by T. GormanPosted on Posted in SECActions

The SEC has brought a number of custody rule cases as part of its broken windows initiative. Its newest proceeding centered on the custody rule, however, is a contested administrative proceeding which names as Respondents an adviser, its two principals, all of whom are securities law recidivists whose prior violations include the custody rule, and the adviser’s chief compliance officer. In the Matter of Sands Brothers Asset Management, LLC, Adm. Proc. File No. 3-16223 (October 29, 2014).

Named as Respondents are the registered investment adviser, Steven Sands, Martin Sands and Christopher Kelly. Sands Brothers Asset provides investment advisory service to a number of pooled investment vehicles. In 2010 the adviser settled a Commission administrative proceeding in which it was ordered to cease and desist from violating the custody rule, censured and paid a $60,000 penalty. The adviser has also been sanctions by the Connecticut Department of Banking for violations of the state’s securities laws. Steven and Martin Sands are co-founds of the adviser. Each is also subject to the 2010 Commission cease and desist order entered against the adviser. Steven Sands has had his broker-dealer registration subjected to a number of conditions by the State of Connecticut and his license suspended by the NASD. Martin Sands has twice been temporarily barred from association or suspended from holding supervisory positions, censured and fined by the NYSE and had restrictions imposed on his broker-dealer license by the State of Connecticut. Attorney Kelly is the chief compliance and operating officer of the adviser.

The custody rule requires an adviser to ensure that a qualified custodian maintains the client assets; has a reasonable basis for believing that the custodian sends quarterly account statements to clients; and ensures that client funds and securities are verified by actual examination each year by an independent public accountant. For an adviser to a pooled investment vehicle, the rule provides an alternative to the verification requirement if its audited financial statements are distributed to all limited partners within 120 days of year end.

In 1999 OCIE examined the adviser and sent a deficiency letter. The examination demonstrated that the representation in the adviser’s ADV stating that it did not have custody of client assets was incorrect. By virtue of the relationship of the adviser to the pooled investment vehicles, and the relationships of the two brothers and the managing member and general partners, Sand Brothers Asset did have custody of the client assets.

In 2010, as a result of subsequent OCIE examinations in 2004 and 2009, and an investigation by the Division of Enforcement, the adviser and brother were named in a Commission administrative proceeding. The proceeding alleged violations of the custody rule and was resolved as noted above.

From 2010 through 2012 Sand Brothers Asset continued to have custody of client assets. Yet the adviser did not submit to a surprise examination by an independent public accountant. The adviser did distribute its funds’ audited financial statements for fiscal years 2010 to 2012 but after the 120 time limit. The circumstances which caused the audits to be delayed were predictable and not unforeseeable. For example, for 2012 the auditors noted that there was a delay in receiving information from management regarding the valuation of assets.

Steven and Martin Sands aided and abetted the violations since they were responsible for ensuring that compliance personnel had the authority to implement whatever procedures and policies were necessary to ensure that the adviser complied with the Advisers Act.

Mr. Kelley, who was tasked in the compliance manual with ensuring compliance with the restrictions and requirements of the custody rule, knew that the audited financial statements were not being distributed on time. Yet at most he reminded people of the time deadline but failed to take any other steps.

The Order alleges violations of the custody rule. The action will be set for hearing.

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by T. GormanPosted on Posted in SECActions

Carter’s, Inc. is the investigation that just keeps on generating cases. The investigation has yielded seven SEC actions charging insider trading and financial fraud. Hedge fund manager Stephen Slawson became the eight person charged in the investigation. SEC v. Slawson, Civil Action No. 1:14-cv-3421 (N.D. Ga. Filed October 24, 2014).

Mr. Slawson is the co-founder and manager of hedge fund TCMP3 Partners L.P. In eight instances, beginning in 2006 and continuing through 2010, he is alleged to have traded on inside information which traces back to a Carter’s, Inc. and generated over $500,000 in illicit trading profits or losses avoided. Typically the information came to him from Dennis Rosenberg, a research analyst retained by the hedge fund. Mr. Rosenberg obtained the inside information from Eric Martin, a Carter’s vice president of investor relations before he was terminated in March 2009. Mr. Martin is currently serving a two year prison term after pleading guilty to one of eleven counts in an indictment charging him with securities fraud. Subsequently, the information came from Richard Posey, a Carter’s vice president of operations who furnished the information to Mr. Martin who then tipped Mr. Rosenberg who then tipped Mr. Slawson.

