More On Legal & Compliancefrom The Advisor's Professional Library
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
Among recent enforcement actions taken by the SEC and FINRA were charges against Eli Lilly and Co. with violations of the Foreign Corrupt Practices Act (FCPA); the barring of an Arizona-based mutual fund manager from the securities industry over actions that led to the fund’s collapse; charges of fraud against four penny stock purchasers; and a research analyst charged with trading and tipping ahead of IBM’s acquisition of SPSS Inc.
FINRA, meanwhile, ordered Pruco Securities to pay $10.7 million in restitution and a fine of $550,000 over findings that it improperly priced mutual fund shares over a period of several years for customers who placed paper orders.
Eli Lilly Charged With FCPA Violations
The SEC announced that it has charged Indianapolis-based Eli Lilly and Co. with violations of the Foreign Corrupt Practices Act (FCPA) for improper payments its subsidiaries made to foreign government officials to win millions of dollars of business in Russia, Brazil, China, and Poland.
According to the SEC’s allegations, Lilly’s Russia subsidiary used offshore “marketing agreements” to pay millions to third parties chosen by government customers or distributors, despite knowing little or nothing about those third parties beyond their offshore address and bank account information. These offshore entities rarely provided any services; in fact, in some instances they served as a channel to convey money to government officials who would in turn provide business to the subsidiary.
The money for alleged “marketing services” in order to induce pharmaceutical distributors and government entities to purchase Lilly’s drugs included approximately $2 million to an offshore entity owned by a government official and approximately $5.2 million to offshore entities owned by a person closely associated with an important member of Russia’s parliament.
There was no specialized or close review of transactions with offshore or government-affiliated entities for possible FCPA violations; paperwork was accepted at face value, and there was little action taken to determine whether the terms or circumstances surrounding a transaction could signify foreign bribery.
Not only that, but the SEC alleges that, despite Lilly’s recognition that the marketing agreements were being used to “create sales potential” with government customers and that it did not appear that any actual services were being rendered under the agreements, it failed for more than five years to shut down the subsidiary’s use of them.
The firm’s Brazilian, Chinese and Polish subsidiaries also made improper payments to government officials or third-party entities associated with government officials.
At the Brazilian subsidiary, one of the pharmaceutical distributors was allowed to pay bribes to government health officials to facilitate Lilly drug product sales of $1.2 million to state government institutions.
Employees of the Chinese subsidiary falsified expense reports to provide spa treatments, jewelry, and other improper gifts and cash payments to government-employed physicians.
And in Poland, the company’s subsidiary made eight improper payments totaling $39,000 to a small charitable foundation founded and administered by the head of one of the regional government health authorities in exchange for the official’s support for placing Lilly drugs on the government reimbursement list.
Lilly agreed, to settle the SEC’s charges, to pay disgorgement of $13,955,196, prejudgment interest of $6,743,538, and a penalty of $8.7 million for a total payment of $29,398,734. Without admitting or denying the allegations, the company also consented to the entry of a final judgment permanently enjoining the company from violating the anti-bribery, books and records, and internal controls provisions of the FCPA, and to comply with other requirements that include the retention of an independent consultant to review and make recommendations about its foreign corruption policies and procedures. The settlement is subject to court approval.
FINRA Orders Pruco Securities to Pay $10.7 Million in Restitution
FINRA announced that it has ordered Pruco Securities, LLC of Newark, N.J., to pay more than $10.7 million in restitution, plus interest, to customers who placed mutual fund orders with Pruco via fax or mail (paper orders) from late 2003 to June 2011 and received an inferior price for their shares. FINRA also fined Pruco $550,000 for its pricing errors and for failing to have an adequate supervisory system and written procedures in this area.
One of Pruco's retail brokerage business units, COMMAND, instituted a practice for handling mutual fund paper orders that was inconsistent with the pricing requirements of the Investment Company Act of 1940, which requires that mutual fund orders are priced on the day the order is received prior to 4:00 P.M. Instead, from late 2003 to June 2011, COMMAND priced more than 850,000 paper orders, on average, one or two days after it received complete orders prior to 4 P.M.
The employees mistakenly believed that they could use "best efforts" (up to two business days) to process mutual fund paper orders and that paper orders could be priced on the date the order was processed, even if Pruco received a complete order prior to that date. As a result of these findings, approximately 37,000 accounts for 34,000 customers will receive more than $10.7 million in restitution, plus interest. The firm is in the process of calculating restitution for up to 3,240 additional customers who will receive restitution upon the firm's completion of its review. The issue was discovered after an inquiry to COMMAND personnel regarding a fax order submitted had not been executed until the day after it was received as a complete order.
FINRA also found that Pruco failed to have an adequate supervisory system to detect and prevent the mispricing of paper mutual fund orders and to ensure that customers who submitted paper mutual fund orders received the correct price. Additionally, Pruco failed to have written procedures for the pricing of mutual fund orders, and did not provide its employees with any training or training materials regarding paper mutual fund pricing requirements.
Pruco neither admitted nor denied the charges, but consented to the entry of FINRA's findings. When determining sanctions, FINRA took into consideration that the firm self-reported the pricing issue, undertook an internal review, implemented changes to its policies and procedures and commenced restitution to the affected customers.
Fund Collapse Results in Ban Against Fund Manager
The SEC barred an Arizona-based mutual fund manager from the securities industry for failing to follow the investment objectives of a stock mutual fund managed by his firm, leading to the fund’s collapse.
