RIA Compliance Blog

SEC Fines Investment Adviser Over Lack of Heightened Supervision

May 13, 2016 | Steve Parker

Last month the Securities and Exchange Commission (SEC) instituted and simultaneously settled an administrative enforcement case in which a civil penalty of $225,000.00 was assessed against Cambridge Investment Research Advisors, Inc. (Cambridge). The action illustrates the importance of designing and implementing effective heightened supervision programs for investment adviser representatives who have a history of allegations of rules violations or other misconduct or disclosure items on the Form U-4.

The case stemmed from an incident that was the subject of a separate SEC proceeding filed in 2013 against Richard P. Sandru, who was an investment adviser representative operating from Cambridge’s Perrysburg, Ohio branch office. In that proceeding, Sandru was found to have forged clients’ signatures on financial planning agreements or, in some cases, adding client charges to the agreements without the clients’ knowledge and without obtaining additional signatures from the clients authorizing the additional charges. Sandru’s conduct, which the SEC characterized as a fraudulent scheme to misappropriate client funds, took place between 2009 and 2011 and potentially affected 47 advisory clients, from whom Sandru allegedly misappropriated “at least $308,850.00.” Sandru was, at this time, an OSJ of Cambridge and supervised two other Cambridge representatives and other administrative assistants.

FINRA Provides Effective Practices for Digital Investment Advice

May 10, 2016 | Patricia Klusmeyer

The Financial Industry Regulatory Authority (“FINRA”) recently released guidance on effective practices for financial services firms that provide digital investment advice services. While the report analyzed rules of the securities industry that relate to such services, it discusses effective practices that “may be valuable to financial professionals generally,” including registered investment advisers. With the increasing use of digital investment advice tools in the financial services industry, FINRA undertook to review a broad range of these tools to ensure broker dealers as well as investment advisers are complying with their legal obligations.

The digital investment advice tools FINRA is referring to include both financial professional-facing tools and client-facing tools. These tools typically perform the necessary functions involved in managing an investor’s portfolio, including customer profile development, asset allocation, portfolio selection, trade execution, portfolio rebalancing, and tax-loss harvesting. Client-facing tools which perform these functions are commonly known as “robo advisors.” Financial professional-facing tools usually include portfolio analysis capabilities in addition to those listed functions.

Proposed Rule 147 Still in Limbo

May 6, 2016 | Bob Terry

In 1974 the Securities and Exchange Commission (“SEC”) adopted Rule 147 as a “safe-harbor” for intrastate offerings under Section 3(a)(11) of the Securities Act of 1933 (the “Act.”) On October 30, 2015, the SEC proposed sweeping changes to Rule 147. Notably, the proposed Rule 147 would be “decoupled” from Section 3(a)(11), instead being proposed under the SEC’s general exemptive authority in Section 28 of the Act.

Substantively, the proposal – while still limited to offerings entirely within one state – significantly liberalizes the restrictions on intrastate offerings contained in the current Rule 147 and Section 3(a)(11). First, it allows general solicitation across state lines (i.e., using the Internet), whereas such solicitation is now widely seen as problematic due to the current statutory and regulatory prohibition against offers outside the offering state. The new rule does not prohibit interstate offers, but simply requires that all sales be made to residents of one state.

Also, the current Rule 147 provides that an issuer can make offers or sales only (i) in the state in which it is incorporated or organized; (ii) in the state where its principal office is located; (iii) in the state in which it earns 80% or its revenues and has 80% of its assets; and (iv) if 80% of the proceeds of the offering are used in the state. The proposed Rule 147 basically requires only one of these standards to be met. The proposal also eliminates the requirement that the issuer be incorporated in the state.

FINRA Sanctions Personnel for Compliance Failures

May 4, 2016 | Steve Parker

A compliance advisor working for City Securities Corporation (“City Securities”) has agreed to a Letter of Acceptance, Waiver and Consent (AWC) in a FINRA enforcement case alleging deficiencies in the way the advisor performed his compliance duties at the broker-dealer. John Walter Ruggles, who first became registered in 1993 and became associated with City Securities in May 2014, was charged with failing to generate monthly Municipal Continuing Disclosure Reports (MCDs), which are required in order to comply with the Municipal Securities Rule Making Board’s (MSRB) disclosure requirements. More specifically, among Ruggles’ tasks were to populate the MCDs with transaction data on behalf of City Securities’ customers and to email the data to the private client group, who would then routinely use the information contained in Ruggles’ emails to prepare customer satisfaction letters to City Securities’ clients regarding recent municipal bond trading activity.