Mr. Martin is alleged to have illegally tipped Mr. Rosenberg on five occasions regarding up-coming earnings announcement for Carters, Inc. During his employment Mr. Martin tipped analysts such as Mr. Rosenberg who covered the company to develop his relationship with them. Mr. Slawson “knew or should have known that Rosenberg’s source at Carter’s was disclosing the information in violation of a fiduciary or similar duty of trust and confidence,” according to the complaint. The five instances where:

3Q 2006 financial results: Initially Mr. Martin informed Mr. Rosenberg that the financial results would not be positive. Mr. Rosenberg informed Mr. Slawson who caused the hedge fund to sell short. After receiving additional firm financial data, Mr. Martin reversed his position, telling Mr. Rosenberg, who tipped Mr. Slawson, that the results would be positive. Mr. Slawson covered the short position. Following the announcement the stock closed up. The hedge fund avoided a loss of about $27,000 by covering the short position.

1Q 2007 financial results: Mr. Martin learned that company earnings would significantly exceed analysts’ expectations. He relayed this information to Mr. Rosenberg who in turn tipped Mr. Rosenberg who caused the hedge fund to purchase shares. Following the earnings announcement the stock price closed up about $1.76 per share compared to the prior day, yielding $42,240 in profits for the hedge fund.

2Q2007 financial results: Mr. Martin again received negative information about the financial results for the quarter. The information was again transmitted down the chain to Mr. Slawson who caused the hedge fund to sell shares and sell short 20,000 shares. Following the earnings announcement the share price of Carter’s closed down about 8.52%. The hedge fund had a profit of about $114,480.

2Q2008 financial results: During the quarter Mr. Martin learned that his company would release earnings that would again exceed market expectations. As in the past he tipped Mr. Rosenberg who in turn tipped Mr. Slawson who caused the hedge fund to buy additional shares of Carter’s, Inc. Following the positive announcement the fund had profits of $17,820.

4Q 2008 financial results: Prior to the announcement of the financial results Mr. Martin learned that the financial results would be “generally positive” for the period. He conveyed that information down what by then had become the usual chain. The hedge fund purchased 10,000 shares of Carter’s stock. Following the announcement of the financial results, the share price closed up over 10% compared to the prior day. The fund had profits of about $15,200.

Following the termination of Mr. Martin, he obtained inside information from Mr. Posey which he then transmitted to Mr. Rosenberg and ultimately to Mr. Slawson in two instances and on another occasion, directly to the hedge fund manager. The first instance involved the second quarter 2009 financial results while the second involved an announcement that the company would delay announcing the third quarter 2009 financial results. In the first Mr. Posey told Mr. Martin that Carter’s would beat the street for the quarter. The information was transmitted to Mr. Rosenberg and then to Mr. Slawson who purchased shares in family accounts and for the hedge fund. Following the announcement of the results the share price closed up slightly, yielding ill-gotten gains in the personal and fund accounts of about $34,604. In the second instance the tipping process was repeated. Mr. Slawson sold shares from his personal account and that of the fund. Following the announcement the share price dropped 23.84% compared to the prior day. Collectively the accounts avoided losses of about $215,916.

Finally, Mr. Martin furnished inside information to Mr. Martin regarding Carter’s second quarter 2010 financial results, including the fact that future guidance would be negative. Mr. Martin furnished this information directly to Mr. Slawson as did Mr. Rosenberg. Based on Mr. Rosenberg’s “statements, the nature of the information provided, and his history of providing similar information, Mr. Slawson knew or should have known that the information was obtained from an insider in violation of a fiduciary or similar duty of trust and confidence,” according to the complaint. Mr. Slawson sold call options and shorted the stock. Following the announcement the share price declined by about $2. The total gains of the fund were about $42,240. Mr. Posey furnished the information to Mr. Martin “by virtue of their close friendship and Posey’s desire to enhance his reputation.”

The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The U.S. Attorney’s Office filed parallel criminal charges. Both cases are pending. See Lit. Rel. No. 23118 (October 24, 2014).

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