SEC ENFORCEMENT TRENDS 2011: Regulated Entities

This is the eleventh in a series of articles that will be published periodically analyzing the direction of SEC enforcement.

The Commission has brought a number of significant cases involving regulated entities in recent months. The cases can be grouped into three categories: 1) Wall Street brokers and bankers; 2) Failure to supervise; and 3) Short selling, churning, misappropriation and similar claims.

Wall Street brokers and bankers

Actions against Wall Street brokers and bankers in some instances were grounded on conflicts of interest where the house benefited at the expense of the client or one client was favored over another. Others cases center on the failure of the firm to fully inform its clients about the impact of the market crisis on its financial statements or a managed fund.

The most significant action against a major Wall Street bank in recent months is Goldman Sachs discussed earlier in this series (here). At the center of what appeared to be an exceeding complex case are claims based on straight forward undisclosed conflicts of interest in which Goldman essentially favored hedge fund client Paulson and Co. over other clients who were solicited to purchase shares in the ABACUS entity. Accordingly to the SEC ABACUS was built at the behest of Paulson so it could bet against the subprime mortgage market. Its construction favored those wagers. Those solicited by Goldman to purchase shares in ABACUS were not told these facts however. The action settled as to Goldman with a consent to a fraud injunction and the payment of a record $550 million civil penalty.

The actions against ICP Asset Management and Wells Fargo also involve conflicts of interest. SEC v. ICP Asset Management, LLC, Civil Action No. 10-cv-4791 (S.D.N.Y. Filed June 21, 2010) is an action against ICP Asset Management, LLC, a registered investment adviser and its related entities, all of which are controlled by defendant Thomas Priore.

The complaint centers on a series of transactions involving four multi-billion dollar collateralized debt obligations known as Triaxx CDOs. According to the SEC, ICP Asset Management and the other defendants engaged in repeated fraudulent conduct to the detriment of its clients. In one series of transactions, it caused the Triaxx CDOs to overpay for bonds, frequently to protect other clients. ICP Asset Management directed more than a billion dollars in fraudulent trades for Triaxx CDOs that were similar and at inflated prices. The defendants also structured trades which benefited its affiliates at the expense of the CDOs, caused them to enter into prohibited transactions and misrepresented the value of the holdings. By early 2010, most of the bonds held by the Triaxx CDOs had been downgraded to junk status from AAA. The case, which alleges violations of Securities Act Section 17(a), Exchange Act Sections 10(b) and 15(c)(1)(a) and Advisers Act Section 206, is in litigation.

The actions against Wells Fargo Securities are based on the sale of two collateralized debt obligations tied to the performance of residential mortgage-backed securities at a time when the housing market was beginning to show signs of distress. Wachovia Capital Markets structured and sold the securities. The Order claims the antifraud provisions were violated in two respects. First, undisclosed excessive mark-ups were charged. Second, with respect to one, Wachovia represented that it acquired assets from affiliates on an arms length basis and at fair market prices. In fact certain assets were transferred from an affiliate at above market prices. To resolve the matter Respondent consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3). In addition, Well Fargo agreed to disgorge $6.75 million and pay a civil penalty of $4.45 million. Respondent was also directed to put portions of the sums paid in a fair fund while other sums were paid directly to purchases. In the Matter of Wells Fargo Securities LLC, Adm. Proc. File No. 3-14320 (April 5, 2011).

In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Admin. Proc. File No. 3-14204 (Jan. 25, 2011) centered on claims that the firm misused customer order information, charged certain customers undisclosed trading fees and failed to maintain proper records in violation of Exchange Act Sections 15(c)(1)(A), 15(g) and 17(a). The conduct on which the Order is based occurred from 2002 through 2007. It involves three types of transactions. The first concerned the use of certain customer order information by the firm’s proprietary Equity Strategy Desk. The second involved improper mark-up and mark-down charges on orders for certain institutional and high net worth individuals, contrary to the firm’s representations to those customers. Finally, in some instances during the time period Merrill agreed to guarantee a customer a specific per-share execution price or a price tied to an agreed upon benchmark. The firm however failed to record them in writing as required by Section 17(a)(1). As a result of this conduct Merrill violated not only the Sections cited above but it also failed to reasonably supervise persons subject to its supervision as required by Section 15(b)(4)(E).