An SEC investigation found that the prospectus of Z Seven Fund (ZSF) stated that it sought long-term capital appreciation and restricted the use of options. However, beginning in September 2009 and contrary to the fund’s stated investment policy, Barry C. Ziskin and his firm Top Fund Management (TFM) invested ZSF in put options for speculative purposes. The losses from options trading and the ensuing investor redemptions ultimately resulted in ZSF’s liquidation in December 2010.
According to the SEC’s order instituting settled administrative proceedings against TFM and Ziskin, both disclosures in ZSF’s prospectuses and statements of additional information claimed that the fund was restricted to trading options only to hedge its portfolio. However, TFM and Ziskin traded put options in such large amounts relative to the size of ZSF’s equity portfolio that their strategy amounted to speculation. In one instance, ZSF’s equity portfolio had a market value of $1,835,607 on July 6, 2010, but ZSF held enough option contracts to protect a portfolio worth $32,858,000 (17.9 times the value of the equity portfolio).
ZSF’s options trading also caused the fund’s performance to plummet. As of October 2009, ZSF had net assets of $5.3 million, but over the next 15 months the fund suffered $3.7 million in losses from options. TFM and Ziskin misled ZSF investors by misrepresenting in a shareholder report that options trading was for hedging purposes.
Without admitting or denying the SEC’s findings, TMF and Ziskin agreed to cease and desist from violations of the antifraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Advisers Act of 1940, and also consented to the entry of an SEC order that censures TFM and bars Ziskin from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization and prohibits him from serving as an officer, director or employee of a mutual fund.
Four Penny Stock Purchasers Charged With Fraud by SEC
The SEC announced that it has charged four securities industry professionals with conducting a fraudulent penny stock scheme, in which they illegally acquired more than 1 billion unregistered shares in microcap companies at deep discounts and then dumped them on the market for approximately $17 million in illicit profits while claiming bogus exemptions from the federal securities laws.
The SEC alleges that Danny Garber, Michael Manis, Kenneth Yellin, and Jordan Feinstein acquired shares at about 30%–60% off the market price by misrepresenting to the penny stock companies that they intended to hold the shares for investment purposes rather than immediately reselling them. Instead, they immediately sold the shares without registering them by purporting to rely on an exemption for transactions that are in compliance with certain types of state law exemptions. However, no such state law exemptions were applicable to their transactions. To create the appearance that the claimed exemption was valid, they created virtual corporate presences in Minnesota, Texas, and Delaware. The SEC also charged 12 entities that they operated in connection with the scheme.
According to the SEC’s complaint filed in federal court in Manhattan, Garber, Manis, Yellin, and Feinstein all live in the New York/New Jersey area and operated the scheme from 2007 to 2010. Each has previously worked in the securities industry, either as a registered representative or as a provider of investment management or financial advisory services.
The SEC’s complaint seeks a final judgment, among other things, ordering all of the defendants to pay disgorgement, prejudgment interest and financial penalties; permanently enjoining all the defendants from future violations of the securities laws; and permanently enjoining all the defendants from participating in penny stock offerings. The investigation is continuing.
Research Analyst Charged by SEC With Pre-Merger Trading, Tipping
In a case already underway, the SEC has filed additional charges—this time against a research analyst accused of trading and tipping in advance of the acquisition of SPSS Inc. by IBM. Already charged in November were two brokers: Thomas Conradt, the analyst’s roommate, and Conradt’s friend David Weishaus.
In an amended complaint filed in federal court in Manhattan, the SEC is now charging research analyst Trent Martin, who was the brokers’ source of confidential information in an insider trading scheme that yielded more than $1 million in illicit profits. Martin worked at a Connecticut brokerage firm and specialized in Australian equity investments. He learned nonpublic information about the impending IBM-SPSS transaction, including the anticipated share price and the names of the companies, from an attorney friend who was working on the deal. The attorney had told Martin about it, seeking advice and moral support on this large assignment.
Instead of keeping the information confidential, Martin capitalized on it by buying shares in SPSS and then telling his roommate Conradt about it. Martin was persistent, too; on the very first business day after his attorney friend told him about the deal, he tried to buy shares in SPSS, but failed in his first three attempts because his brokerage account did not have sufficient funds for the transaction. Rather than give up, Martin wired $50,000 from his checking account into the brokerage account, and then managed to complete his purchase.
Conradt, for his part, once he knew of the IBM-SPSS deal, relayed the information to Weishaus; both of them also took advantage of their illicit knowledge. Martin was specifically named as their source in instant messages between Conradt and Weishaus about their illegal trading.
When he learned of the SEC’s investigation, Martin fled the country for Australia. He is now living in Hong Kong. In a statement, Daniel Hawke, director of the SEC’s Philadelphia regional office, said, “Martin is a licensed professional who knowingly disregarded insider trading laws to enrich himself, and then fled the United States when he learned of our investigation. Martin could run but he could not hide, as the long arm of the SEC will extend to those who flee the United States hoping to avoid the consequences of their unlawful conduct.”
The SEC is seeking disgorgement of ill-gotten gains with prejudgment interest and financial penalties, and a permanent injunction against the brokers. Its investigation is continuing, and it acknowledges the assistance of not only the Options Regulatory Surveillance Authority (ORSA), the New Zealand Securities Commission, and the Australia Securities and Investments Commission, but also of the U.S. Attorney’s Office for the Southern District of New York and the Federal Bureau of Investigation.