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
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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
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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.

 

One of the outstanding issues relating to the Dodd-Frank Act was the SEC’s use of statutory power to regulate conduct that occurred prior to its enactment in July 2010.

The United States Court of Appeals for the District of Columbia recently decided that the SEC did not have the power to impose collateral bars on conduct pre-July 2010. Consequently, the SEC has now determined it will allow those respondents and/or defendants, who are subject to these collateral bars, to apply to have them vacated. See https://www.sec.gov/news/statement/commission-statement-regarding-bartko-v-sec.html. The SEC has determined that it will grant these requests after filing.

In sum, after years of uncertainty and actions predicated on a mistaken application of the Dodd-Frank Act, the SEC is rectifying this injustice, and those subject to this miscarriage of justice will now have some measure of recompense.

At Fox Rothschild, we are constantly advising clients regarding the peril of engaging in the securities industry without the proper license. In fact, we have developed materials to provide our clients with information about the process. See http://www.foxrothschild.com/content/uploads/2016/10/e-book-Horn-Badway-McCoy-Broker-Dealers-Registered-Investment-Advisers-and-Commodities-Futures-Registered-Entities-October-2016.pdf.

A recent case before the SEC has only confirmed this advice. The SEC barred a person from the securities industry, and required disgorgement in the amount of $400,000 because the person failed to register as a broker-dealer while selling private fund interests. The cited person communicated with investors, discussed the investment, handled funds, and received a commission when it sold notes issued by a third party fund, who then proceeded to go out of business. See https://www.sec.gov/litigation/admin/2017/34-80083.pdf.

In short, the SEC is not shying away from requiring broker-dealer registration, and people should think twice before proceeding with any securities activity.

Many people see the green of cannabis as a way to the pot of gold at the end of the rainbow. If you are going to invest in a legal (at a state level) cannabis business, you need to make sure that you know what you purchase.

Whistleblowers
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The SEC recently charged a company and its founder with promoting “record” revenue numbers to investors and touting itself as a leader in the cannabis industry, all the while it generated certain of its earnings from sham transactions through a secret corporate affiliate. The company and its principal agreed to settle the charges, with the principal agreeing to pay $12 million in disgorgement and penalties and accepting a bar from serving as an officer or director of a public company or participating in any penny stocks.

So what do these events tell us? First, there are potential big rewards through investing in this burgeoning industry. Second, there are people looking to take advantage of your desire for large profits.

Investing in these businesses is fine, but make sure your eyes are wide open. Ask question, perform due diligence, and ask more questions. You don’t want to see your investment go up in smoke.

The SEC recently published its latest investor bulletin. The SEC publishes these from time to time to bring awareness to the investing public on certain issues.

The current bulletin notes that the investor.gov web page provides a number of resources for the investing public, which include:

  1. The ability to check on an investment professional.
  2. Self-education about various products.
  3. To learn about online tools to make investing a simpler process.
  4. To learn how to avoid investment fraud.
  5. To stay current with SEC resources.
  6. To start researching public companies.
  7. To consider fees associated with investing.
  8. To gain an understanding of how the market works.
  9. To plan for retirement.
  10. To find SEC contact information.Core Values

For investment professionals, you should be asking yourself why the SEC has issued such guidance. I think that the easy answer requires you to look yourself in the mirror. Apparently, the SEC does not think you are doing a good enough job educating your clients.

The fact that the SEC thinks these are important areas of interest should be notice to you to make sure your own house is in order. Are you doing enough to educate your clients on most of these topics? If not, you may want to revisit your customer service before the SEC does it for you.

Last week, the Securities and Exchange Commission proposed Rule Amendments to Improve Municipal Securities Disclosures.  According to the SEC, these rule amendments are intended to “improve investor protection and enhance transparency in the municipal securities market”.  24752961 - grunge rubber stamp with text disclosure,vector illustrationRule 15c2-12 would be amended to add two new event notices:

– Incurrence of a financial obligation of the issuer or obligated person, if material, or agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the issuer or obligated person, any of which affect security holders, if material; and

– Default, event of acceleration, termination event, modification of terms, or other similar events under the terms of the financial obligation of the issuer or obligated person, any of which reflect financial difficulties.

Currently, Rule 15c2-12 under the ’34 Act requires brokers, dealers, and municipal securities dealers that are acting as underwriters in primary offerings of municipal securities to reasonably determine, among other things, that the issuer or obligated person has agreed to provide to the Municipal Securities Rulemaking Board (MSRB) timely notice of certain events.  The proposed amendments are aimed to “provide timely access to important information regarding certain financial obligations incurred by issuers and obligated persons that could impact such entities’ liquidity and overall creditworthiness.”

There is a 60 day comment period, so firms that are affected by these new rules and wish to comment should consult with counsel as to the most effective way to provide feedback to the SEC.

The SEC recently issued regulatory guidance for robo-advisors. This guidance focuses on what robo-advisors must do to meet their disclosure obligations.

Among other things, the SEC has recommended robust disclosures in the following areas:

  1. The use of algorithms, overrides, third parties, fees and client information.
  2. The limits on use of the robo-advisor model to ensure adequate disclosures.
  3. Adequate and clear investment questionnaires to ensure suitability of investments.

Robo-advisors are a growing trend. Thus, it is only logical that the SEC would provide such guidance. Now that the SEC has spoken, it is on you to ensure that you take the message to heart; or learn the hard way.

The Office of Compliance Inspections and Examinations (or OCIE) recently issued a Risk Alert that identified the five most frequent compliance topics that arising from OCIE examinations. These compliance topics include the following:

  1. Deficient compliance programs,
  2. Late or insufficient filings,
  3. Violations of the custody rule,
  4. Code of Ethics compliance deficiencies, and
  5. Books and records.

Among other things, OCIE noted that it continues to see untailored “off-the-shelf” manuals, deficient or non-existent annual reviews, as well as the systemic failure to follow procedures. So what does this all mean?Core Values

It would certainly appear from OCIE’s analysis that firms continue to take the easy way out when it comes to compliance. There is nothing per se wrong with an “off-the-shelf” compliance manual. The impropriety comes when the firm does nothing to modify that manual to conform to its business model. Not conforming a compliance manual to your individual circumstances is no different from not having a manual.

Equally problematic are the lack of meaningful annual reviews. Any annual review must be meaningful to have any regulatory significance. A meaningful review can look differently from firm to firm, but there are a few components were noting.

First, everyone at the firm must participate in the review process. Compliance comes from the tone at the top. Second, the firm should employ a checklist of required elements, and those that may be firm specific. Third, correct any deficiencies found through this process.

Compliance is not easy. But don’t take the easy way out. Having a robust compliance program takes hard work. Do it now, or pay the SEC later.