Articles Tagged with Enforcement

With the end of the federal government’s fiscal year, the Securities and Exchange Commission (SEC) once again recently released results from the enforcement program, covering November 2022 through October 2023. The release included cumulative totals and highlighted individual cases and enforcement areas of concentration. The annual release serves as a roadmap for where the SEC is spending its resources, and what conduct will likely lead to enforcement actions.

During fiscal year 2023, the SEC’s Enforcement Division filed 3% more total enforcement actions than during 2022. This included an 8% increase in “stand-alone,” or original actions, along with increases in the number of “follow-on” administrative proceedings. These “follow-on” actions are typically filed after an associated criminal, civil, or other regulatory action, and look to impact an individual’s ability to conduct business in the securities industry.

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On August 21, 2023, the U.S. Securities and Exchange Commission (“SEC”) issued an order imposing civil monetary penalties against Titan Global Capital Management USA LLC (“Titan”) for violations of the new investment adviser Marketing Rule, Rule 206(4)-1. The new rule had a mandatory compliance date of November 4, 2022, but advisers could voluntarily adopt the rule sooner. 

Titan elected to comply with the new rule in June 2021; however, the firm did not adopt new policies and procedures or adapt its practices as required by the new rule. Between August 2021 and October 2022, Titan violated the new Marketing Rule by advertising hypothetical performance without adopting policies and procedures reasonably designed to ensure the hypothetical performance was relevant to client’s or prospective client’s financial situation and investment objectives and also by failing to provide information underlying the hypothetical performance as required by the new rule.  Continue reading ›

On August 26, 2022, the U.S. Securities and Exchange Commission (“SEC”) issued an order settling charges against Kovak Advisors, Inc. (“Kovak”), for compliance failures related to its wrap fee program. The case highlights how important it is for an investment adviser to adopt and follow policies and procedures relating to any wrap fee program, to ensure that the adviser’s services are in the client’s best interest.

From 2015 through August 2018, Kovak offered advisory services to clients through a wrap fee program. Clients that participated in the wrap fee program paid a fee that included asset management, trade execution, and other costs. The SEC made three findings during the time Kovak offered the wrap fee program.
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In this first quarter of the year, most investment advisers are working diligently to complete and file their annual updating amendment to Form ADV, including Part 2A, commonly called the “Brochure.” One of the most important requirements in drafting a Brochure is to make sure that all conflicts of interests, together with a description of how the conflict is mitigated or addressed, are fully and fairly disclosed. An administrative action brought by the SEC and settled last week illustrates, and should serve to underscore, the importance of identifying and disclosing such conflicts.

The SEC charged registered investment adviser Moors & Cabot (“M&C”) with breaching its fiduciary duty to investment advisory clients by failing to disclose conflicts of interest relating to revenue sharing payments and other financial incentives that the adviser received from two clearing brokers. The financial benefits included discounts, incentive credits and shared revenue that were contingent upon M&C meeting certain thresholds in total assets maintained in FDIC-insure bank deposit cash sweeps. M&C also received a share of margin interest the clearing firms charged to M&C’s clients who maintained margin loans. M&C also received a portion of postage and handling fees that one of the clearing brokers charged to its clients.

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The Securities and Exchange Commission recently announced the filing of an administrative proceeding against a registered investment adviser and the investment advisers owner/CCO for failing to adopt compliance policies and procedures, a Code of Ethics, and for failing to conduct annual reviews of the same. The advisory firm is Two Point Investment Management, Inc., based in Pittsford, New York. The SEC found that the violations occurred over a 10-year period starting when the adviser first registered with the SEC in 2012.

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Last month, the SEC commenced an administrative enforcement action that highlights the significance of its change in guidance over the use of “hedge clauses” in investment advisory agreements. Recall that in IA-5248, the SEC’s 2019 interpretive release that addressed the standard of conduct for investment advisers, the Commission withdrew the 2007 No-Action Letter previously issued in Heitman Capital Management, LLC (Feb. 12, 2007) (“Heitman Letter”). Prior to IA-5248, the Heitman Letter had frequently been relied upon by investment advisers to permit the use of hedge clauses, or clauses purporting to limit an adviser’s liability, as long as the clause contained an affirmative statement that it should not be construed to waive unwaivable claims under federal and state securities laws. Because the SEC concluded that the Heitman Letter had been often misconstrued, IA-5248 expressly withdrew it.

Prior to the issuance of the Heitman Letter in 2007, the SEC had rather consistently prohibited the use of hedge clauses. The Heitman Letter, however, constituted a departure from that previous near-blanket prohibition. In Heitman, the SEC staff stated that the use of a hedge clause that limits the adviser’s liability except for gross negligence or willfulness may under some circumstances be permitted, depending on “all the surrounding facts and circumstances.” Among the circumstances to be considered were whether it was written in plain English, whether it had been highlighted and explained to the client personally, whether there was a heightened explanation of the types of claims that were not waived, and whether impacted clients had access to other professional “intermediaries” upon whom they relied. After the Heitman Letter, the use of hedge clauses by investment advisers proliferated, not always consistently with the Heitman guidance.