To resolve the matter Merrill consented to the entry of a cease and desist order and agreed to pay a $10 million civil penalty. See also In the Matter of Kimball L. Young, File No. 3-1418 (Jan. 7, 2011); In the Matter of Thomas S. Albright, File No. 3-14179 (Jan. 7, 2011)(action based on charging unauthorized fees).

Other actions brought against Wall Street firms focused on a failure to disclose the effects of the market crisis as it unfolded. The Commissions’ complaint against Citigroup is based on this type of claim as discussed earlier in this series (here). There the firm failed to disclose the full extent of its exposure to the subprime market as it collapsed. Essentially only one of its three portfolios of subprime holdings was disclosed despite the fact that two senior officers were repeatedly told about the undisclosed portfolios. The action settled with the consent of the bank to an injunction based on the books and records provisions, the payment of a penalty and the adoption of new procedures. The two officers involved were named as respondents in an administrative proceeding. Each settled, consenting to the entry of a cease and desist order based on causing books and records provisions and with the agreement to pay a civil penalty.

The actions involving Charles Schwab also center on the market crisis. In this instance its impact on investments in the firm’s YieldPlus Fund. In the Mater of Charles Schwab Investment Management, Adm. Proc. File No. 3-14184 (Jan. 11, 2011); SEC v. Charles Schwab Investment Management Inc., Civil Action No. CV-11-0136 (N.D. Cal. Jan. 11, 2011). The cases are based on four primary claims. First, the SEC alleged that investors were not properly informed about the risks of the Fund. Second, the Fund violated its concentration policy as the market spiraled down during the crisis. Third, misrepresentations were made to investors about the Fund as its NAV as the market began to decline in mid-2007. Finally, the Commission claimed that there were insufficient policies and procedures reasonably designed to prevent the misuse of material, non-public information about the Fund.

The SEC’s complaint and the Order allege violations by: Charles Schwab Investment Management (“CSIM”), a registered investment adviser, and Charles Schwab &Co. (“CS&Co.”), the distributor and transfer agent for the YieldPlus Fund, of Securities Act Sections 17(a)(2) and (3) and aiding and abetting and causing violations of Investment Company Act Section 34(b); by Charles Schwab Investment Management (“CSIM”) of Advisers Act Section 206(4); by Schwab Investments, a series investment company registered under the Investment Company Act, of Section 13(a) of that Act; and by CS&Co. of Exchange Act Section 15(g).

To settle the civil action CSIM and CS& Co. agreed to pay a total of $118,944,996 including $52,327,149 in disgorgement of fees by CSIM, a penalty by CSIM of $52,327,149, a penalty of $5,000,000 by CS&Co. and prejudgment interest. CSIM’s disgorgement obligations can be satisfied in part by payment within 60 days in a related FINRA proceeding of up to about $26.9 million. The Commission is seeking to establish a Fair Fund.

In the related administrative proceeding CSIM, CS&Co. and Schwab Investments consented to the entry of an order requiring them to cease and desist from committing or causing future violations of the sections cited above. CSIM and CS&Co, were also censured and required to retain an independent consultant. Each Respondent was directed to comply with its undertakings.

Another action tied to the impact of the market crisis is the proceeding against Morgan Kegan. In this action the claims centers on charges of false NAV calculation based on the failure to take the required write downs and the market declined. In the Matter of Morgan Asset Management, Inc., File No. 3-1847 (Apr. 7, 2010). The Respondents are Morgan Asset, a registered investment adviser, Morgan Keegan, a broker dealer, James Kelso, Jr., a senior portfolio manager for Morgan Asset and Joseph Weller, an employee of Morgan Keegan where he was controller and head of its Fund Accounting Department. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 206 based on false NAV calculations for five funds which prevented a write down of assets backed by sub-prime loans. The case is in litigation. A related proceeding was brought by FINRA.

