Last week, another chief compliance officer was named in an enforcement action, while a new type of wrongful conduct was identified in the financial services industry – causing “atypical price activity.” In addition, the Commodity Futures Trading Commission resolved two old enforcement matters: a complaint against a former MF Global broker for attempting to manipulate two NYMEX futures contracts, and a complaint against another former broker for unauthorized swaps trades on behalf of a customer. As a result, the following matters are covered in this week’s Bridging the Week:
- Investment Adviser Chief Compliance Officer Blamed in SEC Lawsuit for President’s Theft of Client Funds; SEC Commissioner Criticizes Enforcement Actions Against CCOs Generally (includes My View);
- Causing “Atypical Price Activity” in Gold Futures Results in US $200,000 Fine by COMEX (includes Compliance Weeds);
- Former MF Global Broker Agrees to US $500,000 CFTC Fine for Attempting to Manipulate Palladium and Platinum Settlement Prices From 2006 Through 2008;
- SEC Sanctions Thirty-Six Underwriting Firms More Than US $9 Million for Misleading Offering Statements;
- FCM Broker Fined US $1.2 Million by CFTC for Unauthorized Swaps Trading for Customer;
- Business and Principals Stopped by SEC From Transacting in OTC Security-Based Swaps With Retail Persons;
- Investment Adviser and Mutual Fund Board Members Sued by SEC for Inadequate Advisory Contract Approval Process; and more (includes Compliance Weeds).
Investment Adviser Chief Compliance Officer Blamed in SEC Lawsuit for President’s Theft of Client Funds; SEC Commissioner Criticizes Enforcement Actions Against CCOs Generally
The Securities and Exchange Commission filed two separate administrative complaints last week related to the misappropriation of client funds by the former president of an investment adviser.
In one action, the SEC sued Brian Ourand, the former president of SFX Financial Advisory Management Enterprises, for allegedly stealing client funds from 2006 to 2011. SFX was registered with the SEC as an investment adviser from 1992 through 2012.
In the second action, the SEC sued SFX and Eugene Mason, SFX’s chief compliance officer. The SEC charged Mr. Mason with causing SFX not to have adequate compliance policies and procedures reasonably designed to detect the theft by Mr. Ourand.
According to the SEC, during the relevant time, Mr. Ourand wrote unauthorized checks from client accounts to himself. Without client approval, he also allegedly wired funds from such accounts to others as well as himself. According to the SEC, Mr. Ourand stole in excess of US $670,000 from clients.
The SEC acknowledged that Mr. Mason discovered Mr. Ourand’s activities as a result of a client complaint. In response to the complaint, SFX and Mr. Mason investigated Mr. Ourand’s conduct, SFX fired Mr. Ourand, and SFX reported Mr. Ourand’s theft to criminal authorities, said the SEC.
The SEC said that Mr. Ourand was able to commit his fraud because SFX granted Mr. Ourand full signatory power over client bank accounts. This was because the firm’s compliance policies and procedures “were not reasonably designed, and were not effectively implemented, to prevent the misappropriation of client funds,” said the SEC. The SEC claimed that, as CCO, Mr. Mason was responsible for the implementation of these policies and procedures.
The SEC also said that SFX’s compliance policies and procedures mandated that there be a review of cash flows in client accounts. The SEC said that neither SFX nor Mr. Mason complied with this requirement.
As a result of these and other alleged violations, the SEC charged SFX with engaging in fraudulent conduct and failing to supervise Mr. Ourand, as well as with not having adequate written policies and procedures designed to avoid violations of law. The SEC charged Mr. Mason with causing SFX not to have such policies.
To resolve this matter, SFX agreed to pay a fine of US $150,000 and Mr. Mason a fine of US $25,000, among other sanctions. Mr. Ourand’s action is pending.
In a separate written statement, departing Securities and Exchange Commissioner Daniel Gallagher criticized this and another recent enforcement action involving BlackRock Advisors LLC (click here to access the relevant order) against chief compliance officers, claiming such actions misapplied Commission rules regarding who is responsible for implementing investment adviser compliance policies and procedures.
