by T. GormanPosted on Posted in SECActions

The Commission brought its first action based on Exchange Act Section 15B(c)(1) as amended by Section 275 of Dodd-Frank. Under that provision municipal advisors and their associated persons have a fiduciary duty to their municipal entity clients and are prohibited from participating in any act which is not consistent with their fiduciary duty. In the Matter of Central States Capital Markets, LLC, Adm. Proc. File No. 3-17170 (March 14, 2016).

Central States is registered with the SEC as a municipal advisor, broker-dealer and investment adviser. It was also registered with the state of Missouri as a broker-dealer. Respondents Mark Detter, David Malone and John Stepp are executives at Central States.

Mr. Stepp first became associated with Broker-Dealer in 2008. In 2009 he brought Messrs. Detter and Malone to the firm. The three men provided municipal advisory and municipal underwriting services to municipal entity clients.

In August 2010 Mr. Stepp formed Central States with the intention of separating from Broker-Dealer and taking the municipal advisory and underwriting business he managed with him to the new entity. The firm became a registered municipal advisor with the MSRB. In 2011 Mr. Stepp hired Messrs. Detter and Malone – they joined Central States. The three men remained with Broker-Dealer under Independent Representatives Agreements.

In April 2011 City Council approved an advisory agreement with Central States. Between May and September 2011 the City issued two sets of Temporary Improvement Notes and one set of General Obligation Refunding Bonds. Central States acted as municipal advisor for each offering. As part of its services Messrs. Detter and Malone also procured underwriting services for the three City offerings. Although Broker-Dealer was nominally listed as the underwriter, the associated persons of the Broker-Dealer who furnished those services were full time employees of Central States.

Messrs. Detter and Malone did not disclose the dual role of certain Central States employees when drafting the official statements and offering circulars for the three offerings. The documents stated only that Broker-Dealer was the underwriter and Central States the municipal adviser. The Order alleges violations of Exchange 15B(c)(1) and certain MSRB Rules.

To resolve the action each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order and MSRB Rule G-17 (failure to disclose certain conflicts). The order as to each individual also included MSRB Rule G-23 (prohibits serving as financial adviser and underwriter at same time). The firm was censured. In addition, the firm will pay disgorgement of $251,650, prejudgment interest and a penalty of $85,000. Messrs. Detter and Malone were each barred from association with a broker-dealer and from association with an investment adviser with a right to apply for re-entry after, respectively, two years and one year. Mr. Stepp is subject to a similar prohibition for six months. Finally, Messrs. Detter, Malone and Stepp will each pay a penalty in the amount of, respectively $25,000, $20,000 and $17,500.

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by T. GormanPosted on Posted in SECActions

The SEC’s examination staff has, in recent years, become very aggressive. Some claim it is the front edge of enforcement. Regardless of your view, it is typically beneficial to follow their suggestions. Three indirect subsidiaries of American International Group, Inc. recently learned this lesson the hard way. In the Matter of Royal Alliance Associates, Inc., Adm. Proc. File No. 3-17169 (March 14, 2016).

Respondents in the proceeding are Royal Alliance, SagePoint Financial, Inc. and FSC Securities Corporation. Each is a registered broker-dealer and investment adviser. Each is owned by AIG Advisor Group, Inc., which provides certain shared services, including compliance support for the advisory businesses. Advisor Group is indirectly owned by AIG.

The proceeding centers on undisclosed conflicts and the failure to properly implement procedures to avoid reverse churning despite warnings from OCIE, the Commission’s inspection staff. During the period here Advisor Group firms failed to devote sufficient resources to their compliance infrastructure to support the investment advisory businesses, according to the Order.

First, the Advisory Group firms served primarily retail clients. They invested through an Advisory Managed Program or AMP in portfolios of securities which included stocks, bonds and mutual funds, depending on investment objectives. Clients paid an ongoing advisory fee in the form of either an inclusive “wrap” fee that covered both the advisory services and trading costs or a non-wrap fee which excluded the trading costs which were paid separately.

Over a two year period beginning in 2012, Respondents invested advisory clients in mutual fund share classes with 12b-1 fees when there were lower-fee classes of the same funds available that did not have such charges. In their capacity as broker-dealers Respondents were paid the 12b-1 fees from the AMP advisory client investments. This resulted in Respondents being paid about $2 million in 12b-1 fees that would otherwise not have been available. While the firms disclosed in Forms ADV that 12b-1 fees were paid, the conflict with regard to the selection of mutual fund shares was not. This resulted in a breach of fiduciary duty by Respondents.

Second, under the advisory compliance policies and procedures in effect since 2009, the three firms were required to monitor the level of trading activity in their advisory accounts for inactivity or what is called reverse churning. That results when the client is charged a wrap fee that includes advisory services and trading costs but the client trades infrequently. Under those circumstances a wrap fee may not be advantageous for the client.

Under Advisor Group procedures there should have been a review periodically to avoid reverse churning. In 2010 OCIE discovered that there had been a significant lap of time since the last review. Following the review the three firms refunded about $526,739 and enhanced their inactive account procedures. The same issue arose when OCIE began another examination in 2013. This review resulted in a refund to 1,392 advisory clients of $739,500.

The Order alleges violations of Advisers Act Sections 206(2), 206(4) and 207. In resolving the matter the SEC took into account the remedial efforts of Respondents. The firms also agreed to implement a series of undertakings which included the retention of an independent consultant.

Respondents consented to the entry of a cease and desist order from committing or causing any violations and any future violations of the Sections cited in the order. They were also censured. In addition, the three firms, jointly and severally, agreed to pay disgorgement of $1,956,460 along with prejudgment interest. They will also pay on the same basis a penalty of $7.5 million.

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