Finally, In the Mater of AXA Roenberg Group, Adm. Proc. File No. 3-14224 (Feb. 3, 2011) is a case which involved a computer modeling error that resulted losses in client accounts. The proceeding naming as Respondents AXA Rosenberg Group LLC, a holding company, AXA Rosenberg Investment Management LLC, an institutional money manager and registered investment adviser, and Bar Rosenberg Research Center LLC, an investment adviser that developed and maintained the computer model at issue here. According to the Order, in June 2009 senior management at the holding company and the money manager discovered that there was an error in a computer model used in the management of the portfolios. The error was fixed for U.S. managed portfolios in September 2009 and for others in late October and early November. However, it adversely impacted 608 of 1421 client portfolios managed by AXA Rosenberg Investment and caused $216,806,864 million in losses. In November 2009 an employee informed the CEO of the money manager and an investigation was conducted. It was disclosed to the Commission in late March 2010 and to investors, who had been complaining about performance, on April 15, 2010. The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Advisers Act Sections 206(2) and 206(4).

To resolve the proceeding Respondent AXA Rosenberg consented to the entry of a cease and desist order based on the Securities Act Sections cited in the Order. Respondent AXA Rosenberg Investment Management also consented to the entry of a cease and desist order based on Advisers Act Section 206(2). Respondent Barr Rosenberg consented to the entry of a cease and desist order based on Advisers Act Sections 206(2) and 206(4). Respondents also agreed to pay a penalty of $25 million and to implement certain undertakings. In accord with their undertakings Respondents will compensate clients for the harm caused by the conduct set forth in the Order in the total amount of $216,806,864. This amount was calculated by an expert retained by AXA Rosenberg Group.

Failure to supervise

Failure to supervise has traditionally been a key focus of SEC Enforcement with regard to regulated entities. In 2010 and early 2011 the Commission brought several cases in this area. Three significant actions are the Initial Decision in the actions involving former Farris Baker Watts General Counsel Ted Urban and those involving TD Ameritrade and Mellon Securities.

The Urban case traces to the difficulties Ferris confronted beginning in January 2003 when Stephen Glantz was hired as a registered representative. Mr. Glantz was a big producer but had a history of customer complaints. Stephen Glantz brought a number of clients to the firm, including David Dadante and his IPOF Fund. Difficulties with Messrs. Dadante and Glantz began almost immediately. By April 2003 there were compliance concerns about their trading. Mr. Dadante accumulated large positions in Innotrac, as did other accounts of Stephen Glantz. Eventually, IPOF’s position Innotrac’s poison pill. The Fund also accumulated millions of dollars in margin debt, exceeding $18 million at one point. Eventually Messrs. Glantz and Dadante pleaded guilty to securities fraud charges. Mr. Glantz was sentenced to 33 months in prison while Mr. Dadante received a thirteen year sentence. See, e.g., U.S. v. Glantz, No. 1:07-CR-464 (N.D. Ohio). The SEC filed a parallel case, SEC case. SEC v. Dadante, Case No. 1:06-cv-0938 (N.D. Ohio).

In the proceeding against Mr. Urban the Enforcement Division argued that he was the supervisor of Stephen Glantz. Once he became involved with addressing the red flags raised by his conduct Mr. Urban was obligated to respond vigorously and failed to do so, the Division argued. In the end Mr. Urban should have taken his concerns to the board of directors. He did not and thus violated his obligations according to the Division.

Chief Administrative Law Judge Brenda P. Murray rejected the Division’s arguments. There is no doubt that Stephen Glantz violated the antifraud provisions of the federal securities laws based on his guilty plea. Although Mr. Urban did not have “any of the traditional powers associated with a person supervising brokers . . .,” the case law dictates that he be considered a supervisor of Mr. Glantz. His position differed significantly from that of others who faced similar situations however. Here, the Judge concluded that “almost all the business leaders at FBW either lied to Urban or kept information from him, and people with clear supervisory responsibility over Glantz did not carry out their supervisory responsibilities. The undisputed evidence is that managers at FBW told Urban that Glantz was being supervised.”

