by T. GormanPosted on Posted in SECActions

Failure to disclose conflicts of interest and/or to comply with firm procedures are the predicates for a series of SEC enforcement actions involving regulated entities. The most recent example of these trends is an action involving an investment advisory subsidiary of a large financial services firm which was fined $20 million in an administrative proceeding. In the Matter of Guggenheim Partners Investment Management, LLC, Adm. Proc. File No. 3-16735 (August 10, 2015).

GPI is a registered investment adviser which provides services to institutional clients, high net worth individuals and private funds. It is a wholly owned, indirect subsidiary of Guggenheim Partners, LLC, a private financial services firm based in Chicago and New York. The Order alleges a series of violations:

Conflict: July 29, 2010 a GPI Client extended a $50 million loan to a Senior Executive of the advisor. Client had accounts managed by the advisor as well as other accounts. The loan was evidenced by a promissory note and secured by certain assets of Senior Executive, including his residence and personal guarantee. Although Client could demand payment at any time after August 30, 2010, the note had a two year term. Subsequently, on October 3, 2011 Senior Executive refinanced the obligation. During its term the obligation was current.

The purpose of the loan was to permit Senior Executive to invest in two transactions. In August 2010 GPI put certain advisory clients into the transactions. Client invested in the two transactions as did Senior Executive who participated in structuring them. The terms of Senior Executive’s investments differed from those of Client.

At the time of the loan the firm’s Code of Ethics and Insider Trading Policy specified that the firm and its employees owe a fiduciary duty to clients. It directed that employees were to avoid any actual or potential conflicts of interest. The Code also specified that full disclosure of conflicts be made to clients. While a number of firm executives knew of the loan, nobody informed the compliance staff. No disclosure was made.

Fees: Beginning in 2009 GPI inadvertently charged an institutional client $6.5 million in asset management fees for investments it did not manage. The firm provided non-advisory services for the client such as back office processing and trade reconciliation. Nevertheless, GPI charged the client an operational service fee that was lower than the asset management fee it charged for discretionary investments. Although the error was discovered in January 2013 the client was not notified for a year and the correction was not made for several more months.

Gifts: The GPI Code also specified that supervised persons could only accept gifts of de minimis value and that exceptions had to be approved by the chief of compliance on a case by case basis. Between 2009 and 2012 at least seven firm employees took 44 unreported flights on private client planes. Yet the compliance logs only recorded one flight. The firm thus failed to enforce its Code with respect to gifts, according to the Order.

Errors: In 2010 the firm failed to follow its policies and procedures regarding errors. That policy required that an appropriate investigation be undertaken and the matter documented. In September the firm entered an order for $80 million of bonds and then allocated them in a manner that conflicted with the underwriter’s rules. When the underwriter refused a request for an exception, the firm reallocated the purchase and labeled it a “trade fail” and a “trade revision” rather than following its procedures.

Books: The Order alleges that the firm failed to properly maintain its books and records. Certain assets not managed by GPI appear on its books and records. The firm’s order memoranda, however, designated the trades as having been entered pursuant to its discretionary authority when they were not. This resulted in inaccurate information being produced to the staff in response to a request.

The Order alleges violations of Advisers Act Sections 204, 204A, 206(2) and 206(4).

To resolve the proceeding the firm will implement certain undertakings, including the retention of a consultant and, generally, the implementation of the recommendations made by that person. The firm also consented to the entry of a cease and desist order based on the Sections cited in the Order, a censure and to pay a penalty of $20 million.

Tagged with: , , , ,

by T. GormanPosted on Posted in SECActions

Amid all the concern regarding the selection by the SEC of an administrative rather than a district court forum for brining agency enforcement action comes a decision which has the potential to change the tenor of the debate, at least temporarily. Administrative Law Judge Cameron Elliot issued an Initial Decision in which he found a Wells Fargo compliance officer violated Exchange Act Section 17(a) by altering documents during a Commission investigation but declined to impose any remedy or penalty as “overkill.” In the Matter of Judy K. Wolf, Adm. Proc. File No. 3-016195 (August 5, 2015).

The proceeding involving Ms. Wolf is one of three instituted by the Commission centered on the acquisition of Burger King by 3G Capital Partners. Initially, the agency brought an action against Wells Fargo broker Waldyr Da Silva Prado Neto, who misappropriated inside information about the transaction from a client, tipped others who traded and traded for his own account. SEC v. Prado, Civil Action No. 12-CIV-7094 (S.D.N.Y. Sept. 20, 2012); see also U.S. v. Prado, Case No. 13-mg-2201 (S.D.N.Y. Sept. 13, 2013). Then the Commission brought an action against Wells Fargo for failing to establish and enforce procedures to prevent the misuse of material, non-public information. In the Matter of Wells Fargo Advisors, LLC, Adm. Proc. File No. 3-16153 (Sept. 22, 2014).

The action naming Ms. Wolf is the third. She was a compliance consultant for Wells Fargo Advisors prior to her termination in June 2013. On September 2, 2010, the day the Burger King deal was announced, Ms. Wolf began a review of the trading surrounding the deal, according to the Order. She concluded that: 1) Mr. Prado and his customers represented the top four positions in Burger King securities firm-wide; 2) Mr. Prado and his customers purchased Burger King stock within 10 days of the announcement; 3) Mr. Prado and his customers each had profits that exceeded the $5,000 threshold specified in the review procedures; 4) Mr. Prado and Burger King were located in Miami; and 5) Mr. Prado, his customers and the acquiring company were all Brazilian. News articles about the event were not printed and included in the file despite a provision in the procedures requiring this step. The review was closed and not forwarded to the branch manager. Supervisors at Wells Fargo did not learn about the review until two years later when the SEC filed its insider trading action against Mr. Prado.

