SEC Enforcement

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In rapid succession, the SEC has issued warnings and announced sanctions against registered investment advisers for fee and expense practices, false statements regarding assets under management, and misleading performance data.  No one should be surprised that the SEC is actively seeking to uncover transgressions in the RIA field.

Initially, the SEC’s Office of Compliance Inspections and Examinations issued a Risk Alert outlining a variety of RIA failures concerning the proper calculation and disclosure of fees and expenses.   See https://www.sec.gov/ocie/announcement/risk-alert-advisory-fee-expense-compliance.  In particular, the alert detailed a series of failures that OCIE found in its examinations of RIAs, among other things, RIAs failed to properly value assets, overbill, use incorrect fees or time periods.

Similarly, the SEC also sanctioned a principal of a closed RIA for falsely stating it was subject to SEC registration.  See https://www.sec.gov/litigation/admin/2018/ia-4875.pdf.  Although we believe it admirable for someone to want to achieve SEC RIA registration status, you want to be accurate when you make this claim.  Apparently, this individual was not, and lying to the SEC will always incur its wrath.

Finally (and this is a pet peeve with us), the SEC also sanctioned a RIA for using misleading performance data.  See https://www.sec.gov/litigation/admin/2018/ia-4885.pdf.  The RIA was caught using hypothetical back-tested performance data– a pretty big no-no.  We are constantly advising RIA clients of the pitfalls in using any type of performance data, and this case illustrates how closely the SEC will look at its use.

In sum, RIAs have to be careful the SEC is watching.

 

 

In a recent speech, new SEC Chairman Jay Clayton warned lawyers, who advice clients on bitcoins and initial coin offerings (“ICOs”), to be aware the SEC is lurking out there waiting to pounce.  Of course, he did not say it exactly like that, but he might as well have used those exact words.

Clayton stated that the SEC Staff is monitoring (he called it being on “high alert”) lawyers, who advice clients on these transactions.  Apparently, the SEC believes that certain lawyers may be advising clients to skirt the federal securities laws in the process.  In particular, he mentioned that ICOs were becoming more problematic.  ICOs are essentially mechanisms to raise capital for start-ups.  Additionally, despite the SEC’s pronouncement to the contrary that ICOs and bitcoins are governed by the federal securities laws, Clayton claims the SEC Staff has seen lawyers structure ICOs resembling securities transactions, and then claim the bitcoins are not securities.  For the record, the SEC has already brought several enforcement actions in this space to stop fraudulent activity.

Nonetheless, Chairman Clayton’s remarks are extraordinary because, given the lack of a judicial or statutory framework in this area, he is essentially suggesting lawyers have to be more certain as a legal matter in their opinions than Congress, the courts, and even his own agency.  Such a position is remarkable, and represents a titanic shift in the SEC’s previous policy of only going after lawyers who engage in fraudulent conduct.  I warned of this very possibility in an article I wrote several years ago, and the new administration apparently wants to continue the practice.  See http://www.foxrothschild.com/publications/the-empire-strikes-back-the-secs-new-assault-on-lawyers/.

Finally, Chairman Clayton’s warning is a sad commentary on the failure of a government regulator to actually address the real issue, and instead scapegoat a likely target.  Instead of twisting and misinterpreting Shakespeare’s famous and often misused quote “let’s kill all the lawyers” (Henry VI,” Part II, act IV, Scene II, Line 73), it would have been probably more worthwhile for Chairman Clayton to outline a set of new SEC specific rules or regulations in this area so that lawyers would be able to provide a definitive framework for their clients, who undertake ICOs or other bitcoin transactions.

 

The SEC recently upheld a statutory disqualification that FINRA imposed where the representative filed a false U-4 and falsely answered compliance questionnaires. It appears as though the registered representative failed to disclose tax liens and a bankruptcy on his U-4. So is statutory disqualification the proper punishment for this misdeed.

According to FINRA and the SEC, the answer is a resounding yes and, unfortunately for the registered representative, this makes sense. After all, the U-4 is the lynchpin of what must be disclosed to FINRA and members firms. The answers serve as the basis for whether a registered representative will be hired, retained and supervised.

24752961 – grunge rubber stamp with text disclosure,vector illustration

Similarly, firms use compliance questionnaires to determine if there are compliance issues that need to be addressed. The firm cannot satisfy that purpose when the responses are a lie.

The moral of the story, do not lie on your U-4 and compliance questionnaires. It is only a matter of time before you are caught, and you will be caught. Why throw away your career when the true answers may not have had any impact on the person’s career or position with the member firm.

The SEC recently announced an enforcement initiative that will target retail investor harm. The agency’s task force will use data analytics to find widespread problems regarding fee disclosures and unsuitable investment recommendations. In addition to data analytics, the SEC will rely upon tips, complaints and referrals that come into the SEC.

