SEC Speaks Out About Using the Word "May" in Disclosures

The SEC has once again brought action against a firm for failure to properly disclose existing conflicts of interest. According to the SEC’s Order, the firm entered into an ‘undisclosed’ arrangement with an unaffiliated broker-dealer to provide trade execution for the adviser’s clients at a commission rate of $0.01 per share. However, under their existing arrangement, the broker-dealer charged the adviser’s clients between $0.04 and $0.06 per share, and then paid the amount exceeding $0.01 per share commission to the adviser’s affiliated broker-dealer as a “referral fee.” In that way, the affiliated broker-dealer and the adviser were actually paid between $0.03 and $0.05 per share on the adviser’s client.

The adviser’s ADV Part 2A disclosed that its affiliated broker-dealer “may” receive referral fees when obviously it was receiving them. All advisers should review their disclosures on at least an annual basis to make sure they accurately reflect what is occurring as opposed to what might occur in the future.

Please click here to read the full Order.

SEC Administrative Hearings Gain More Bite

Traditionally, the Securities and Exchange Commission (“SEC”) has only been able to impose penalties on regulated entities and individuals through the administrative process. Since passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC is now able to apply civil penalties against any person or company. This change has created some increased efficiencies as well as potential problems.

Prior to Section 929P of Dodd-Frank, the best alternative to an administrative hearing for non-regulated entities was for the SEC to file a lawsuit in Federal Court. Defendants often consider the administrative option to be quicker and less costly. But the advantages of the administrative option for the SEC appear to be even greater and include: limited discovery, no right to a jury trial, and inherently biased administrative law judge, and a biased appeal to the SEC Commissioners. This last point brings up an obvious ethical problem.

The administrative judges are appointed by the SEC and any appeal of the judges’ decision is appealed to the SEC Commissioners. Since it takes a vote of the SEC Commissioners to proceed with an enforcement action, those Commissioners are hearing the appeal of the case they authorized to proceed in the first place. The judges are not held to any code of conduct or code of ethics.

Since the passage of Dodd-Frank, the SEC has not lost a single administrative process case. They have a 100% success rate. However, their record was only about 60% successful when they filed lawsuits in Federal Court.

The SEC has been open with its intention to try more cases in its administrative process and defendants who had hoped to fight the SEC’s allegation in Federal Court may find that they are instead sent to an administrative process without many of the tools they had hoped to use such as the right to a jury, expansive discovery, dispositive motions, evidentiary challenges, or even time to prepare for trial.

One good option to help prevent an administrative process is to better understand your business and how to avoid actions that can introduce you to the process. A solid Compliance program that helps define your potential risks and implements processes to mitigate your risk exposure is essential. Please click here to read the complete story.

If you would prefer to focus your attention on your clients and the day-to-day operation of your firm, Red Oak Compliance Solutions is here to help with any or all of your compliance requirements.

The SEC Filed a Record Number of Enforcement Cases in 2014

The SEC just issued a press release announcing that they filed a record number of enforcement cases in the 2014 fiscal year that ended September 30. The SEC reported that it filed 755 enforcement actions during this time frame as compared to 686 and 734 in the prior two years. The SEC obtained orders totaling $4.16 Billion in disgorgement and penalties as compared to $3.4 Billion and $3.1 Billion for 2013 and 2012. The SEC highlighted cases against investment advisers and investment companies including cases against a private equity firm for misallocation of expenses. Andrew J. Ceresney, Director of the SEC's Division of Enforcement stated, "I am proud of our excellent record of success and look forward to another year filled with high-impact enforcement actions." Please click here to read the full story.

If you have any questions or concerns regarding your compliance program, Red Oak Compliance Solutions is here to help you enhance your compliance program and help keep you away from any questionable activity.

Culture of Compliance

As my Compliance career has progressed, I’ve noticed a few recurring themes like, we sure could use more Analysts and there must be better a better way. While that may be the same sentiment in other industries; a recent survey by Cipperman Compliance Services (“CCS”) indicates that my assumptions were correct. They found that the compliance function in the surveyed firms tended to be underfunded and understaffed. Their survey included asset managers, broker-dealers, alternatives managers and wealth managers.

A number of findings, while no surprise at all, were a little troubling including, 74% of respondents (responsible for compliance duties) believed that their firms should commit more resources to the compliance function and 83% of broker-dealers and 58% of asset managers said they needed to focus more resources on compliance.

Compliance is your level of protection for your Clients, the Advisors and for the firm itself. According to the old adage, “the best defense is a good offense” and I tend to agree. When compliance is understaffed and/or underfunded, the process becomes reactionary or defensive, with only the resources to respond to issues as they arise rather than taking the offensive and trying to uncover weaknesses in the system before there are problems.

So what kind of commitment to compliance would be adequate? Todd Cipperman the Chief Executive Officer of CCS says, “Firms should spend a minimum of 5% of revenues or 2 bps of assets under management on the compliance function. Investing in compliance protects the franchise and preserves assets under management. We view compliance as the firm’s defense. And defense wins championships.” I couldn’t agree more.

Please click here to read the full story.

