Archive for April, 2013

SEC Sanctions RIA and its CEO for Deficient Compliance Program

Thursday, April 25th, 2013

The SEC has sanctioned Virginia-based Foxhall Capital Management (“Foxhall”) and its CEO based on an examination conducted in 2009.  While Foxhall had written compliance policies and procedures in place, the SEC found that they were not reasonably designed to prevent violations of the Investment Advisers Act and its rules.  Specific failures and deficiencies included, the following:

  • Failure to follow the stated policies and procedures written in its compliance manual;
  • Failure to maintain adequate records of its trading; and
  • Failure to timely conduct the required 2007 annual compliance review.

The cited deficiencies were primarily caused by Foxhall’s trade management system, which did not properly interface with its custodian’s trading platform.  Foxhall was aware of the issue in 2007, but did not replace its trade management system until 2009.  As a result, for the period in question, Foxhall did not possess accurate real-time information from the custodian regarding clients’ actual account balances when making initial allocations to clients for block trades.  Due to this inaccurate information, some clients who were allocated to receive certain shares did not have sufficient funds in their accounts to purchase the allocated shares.  Foxhall’s unwritten practice was to reallocate those unallocated shares to other clients with sufficient cash within the same investment model at the execution price.  Because Foxhall typically learned of the existence of the unallocated shares days later, this resulted in some clients paying more for the stock than they would have paid had Foxhall bought the shares on the open market at the time of the reallocation.   In particular, the SEC cited over 400 instances where Foxhall reallocated unallocated shares to clients other than those originally intended to receive the shares and those clients suffered approx $20,183 in losses.

The SEC found that Foxhall did not categorize the reallocated shares as trade errors, but treated them as administrative errors.  If the reallocated shares had been labeled as trade errors, Foxhall’s compliance procedures required Foxhall to document the trade error and perform a profit and loss analysis for the trade.  The written policy also required Foxhall to make any client whole if any trade error resulted in a loss to the client.

As a result of the above, Foxhall agreed to pay approximately $22,000 in disgorgement and prejudgment interest and a civil penalty of $100,000.  In addition, its CEO agreed to pay a civil penalty of $25,000.

Finra Backpedals, Pulls Plan Mandating Web Links to BrokerCheck

Thursday, April 25th, 2013

Investment News reported that FINRA has withdrawn its proposal that would have required FINRA members to include “a prominent description of and link to” BrokerCheck on their websites and social-media pages.

Every year, brokers have to provide the BrokerCheck hotline number and FINRA website address to their clients in writing. Under the proposal, a broker or firm’s website would have been required to include a direct link to the broker’s or firm’s specific BrokerCheck page.  FINRA proposed the rule as a way to increase investor usage of BrokerCheck. FINRA spokeswoman Michelle Ong said that the agency withdrew the rule due to feedback it received in 24 comment letters.

CFPB Seeks New Rules Requiring Advisors to Translate Their Professional Designations

Thursday, April 25th, 2013

In an attempt to reduce consumer confusion and risk, the Consumer Financial Protection Bureau released a report last Thursday (April 18), calling upon the SEC and Congress to set up new rules requiring advisers to provide information on their professional designations, the meaning of those certifications and the qualifications they impart.

In a cry that has been echoed for years now, the CFPB found that consumers, older Americans in particular, have trouble differentiating between the designations. The report offers recommendations to help facilitate and improve the ability of older consumers to sort out and assess the numerous varying “senior designation” titles that financial advisers use to market their services. These designations imply special training and experience in providing financial advice to seniors.

In one of its recommendations, The CFPB suggested that the SEC create a database for consumers to quickly and easily verify the designations. This envisioned database tool will provide users with the adviser’s existing designations, but in addition, would also allow for a comparison of the designations.


Advisers at Non-Protocol Firms Still Sued

Thursday, April 25th, 2013

According to a Wall Street Journal report on April 18th, litigation against brokers who depart AllianceBernstein Holding is picking up.  The firm is trying unusually hard to keep clients from walking out with their departing brokers, and has won injunctions in 8 of the 12 cases it’s filed since 2011.  Previously, in 2010, the firm didn’t sue a single departing broker.

“Clients have to believe that talking to us and sharing confidential client information is safe,” says Mr. Kraus, AllianceBernstein’s chairman and chief executive since December 2008.  Mr. Kraus says the money manager goes to court only when executives believe client information is being misused. In the latest lawsuit, filed last month, AllianceBernstein accused a financial adviser of reneging on an agreement to stay away from his old clients for 60 days after leaving for Credit Suisse Group.  In 2012, the firm sued a San Diego based FA who defected to Morgan Stanley, alleging he ”confidential client information” and gave it to Morgan Stanley a week before he left. The FA has contended that taking client contact information is consistent with securities-industry practice. The case is ongoing.   The number of recruitment related lawsuits generally has been shrinking since the introduction of the Protocol for Broker Recruiting in 2004.  But AllianceBernstein is not a member.  Some securities lawyers say the lawsuits are a warning to top-performing financial advisers who are still at AllianceBernstein’s private-client unit, but are discouraged by its recent performance.