Throughout the time period, the Judge found, Mr. Urban acted reasonably when confronted with a “red flag,” taking the appropriate follow-up action. Based on the information available to him, Mr. Urban had every reason to believe that the appropriate steps were being taken . . . The evidence in the record indicates Urban has a reasonable basis for relying on Akers’ representations.” Mr. Urban had few other options. He knew that other senior officials at the firm would not interfere with Mr. Akers, who had unquestioned authority over brokers. Likewise, going to the board of directors was not, as the Division argued, a viable option. Without the support of other executives, which he could not obtain, challenging Mr. Akers at the board level would be futile. Thus the Judge found “the evidence is that Urban performed his responsibilities in a cautious, objective, through and reasonable manner. He believed people were carrying out their responsibilities and he repeatedly prodded them to do so to assure that Glantz was being adequately supervised.” The Division of Enforcement has appealed to the Commission. In the Matter of Theodore W. Urban, Adm. Proc. File No. 3-13655, Initial Decision (Sept. 8, 2010)

An action for failure to supervise was also brought against TD Ameritrade. In the Matter of TD Ameritrade, Inc., Adm. Proc. File No. 3-14225 (Feb. 3, 2011). In this settled proceeding the Order alleged that for approximately eighteen months beginning in January 2007 Respondent failed to reasonably supervise its registered representatives in connection with the offer and sale of shares in the Reserve Yield Plus Fund, a mutual fund managed by The Reserve. There was a training program for registered representatives. However, at times the fund was mischaracterized as a money market fund or as safe as cash when in fact it was not. The Order alleges violations of Securities Act Section 17(a)(2).

The proceeding was resolved with Respondent agreeing to implement certain undertakings, to compensate certain customers which is expected to total up to $10 million and to the entry of a censure. No penalty was imposed at this time. If the undertakings are not fully implemented the Division of Enforcement reserved the right to reopen the matter for consideration of other relief.

In the Matter of BNY Mellon Securities LLC, Adm. Proc. File No. 3-14191 (Jan. 14, 2011) is a proceeding in which Order claimed that Respondent failed to reasonably supervise the manager on its institutional order desk and traders under his supervision from November 1999 through March 2008. During the period the order desk manager failed to meet his duty of best execution to certain customers. Orders were executed at stale or inferior prices which were frequently outside the National Best Bid and Offer at the time of execution. In some instances the orders were executed in cross trades with a favored handful of accounts held by hedge funds and certain individuals.

While Respondent had written supervisory procedures establishing a best execution committee, it failed to set up procedures to follow-up on red flags. Respondent also did not have procedures to determine if the order desk manager was fulfilling his responsibility to conduct a daily best execution review of executions on regional exchanges. Although Respondent maintained statistics which showed if executed orders were outside quote at a greater rate than industry averages, beginning in the third quarter 2003 there were no procedures to follow-up. The procedures for monitoring best execution obligations on regional exchanges were also inadequate. As a result of this conduct Respondent failed to reasonably supervise the order desk manager and his traders with the meaning of Exchange Act Sections 15(b)(4)(E) with a view to preventing and detecting violations of Securities Act Section 17(a). To resolve the matter Respondent agreed to certain undertakings and consented to the entry of a censure. Respondent also agreed to pay disgorgement of $19,297,016 along with prejudgment interest and a civil penalty of $1,000,000. The penalty was limited to that amount based on the cooperation of Respondent. See also, In the Matter of Mark Shaw, Adm. Proc. File No. 3-14192 (Jan. 14, 2011)(settled action against Mark Shaw, the registered representative and the institutional desk order manager at Mellon; the action settled with a consent to the entry of a cease and desist order based on the antifraud provisions, an order barring Mr. Shaw from association with any broker or dealer and directing that he pay disgorgement of $195,300 along with prejudgment interest and a civil penalty of $150,000).

