Enforcement

SEC Files First Regulation Best Interest Enforcement Case

June 28, 2022 | Steve Parker

Earlier this month, the Securities and Exchange Commission filed its first-ever civil lawsuit seeking to enforce Regulation Best Interest. The case, filed in a federal district court in California, seeks permanent injunctions, disgorgement with prejudgment interest and civil penalties against broker-dealer Western International Securities Inc. and five of its registered representatives. Regulation Best Interest, also known as “Reg BI,” became effective in mid-2020, requiring broker-dealers and their associated persons to act in the best interest of their retail clients when making recommendations.

Reg BI does not apply to registered investment advisers, but, at the time of its adoption in 2019, the SEC issued guidance in which it affirmed and substantially clarified its view of what investment advisers must do to comply with their fiduciary obligations to their clients. Among those obligations is to act in the client’s best interests at all times. Both broker-dealers and investment advisers are required to deliver Client Relationship Summaries to their clients and prospective clients at various times. This document, among other things, describes conflicts of interests the firm has relating to the services it provides or the fees it receives.

Rollover Disclosure & Documentation Requirements to be Enforced Beginning July 1, 2022

May 18, 2022 | Patricia Klusmeyer

While the majority of the Department of Labor’s new fiduciary rule, Prohibited Transaction Exemption 2020-02 (“PTE 2020-02), became enforceable on January 31st, some of the requirements pertaining to rollover recommendations are set to be enforced on July 1, 2022.

As detailed in this blog post, the DOL provided transition relief in its Field Assistance Bulletin, FAB 2021-02 by extending the enforcement date of PTE 2020-02 through January 31, 2022 for investment advice fiduciaries who are working diligently and in good faith to comply with the “Impartial Conduct Standards” for any transactions that are exempted under PTE 2020-02. These standards include a best interest standard, a reasonable compensation standard, and a requirement to avoid any materially misleading statements about the recommended transaction and other relevant matters.

PTE 2020-02 also requires investment advice fiduciaries to document the specific reasons any rollover recommendations from an employee benefit plan to another plan or an IRA, from an IRA to a plan, from an IRA to another IRA, or from one type of account to another is in the best interest of the retirement investor. PTE 2020-02 further requires this documentation to be provided to the retirement investor prior to engaging in the rollover. In FAB 2021-02, the DOL announced that it would not enforce the documentation and disclosure requirements for rollover recommendations under PTE 2020-02 through June 30, 2022.
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Exchange-Traded Product Probe Results in Fines for Investment Advisory Firms

January 21, 2021 | Steve Parker

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.

SEC Enforcement Continues to Sanction RIAs Over Excessive Fees

September 18, 2020 | Steve Parker

As illustrated in two recent cases, the SEC’s Enforcement Division continues to root out RIAs that receive excessive undisclosed fees, particularly 12b-1 fees and mutual fund revenue sharing payments. As we have noted repeatedly, the SEC has focused on this issue in the last several years. At issue is whether an adviser properly disclosed to its clients that its representatives or an affiliated broker-dealer would receive 12b-1 fees based upon the recommendation of a mutual fund share class that pays such a fee when other classes that do not carry such a fee are available to the client.

In the first case, SCF Investment Advisors (SCF), a California-based registered investment adviser, consented to more than $700,000 in monetary sanctions imposed by the SEC relating to the firm’s practice of receiving 12b-1 fees in advisory accounts without proper disclosure. According to the order, SCF used mutual funds and money market funds that paid 12b-1 fees, although the receipt of those fees was not disclosed to clients and less expensive alternatives were available. The firm’s affiliated broker-dealer also received revenue sharing payments, a practice that was also not disclosed. As a result of those charges, SCF and its affiliates were unjustly enriched, and the clients’ performance was lower than it would have been had the practices not existed.

In 2018, the SEC granted RIAs the opportunity to enter into consent orders that did not carry civil penalties by self-reporting the receipt of undisclosed 12b-1 fees. In those cases, however, the firms would nevertheless be required to reimburse clients the amounts received in 12b-1 fees. In April of this year, as a result of that self-disclosure initiative, the SEC announced that the initiative resulted in 95 RIAs returning nearly $140 million to their customers. Continue reading ›

US Supreme Court Disgorgement Ruling Leaves Open Questions

August 18, 2020 | Steve Parker

Earlier this summer, the US Supreme Court handed down a highly anticipated decision clarifying the powers of the Securities and Exchanges Commission in civil enforcement proceedings. The court ruled by a margin of 8 to 1 that the SEC can obtain disgorgement from a defendant because disgorgement is a form of equitable relief. As such, the remedy is based on district courts’ inherent powers to enter remedies based on fairness and equity. But we anticipate that the lower courts will still have difficulty in answering questions relating to the equitable remedy with uniformity, most likely resulting in those questions eventually coming back to the high court for resolution.

The case, Liu v. SEC, involved a lower court’s order that a married couple must pay $27 million in disgorgement as a result of the husband’s raising that amount from Chinese investors in a fraudulent EB-5 offering. The funds were ostensibly raised to fund a new cancer clinic, but ultimately the funds were misused. The husband funneled some of the money to the wife and some to other related companies. Both husband and wife were paid millions of dollars in salaries alone. The disgorgement award held both husband and wife jointly and severally liable for the full amount.