Many advisors believe that the Protocol can be used for all departing brokers, but if your firm is not a signatory to the Protocol any employment restrictions are still effective, unless state law does not allow them or otherwise frowns upon them.

Raymond James Sweetens the Pot for Hybrids

Thursday, April 25th, 2013

As recently reported by Investment News, advisers with Raymond James Financial Services who have at least $100 million in discretionary assets under management can choose to retain 100% of their advisory fees and pay a quarterly fee based on assets under management, instead of the traditional payout on fee revenues they produce.  Raymond James will charge advisers six basis points on the first $100 million under management, three basis points on the next $100 million, one basis point on assets between $200 million and $300 million, and nothing after that, for a maximum of $100,000 per year.

Hybrids are among the fastest growing segments of the retail securities market and a key target for Raymond James. “It’s about getting competitive for advisers we want to attract, and partly a defensive move so we remain competitive for advisers here already,” said Scott Curtis, president of Raymond James Financial Services. “We have had a few significant teams [leave] in the last two-plus years,” he said. “It turned out that economically we couldn’t match offers from other organizations,” Mr. Curtis added, mentioning competitors like Schwab Advisor Services, Focus Financial Partners LLC, Hightower Advisors LLC and Dynasty Financial Partners.

Raymond James will also reimburse clients’ 12(b)-1 fees on fund shares in clients’ managed portfolios.  “No other organizations that we’ve seen that are [supporting hybrids are] allowing 12(b)-1 fees to flow back to clients,” Mr. Curtis said. “In all other cases they’re being retained by the custodial firms [and] it’s a material amount of revenue.”

Raymond James needed to act because “large reps with large advisory businesses at all the firms [are] very seriously considering leaving the [independent broker-dealer] platforms,” said Joe Duran, chief executive of United Capital Financial Partners, Inc.

DOL Guidance on Hiring Interns

Tuesday, April 23rd, 2013

As the summer approaches, many employers’ thoughts are turning to summer internship programs.  An important issue facing such companies, and one that has received a lot of media attention recently, is whether interns must be treated as employees.  If interns are considered employees they must be compensated for their services as required by the Fair labor Standards Act (“FLSA”).

The Department of Labor (“DOL”) uses six criteria to determine if interns should be excluded from the FLSA’s minimum wage and overtime pay requirement.  They are:

  1. The training received is similar to training which would be given in an educational environment;
  2. The internship is for the benefit of the intern;
  3. The intern does not displace regular employees, but works under the close supervision of existing staff;
  4. The business derives no immediate advantage from the activities of the intern; and on occasion, its operations may be impeded;
  5. The intern is not necessarily entitled to a job at the conclusion of the internship; and
  6. The business and the intern understand that the intern is not entitled to wages for the time spent in the internship.

The DOL has explained that if any one of these factors is not met, the intern will be classified as an employee and shall be subject to the requirements of the FLSA.  The intern would therefore have to be paid no less than the applicable minimum wage and overtime if more than 40 hours are worked in a week.  The DOL further explained that an internship that is focused around an employer’s business operations is likely to constitute employment as opposed to one that is structured around a classroom or academic experience.  If the business uses interns in place of employees or would have hired additional workers to do the work being done by the interns, the interns are employees entitled to compensation under the FLSA.

Business should provide prospective interns with a written agreement setting forth the goals and objectives of the internship program, the intern’s responsibilities and duties and any compensation or academic credit that will be awarded.  Further, as the classification of interns under the FLSA is a fact–specific inquiry, an attorney should be consulted before preparing such agreements and hiring interns.

Commisioner Aguilar Calls For End To Mandatory Arbitration Provisions

Tuesday, April 23rd, 2013

Earlier this year, we posted an article about Massachusetts’ call to ban mandatory arbitration clauses in agreements between advisers and their clients.  Certain states, such as North Carolina, do not have specific bans, but consider a mandatory arbitration clause to be a violation of an adviser’s fiduciary duty.

It now appears that the SEC Commissioner Luis Aguilar agrees.  In a recent WSJ article reporting on Aguilar’s speech at the annual NASAA conference, Aguilar is quoted as saying “investors should not have their option of choosing between arbitration and the traditional judicial process taken away from them at the very beginning of their relationship with their brokers and advisers.”  He goes on: “By providing investors with the ability to choose the forum in which to bring their legal claims and protect their legal rights, we enhance investor protection and add more teeth to our federal securities laws.”

