Articles Tagged with Enforcement

The U.S. Circuit Court of Appeals for the District of Columbia recently denied a petition to review an order of the Securities Exchange Commission (“SEC”) imposing sanctions against Raymond J. Lucia and investment adviser Raymond J. Lucia Companies, Inc. (“Lucia Companies”) for violations of the Investment Advisers Act of 1940 and the advertising rule thereunder, Rule 206(4)-1. In denying the motion, the DC Circuit affirmed the SEC’s broadened views on the use of back-tested performance in marketing and advertising materials.

As discussed previously, this case involves the improper use by an investment adviser of back-tested performance data in retirement-planning seminars. Raymond J. Lucia, and Lucia Companies allegedly used a hypothetical inflation rate that was lower than actual historical rates to make their performance results more favorable. In addition, the performance data allegedly failed to reflect the deduction of advisory fees and was not calculated in a manner fully consistent with the advertised investment strategy. As a result, the SEC barred Raymond J. Lucia from the securities industry and imposed civil penalties of $300,000.

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Last month the Securities and Exchange Commission (“SEC”) sanctioned a registered investment adviser and its managing member for violating the Investment Adviser’s Act of 1940 (“Adviser’s Act”) and for acting as an unregistered broker-dealer in connection with the services the adviser provided to a private fund that it managed and the fees charged for those services.

Blackstreet Capital Management, LLC (“Blackstreet”) serves as the manager of two private equity funds (the “Funds”).  In the Funds’ governing documents, Blackstreet disclosed to the Funds’ investors that it would charge fees for brokerage services rendered in connection with acquiring portfolio companies.  Blackstreet did, in fact, perform brokerage services including soliciting transactions, identifying buyers and sellers, negotiating and structuring transactions, arranging for financing, and executing transactions. In exchange for those services it received over $1.8 million.

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Increased focus on cybersecurity by the Security Exchange Commission’s (“SEC”) continues as it recently issued charges against Morgan Stanley Smith Barney (“Morgan Stanley”) for failing to adopt written policies and procedures reasonably designed to protect confidential client information. These charges stemmed from a cybersecurity breach which began in 2011 and continued until 2014, resulting in the misappropriation of confidential client information in over 730,000 client accounts.

Broker-dealers and investment advisers are required pursuant to Regulation S-P and comparable regulation of the Federal Trade Commission to adopt written policies and procedures reasonably designed to protect client records and information. These policies and procedures must address the administrative, technical, and physical safeguards in place, and must be reasonably designed to insure the security and confidentiality of client records and information, protect against unanticipated threats, and prevent unauthorized access.

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The Securities Exchange Commission (“SEC”) recently settled charges against a New Jersey private fund administrator, Apex Fund Services (“Apex”), for failing to notice or correct what it contended were clear indications of fraud by two of its clients, ClearPath Wealth Management (“ClearPath”) and EquityStar Capital Management (“EquityStar”). The SEC’s Division of Enforcement noted that Apex failed to “live up to its gatekeeper responsibility” and thereby enabled the fraudulent activities of these two investment advisers.

Apex provided accounting and administrative services to various private funds, including several managed by ClearPath and EquityStar. Its duties as fund administrator included keeping records, preparing financial statements, and preparing investor account statements. The SEC charged both ClearPath and EquityStar with securities fraud in enforcement actions, finding that ClearPath had allegedly misappropriated fund assets and used fund assets for unauthorized investments, and that EquityStar had allegedly made materially false and misleading statements to investors and prospective investors of its funds regarding undisclosed withdrawals of fund assets.

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The Securities Exchange Commission (“SEC”) recently filed suit against a North Carolina investment adviser for allegedly defrauding investors in the sale of certain real estate-related investments in unregistered pooled investment vehicles. The adviser, Richard W. Davis Jr., solicited investors primarily from the Charlotte, North Carolina region and was able to raise approximately $11.5 million from 85 investors, the majority of which were individuals with retirement accounts. However, he allegedly failed to disclose to clients that the money in the funds was being steered towards several other entities beneficially owned by himself.

Davis allegedly told investors in one of his funds that the fund’s capital would be invested in short term fully secured loans to real estate developers. He allegedly failed to mention, however, that many of the real estate developers receiving these loans were companies owned and operated by himself, creating an inherent conflict of interest. Furthermore, the companies never repaid the loans in full and Davis allegedly failed to inform his investors of this or reappraise the value of the fund’s investment. Instead, Davis allegedly misrepresented the value of the pooled fund by repeatedly stating that it had not lost any value.

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Chief Compliance Officers (“CCOs”) play an important role in registered investment adviser firms, as they are responsible for ensuring the firm is developing adequate compliance programs and following its compliance policies and procedures. In the past, the Securities Exchange Commission (“SEC”) has generally avoided second-guessing the professional judgment of CCOs. However, recent SEC enforcement actions show a clear trend towards growing scrutiny over the conduct of CCOs and towards enforcement actions being taken against them.

Two high-profile cases from 2015 illustrate the shift in the SEC’s tone towards CCOs. First, in an April enforcement action against BlackRock Advisors the SEC charged the firm with failing to disclose the outside business interests of one of the firm’s portfolio managers to its board of directors or advisory clients, as well as failing to adopt any policies and procedures addressing outside business activities. In addition, the SEC also charged the then-CCO for causing BlackRock’s compliance-related violations by failing to ensure the firm adopted the required policies and procedures. BlackRock settled the charges with a $12 million penalty, while the then-CCO paid $60,000.

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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.

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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.

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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.

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The Financial Industry Regulatory Authority (“FINRA”) recently filed its revised pay-to-play rules proposal with the Securities Exchange Commission (“SEC”). Investment advisers have been awaiting FINRA’s pay-to-play rules ever since the SEC announced last year that it would not recommend enforcement action against an investment adviser or its associated persons for the payment to a third party for the solicitation of a government entity for investment advisory services until either FINRA or the Municipal Securities Rulemaking Board (“MSRB”) had adopted its own pay-to-pay rules for broker-dealers.

Pay-to-play activities involve the practice of making cash or in kind contributions, or soliciting others to make those contributions, to state or local officials or other government entities as an incentive for the receipt of government contracts. Pursuant to Rule 206(4)-5, investment advisers are prohibited from providing a government entity with investment advisory services for compensation within two years of contributing monetarily to that government entity. In addition, and of particular interest here, under Rule 206(4)-5 investment advisers may not provide payment to any third party to solicit a government entity for investment advisory services on behalf of the investment adviser unless that third party is a registered investment adviser, a registered broker-dealer, or a registered municipal adviser.

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