SEC Enforcement

The “New” SEC is Acting Just Like The “Old” SEC by Protecting the Securities Industry from Responsibility for its Actions

Published on: December 9, 2010 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission has announced a proposal to temporarily extend a rule that facilitates certain proprietary trading by entities that are registered as both broker-dealers and investment advisers. The proposed extension would move Rule 206(3)-3T’s expiration date by two years, from December 31, 2010 to December 31, 2012. It would also would allow the SEC to complete a study mandated under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Rule 206(3)-3T gives dually registered firms another way to satisfy consent and disclosure requirements that they would otherwise only be able to meet on a transaction-by-transaction basis. Having just the one option would limit the availability that non-discretionary advisory clients would have to certain securities.

The extension would give the SEC the time that it needs to study the regulatory issues related to dual registrants’ principal trading. Dodd-Frank is requiring the SEC to look at any divergent regulations between investment advisers and brokers and use rulemaking to fix gaps so as to better protect investors. The agency has until January 21, 2011 to notify Congress of its findings.

Dodd-Frank’s Section 913 has generated a lot of debate because it could allow for most broker-dealers to be considered fiduciaries under the 1940 Investment Advisers Act. Right now, brokers don’t have to meet the fiduciary standard that investment advisers must satisfy even though both offer similar services. However, instead of holding brokers to the statutory fiduciary standard, the SEC might end up obligating them to fulfill various consent and disclosure requirements at the start of a retail relationship.

Shepherd Smith Edwards & Kantas LTD LLP Founder and Securities Fraud Attorney William Shepherd thinks that it is time to hold brokers responsible to a fiduciary standard: “The only educational requirement to become a licensed securities broker is four months of on-the-job training and the passing of a half-day test. Yet, on average, securities brokers at major firms are paid more than doctors, lawyers and other professionals who must often attain seven or eight years of higher education. Many clients entrust securities brokers with their life savings, retirement assets, and their financial life blood. Why shouldn’t these brokers and the firms required to supervise them be held responsible if the investors are ripped-off? Financial advisers perform the same function but have a fiduciary duty to investors, simply meaning they must put the client’s interest first when advising them. Why should securities brokers be held to a different standard and not be allowed to lull investors into trusting them, while selling their victims the highest commission products that they can find without regard to the client’s best interest? In fact, most state laws currently hold that when a broker is recommending securities to an unsophisticated investor, the broker has a fiduciary duty to that client. What the SEC is trying to do is to pass a rule that makes brokerage firms LESS RESPONSIBLE than they are at present. These endless tactics perpetrated by securities regulators, at the behest of Wall Street, and are yet another type of bail-out move by the Securities Cartel that controls this nation.”

Related Web Resources:
Read the Proposed Rule (PDF)

1940 Investment Advisers Act

Institutional Investor Securities Blog
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Actions of Former Ferris, Baker Watts, Inc. General Counsel Accused of Supervising Rogue Broker to be Reviewed by SEC

Published on: December 9, 2010 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission will be taking a closer look at the actions of ex- Ferris, Baker Watts, Inc. General Counsel Theodore Urban. Urban has been accused of failing to reasonably supervise stockbroker Stephen Glantz, who was involved a stock market manipulating scam with Innotrac Corp. stock.

It is rare for the SEC to examine the actions of a general counsel. However, the agency says it is looking at the case because the proceedings bring up key “legal and policy issues,” such as whether Urban acted reasonably in the manner that he oversaw Glantz and chose to respond to signs of broker misconduct. The case also brings up the questions of whether securities professionals such as Urban should be made to “report up” and if his status as a lawyer and his role as “FWB’s general counsel affect is liability for supervisory failure.”

Earlier this year, Securities & Exchange Commission Administrative Law Judge Brenda Murray ruled that Urban did not inadequately supervise Glantz and that the proceedings against him be dropped. Murray said that per the 1934 Securities Exchange Act, a person cannot be held liable for supervisory deficiencies if appropriate procedures for detecting and stopping the violations were applied, She said that Urban had no reasonable grounds to think that procedures had not been followed.

