Investment advisers, as fiduciaries, are required to disclose material conflicts of interest. Those disclosures should be incorporated into their brochure – Part II of Form ADV. Those obligations, and the repeated failure of advisers to properly disclose material conflicts, are at least part of the reason the number of actions brought against investment advisers have continued to rise in recent years. The Commission’s most recent case in this area focuses not just on a failure to disclose a potential conflict but false representations that helped conceal the conflict. In the Matter of WBI Investments, Inc., Adm. Proc. File No. 3-19904 (August 5, 2020).

Respondents WBI and Millington Securities, Inc. are registered investment advisers. Millington is affiliated with WBI and serves as an introducing broker for that firm’s orders placed on behalf of advisory clients. Those clients included two ETFs. Millington did not charge WBI or its clients explicit commissions for its brokerage services.

Millington was in fact paid for order flow. To execute the orders forwarded by WBI, Millington sent them to a group of executing brokers each day. The orders were executed in large blocks by the group of executing brokers. Millington charged a flat fee for each share of stock purchased or sold, typically $0.0125 for a trade and $0.0150 for an ETF. Stated differently, the firm was paid for order flow. The amounts collected were retained by Millington.

The executing brokers were paid by Millington through a net trading arrangement. Under that arrangement the securities bought or sold in the market were executed at one price and then bought or sold at a different price. The prices were netted with the difference going to the executing brokers.

Clients were told that Millington received payment for order flow in connection with orders placed by WBI on behalf of clients. That arrangement would continue even if an arrangement with another broker might be cheaper for clients, according to the disclosure.

What clients were not told until early 2017 is that the payment for order flow arrangements in general added or subtracted, depending on whether the transaction was a purchase or sale, about $0.02 to $0.03 per share to the market prices received by the executing brokers. Clients were also not told that the arrangement impacted the prices at which WBI’s client orders were executed. Indeed, on three instances in the late fall to early spring time period of 2014 and 2015 Respondents gave assurances that the payment for order flow arrangements did not affect the price at which WBI’s client orders were executed.

The statements made by Respondents were materially misleading. In addition, at the time neither firm had adopted and implemented policies and procedures designed reasonably to prevent such violations. The Order alleges violations of Advisers Act Sections 206(2) and 206(4).

To resolve the proceedings each Respondent consented to the entry of a cease and desist order based on the sections cited in the Order and to a censure. In addition, Millington will pay a penalty of $250,000 while WBI will pay $750,000. The funds will be transferred to the general fund of the U.S. Treasury, subject to Exchange Act Section 21F(g)(3).

Print Friendly, PDF & Email
Tagged with: , ,

Financial fraud has long been a key area for SEC Enforcement. Despite efforts such as forming a new task force, few significant financial fraud actions have been filed in recent years. Nevertheless, on the last day of July the Commission did file a financial fraud case against an issuer and others, In the Matter of Valeant Pharmaceuticals International, Inc., Adm. Proc. File No. 3-19899 (July 31, 2020).

The Quebec based pharmaceutical firm has shares listed on the TSX in Toronto and the NYS. In 2014 and 2015 the firm was pursuing a growth by acquisition strategy. In conjunction with that approach the firm adopted certain non-GAAP disclosures that it claimed were meaningful and consistent with operations and trends.

Part of the firm’s strategy centered on its relation with Philidor Rx Services LLC, a licensed pharmacy based in Hatboro, Pennsylvania that was formed in early 2013. Valent acquired an option to purchase the pharmacy in mid-December 2014. The relationship was terminated on October 30, 2015 following extensive media reports discussing the relation.

By the end of the third quarter of 2014 Valeant obtained a $75 million order from Philidor. The order included one-time special pricing implemented by the company under which Philidor paid 4% over the wholesale cost, something not available to Valeant’s other clients. The arrangement also exceeded Philidor’s credit limit. Valeant then approved a $70 million credit increase to permit the order to be processed. At the time, Philidor had a significant account receivable and an overdue balance with Valeant.

In early December 2014, Valeant received a $130 million order from Philidor. Another credit increase was approved. Valeant did not follow its standard operating procedure in approving the increase. Later one of the products had to be substituted with an equivalent dollar cost. The contract was executed about two weeks later.

When Valeant reported its results for the quarters ended September 30, 2014 through September 30, 2015 the disclosures were misleading. Specifically, while the company announced double digit organic growth for each quarter, that would not have been true in the third quarter without Philidor. While the firm claimed to have exceeded its guidance and analysts’ consensus on Cash EBP (one of its non-GAAP measures), that would not have happened without Philidor. And, while the dermatology unit reported significant revenue for the third and fourth quarter of 2014, there was no acknowledgement that Philidor accounted for 13% and 16% of those revenues in 3Q and 4Q. Indeed, Valeant did not disclose the requisite information about Philidor in the MD&A section of its quarterly reports on Form 10Q and annual report on Form 10K.

In the second quarter of 2015 the firm recorded revenue for price appreciation credits received under its Distribution Service Agreements with wholesalers. A provision in the agreement allowed the Valeant to offset distribution fees owed to wholesalers with credits for price increases on its products held by wholesales in inventory. Under this approach price increases actually increased revenue in two ways. First, from the actual price increase. Second, from the previously sold products held by wholesalers.

In June 2015 Valeant recorded about $110 million in net price appreciation revenue through a 500% price increase on one drug. The entire amount of the increase was erroneously attributed as revenue to numerous products.

Four months later the firm made an investor presentation regarding Phildor. The presentation was in response to media and analyst presentations. In April 2016 the firm restated the financial statements for the year ended December 31, 2014 that had been included in its annual report on Form 10-K. Reported revenue attributed to Philidor was reduced by about $58 million – the revenue had been recognized prematurely. The firm also disclosed the existence of the price appreciation agreements for the first time. It did not disclose the impact from those clauses earned in 2015 on certain GAAP and non-GAAP measures. The Order alleges violations of Securities Act Sections 17(a)(2) and 30, and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and certain related rules.

Respondent resolved the proceedings, consenting to the entry of a cease and desist order based on the sections and rules cited in the Order. The firm also cooperated with the investigation and engaged in certain remedial acts. Respondent also agreed to pay a penalty of $45 million. The funds will go to a fair fund. See also In the Matter of J. Michael Pearson, Adm. Proc. File No. 3-19900 (July 31, 2020)(CEO and COB of the firm; resolved similar charges with consent to a cease and desist order based on the same sections and, in addition, SOX Section 304(a); paid penalty of $250,000); In the Matter of Howard B. Schiller, Adm. Proc. File No. 3-19901 (July 31, 2020)(Ex. V.P. and CFO; resolved with a consent to a cease and desist order based on same sections as forgoing proceeding; and payment of $100,000 penalty); In the Matter of Tanya R. Carro, CPA, Adm. Proc. File No. 3-19902 (July 31, 2020)(controller of firm; resolved with a consent to a cease and desist order based on the same sections as above (Order include Rule 102(e)), an order denying her the privilege of appearing and practicing before the Commission as an accountant with the right to reapply after one year; and the payment of a penalty in the amount of $75,000).

Video Program: “Securities Fraud, the Pandemic and Compliance: Protect Your Organization,” August 6, 2020, 12:00 p.m. ET. Chair, Tom Gorman. Free registration, materials & CLE (here)

Print Friendly, PDF & Email