More On Legal & Compliancefrom The Advisor's Professional Library
- Books and Records Rule Thorough and complete books and records enable RIAs to demonstrate that they have fulfilled their fiduciary obligations to clients and complied with applicable rules and regulations.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
Recent enforcement actions taken by FINRA and the SEC include fines and suspensions, as well as expulsions, of firms and principals for a wide variety of violations that include misuse of customer shares and funds; misleading sales materials; falsification of records and applications; and the sale of thousands of shares of unregistered stock.
Egan-Jones, Founder Agree to Settle SEC Charges
Egan-Jones Ratings Co. (EJR), and its president, Sean Egan, have agreed to settle SEC charges that they made willful and material misstatements and omissions when registering with the agency to become a nationally recognized statistical rating organization (NRSRO) for asset-backed securities and government securities.
An SEC order that found EJR falsely stated in its registration application that it had been rating asset-backed and government securities issuers since 1995. Actually, EJR had issued no such ratings before it filed its application. In addition, the SEC’s order found EJR to have violated conflict-of-interest provisions, and that Egan caused EJR’s violations.
In EJR’s July 2008 application to become an NRSRO, it claimed to have 150 outstanding asset-backed securities (ABS) issuer ratings and 50 outstanding government issuer ratings, and also claimed to have been issuing credit ratings in these categories continuously since 1995. Egan signed the application, certifying it as accurate.
In actuality, EJR was not eligible for an NRSRO registration in either category, because it had not issued any ABS or government issuer ratings made available through the Internet or any other readily accessible means. In addition, the SEC found that EJR continued to make material misrepresentations about its experience in the annual certifications that followed, as well as making other misstatements in SEC submissions. It also was found to have and violated recordkeeping and conflict-of-interest provisions governing NRSROs, thus evading standards intended to safeguard credit rating integrity.
To settle the charges, EJR and Egan agreed to be barred for at least 18 months from rating asset-backed and government securities issuers as an NRSRO. The firm and Egan also agreed to conduct a comprehensive self-review and correct the deficiencies found by SEC examiners in 2012, and provide the SEC with a report that Egan is to sign under penalty of perjury enumerating the steps the firm has taken to comply. Neither EJR nor Egan has admitted or denied the findings.
FINRA moved against Westor Capital Group and Richard Hans Bach, its president, chief compliance officer and operations principal, on charges that the firm failed to deliver securities to customer accounts, kept customers from taking out their own money and engaged in other violations of federal securities laws and rules.
In one instance, Westor refused to allow one customer to withdraw $97,000 from his account and, without customers’ permission, also misused 65,000 of their fully paid shares to effect and cover another client’s short sales.
Westor mainly trades in microcap securities through its own accounts, which are held at several different brokerage firms. According to FINRA, it lacks the ability to track and reconcile its customers' stock positions, enabling it to cover up its own improper use of securities.
FINRA sought a temporary cease-and-desist order (TCDO) against both the firm and Bach to prevent further misappropriation and misuse of customer funds and securities during the time required for a formal disciplinary proceeding to occur. It also filed a complaint against both, in which they were charged with failing to allow customers to withdraw account balances and deliver securities, misusing customer securities, failing to maintain physical possession or control of securities, and for operating an unapproved self-clearing business.
Both Westor and Bach can file a response and request a hearing before a FINRA disciplinary panel.
FINRA Expels Hedge Fund Capital Partners, Principal
Howard Gordon Jahre, principal of Brooklyn-based Hedge Fund Capital Partners was barred from any association with any FINRA member and the firm was expelled from FINRA membership over numerous violations that included everything from misleading sales materials to allowing unregistered persons to act in registered capacities.
FINRA’s findings indicated that the firm and Jahre distributed exaggerated, misleading and unbalanced institutional sales materials in the form of emails from Jahre. The firm also distributed additional biased institutional sales materials and failed to retain copies.
The National Adjudicatory Council (NAC) imposed the sanctions following appeal of an Office of Hearing Officers (OHO) decision, which was appealed to the SEC but subsequently withdrawn.
Oakbrook Investment Brokers Expelled, Principal Barred by FINRA
Illinois-based Oakbrook Investment Brokers was expelled from FINRA and its principal, Robert George Stevens, was barred from associating with FINRA members on findings that, among other things, Stevens backdated continuing education test forms for registered representatives of the firm and presented them at a FINRA examination.
Other findings included lack of a Firm Element continuing education training plan; failure to do due diligence on an offering and to preserve records of customer purchases/refunds; use of unapproved email addresses by firm representatives for securities-related communications; failure to review electronic correspondence; and failure to prepare an accurate general ledger, trial balances and net capital calculations for two dates.
Numerous other violations were found by FINRA, and while neither the firm nor Stevens admitted or denied findings, both consented to their entry and to the sanctions.
Gary Hume, principal, and his firm, ACAP Financial, were both the target of FINRA enforcement actions on findings that the firm sold more than 27 million unregistered shares of an entity to the public after it, and Hume, acting as compliance officer, took the absence of a restrictive legend on the stock certificates and the clearance of the stock through the transfer agent as evidence that the shares were freely tradable.
In spite of red flags that indicated the stock sales may have been part of an illegal distribution, both Hume and the firm failed to make sure that the registered representative had the necessary information to know whether the unregistered shares could be sold in compliance with Securities Act Section 5. In addition, Hume was responsible for creating and maintaining the firm’s WSPs; however, the firm had no written or formal procedures regarding restricted stock transactions or the receipt of stock certificates, given its business model. The firm’s procedures gave no guidance on how to determine whether the stock was freely tradable.
While the decision has been appealed to the SEC and the sanctions are not in effect pending consideration of the appeal, FINRA’s decision on sanctions include a fine for the firm of $100,000, as well as a requirement that it revise its WSPs and retain an independent consultant to review and approve the procedures. In addition, the firm is to be suspended from receiving and liquidating unregistered penny stocks until the procedures are approved by the consultant and implemented.
There is also a fine for Hume of $25,000. He is also to be suspended from association with any FINRA member in any capacity for six months, and must requalify before he can act in any capacity requiring qualification. The NAC imposed the sanctions following the call for review of an OHO decision.