According to Mr. Gallagher, investment advisers have the responsibility to implement such policies under the applicable rule, not CCOs (SEC Rule 275.206(4)-7; click here to access). Mr. Gallagher claimed that any contrary position risks
sending a troubling message that CCOs should not take ownership of their firm’s compliance policies and procedures, lest they be held accountable for conduct that … is the responsibility of the adviser itself. Or worse, that CCOs should opt for less comprehensive policies and procedures with fewer specified compliance duties to avoid liability when the government plays Monday morning quarterback.
Mr. Gallagher said he voted against the two enforcement actions naming the CCOs of BlackRock and Mr. Mason because, in both cases, the SEC charged the CCO with not implementing compliance policies and procedures that addressed the substantive violation of the investment adviser (in the BlackRock matter, a conflict of interest of one of its portfolio managers and in the SFX matter, the misappropriation of clients funds by the adviser’s former president).
Mr. Gallagher claimed it is unfair to name CCOs in enforcement actions because the language of the relevant regulation "is not a model of clarity" although it appears to place the burden for implementing compliance policies and procedures on investment advisers, not CCOs. In any case, he said, “we should not be resolving this uncertainty through enforcement actions.”
My View: Mr. Gallagher’s legal analysis is spot on. The relevant regulation clearly states that if you are an investment adviser you must “adopt and implement written policies and procedures to prevent violation by you and your supervised persons” of applicable law (emphasis added). The same regulation separately says that chief compliance officers are responsible for administering such policies. The difference between the responsibilities of the adviser itself and the CCO could not be clearer and Mr. Gallagher is diplomatic when he says the relevant language is "not a model of clarity." Worse, the recent enforcement actions against BlackRock’s and SFX’s CCOs continue a worrisome development worldwide whereby regulators increasingly are looking to CCOs as the insurers of financial services firms’ overall compliance with law. (Click here for background in the article, "FCA Sanctions Bank of Beirut, Former Compliance Officer and Former Internal Auditor for Providing Misleading Information Regarding AML Systems and Controls Remediation" in the March 8, 2015 edition of Bridging the Week.) As Mr. Gallagher correctly points out, this confuses the role of CCOs with business supervisors, and places on CCOs untenable obligations and potential liability.
- Causing “Atypical Price Activity” in Gold Futures Results in US $200,000 Fine by COMEX: The Commodity Exchange, Inc. filed a disciplinary action against Mirus Futures LLC (now known as Ninja Trader Brokerage), claiming that on January 6, 2014, the firm failed to monitor the functioning and connectivity of its trading platform with CME Group’s Globex electronic system. According to the exchange’s notice of disciplinary action, “[t]his failure resulted in unusually large and atypical price activity …which resulted in a disruptive and rapid price movement in the February 2014 Gold Futures market and prompted a Velocity Logic event.” (Generally, a velocity logic event occurs when the market moves a predetermined number of ticks up or down within a predefined time and prompts a temporary pause in trading; click here for details.) COMEX charged Mirus with failure to supervise and conduct detrimental to the exchange. The firm settled with COMEX by agreeing to pay a fine of US $200,000. Separately LCM Commodities, Inc. agreed to pay a fine of US $95,000 to the New York Mercantile Exchange for allegedly executing “numerous” block trades for customers from November 2012 through April 2013 and not reporting such transactions within required time frames and failing initially to report accurate trade details. In addition, Simon Posen agreed to pay a fine of US $75,000 and be suspended from accessing any CME Group market for five weeks because of his entry of “numerous” orders in gold and crude oil futures from September 2013 through February 2014 without the intent to trade, but to induce other market participants to trade against smaller orders of his on the opposite side of the market. When these smaller orders were executed, Mr. Posen cancelled his other orders within one-second claimed COMEX and NYMEX. Similarly, Raphael Kurlansik agreed to be fined US $35,000 by NYMEX and be suspended from accessing any CME Group market for 10 business days for allegedly entering large orders in heating oil futures on multiple days in June and July 2014 to also induce market participants to trade opposite smaller orders he had resting on the opposite side of the market. After receiving a fill on his smaller orders, Mr. Kurlansik canceled his large orders within one half second, claimed NYMEX.