This heightened analysis of the retail investor market should be a wake-up call to firms who service the retail investor space. There are a few questions that you should be asking as you move forward:

  1. Do I have a rigid supervisory system to make sure clients are receiving suitable investment advice for the fee being paid?
  2. If my firm does not have a robust supervisory system over retail investment advice, what is the firm doing to develop and deploy such a system?
  3. What does you supervisory system provide if it finds unsuitable investment recommendations?

There are certainly additional questions that firms can ask themselves, but the point is made. What are you doing to make sure the SEC does not have an issue with the retail investment advice that you are giving to your clients? If you cannot answer that question, you had better go back to the drawing board.

It is almost axiomatic that the SEC “enjoys” bringing enforcement actions against lawyers.  The SEC believes that lawyers have a special duty to protect and police the securities markets, and, when a lawyer fails, the SEC is right there to pounce.

In fact, the SEC fined and barred an attorney from practicing before the Commission because the attorney failed to conduct proper due diligence when acting as underwriter’s counsel in misleading municipal bond offerings.  See https://www.sec.gov/litigation/admin/2017/33-10335.pdf.  The SEC claimed that the lawyer prepared erroneous documents regarding on-going disclosure obligations. The SEC stated the lawyer never went beyond relying upon the issuer’s claims, and ignoring red flags concerning the inaccuracy of the disclosure.

If you are lawyer, you cannot outrun the long-arm of the SEC, please take precautions!

Core Values

Despite numerous warnings, some people just do not get it.   The SEC barred a broker from the industry because the broker used personal email and text messages to obtain client investments.  See the Commission’s website.

The SEC found these personal communications were never submitted to the firm for review.  As a result, the broker aided and abetted his firm’s books and records violations.  Further, the broker also made numerous other violations as well.

This scenario demonstrates the critical requirement to only use firm sponsored media for client communications.

The SEC recently announced that it charged a former broker with knowingly or recklessly trading unsuitable investment products for five customers and taking $170,000 for one of those customers. These charges follow a prior SEC Investor Alert warning about excessive trading and churning as well as another one focused on the risks associated with exchange-traded notes.

The broker must not have read those two alerts. According to the SEC, the broker enriched himself by systematically disregarding client investor profiles. He repeatedly traded in risky, unsuitable and volatile products like leveraged exchange-traded funds and exchange-traded notes.

Money and calculator
Copyright: denikin / 123RF Stock Photo

This case provides a number of lessons that firms should take away. Specifically, the SEC publishes Investor Alerts for a reason. The SEC is doing your work for you by flagging an issue for investors, as well as firms.

The second thing that this case hammers home is that firms must be more diligent in their broker supervision. As part of the firm’s ordinary surveillance, it should have flagged the unsuitable sale of highly volatile products to relatively unsophisticated clients.

A valuable thumb rule to follow is that as the sophistication of the products increases so should the sophistication of the customer buying those products. Although this rule of thumb will not completely stop all bad brokers, it will go a long way toward flagging those brokers before they cause harm to your clients and liability for your firm.

 

The SEC has recently issued an Investor Alert regarding commentary provided about investors from what appear to be independent sources. It turns out, many of those independent sources are not independent at all. Instead, they are paid shills.

The SEC has instituted enforcement actions against such companies for generating deceptive articles on investment websites. Among other things, these companies:

  1. Failed to disclose that they received payment even though companies had paid them directly or indirectly.
  2. Used different pseudonyms to publish multiple articles the promoted the same stock.

    24752961 - grunge rubber stamp with text disclosure,vector illustration
    24752961 – grunge rubber stamp with text disclosure,vector illustration
  3. Falsified their credentials; misrepresenting themselves as accountants or a fund manager, for example.

So where does that leave firms that rely upon commentaries for the sale of stock. For one, if you pay for it, you had better disclose that you paid for it. If you did no pay for it, do a little digging to make sure that the commenter is legitimate. If not, stay away lest the SEC pay a visit.

The SEC recently announced fraud charges, and sought an emergency asset freeze against a pastor who was accused of exploiting church members, retirees, and laid-off autoworkers. Apparently, he mislead these people by purportedly selling them on a successful real estate business.

The pastor cloaked his fraud in faith-based rhetoric, including references to the bible and suggestions that he was praying for investors. As a result, his defrauded investors thought that he was more trustworthy than a banker, investing nearly $7 million in this scheme.

Money and calculator
Copyright: denikin / 123RF Stock Photo

The message here is that fraud lurks everywhere and that affinity schemes are alive and well. Unfortunately, for those defrauded, they had access to public information that may have helped them avoid the fraud.

Neither the pastor nor his investment firm were registered with the SEC. A simple check on the SEC’s investor web side would have revealed no records for the pastor or his firm.

Undoubtedly, he would have still gotten some of those who checked, but look before you leap into an investment. Be wary of those who are focused on a particular group as a source of investing funds; it may be an affinity fraud.