Best Interest Contract Exemption (BICE) and other requirements. BICE permits a firm to charge commissions if the adviser and the client enter into a contract that specifies that all advice be in the best interests of the client, clearly discloses all conflicts, directs the customer to a webpage disclosing the compensation arrangements entered into by the adviser and firm, and makes customers aware of their right to complete information on the fees charged. In addition, broker-dealers will need to have procedures in place to encourage advisers to make recommendations in the client’s best interests.

Finally, there was industry concern that the sale of certain financial products considered to be riskier or more expensive than others (i.e., annuities, insurance, and mutual funds) on commission would have been barred under the Rule. However, the Rule permits such sales under the BICE.

Investment Advisors Beware: Ten Things OCIE Is Looking At

The SEC is increasing the number RIA inspections by the Office of Compliance Inspections and Examinations (OCIE) and has signaled an aggressive agenda for such exams. Here is a non-exhaustive list of items a Chief Compliance Officer and his or her staff may want to consider well in advance of getting a call from OCIE:

  1. Cybersecurity Policies and Procedures: Make sure the firm’s policies are periodically reviewed and cover key issues (e.g., electronic security (passwords, encryption, “need to know” segmentation), physical security, employee training, incident response planning, and vendor due diligence).
  2. Product Selection: For both RIAs and BDs, the SEC is taking a close look at certain products (e.g., variable annuities) sold to retail investors. Ensure proper monitoring of client recommendations and allocations.
  3. Performance Advertising: Pay particular attention to the distinctions between true actual performance, model performance, and back-tested performance.
  4. Third-Party Affiliations: Disclose any business relationships with 3d parties (e.g., solicitor and sub-advisory relationships) and the potential conflicts they pose.
  5. Fee Structure/Reverse Churning: OCIE is looking at disclosures re: fee structure and the appropriateness of fee-based compensation (e.g., is a firm actively managing an account or just collecting fees).
  6. Custody: “Custody” is broadly defined in Rule 206(4)-2. Firms that have custody need to comply with the Rule’s requirements (e.g., hire an independent CPA to conduct an annual surprise audit).
  7. Code of Ethics/Insider Trading: Make sure the Code is up to date and has adequate personal trading and disclosure restrictions.
  8. Best Execution: If firm has authority to pick BDs, make sure to disclose how firm selects BDs and any “soft dollar” arrangements.
  9. Principal Trading: Disclose it; make sure Rule 3T being followed.
  10. Anti-Money Laundering Policies: For firms that are also BDs, make sure to have AML policies and procedures designed to pick up on suspicious activity (e.g., lots of relatively small transactions).

SEC Sues R.I. Agency and Wells Fargo Claiming They Misled Investors in Curt Schilling’s Video Game Company

The SEC has sued the Rhode Island Economic Development Corporation (RIEDC) and bond underwriter Wells Fargo alleging that RIEDC and Wells Fargo misled bond investors in connection with their investments in Curt Schilling’s failed video game company, 38 Studios. RIEDC had lured 38 Studios to Rhode Island with significant incentives, including the bond deal, only for 38 Studios to fail.

According to the SEC, investors, who poured $75 million into 38 Studios, were not told that it needed substantially more money to produce a video game. In addition, Wells Fargo allegedly failed to disclose that it had a side deal with 38 Studios, which presented a potential conflict of interest. When the company went belly up, the investors were left with the bag. Although neither Schilling nor his company is accused of any wrongdoing in the SEC action, they have been sued civilly.

Municipal finance deals face increased SEC scrutiny. This applies to issuers and underwriters. As SEC Director of Enforcement Andrew Ceresney has stated, “[m]unicipal issuers and underwriters must provide investors with a clear-eyed view of the risks involved in an economic development project being financed through bond offerings.”