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SEC Enforcement News: Protection of the Retail Investor

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  • Posted on: Jul 9 2018

In today’s post, this Blog looks at SEC enforcement actions and/or settlements of potential enforcement actions, the focus of which is the protection of the retail investor.

New York-Based Investment Firm and Two of its Managers Charged for Failing to Supervise Brokers Who Defrauded Customers

On June 29, 2018, the SEC announced (here) that it had charged New York-based broker-dealer Alexander Capital L.P. (“Alexander Capital”) and two of its managers for failing to supervise three brokers who made unsuitable recommendations to investors, “churned” accounts, and made unauthorized trades that resulted in substantial losses to the firm’s customers while generating large commissions for the brokers.

The SEC found that Alexander Capital failed to supervise William C. Gennity, Rocco Roveccio, and Laurence M. Torres, brokers who were previously charged with fraud in September 2017 (here).  According to the SEC, Alexander Capital lacked reasonable supervisory policies and procedures and systems to implement them, and had these systems been in place, Alexander Capital likely would have prevented and detected the brokers’ wrongdoing.

In separate orders (here) and (here), the SEC found that Philip A. Noto II (“Noto”) and Barry T. Eisenberg (“Eisenberg”) ignored red flags indicating excessive trading and failed to supervise brokers with a view to preventing and detecting their securities-law violations.

“Broker-dealers must protect their customers from excessive and unauthorized trading, as well as unsuitable recommendations,” said Marc P. Berger, Director of the SEC’s New York Regional Office.  “Alexander Capital’s supervisory system – and its personnel – failed its customers, and today’s actions reflect our continuing efforts to protect retail customers by holding firms and supervisors responsible for such failures.”

Alexander Capital agreed to be censured and pay $193,775 of allegedly ill-gotten gains, $23,437 in interest, and a $193,775 penalty, which will be placed in a Fair Fund to be returned to harmed retail customers.  Alexander Capital also agreed to hire an independent consultant to review its policies and procedures and the systems to implement them.  Noto agreed to a permanent supervisory bar and a $20,000 penalty and Eisenberg agreed to a five-year supervisory bar and a $15,000 penalty.  The penalties are to be paid to harmed retail customers.  Alexander Capital, Noto and Eisenberg agreed to settle the charges without admitting or denying the findings in the SEC’s orders.

A copy of the SEC’s Order Instituting Administrative Proceedings Pursuant To Section 15(b) of The Securities Exchange Act of 1934, Making Findings, and Imposing Remedial Sanctions can be found here.

Morgan Stanley Agrees to $3.6 Million Settlement in Connection With The Failure to Detect or Prevent Misappropriation of Client Funds

On June 29, 2018, the SEC announced (here) that Morgan Stanley Smith Barney (“MSSB”) had agreed to pay a $3.6 million penalty and to accept certain undertakings in connection with its failure to protect against the misuse or misappropriation of funds from client accounts.

According to the SEC, MSSB failed to have reasonably designed policies and procedures in place to prevent its advisory representatives from misusing or misappropriating funds from client accounts.  The SEC found that although MSSB’s policies provided for certain reviews of disbursement requests, the reviews were not reasonably designed to detect or prevent such potential misconduct.

The SEC concluded that MSSB’s insufficient policies and procedures contributed to its failure to detect or prevent one of its advisory representatives, Barry F. Connell (“Cornell”), from misusing or misappropriating approximately $7 million out of four advisory clients’ accounts in approximately 110 unauthorized transactions occurring over a period of nearly a year.

“Investment advisers must view the safeguarding of client assets from misappropriation or misuse by their personnel as a critical aspect of investor protection,” said Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office.  “Today’s order finds that Morgan Stanley fell short of its obligations in this regard.”

Without admitting or denying the findings, MSSB consented to the SEC’s order, which includes a $3.6 million penalty, a censure, a cease-and-desist order, and undertakings related to the firm’s policies and procedures.  Morgan Stanley previously repaid the four advisory clients in full, plus interest.

The SEC previously filed fraud charges against Connell (here), who was also criminally charged by the U.S. Attorney’s Office for the Southern District of New York.  Both sets of charges against Connell remain pending.

A copy of the SEC’s Order Instituting Administrative and Cease-and-Desist Proceedings, Pursuant to Section 15(b) of The Securities Exchange Act of 1934 and Sections 203(e) and 203(k) of The Investment Advisers Act of 1940, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order can be found here.