The trial court ordered the couple to disgorge the full amount raised in the fraudulent scheme as “ill-gotten gains.” The defendants challenged the amount of disgorgement imposed on several grounds, including that the amount should be offset by legitimate expenses incurred by the defendants. A disgorgement award that was not limited to net profits, they argued, constituted a penalty and therefore, could not be imposed consistent with other limitations on awards of civil penalties. Continue reading ›

Recent Merrill Lynch Scenario Underscores Need to Avoid Unnecessary Mutual Fund Fees

June 16, 2020 | Steve Parker

Last week, the Financial Industry Regulatory Authority (FINRA) issued a Letter of Acceptance Waiver and Consent (AWC) censuring Merrill Lynch and ordering $7.2 million in restitution to investor clients. Merrill had already reimbursed the clients as a result of an internal review and had self-reported the underlying violations to FINRA, a move that earned praise from FINRA in the AWC.

At issue was the failure to honor rights of reinstatement in connection with mutual fund purchases. Mutual fund companies usually offer various rights to their shareholders, as set forth in a fund’s prospectus or the fund’s statement of additional information. Some funds grant shareholders a right of reinstatement, which allows investors to buy fund shares without incurring a front-end charge if the investor previously sold shares of any fund within the same family. Usually, this involves A-shares, but it could apply to different classes of shares, depending on the fund company. Similarly, a right of reinstatement usually allows the investor to recoup any previously charged contingent deferred sales charge relating to the sale of a fund within the family. Rights of reinstatement typically specify that the new purchases must occur within 30 to 90 days of the prior sale, but the period could be as up to one year later, depending on the fund and the particular situation. Continue reading ›

Wells Fargo Settles Enforcement Case Over Unsuitable ETF Recommendations

March 30, 2020 | Steve Parker

Last month Wells Fargo Advisors Financial Network LLC agreed to settle administrative charges brought by the SEC, and will pay a $35 million civil penalty in order to resolve the matter. According to the allegations, Wells Fargo failed to supervise investment adviser representatives who recommended inverse exchange-traded funds to their customers, leading to investor losses.

Inverse ETFs allow investors to short the entire market or a sub-market, depending on the ETF involved. However, because they usually “re-set” every day, inverse ETFs are not designed to be held for longer than a single trading day. Instead, they are designed to be used by traders to implement risk hedges on an intra-day basis. If they are held on a long-term basis, they will not necessarily perform consistently with the long-term direction of the market being shorted. This is especially true in volatile markets.

These risks are often described in detail in the product prospectuses but are not often explained sufficiently by financial advisers. In fact, advisers who are not specifically trained on the products often do not understand their unique characteristics. For example, a single-inverse ETF based on a particular index will usually lose money even if the index performance remains flat. In fact, even if the index falls the ETF can lose money.

SEC Charges Adviser and its COO with Fraud for Orchestrating Sham Cross Trade between Clients

April 22, 2019 | Parker MacIntyre

A recent pair of SEC enforcement Orders against registered investment adviser Talimco, LLC and its Chief Operating Officer Grant Rogers highlight the need for advisers to be ever-mindful of their fiduciary duties to both clients when effecting cross trades between such clients.

Cross trading occurs whenever an adviser arranges a securities transaction between two parties, both of whom being advisory clients of the firm. While “principal trading” (where the adviser buys or sells for its own proprietary account) and “agency cross trading” (where the adviser acts as a broker and receives compensation) are accorded heightened scrutiny and require additional disclosures and consents, this recent pair of Orders show that even ordinary cross trades can be highly problematic when one client is favored over another.

In this particular case, the SEC alleges that Talimco and Rogers went so far as to manipulate the auction price of a commercial loan participation in a sham transaction between two of its clients that distinctly advantaged one client over the other. Continue reading ›

Firm’s Failure to Act on Numerous Compliance “Red Flags” Results in $250,000 Penalty and Censure by SEC

April 4, 2019 | Parker MacIntyre

A recent settled SEC Order with Wedbush Securities, Inc., a dually-registered investment adviser and broker-dealer, has resulted in a censure and $250,000 fine against that firm. The genesis of this rather harsh result is what the SEC alleges to be the firm’s lack of an ability to follow-up on obvious compliance “red flags” that, in this case, pointed to an extensive and long-running “pump and dump” scheme involving one of the firm’s registered representatives. Indeed, as noted by Marc P. Berger, Director of the SEC’s New York Regional Office, “Wedbush abandoned important responsibilities to its customers by looking the other way in the face of mounting evidence of manipulative conduct.”

The SEC’s regulatory requirements compel broker-dealers to adopt policies and procedures that are sufficiently tailored to determine whether their associated persons are violating the securities laws and to prevent them from violating the securities laws. Broker-dealers are also compelled to ensure that these policies and procedures are sufficiently implemented to discover and prevent securities law violations. Continue reading ›

Robo-Adviser Settles Charges with SEC for Making Misleading Statements

January 25, 2019 | Elizabeth Dalziel

Demonstrating its regulatory interest in the robo adviser industry, on December 21, 2018, the Securities and Exchange Commission issued an Order Instituting Administrative and Cease-and-Desist Proceedings against Wealthfront Advisers, LLC, a registered investment adviser which uses a software-based “robo adviser” platform in servicing its clients. The action is the second case against robo advisers filed on the same day. Wealthfront submitted an offer of settlement in light of the proceeding.

According to the SEC’s Order, Wealthfront utilizes a proprietary tax loss harvesting program (“TLH”) to help its clients garner tax benefits. These tax benefits would typically come through selling assets at a loss, which could potentially be used to reduce income or gains and create a lower tax liability. From October 2012 onward, Wealthfront has featured whitepapers on its website that provide information about the TLH strategy. Continue reading ›