However, Murray’s decision isn’t final until the SEC enters its final order, and on Tuesday the commission declined Urban’s motion requesting that the SEC affirm Murray’s ruling. Division lawyers have said that Murray’s decision was not consistent with previous SEC precedent, lowers the standards that supervisors at dealers, brokers, and investment advisers must meet, and did not protect the investing public by making Urban accountable to sanctions.

SEC to Review Actions of Bank General Counsel Who Supervised Rogue Broker, Law.com, December 9, 2010

Read the SEC order denying motion for summary affirmance (PDF)

Read the administrative law judge’s ruling (PDF)

Ex-Ferris, Baker Watts, Inc. General Counsel Did Not Fail to Properly Supervise Broker Fraudster, Says SEC Judge, Stockbroker Fraud Blog, September 30, 2010

Compliance with 1934 Securities Exchange Act Reporting Requirements During Annual Broker-Dealer Audits is Key, Say SEC Officials

Published on: November 29, 2010 | by Shepherd Smith Edwards & Kantas, LLP

Securities and Exchange Commission Division of Trading and Markets Robert Cook and Chief Accountant James Kroeker are reminding auditors that it is important that they comply with specific 1934 Securities Exchange Act reporting requirements when performing annual broker-dealer audits. Earlier this month, the two SEC officials sent a letter to American Institute of Certified Public Accountants Stock Brokerage and Investment Banking Expert Panel Chair Stephen Zammitti.

Per Kroeker and Cook, under the 1934 Securities Exchange Act’s Rule 17a-5, broker-dealers must file yearly reports, supplemental reports, and supporting schedules. They also noted that Under Rule 15c3-1, a supporting schedule must include required and actual net capital and, when applicable, computation of the customer reserve requirement, as well as information about possession or control requirements.

The two SEC officials issued the reminder that brokerage firms have to submit an accountant’s report about the supporting schedule from a registered public accounting firm and that the yearly financial report audits must meet accepted auditing standards. Cook and Kroeker also said that even though the Dodd-Frank Act gave the Public Company Accounting Oversight Board the authority to put forth an auditing and attestation standard for broker dealers’ PCAOB-registered auditors, per recent SEC interpretive guideline auditors should keep adhering to AICPA standards until further rulemaking. The two SEC officials emphasized the need for accounting firms to review internal accounting records, the accounting system, and procedures for safeguarding securities and that, per Rule 17a-5, the audit and review’s scope must be enough to provide enough assurance that any “material inadequacies… would be disclosed.”

Related Web Resources:
View the Letter (PDF)

Read the SEC Guidance (PDF)

The 1934 Securities and Exchange Act
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SEC Adopts Direct Access Rule Prohibiting “Naked” Access to ATSs or Exchanges

Published on: November 21, 2010 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Commission has adopted a rule that prohibits brokers from having “naked” access to alternative trading systems (ATS) or exchanges while requiring brokers with market access to put into place supervisory procedures and risk management controls to prevent market errors and other problems. Under the 1934 Securities Exchange Act’s new Rule 15c3-5, both broker-dealers that belong to an ATS or an exchange and ATS broker-dealer operators that allow direct trading by persons who aren’t dealers or brokers must put into place certain supervisory procedures and controls to effectively get rid of “naked” access arrangements (also known as “unfiltered” access arrangement) that have allowed customers to bypass broker-dealers and their risk management controls completely while giving them direct electronic access to an ATS or an exchange.

Also per the new rule, new risk management controls must be put into place to stop orders that exceed capital thresholds or pre-set credit, do not comply with regulatory requirements, or appear erroneous in another way. Brokers-dealers also must implement certain controls before the orders are sent to ATSs or exchanges, set up, document, and maintain procedures to regularly evaluate the risk management controls, and tackle any problems as soon as possible.