Wells Fargo Advisors Settles Charges of Misconduct in The Sale of Financial Products to Retail Investors

On June 25, 2018, the SEC announced (here) that Wells Fargo Advisors LLC (“Wells Fargo”) had agreed to settle charges of misconduct in the sale of financial products known as market-linked investments, or MLIs, to retail investors.

The SEC found that Wells Fargo generated large fees by improperly encouraging retail customers to actively trade the products, which were intended to be held to maturity.  As described in the SEC’s order, the trading strategy – which involved selling the MLIs before maturity and investing the proceeds in new MLIs – generated substantial fees for Wells Fargo, which reduced the customers’ investment returns.

The SEC found that the Wells Fargo representatives involved did not reasonably investigate or understand the significant costs of the recommendations.  The SEC further found that Wells Fargo supervisors routinely approved these transactions despite internal policies prohibiting short-term trading or “flipping” of the products.

“It is important that brokers do their homework before they recommend that their retail customers buy or sell complex structured products,” said Daniel Michael, Chief of the Enforcement Division’s Complex Financial Instruments Unit.  “The products sold by Wells Fargo came with high fees and commissions, which Wells Fargo should have taken into account before advising retail customers to sell their investments and reinvest the proceeds in similar products.”

Without admitting or denying the SEC’s findings, Wells Fargo agreed to return $930,377 of ill-gotten gains, plus $178,064 of interest, and to pay a $4 million penalty.  Wells Fargo also agreed to a censure and to cease and desist from committing or causing any violations and any future violations of certain antifraud provisions of the federal securities laws.  In imposing the foregoing sanctions, the SEC recognized that Wells Fargo took remedial steps to address the allegedly improper sales practices.

A copy of the Order Instituting Administrative and Cease-and-Desist Proceedings, Pursuant To Section 8A of The Securities Act of 1933, Section 15(b) of The Securities Exchange Act of 1934, and Section 203(e) of The Investment Advisers Act of 1940, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order can be found here.

Merrill Lynch Agrees to Pay $42 Million to Settle Charges That it Mislead Customers about Trading Venues

On June 19, 2018, the SEC announced (here) that it had charged Bank of America’s Merrill Lynch, Pierce, Fenner & Smith (“Merrill Lynch”) with misleading customers about how it handled their orders.  Merrill Lynch agreed to settle the charges, admit wrongdoing, and pay a $42 million penalty.

The settlement with the SEC follows a similar resolution with the New York attorney general in a related investigation (discussed here), under which Merrill Lynch admitted to engaging in a masking scheme and agreed to pay a $42 million fine.

According to the SEC, Merrill Lynch falsely informed customers that it had executed millions of orders internally when it actually had routed them for execution at other broker-dealers, including proprietary trading firms and wholesale market makers.  Merrill Lynch called this practice “masking.” Masking entailed reprogramming Merrill Lynch’s systems to falsely report execution venues, altering records and reports, and providing misleading responses to customer inquiries.  By masking the broker-dealers who had executed customers’ orders, Merrill Lynch made itself appear to be a more active trading center and reduced access fees it typically paid to exchanges.

After Merrill Lynch stopped masking in May 2013, it did not inform customers about its past practices, but instead took additional steps to hide its misconduct.  Altogether, the SEC found that Merrill Lynch falsely told customers that it executed more than 15 million “child” orders (portions of larger orders), comprising more than five billion shares, that actually were executed at third-party broker-dealers.

“By misleading customers about where their trades were executed, Merrill Lynch deprived them of the ability to make informed decisions regarding their orders and broker-dealer relationships,” said Stephanie Avakian, Co-Director of the SEC’s Enforcement Division.  “Merrill Lynch, which admitted that it took steps to ensure that customers did not learn about this misconduct, fell far short of the standards expected of broker-dealers in our markets.”

“Institutional traders often make careful choices about how and where their orders are sent out of a concern for information leakage,” said Joseph Sansone, Chief of the Enforcement Division’s Market Abuse Unit.  “Because of masking, customers who had instructed Merrill Lynch not to route their orders to third-party broker-dealers did not know that Merrill Lynch had disregarded their instructions.”

The SEC censured Merrill Lynch and required it to pay a $42 million civil penalty.

A copy of the Order Instituting Administrative and Cease-and-Desist Proceedings, Pursuant To Section 8a of The Securities Act of 1933, Section 15(b) of The Securities Exchange Act of  1934, and Section 203(e) of The Investment Advisers Act of 1940, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order can be found here.

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