In July 2012 the Commission requested as part of its on-going investigation, that Wells Fargo produce its compliance files relating to Mr. Prado. Although the production was eventually certified as complete, it did not include Ms. Wolf’s file. When a second request was made in January 2013, that file was included in the production. Ms. Wolf’s log stated she opened an investigation on September 2, 2010 and recited the basic stock opening and closing prices, noting a 24% increase over the prior close. The notes also stated that rumors had been circulating for several weeks regarding a private equity group. It cited a price increase in the stock as of “9/2/12.”

Ms. Wolf provided contradictory testimony during the investigation. Initially, she testified that the file had not been altered. She claimed that the date of 9/1/12 in the file was a typo. Ms. Wolf stated that the news articles were a primary reason for closing the file. Later Wells Fargo produced documents indicating that the Burger King log entry had been altered on December 28, 2012. A prior version of the log was produced that did not contain the reference to the news articles. The metadata was produced. Following her termination from Wells Fargo the Commission took Ms. Wolf’s testimony a second time. During the testimony she admitted altering the log.

Following a hearing at which Ms. Wolf’s testimony was largely consistent with that of her second appearance before the staff during the investigation, she was found to have violated Exchange Act Section 17(a) as alleged in the Order. Wells Fargo had admitted to violations of Exchange Act Section 17(a) and the related rules.

While Ms. Wolf claimed during her testimony that it was not inappropriate to alter a compliance record after the fact as long as there was no “intent to mislead.” The Initial Decision found this testimony “unconvincing.” Ms. Wolf’s liability did not hinge on whether she knew about the Burger King acquisition rumors in 2010 when she closed her review. Rather, the critical question was whether “she knew, or recklessly disregarded the risk, that the altered Long [containing added information about the rumors] would ultimately be produced to the Commission, purporting to be the Log that existed in 2010 when she conducted her review. Even assuming that she had in fact reviewed the new articles regarding the acquisition rumors, by failing to note when . . . [the additions were added] to the Log, any viewer of the Log would have the erroneous impression that . . . [all the material] had been present in the original 2010 Log,” the ALJ concluded.

The ALJ also rejected testimony from Ms. Wolf that when she first testified during the staff in investigation in 2012 she did not recall having added the . . . [sentences] several weeks earlier and assumed they were from 2010. While Ms. Wolf claimed it was common practice to retroactively supplement the Log if that were the case “when Wolf testified in 2013, Wolf would have had no reason to assume that she must have added the Two Sentences in 2010 . . .” The conclusion that Ms. Wolf acted with scienter is bolstered by her motive. As she became aware that the Commission was expanding its inquiry regarding the Burger King deal, adding the information would make her review appear to be a better job.

The critical question was the remedy to be imposed. At the hearing Ms. Wolf presented testimony regarding her inability to pay. Since being discharged she has been unable to secure employment. Her son has been assisting her and she has been unable to pay her attorney.

Ms. Wolf’s former husband is on disability. She generally assists him with the related paper work and sometimes financially. Several assets for which she is listed as a co-owner are actually his. She testified that any fine over $100 would be a burden and anything over $500 would make it difficult for her to continue assisting her ex-husband.

In considering whether a cease and desist order should be entered the Steadman factors were used as a guide. There is no doubt that Ms. Wolf acted with scienter, the ALJ concluded. She also continues to insist that while a better job could have been done “she is not culpable” because there was no intent to deceive. While she regrets the “profound” effect this has had on her, Ms. Wolf “does not recognize the wrongful nature of her misconduct.”

Nevertheless, the incident was isolated and Ms. Wolf has provided assurances against future violations. Indeed, she is unlikely to ever be in a position to replicate her conduct.

While at least some factors weigh in favor of a sanction, “I find . . . that they are decisively outweighed by the remaining public interest factors: egregiousness, degree of harm, and deterrence.” Here the violation was not egregious and it did not cause any proven harm to investors in the market place.

The critical question becomes deterrence. Ms. Wolf is a low level employee. While others above her might have been charged and knew of her conduct, she did not attempt to implicate them. If she is sanctioned there is a likelihood that others in the industry would see it as “a bad apple,” resulting in no examination of their practices. That would be a “misperception, as the settled proceeding against Wells Fargo demonstrates. Wells Fargo clearly had much deeper and more systemic problems than one bad apple. . . Thus, any sanction here will not only fail to have the desired general deterrent effect, but may actually be counterproductive.”

One final factor is that Ms. Wolf worked in compliance. While those individuals are subject to the securities laws, the risk is much higher for them. “The temptation to look to compliance for the ‘low hanging fruit’ . . . should be resisted. There is a real risk that excessive focus on violations by compliance personnel will discourage competent persons from going into compliance, and thereby undermine the purpose of compliance programs in general,” the ALJ wrote, citing Commissioner Gallagher’s comments on charging compliance officials. While “I do not condone Wolf’s misconduct . . .it is clear that sanctioning Wolf in any fashion would be overkill. Accordingly, no sanction will be imposed.”

Tagged with: , , ,