The AWC alleges that Ruggles’ supervisor confronted Ruggles with the fact that he had not received the MCDs due for February 2015, and asked Ruggles to produce documentation showing that Ruggles had performed the tasks going back to June 2014. Ruggles provided six printed emails to his supervisor in response to the supervisor’s request. Those emails contain the trade details that were supposed to have been included in the MCDs. The supervisor, however, attempted to verify the data contained in Ruggles’ printed emails, but in investigating the situation found (1) that City Securities’ email backup files did not contain any of the emails that Ruggles provided, (2) that several of the execution dates referenced on the bond trades in the emails were different from the actual execution dates as reflected in the transaction data, (3) that for a period of approximately five months, the firm’s compliance system showed that Ruggles had not opened and viewed the MCDs from which he was supposed to have taken the data, and (4) that the falsified emails contained erroneous dates in the subject lines.

DOL Releases Final Fiduciary Rule

April 20, 2016 | Patricia Klusmeyer

The Department of Labor (“DOL”) released the final version of its new fiduciary rule on Wednesday April 6, ending months of widespread speculation and apprehension in the financial services industry. The DOL appears to have heard the thousands of public comments asking for more clarification and simplification, particularly as related to the Best Interests Contract (“BIC”) exemption. The final rule contains some notable deviations from the proposed rule.

As we discussed in an earlier blog post, the former definition of fiduciary for providing investment advice to a covered employee benefit plan under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code of 1986 (“Code”) stated that financial advisers were generally only fiduciaries if such investment advice was given on a regular basis and pursuant to a mutual understanding that the advice would serve as the primary basis for investment decisions and would be individualized to the particular needs of the plan. This definition typically encompassed only financial advisers in established and ongoing relationships with their clients, such as investment advisers who provided investment advice to covered plans. Meanwhile, broker-dealers and insurance agents were generally excluded, and broker-dealers were only held to the same suitability standard for retirement plans that applies to their recommendations made to non-retirement plans.

SEC Enforcement Case Arises From “Free Dinner” Seminar Fraud

April 18, 2016 | Steve Parker

Earlier this month, the Securities and Exchange Commission (SEC) filed a civil lawsuit against four individuals who are alleged to have defrauded seniors through so-called “Free Dinner” investment seminars conducted by their investment adviser firm. The SEC alleged that Joseph Andrew Paul and John D. Ellis, Jr., who managed and jointly owned Paul-Ellis Investment Associates, LLC (PEIA), created materially false and fraudulent marketing material in order to induce Florida residents to attend the “Free Dinner” seminar. More specifically, the SEC alleged that the marketing materials included performance return statistics that were not consistent with the actual track record of the firm, but rather had been copied and pasted from another advisory firm’s website.

The individuals were also alleged to have recruited James S. Quay of Atlanta, Georgia and Donald H. Ellison of Palm Beach, Florida, who allegedly used the false material to mislead seniors who responded to the “Free Dinner” invitation. The SEC further alleges that Mr. Quay used an alias, Stephen Jameson in order to conceal his true identity. Mr. Quay was previously involved and was held liable in an enforcement action brought by the SEC in 2012. Before that, Quay was an active sales agent in a multi-million dollar Ponzi scheme operated by an attorney in Atlanta, Georgia. According to the SEC, Quay was also convicted of tax fraud in 2005.

SEC Charges Georgia Based Fund Investment Adviser With Front-Running and Other Fraud

April 4, 2016 | Steve Parker

Last month the Securities and Exchange Commission (“SEC”) commenced an administrative proceeding against an Augusta Georgia investment adviser to a hedge fund called Geier International Strategies Fund, LLC (“GISF”). According to the SEC’s Order Instituting Administrative Proceedings, Christopher M. Gibson, the fund’s adviser, caused the fund to invest the majority of the fund’s assets in a single security, then personally profited and helped both his friends and a preferred investor in the fund to personally profit at the expense of the fund and its other members by engaging in frontrunning and other fraudulent conduct.