The SEC believes that to put into place these new systems will initially cost broker-dealers some $100 million. Maintenance of the systems is expected to cost about $100 million a year.

Related Web Resources:
SEC Adopts New Rule Preventing Unfiltered Market Access, SEC.gov, November 3, 2010

SEC rule to clamp down on ‘naked access,’ Financial Times, November 4, 2010

Investment Adviser Southridge Capital Management and Its Hedge Fund Manager Face SEC Securities Fraud Charges for Allegedly Overvaluing Portfolio Assets

Published on: November 5, 2010 | by Shepherd Smith Edwards & Kantas, LLP

Along with Connecticut regulators, the Securities and Exchange Commission is charging Southridge Capital Management and its hedge fund investment manager Stephen M. Hicks with financial fraud. The two are accused of fraudulently overvaluing portfolio assets.

According to the SEC, Hicks fraudulently misstated the assets’ acquisition price when he overvalued the largest position that the funds held. Hicks also allegedly arranged a transaction involved the sale of a Southridge fund-acquired telecommunications company (when the company defaulted on a $769,000 note) to Fonix Corporation, which made the purchase in exchange for securities that were valued at $33 million in 2004.

The SEC claims that the asset sold and the securities obtained were not accurately valued, Fonix’s position was wrongfully valued at its acquisition cost, and since 2004 the funds have accrued or paid hundreds of thousands of dollars in management fees. The SEC also contends that Hicks fraudulently solicited clients to place their money in new funds and told them that most of their money would be placed in free trading shares that were unrestricted, near cash, or cash. However, by 2007 many of the investors were having a difficult time redeeming their money from what were significantly illiquid securities. The SEC is seeking disgorgement of profits, injunctive relief, financial penalties, and prejudgment interest.

Meantime, in Connecticut, Banking Commissioner Howard F. Pitkin is charging Southridge and Hicks with overvaluing assets that they managed and lying to investors. The state is accusing the investment firm of purposely using bogus financial statements to overvalue the assets of five funds so that clients could be charged larger fees. State regulators contend that the alleged securities misconduct allowed Hicks and Southridge to collect over $26 million in fees.

Related Web Resources:
SEC Charges Connecticut-Based Hedge Fund Manager with Fraud in Valuing Portfolio Assets, Making Misrepresentations to Investors, and Misuse of Investor Assets, SEC.gov, October 25, 2010
Southridge Capital Management Founder Charged With Fraud Though He May Not Know It Yet, Dealbreaker, October 25, 2010
Institutional Investor Securities Blog
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SEC Commissioner Luis Aguilar Encourages Agency Not to Refrain From Exercising Enforcement Powers from Dodd-Frank to Protect Investors

Published on: October 25, 2010 | by Shepherd Smith Edwards & Kantas, LLP

SEC Commissioner says the Securities and Exchange Commission should go back to employing a “muscular approach” and use its new enforcement powers bestowed under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The financial reform legislation gives the SEC more authority and enforcement tools in the areas of extraterritorial reach, subpoenas, aiding and abetting liability, and whistleblowing. The SEC also now has oversight over hedge and private equity funds and over-the-counter derivatives.

Aguilar spoke on October 15 at the University of California at Berkeley’s Center for Law, Business and the Economy. He says that his views are his own.

Aguilar says that Americans must feel as if the SEC will use whatever tools and powers at its disposal to protect investors from. He notes that action, not rhetoric, is now required. Aguilar cites areas that the SEC has been slow to deal with in terms of enforcement action. For example, there is the area of clawbacks. Aguilar noted that even though the 2002 Sarbanes-Oxley Act lets the commission bring an enforcement action against CFO’s and CEO’s to recover incentive pay and bonuses related to a financial restatement because of misconduct, the SEC waited five years to exercise this authority when it brought action against ex- CSK Auto Corp. (CAO) CEO Maynard Jenkins. Aguilar says that if the law had been enforced earlier, less investors might have been harmed.