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Late last year, the SEC announced the settlement of five enforcement cases against RIA firms relating to their recommendations and purchases of complex exchange-traded products (ETPs) in clients’ accounts. The settlements – against Benjamin F. Edwards & Co., Royal Alliance Associates, Inc., Securities America Advisors, Inc, Summit Financial Group, Inc., and American Portfolios Financial Services. The actions were announced in connection with the SEC’s ETP initiative.

These cases may be the first of many, and they followed a joint statement from SEC Chairman and division heads in October of last year indicating that firms would be examined relating to their use of complex ETPs. However, the SEC has not formally announced a new initiative on the subject. Earlier in 2020, the SEC had resolved a similar charge against Wells Fargo resulting in a $35 million fine.

Generally, the products in question were those that track market volatility and are designed as short-term investments. Typically, these products are tied to the CBOE volatility index or VIX. Examples of such products are the VelocityShares Daily Inverse VIX Short Term Exchange-Traded Notes and the ProShares VIX Short-Term Futures ETF, both of which are tied to the performance of the S&P 500 VIX Short-Term Futures Index. The product offering materials describe the objectives of these products as to manage trading risks on a daily basis, and warn that their use over periods longer than a single day is not suitable, as the risk control objective will not be met by using them over such longer period. The issuers’ materials clearly describe that the products could lead to substantial losses when held in portfolios over periods longer than a single day.

Recent developments within two of the three branches of the federal government portend significant potential changes in the SEC’s ability to obtain disgorgement of ill-gotten gains in civil actions brought by its enforcement arm. Early in November, the U.S. Supreme Court decided to hear an appeal of a Ninth Circuit case, SEC v. Liu, involving the issue of whether the SEC has statutory authority to obtain disgorgement at all. Then, not three weeks later, the U.S. House of Representatives responded by passing H.R. 4344, a bill explicitly codifying the SEC’s authority to obtain disgorgement. While the ultimate decision of the high court remains months away, and the House’s action has no legal significance until a companion bill in the Senate is acted upon and the two bills are passed by both chambers, these developments are of great significance to securities litigators and SEC-watchers alike.

Disgorgement has long been a powerful arrow in the SEC’s enforcement quiver, allowing it to obtain, on behalf of aggrieved investors, reimbursement of ill-gotten gains. However, despite it having obtained billions of dollars in disgorgement in civil actions over the last few decades, no statute explicitly confers the SEC with authority to seek this remedy. Rather, lacking any express authority, federal judges have implied it in scores of decisions dating back to the 1970s. Now, that entire foundation has come into question, prompted first by the Supreme Court’s 2017 decision in Kokesh v. SEC, and now by the high court’s acceptance of the Liu appeal.

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In a recently-announced administrative proceeding, the SEC has entered a permanent securities industry bar against Joseph B. Bronson, effectively preventing Bronson from ever again associating with any investment adviser, broker, dealer, or municipal securities dealer/advisor. The SEC Order barring Bronson—consented to by Bronson—comes on the heels of an August final judgment against Bronson and his former RIA, Strong Investment Management, obtained by the SEC in a civil case filed in a California federal district court. This final judgment against Bronson and his RIA was especially harsh as it found him and the firm jointly and severally liable for nearly $1 million in disgorgement plus $100,000 in prejudgment interest. Bronson was also individually ordered by the court to pay a $184,000 civil penalty.

The Bronson case is instructive as it highlights an especially egregious case of fraudulent conduct and fiduciary disregard in the form of a “cherry-picking” scheme that—while invisible to Bronson’s clients—did not go unnoticed by the regulators. In a nutshell, over a four-year period, Bronson utilized his firm’s omnibus trading account at two different broker/dealers to effect a bald-faced cherry-picking scheme, whereby he entered block trades via the omnibus account, waited to see the trades’ intra-day performance, and then disproportionately allocated the winning trades to his own personal accounts and the losers to client accounts.

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The SEC has just concluded settlement negotiations with two large RIA subsidiaries of the Bank of Montreal, resulting in a total settlement of almost $38 million—with $25 million of that in disgorgement. The SEC’s announcement and administrative order resolves enforcement proceedings against BMO Harris Financial Advisors, Inc. (“BMO Harris”) and BMO Asset Management Corp. (“BMO Asset”)(together, the “BMO Advisers”) involving conflicts of interest violations under the Advisers Act antifraud provisions.

The SEC’s administrative settlement with the BMO Advisers marks yet another significant action by the Commission against RIAs for failing to disclose material conflicts of interest. As fiduciaries, RIAs must seek to avoid conflicts of interest with clients, and, at a minimum, must fully disclosure all material conflicts. The SEC enforces violations of this requirement pursuant to Advisers Act Section 206(2), which prohibits RIAs from engaging in “any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.”

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