Compliance Weeds: The Mirus Futures settlement serves as a reminder to firms of their obligation to ensure that their automated trading systems are functioning reliably at all times. Although exchanges may not have express provisions requiring firms to maintain robust ATSs, they will use a variety of provisions to prosecute firms if a breakdown in a system impacts a market detrimentally – including possibly charging a firm with disruptive trading itself. (Click here for more details in the article “CME Group and ICE Futures U.S. Each Fine a Trader for Automated Trading System Malfunction” in the March 29, 2015 edition of Bridging the Week.) Both the Financial Industry Association and the Futures Industry Association recently have published best practices for firms in connection with their ATSs. (Click here for details in the article “SEC Proposes FINRA Oversee Certain High-Frequency Trading Firms; FINRA and FIA Issue Best Practice Guidance” in the March 29, 2015 edition of Bridging the Week.) Firms with ATSs should review these best practices and adopt as many as practical.
- Former MF Global Broker Agrees to US $500,000 CFTC Fine for Attempting to Manipulate Palladium and Platinum Settlement Prices From 2006 Through 2008: Joseph Welsh, a former broker for MF Global, agreed to settle charges by the Commodity Futures Trading Commission against him that, from at least June 2006 through May 2008, he attempted to manipulate palladium and platinum settlement prices on the New York Mercantile Exchange. According to the CFTC, Mr. Welsh engaged in such conduct on behalf of Christopher Pia, the trader for his client, Moore Capital Management LLC. In a complaint filed in March 2012 (click here to access), the CFTC alleged that Mr. Pia entered orders to try to increase the prices of palladium and platinum during the closing period, which would impact the settlement prices. The CFTC charged that Mr. Welsh typically placed Mr. Pia’s market on close orders in the last five or ten-seconds of the closing period with a NYMEX floor clerk. According to the CFTC, “[Mr.] Welsh placed orders with the floor clerk with directions that indicated that he wanted to push the settlement prices higher.” To settle this matter, Mr. Welsh agreed to pay a fine of US $500,00, never to trade any platinum or palladium contracts regulated by the CFTC, and to attend annual continuing education programs for five years that address abusive and manipulative trading practices. The CFTC settled charges to a related complaint against Mr. Pia for his payment of a fine of US $1 million in 2011 (click here to access the relevant order of settlement), and against Moore for its payment of a fine of US $25 million in 2010 (click here to access the relevant order of settlement).
- SEC Sanctions Thirty-Six Underwriting Firms More Than US $9 Million for Misleading Offering Statements: Thirty-six municipal underwriting firms settled enforcement actions brought by the Securities and Exchange Commission related to their use of municipal offering statements that contained allegedly materially false statements or omissions. The SEC brought its actions under its “Municipalities Continuing Disclosure Cooperation Initiative,” announced in 2014, that offered favorable terms to municipal underwriters who self-report securities law violations rather than wait for such violations to be detected. (Click here for details in the article “SEC to Municipal Issuers and Underwriters: Come One, Come All – Turn Yourself In” in the March 17, 2014 edition of Bridging the Week.) The SEC also charged the firms with failure to conduct adequate due diligence to detect their false statements or omissions. Among the firms paying the largest fines – US $500,000 – were Goldman Sachs & Co., JP Morgan Securities, and Merrill Lynch, Pierce, Fenner & Smith. In aggregate, the firms agreed to pay US $9.29 million in fines.
- FCM Broker Fined US $1.2 Million by CFTC for Unauthorized Swaps Trading for Customer: The Commodity Futures Trading Commission settled charges against Christopher Evans for executing 30 unauthorized bilateral swap transactions opposite a customer in order to hide trading losses from the customer and his “unnamed” employer from January through July 2013. (According to the National Futures Association’s BASIC system, Mr. Evans was registered as an associated person with FCStone LLC from November 2007 through July 2013.) The unauthorized trades were alleged to have caused approximately US $1.2 million of trading losses for the aggrieved customer that were later reimbursed by Mr. Evans’ employer. The CFTC charged Mr. Evans with general fraud, fraud by deceptive devices or contrivances (under the CFTC’s new anti-fraud based manipulation authority), fraud in violation of business conduct standards for swap dealers and unauthorized transactions. In addition to paying a fine of US $1.2 million, Mr. Evans was required never to trade on or subject to the rules of any CFTC registered entity, among other prohibitions.