The SEC commissioner wants the SEC to “resist” the trend toward an entrenched two-tier market where different investors are overseen and protected differently. He says that recent SEC cases involving pension funds and auction-rate securities are clear indicators that institutional investors also need protections.

Our securities fraud law firm works with institutional investors throughout the US. We have helped many clients recoup their financial losses.

Related Web Resources:
Speech by SEC Commissioner: An Insider’s View of the SEC: Principles to Guide Reform, SEC.gov, October 15, 2010

SEC Commissioner Luis Aguilar

Dodd-Frank Wall Street Reform and Consumer Protection Act (PDF)

SEC Charges Investment Adviser With Allegedly Making Unsuitable Hedge Fund Recommendations to Elderly Clients

Published on: October 15, 2010 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission has charged investment adviser Neal Greenberg with securities fraud and breach of fiduciary duty related to the making of recommendations and marketing of hedge funds to investors. According to the SEC, Greenberg, who was the CEO of Tactical Allocation Services LLP and also the portfolio manager of Agile Group LLC, made unsuitable recommendations to clients, many of whom were elderly and/or retired or close to retirement, when he suggested that they invest in the hedge funds run by his firms.

The SEC contends that the investment adviser issued misstatements when he said that the hedge funds were suitable for older and conservative clients, many of whom were seeking low-risk investments that came with significant capital protection. For example, Greenberg allegedly “falsely stated that the Agile hedge funds” were low risk, highly diversified, and offered liquidity when in fact, the funds, which held approximately $174 million from over 100 clients, were non-diversified in their holdings and used leverage. Greenberg also is accused of claiming that the Agile funds “used leverage” in a manner that did not “significantly increase” their risk profile. Yet, says the SEC, for 2007 and 2008 the risk disclosures in private placement memoranda for the hedge funds from Agile contradicted the “false and misleading” misrepresentations made by Greenberg.

The SEC is also accusing Greenberg of failing to make sure that adequate compliance procedures and policies were put in place for determining whether certain investments were suitable for clients’ specific needs. The commission says Greenberg failed to tell clients that they were going to have to pay management and performance fees on the leveraged part of their investments. Between 2003 and 2006, investors paid about $2 million in these undisclosed fees.

Related Web Resource:
Read the SEC Order Against Greenberg (PDF)
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Ex-Ferris, Baker Watts, Inc. General Counsel Did Not Fail to Properly Supervise Broker Fraudster, Says SEC Judge

Published on: September 30, 2010 | by Shepherd Smith Edwards & Kantas, LLP

According to Securities & Exchange Commission Administrative Law Judge Brenda Murray, former Ferris, Baker Watts, Inc. general counsel Theodore Urban did not fail to reasonably supervise broker, Stephen Glantz, who has admitted to his involvement in a stock market manipulating scheme involving Innotrac Corp. stock. Murray says that Urban performed his job in a “thorough and reasonable manner” and that he was careful and objective.

Urban had been accused of allegedly abdicating his supervisory responsibilities by not responding to red flags related to the Glantz’s alleged misconduct even though prior to the broker’s hiring, he had already been flagged because of several customer complaints and his “questionable reputation in the industry.”

The SEC would later also find that Glantz had been involved in unauthorized, manipulative transactions of TC Healthcare, Inc. stock in February 2005. After pleading guilty to violations of Section 10(b) of the Securities Exchange Act of 1934, in 2007 he was sentenced to 33 months in prison and ordered to pay $110,000 in restitution

When determining whether Urban, who was Glantz’s supervisor, properly supervised him in a manner intended to prevent securities fraud violations, ALJ Murray noted that per the 1934 Securities Exchange Act, a person cannot be held liable for supervisory deficiencies if the proper procedures that should have detected and stopped the violations were applied and the person had no reasonable grounds to believe that the procedures were not being followed.