Trust - How would you handle a net capital issue?

Trust, an essential element in the relationship between financial Representatives , the public and the regulators is delicate and must be nurtured over time . . . and it can be lost in an instant.

That’s what Charles “Chuck” Moore and Crucible Capital Group learned on August 8, 2014 when the SEC announced charges against the New York brokerage firm and its founder for allegedly violating the net capital requirements and subsequently falsifying books and records to conceal the deficiencies. The uniform net capital rule was created by the U.S. Securities and Exchange Commission ("SEC") in 1975 to regulate directly the ability of broker-dealers to meet their financial obligations to customers and other creditors.

The rule requires those firms to value their securities at market prices and to apply to those values a haircut (i.e., a discount) based on each security's risk characteristics. The haircut values of securities are used to compute the liquidation value of a broker-dealer's assets to determine whether the broker-dealer holds enough liquid assets to pay all its non-subordinated liabilities and to still retain a "cushion" of required liquid assets (i.e., the "net capital" requirement) to ensure payment of all obligations owed to customers if there is a delay in liquidating the assets.

“The net capital rule is a principal tool by which the SEC monitors the financial health of brokerage firms,” said Amelia A. Cottrell, an associate director in the SEC’s New York Regional Office. “It is therefore crucial that SEC examiners have prompt access to accurate and complete information about a firm’s financial condition.” It would be fair to say that most companies face financial challenges at some point. How firms deal with these challenges can either build or destroy trust. The charges allege that Charles “Chuck” Moore and Crucible Capital Group attempted to disguise the firm’s extensive and repeated net capital insufficiencies by improperly off-loading its liabilities onto the books of an affiliated firm and improperly treating non-marketable stock as an allowable asset.

Apparently Crucible entered into an expense-sharing agreement with another firm owned by Moore called Angelic Holdings. Angelic contracted to pay Crucible’s expenses. The vendors of Crucible were to bill Angelic for services they performed for Crucible. Moore provided SEC examiners with copies of invoices that had been doctored to eliminate significant past due amounts. The SEC examiners and investigators noted the falsifications. They also found that Angelic did not have the resources to pay the debts of vendors making the expense sharing agreement illegitimate. The case has been referred to criminal authorities for prosecution. Click here to read the SEC Press Release.

If you would prefer to focus your attention on your clients and the day-to-day operation of your firm, Red Oak Compliance Solutions is here to help with any or all of your compliance requirements.

FINRA Fines Heating Up

Summer temperatures in Texas are heating up almost as fast as the Financial Industry Regulatory Authority’s (FINRA’s) monthly “Disciplinary and Other FINRA Actions” publication. Reported recently by ThinkAdvisor.com citing an analysis by the law firm Sutherland Asbill & Brennan (Sutherland), FINRA is on track to assessing 49% more in fines this year than last year’s $57 million.

The first half of 2014 has already seen fines totaling $42.4 million compared with $23 million during the first half of 2013. At the current rate, fines in 2014 will total approximately $85 million which is still lower than the $111 million reported by FINRA in 2006. The Sutherland study also noted that FINRA “appears to be repositioning itself as its actions shift from cases relating to the financial crisis to more technical issues,” such as books and records and trade reporting violations.

Issues drawing the most heat so far this year are:

• Books and Records: $13.7 million in fines, 61 cases
• Anti-Money Laundering: $11.3 million in fines, 17 cases
• Net Capital: $9.7 million in fines, 18 cases
• Unregistered Securities: $9.2 million in fines, 11 cases
• Trade Reporting: $6.7 million in fines, 92 cases

One reason noted by Sutherland for the higher total is that fines themselves have been higher in 2014 than 2013. During the first half of 2013 there were only two fines of $1 million or more totaling $2.3 million. So far this year there have been five fines totaling $20.4 million. One anti-money laundering compliance failure case involving penny stock transactions resulted in an $8 million fine.

The study by Sutherland also found that as fines are heating up, disciplinary actions are cooling off . . . slightly. Fines are up 49% so far this year and disciplinary actions are down about 7% with 558 actions during the first half of this year (597 during first half of 2013). Please click here to ready the full article.

While there is not much we can do about the temperature, Red Oak stands ready to help you and your firm keep your cool year round.

State Securities Regulators Survey Investment Advisors on Cybersecurity

Several states have now joined the SEC and FINRA’s initiative to assess cybersecurity preparedness and have sent out questionnaires or will be shortly.

These questionnaires contain questions ranging from the very specific to the very broad. Some questions include:

• Does your firm utilize laptop or tablet computers, or other portable electronic devices?
• Is the encryption software installed on all laptop or tablet computers, or other portable electronic devices?
• Identify the encryption software vendor: __________________
• Does your firm utilize antivirus software?
• Identify the antivirus software vendor: ___________________
• Is the antivirus software installed on all fixed workstations and portable electronic devices?
• How often are updates downloaded to the antivirus software?
• Has your firm created and implemented a written information security program?

We believe the states will institute regulations regarding cybersecurity by early next year after assessing the responses to their questionnaires. Click here for a copy of the questionnaire for Massachusetts.