- Business and Principals Stopped by SEC From Transacting in OTC Security-Based Swaps With Retail Persons: The Securities and Exchange Commission enjoined Sand Hill Exchange, an unincorporated business, and Gerritt Hall and Elaine Ou, who both ran Sand Hill, from selling over-the-counter security-based swaps to retail clients. Under the Dodd-Frank Wall Street Reform and Consumer Protection Action, OTC security-based swaps may only be offered to highly sophisticated or financially capable persons or entities known as eligible contract participants. Mr. Hall and Ms. Ou effectively ran Sand Hill as a securities exchange, without required registration, beginning in February 2015 (thus any transaction on the exchange was effectively an OTC transaction). The exchange effectively offered binary options linked to liquidity events (e.g., mergers, initial public offerings and dissolutions) and to the value of private companies and their securities. Sand Hill accepted payments of deposits by customers in both US dollars and Bitcoin. In addition to ceasing the offer and sales of OTC security-based swaps to retail persons, the respondents agreed to pay a fine of US $20,000. Previously, Sand Hill refunded all deposits to users.
- Investment Adviser and Mutual Fund Board Members Sued by SEC for Inadequate Advisory Contract Approval Process: The Securities and Exchange Commission sued a mutual fund adviser, its principal and three mutual fund board members for violating their legal obligation to evaluate and approve contracts with any investment adviser to a mutual fund and for an investment adviser to provide such information as is “reasonably necessary” by the mutual fund board to evaluate the terms of such contracts. According to the SEC, Commonwealth Capital Management acted as an investment adviser to various mutual funds within the World Funds Trust and World Funds Inc. family. Prior to retaining CCM as investment adviser in 2008, WFT’s board requested certain documents from CCM and its owner, John Pasco, III, and asked them to complete a questionnaire. Among the information requested by the board was certain information related to how CCM’s fees compared to other advisers. This information was not provided. According to the SEC, the board asked for other information related to the nature and quality of CCM’s services; however, said the SEC, “[t]he materials CCM provided to the Trustees in response … did not permit a sufficient evaluation of the nature and quality of such services.” Nevertheless, the trustees of WTF approved the retention of CCM, claimed the SEC, without receiving all the information they reasonably needed to evaluate the relevant advisory contracts. Similarly, prior to retaining CCM as its investment adviser in 2009 and 2010, WFI’s board of directors implemented a similar process of requesting information from CCM and Mr. Pasco, and received similarly inadequate (and sometimes incorrect) information and documents, said the SEC. Similarly, WFI’s trustees approved CCM’s retention without receiving all the information they reasonably needed to evaluate CCM. As a result, charged the SEC, CCM did not provide all necessary information requested by the two funds’ boards, and, in the case of WTF, its trustees likewise failed to follow up when they did not receive information necessary for their evaluation. Mr. Pasco, claimed the SEC, caused CCM’s violations. Each of the three trustees agreed to a fine of US $3,250 by the SEC, while CCM, Mr. Pasco and Commonwealth Shareholder Services, Inc. – the fund administrator to WFT and WFI – agreed to be jointly and severally liable to pay an aggregate fine of US $50,000.
Compliance Weeds: In this matter, the requirement that an investment company’s board members request and evaluate information “as may be reasonably necessary” to appoint an adviser is established by statute (Section 15(c) of the Investment Company Act; click here to access). Thus the failure of board members to follow this requirement, including following up when incomplete information was provided in response to a request for information, may be deemed a violation of law, as the SEC charged in this matter. However, not following up on incomplete or facially inaccurate information in response to any internal investigation or review, or due diligence inquiry, could cause later regulatory issues for any regulated firm – whether the initial request was mandated by law or not – if it turns out that review of the missed information might reasonably have prevented a regulatory breach down the line. Moreover, the determination of reasonableness will likely only be determined after the fact. Be mindful!
And even more briefly:
- Worldwide Trade Organizations Endorse ISDA’s Key Principles for Governing Trade Reporting and Data Harmonization: Ten industry organizations, including the Managed Futures Association and the Futures Industry Association, endorsed principles for data reporting in connection with over-the-counter derivatives proposed by the International Swaps and Derivatives Association. Among other things, these principles call for the harmonization of reporting requirements across borders; the adoption and use of open standards (e.g., legal entity identifiers, unique trade identifiers, unique product identifiers); the adoption of global standards; the amendment of laws or regulations to permit policy makers to access and share data across borders, as necessary; and the tracking and measuring of reporting followed by the sharing of results with market participants and regulators.