Short selling, churning, misappropriation and other claims

The Commission has also brought a number of actions involving short selling, churning, suitability and misappropriation against regulated entities and their affiliates. These include:

Short selling: These actions are generally based on alleged violations of Rule 105 of Regulation M which prohibits buying an equity security made available through a public offering from an underwriter or broker or dealer participating in the offering after having sold short the same security during a restricted period (generally defined as five business days before the pricing of the offering). Recent settled actions include:

In the Matter of Peter G. Grabler, Adm. Pro. File No. 3-13886 (Filed May 11, 2010); SEC v. Grabler, Civ. Action No. 1:10-cv-10798 (D. Mass. Filed May 11, 2010). Between February 2006 and November 2008 Mr. Grabler violated the rule 124 times according to the Order. Respondent settled by consenting to the entry of a cease and desist order in the administrative proceeding and an order requiring him to disgorge his profits of $636,123 along with prejudgment interest of $35,232. In the civil action, he agreed to an order requiring him to pay a penalty of $318,061. See also Litg. Rel. 21522 (May 11, 2010).

In the Matter of Leonard Adams, Adm. Proc. File No. 3-13885 (May 11, 2010); SEC v. Adams, Civ. Action No. 1: 10-cv-10799 (D. Mass. Filed May 11, 2010). Mr. Adams is alleged to have violated Rule 105 in connection with at least 95 offerings from March 2006 through December 2008. He settled, agreeing to the entry of a cease and desist order and undertaking to pay disgorgement equal to his trading profits along with prejudgment interest. In the related district court action, he consented to the entry of an order requiring that he pay a civil penalty of $165,693.00. See also Litg. Rel. 21521 (May 11, 2010).

In the Matter of Carlson Capital, L.P., Adm. Proc. File No. 3-14066 (Sept. 23, 2010). In four instances in 2008, Respondent bought shares from an underwriter or broker participating in a public offering after having sold short the same security during the restricted period. As a result, Respondent made over $2 million in illegal profits. The firm settled, consenting to the entry of a cease and desist order from committing or causing any violations and any future violations of Rule 105 of Regulation M. The firm was censured and ordered to disgorge $2,256,386 along with prejudgment interest and to pay a civil penalty of $260,000.


SEC v. Konaxis, Case No. 1:11-CV-10489 (D. Mass. Filed March 23, 2011). Respondent was registered representative James Konaxis, formerly of Sentinel Securities, Inc. According to the Commission’s complaint, Mr. Konaxis excessively traded the account of a client. Initially it was valued at $3.7 million. After two years its value had diminished to about $1.6 million while the defendant earned approximately $550,000 in commissions. The client is a widow from September 11. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Mr. Konaxis consented to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint and to a penny stock bar. He has also agreed to have the court resolve issues regarding disgorgement, prejudgment interest and the imposition of a penalty. In a related administrative proceeding Mr. Konaxis has agreed to the entry of an order which will bar him from the securities industry. See also In the Matter of Prime Capital Services, Inc., Adm. Proc. File No. 3-13532 (Filed Mar. 16, 2010)(action based on suitability claims).


SEC v. Starr, Civil Action No. 10 CIV 4270 (S.D.N.Y. Filed May 27, 2010) is an action against investment adviser Kenneth Starr and his controlled entities. Mr. Starr has served as an investment adviser to high net worth individuals for years, managing client funds and in some instances paying their bills. According to the SEC, Mr. Starr abused his signatory power by misappropriating client funds. About $7.6 million of client money was used by Mr. Starr to purchase a Manhattan apartment for himself. In other instances, he improperly transferred client funds from their accounts for his personal use. His improper actions were facilitated by a failure to comply with the custody rules. The complaint, which seeks emergency relief including an asset freeze and the appointment of a receiver, is in litigation. A parallel criminal action was filed by the U.S. Attorney’s office in which Mr. Starr has pleaded guilty. U.S. v. Starr (S.D.N.Y. Filed May 27, 2010). See also SEC v. Juno Mother Earth Asset management, LLC (S.D.N.Y. filed March 15, 2011).

Next: Analysis and Conclusions