Section 921(a) of the Dodd-Frank Act authorizes the SEC to prohibit or restrict mandatory pre-dispute arbitration provisions in customer agreements, if such rules are in the public interest and protect investors.  To date, the SEC has not exercised its rule making authority regarding mandatory arbitration provisions; however, if entirely up to him, Aguilar would change that.  In his concluding comments regarding arbitration provisions, he states, “I believe the Commission needs to be proactive in this important area. We need to support investor choice.”

Obama Budget Proposal Calls for Increase in SEC Funding

Tuesday, April 23rd, 2013

The White House released its FY 2014 budget proposal on April 10. Under the proposal, the SEC’s budget would see an increase from $1.42 billion to $1.67 billion. The increase comes in response to the Agency’s annual budget request, which stated that its top priority is to bolster examination staff to conduct adviser exams.

According to Agency data, only 8% of the approximately 11,000 registered advisers were examined in 2012. The Agency also noted that 40% of advisers active in 2012 have yet to have been examined.

The new appropriation for the SEC is projected to bring in 676 additional staff members (325 examiners), helping the Agency facilitate an increase in the percentage of advisers examined each year, the rate of first-time examinations, and the examination coverage of investment advisers and newly registered private fund advisers.

Representative Waters Introduces New User Fee Bill

Tuesday, April 23rd, 2013

Representative Maxine Waters of California has introduced H.R. 1627 (the “Bill”). The Bill was and co-sponsored by Representative John Delaney of Maryland. The Bill gives the SEC the authority to seek fees that in the aggregate are equal to the estimated costs of the SEC in carrying out additional inspections and examinations for such fiscal year.

MarketCounsel believes that the Bill is an improvement from Rep. Waters’ 2012 bill, but we still have some concerns  Key provisions and our concerns/opinion follow.

The “additional inspections and examinations” are any number that exceeds those conducted in 2012.  There is nothing to stop the SEC from trying to examine every adviser every year.  Because these fees would be outside of typical appropriations there are few repercussions to doing too many exams.

The frequency of adviser examinations will likely be excessive.  The SEC will be handed a blank check from advisers to conduct as many exams as they want and pass through the cost of additional exams to advisers.

Since the year 2012 remains as the baseline year in perpetuity, there is no adjustment to how much advisers pay for regardless of any other appropriations.  So if the SEC gets a huge bump to in funding, advisers will still be paying user fees for any exams greater than 2012, while other industries will not be subject to the same.

Independent advisers did score a win in the revision in that the impact of special interest lobbying seems to have been removed from this version of the bill.  Assets managed for an investment company are no longer excluded from the SEC’s calculation of how much of a user fee advisers are subject to.

Finally, certain concerns that we raised following Rep. Waters’ first draft in 2012 remain.

  • We disagree with the general assumption that investment adviser examinations need to be conducted more frequently.  There been no evidence that more frequent examinations results in less problems.  In fact, as FINRA conducts more frequent examinations, they have missed the majority of the major frauds that have impacted the financial services industry and our nation’s economy.  One could more easily argue (tongue-in-cheek) that more frequent examinations have resulted in an increase prevalence of fraud.
  • The Comptroller General will “audit” the use of the fees collected by the SEC, as well as the formulas to collect fees and adjustments to the formula, but it is unclear what they are auditing.  One would assume that the Comptroller General will just be auditing the formula used in arriving at the increased cost for the audits, not the underlying decision of how many exams are necessary.  In addition, the periodic audit does not appear to review the SEC’s process and quality of its examinations.  One of the factors used to determine user fees is the anticipated cost of examinations, which creates a conflict of interest for the SEC in that they are able to impose higher fees as a reward for frequent, inefficient and lengthy examinations.

MarketCounsel prefers a user fee solution over any option that includes oversight by a self-regulatory organization, but does not want advisers to concede a blank check being given to the SEC.

Word seems to be that the bill is going to have trouble getting out of committee, let alone passing.  It remains unclear why certain advisers are supporting this bill given that Congressional leadership has shown apathy towards the entire issue of adviser oversight.  We can agree that advisers should be examined more frequently than every 15 years as some are, but MarketCounsel continues to support the notion that the SEC obtain its funding through the normal budget and appropriations process and not on the backs of American small businesses.

Daniel Bernstein comments on the cause and effect of RIA’s inflating their AUM in @finplan

Monday, April 22nd, 2013

“The SEC defines AUM in the instructions to Part 1 of its Form ADV. “Sometimes AUM isn’t common sense, and advisors do a bad job quantifying it. The new version of form ADV Part 2, which allows advisors to define AUM differently if they disclose their methodology properly, further confuses the issue.” Read Dan’s full commentary at