- CFTC Staff Extends Expiration Date of No-Action Relief Related to Certain Reporting Obligations of Swap Dealers and MSPs: Staff of the Commodity Futures Trading Commission again extended no-action relief to swap dealers and major swap participants from their obligation to report valuation data for cleared swaps. The new extension expires June 30, 2016. (Click here for additional details in the article “CFTC Further Extends Valuation Data Reporting Relief for SDs and MSPs” in the June 19, 2015 edition of Corporate and Financial Weekly Digest by Katten Muchin Rosenman LLP.)
- ESMA and IOSCO Announce Their Strategic Direction Through 2020: Both the European Securities and Markets Authority and the International Organization of Securities Commissions disclosed their priorities through 2020. ESMA’s priorities will be to enhance its assessment of risks to investors, markets and financial stability; complete a single rulebook for all EU financial markets; encourage greater commonality in approach and coordination among the disparate EU regulators; and enhance its role as direct supervisor of certain entities including credit rating agencies and trade repositories. IOSCO announced 43 initiatives it will pursue through 2020, including also identifying risks from securities markets, technology and product development, including the unintended consequences of changes or proposed changes in law and regulations; developing standards and guidance for securities markets; and enhancing the exchange of information and cooperation in the supervision of markets and market intermediaries. Separately, ESMA also issued its 2014 annual report.
And finally -- A Letter to the Editor:
- Brian Kaye, a former head of the Fimat Group and a former head of the Commodities Division of Société Générale, wrote the following in response to last week’s article entitled “UK Fair and Effective Markets Review Calls for Upping the Standards in UK and Global Fixed Income, Currency and Commodity Markets” (click here to access last week’s edition of Bridging the Week):
This subject is very significant but your “my view” comment perhaps is insufficient.
Ethics and rules are not about the same thing. I am in NO WAY saying that abuses did not occur in “my day” but there was an ethical overlay that in some measure precluded the necessity for detailed rules. Indeed, as you say, detailed rules promote a box-ticking mentality rather than an ethical code.
One needs to go a little further, however and look at the RESULTS of ethical malfeasance: Who LOST as a consequence of LIBOR rigging? Who GAINED? Clearly the employers, direct and indirect LOST because they were being defrauded into paying bonuses that were revenue-related, but in the wider world? For every borrower who was hurt by a higher LIBOR there was a depositor who obviously benefitted from a higher LIBID.
That the manipulators are scumbags is evident. That they do not deserve to work in any respectable company – ditto. But there needs to be SOME sense of proportion.
Got a vague feeling that compulsory reading (and testing thereon) of a biography of Teddy Roosevelt might be more use than a boxful of rules.
For more information, see:
Business and Principals Stopped by SEC From Transacting in OTC Security-Based Swaps With Retail Persons:
Causing “Atypical Price Activity” in Gold Futures Results in US $200,000 Fine by COMEX
Mirus Futures (Ninja Trading):
CFTC Staff Extends Expiration Date of No-Action Relief Related to Certain Reporting Obligations of Swap Dealers and MSPs:
ESMA and IOSCO Announce Their Strategic Direction Through 2020:
FCM Broker Fined US $1.2 Million by CFTC for Unauthorized Swaps Trading for Customer:
Former MF Global Broker Agrees to US $500,000 CFTC Fine for Attempting to Manipulate Palladium and Platinum Settlement Prices From 2006 Through 2008:
Investment Adviser and Mutual Fund Board Members Sued by SEC for Inadequate Advisory Contract Approval Process:
Investment Adviser Chief Compliance Officer Blamed in SEC Lawsuit for President’s Theft of Client Funds; SEC Commissioner Criticizes Enforcement Actions Against CCOs Generally:
SFX and Mason:
Statement of Commissioner Gallagher:
SEC Sanctions Thirty-Six Underwriting Firms More Than US $9 Million for Misleading Offering Statements:
Worldwide Trade Organizations Endorse ISDA’s Key Principles for Governing Trade Reporting and Data Harmonization:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 20, 2015. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.
© 2021 Katten Muchin Rosenman and Gary DeWaal. All Rights Reserved.