More specifically the Order alleges that in 2011 GISF had 21 investors and a total asset value of approximately $60 million. In early, Gibson, who had previously advised the fund through a Georgia registered investment adviser called Geier Group, LLC, caused the fund to purchase large quantities of Tanzanian Royalty Exploration Corporation (“TRX”), and Alberta, Canada based gold mining resource company that has never been profitable. The fund held 10.3% of all of TRX’s outstanding common stock by April 29, 2011, a holding that was valued at over $70 million at the time. However, as TRX’s value plunged from late April to late September, the fund’s value also declined precipitously.

SEC Creates Office of Risk and Strategy

March 21, 2016 | Steve Parker

As part of its overall goal to increase its ability to examine registered investment advisers, earlier this month the Security and Exchange Commission (“SEC”) announced that it has created a new office within the Office of Compliance Inspections and Examinations (“OCIE”) designed to consolidate the SEC’s current operation in the area of market surveillance, quantitative analysis and risk assessment. The newly created office — the Office of Risk and Strategy — will also provide operational risk management and organizational strategy for OCIE. The SEC also announced that it had selected Peter B. Driscoll to lead the new Office of Risk and Strategy. He will manage members of the investment advisor/investment company examination staff dedicated to the new office.

The SEC currently examines annually about 10% of all 11,000 registered investment advisers. The newly created Office of Risk and Strategy is part of a series of steps designed to heighten RIA oversight. The SEC has announced that it plans to in increase the number of examiners of investment advisers by almost 20% this year, bringing the number to 630. Informally, commissioners have also suggested that the Commission may require RIAs to hire third parties to conduct private compliance reviews.

For many years, and to an increasing degree over the past few years, the SEC’s examination program has been driven by risk evaluations derived in part from data-driven surveillance and reviews. According to the director of OCIE, Marc Wyatt, the new Office of Risk and Strategy will lead the SEC’s existing risk-based, data-driven exam program in a way which he describes will bring a “transparent approach to protecting investors.” Continue reading ›

CFPB Issues First Cybersecurity Order Against Payment Platform for Deceptive Practices

March 18, 2016 | Patricia Klusmeyer

The Consumer Financial Protection Bureau (“CFPB”) recently instituted a cybersecurity enforcement action against an online payment platform, Dwolla, Inc., in the form of a consent order. This consent order is significant because it is the first time the CFPB has sought to institute an enforcement action in the cybersecurity arena after it was given the authority to do so under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), highlighting the increasing emphasis being placed by financial regulators on cybersecurity practices. The Securities and Exchange Commission (“SEC”), Financial Industry Regulatory Authority (“FINRA”), and the Federal Trade Commission (“FTC”), among others, have all been quite active in policing data security practices of financial institutions in recent years. The SEC even listed cybersecurity control procedures of registered broker-dealers and investment advisers as one of its examination priorities for 2016.

The Dodd-Frank Act gives CFPB supervisory authority over providers of consumer financial products or services. It also authorizes CFPB to take enforcement action to prevent unfair, deceptive or abusive acts or practices from these providers. In this case, Dwolla allegedly made several exaggerated claims regarding the strength of its data security practices that the CFPB found to be deceptive within the meaning of the Dodd-Frank Act.

SEC Charges Fund Manager with Fraudulently Misleading Investors

March 11, 2016 | Patricia Klusmeyer

The Securities and Exchange Commission (“SEC”) recently brought an administrative proceeding against unregistered fund manager Steven Zoernack and his firm, EquityStar Capital Management, LLC (“EquityStar”), for engaging in allegedly fraudulent conduct in violation of federal securities and investment adviser laws. Mr. Zoernack and EquityStar allegedly concealed Mr. Zoernack’s criminal history, used false identities, and distributed false and misleading marketing materials, among other things, in their bid to lure investors.

As alleged, Mr. Zoernack created EquityStar in May of 2010 to serve as the investment adviser for two private investment funds, Global Partners and Momentum. Between 2011 and 2014 Mr. Zoernack actively sought investors for the two funds, managing to sell approximately $5.6 million of interests in Global Partners and Momentum. As EquityStar’s managing member and sole employee, he handled all activities of the firm and drafted all marketing and offering materials. In the furtherance of these activities, Mr. Zoernack allegedly made many material misrepresentations to investors and prospective investors regarding himself and EquityStar.