Related Web Resources:
SEC Judge Finds Investment Bank GC was not Negligent in Supervising Rogue Broker, The Blog of Legal Times, September 8, 2010
Judge: Former general counsel of Ferris, Baker Watts was not responsible for supervising broker convicted of securities fraud, Baltimore Sun, September 9, 2010
Broker Glantz charged with fraud in Innotrac stock scheme, Cleveland.com, September 4, 2007 Continue Reading ›

SEC Examining Whether Investment Advisers of Alternative Investment Funds Have Sufficient Due Diligence Processes in Place

Published on: September 28, 2010 | by Shepherd Smith Edwards & Kantas, LLP

The SEC’s Office of Compliance Inspections and Examinations is checking the due diligence processes at investment advisers of private pools of capital. In a letter sent this month to the chief compliance officers of registered investment advisers that have alternative investment options in their portfolios, OCIE asked the CCOs to provide copies of the investment firm’s trade blotter, due diligence policies and procedures, compliance policies and procedures, the names of the staff that take part in the due diligence process, and the names of third parties that provide due diligence services.

OCIE also requested all marketing materials that are offered to existing and potential clients, as well as current financial records. The SEC wants to know how fund managers are managing any conflicts of interest while performing due diligence.

The probe comes nearly two years after Bernard Madoff’s Ponzi scam was discovered. Many of his investors became indirectly involved with the scheme through advisors that had invested in his funds.

In securities fraud lawsuits filed by some of the investors against their advisers, the plaintiffs contend that proper due diligence would have allowed the scam to be uncovered sooner. The SEC has also come under fire for failing to detect the scheme despite examining and investigating Bernard Madoff’s company on several occasions.

During this review, OCIE staff will visit the investment firms. They also want to meet with personnel knowledgeable about the due diligence process and with the firm’s investment committee head.

Related Web Resources:
SEC Scrutinizing Due Diligence Processes at Advisers of Alternative Investment Funds, US Law Watch, September 15, 2010
Office of Compliance Inspections and Examinations, SEC Continue Reading ›

Citigroup Settles Subprime Mortgage Securities Fraud Claims for $75 Million

Published on: August 3, 2010 | by Shepherd Smith Edwards & Kantas, LLP

For $75 million, Citigroup will settle federal allegations that it failed to disclose that its subprime mortgage investments were failing while the market was collapsing. This is the first securities fraud case centered on whether investment banks fairly disclosed their own financial woes to shareholders.

Unlike the Goldman Sachs case, which resulted in a $550 settlement and involved allegations that the investment bank misled investors, Citigroup is accused of misleading its shareholders. This also marks the first time the SEC has filed securities fraud charges against very senior bank executives for their alleged roles in subprime mortgage bonds.

The SEC contends that Citigroup failed to reveal the true nature of its financial state until November 2007. Just that summer the investment bank told investors that it had about $13 billion of exposure to subprime mortgage related-assets that were declining in worth. However, Citigroup left out about $43 billion of exposure to similar assets that bank officials thought were very safe.

Key evidence against Citigroup centers on an announcement that it prepared for investors that cautioned that the quarter was likely going to be one of lower earnings in the fall of 2007. However, the investment bank did not reveal its full subprime exposure. Former Citigroup investor relations head Arthur Arthur Tildesley Jr., who has agreed to pay an $80,000 fine over allegations he omitted key information in the shareholder disclosures, is accused of preparing the statement. Former chief financial officer Gary L. Crittenden, who has settled the SEC case against him for $100,000, recorded the audio message to investors.

The government was eventually forced to bail out the investment bank. Citigroup is not admitting to or denying the charges by consenting to settle. Now, however, the investment bank has to defend itself from private shareholder complaints.

Related Web Resources:
SEC Charges Citigroup and Two Executives for Misleading Investors About Exposure to Subprime Mortgage Assets, SEC, July 29, 2010
Citigroup Pays $75 Million to Settle Subprime Claims, NY Times, July 29, 2010
Citigroup agrees $75m fraud fine, BBC News, July 29, 2010 Continue Reading ›