Warning to Advisers and Brokers: The SEC Is Putting You Under a Microscope

            Investment advisers and brokers can expect greater scrutiny for small infractions, according to interpretations of a speech recently given by the Chairwoman of the Securities and Exchange Commission.  During a keynote speech before the Securities Enforcement Forum 2013, Mary Jo White said, “retail investors, in particular, need to be protected from unscrupulous advisers and brokers, whatever their size and the size of the violation that victimizes the investor.”  Securities insiders believe this comment signals a new focus by the SEC on minor transgressions by advisers and brokers that may portend more serious violations.

            An article appearing in the publication InvestmentNews quotes several securities industry participants who believe this reflects a new direction for the agency and a commitment to enforcement in the realm of asset management.  Small violations for advisers may result in further investigation for the existence of more significant problems, such as misleading descriptions of investment performance and philosophy, improper fee disclosures and inaccurate registration information.  As for brokers, identification of minor violations may spur an examination looking for net-capital violations or selling away.  According to former SEC litigation attorneys quoted in the article, advisers and brokers should now consider a deficiency letter as a possible blueprint for follow-up actions by enforcement. 

One former enforcement official expressed his belief that a failure to follow appropriate supervisory and suitability procedures may lead to SEC enforcement action.  Another predicts that the agency’s enforcement staff will begin initiating cases against advisers and brokers that were previously handled as regulatory matters.  Overall, the SEC appears to be continuing its efforts to develop new responses to often undetected frauds that continue to threaten the financial security of retail investors.

U.S. Regulators Continue to Expand Actions Against Aiders and Abettors of Large-Scale Fraud

            Last month we wrote about the Commodity Futures Trading Commission’s unprecedented lawsuit against U.S. Bank for aiding and abetting the $1.2 billion fraud perpetrated by Russell Wasendorf, Sr., that resulted in the collapse of Peregrine Financial Group.  It was an opening salvo by a major U.S. regulator against a firm that did not fall within the traditional umbrella of the CFTC’s jurisdiction.

Adopting a similarly aggressive enforcement strategy, the Securities and Exchange Commission has charged TD Bank with violating several sections of the Securities Act for assisting the convicted Florida attorney, Scott Rothstein, in perpetrating a massive Ponzi scheme.  Rothstein’s scheme is now infamous.  Between 2005 and 2009, he used his South Florida-based law firm, Rothstein, Rosenfeldt and Adler, P.A., to sell non-existent discounted settlements to unsuspecting investors.  In particular, he claimed to represent plaintiffs who had reached confidential settlements that would be paid out in periodic distributions over an extended period of time.  He told investments that his purported clients wanted lump sum payments and were willing to sell their settlements at a discounted rate.  The settlements did not exist, and Rothstein’s investors lost enormous sums of money.

In furtherance of his scheme, Rothstein maintained several trust accounts at TD Bank, where the settlement proceeds were purportedly held.  A Regional Vice President of the bank falsely represented to investors that TD Bank restricted the movement of the settlement funds in those accounts for the exclusive benefit of the investors.  He also issued false “lock letters” stating that the accounts were irrevocably restricted so that the bank would distribute the funds only to specific bank accounts belonging to the investors.  Additionally, the bank also falsely assured investors that the trust accounts did maintained the account balances that Rothstein said they did.

Rothstein has been punished for perpetrated his vast Ponzi scheme.  He was disbarred by the Florida Supreme Court and convicted by the U.S. District Court and sentenced to 50 years in prison.  Federal regulators also sprang into action.  In 2012, the SEC initiated an enforcement action against two individuals who directed the largest number of investors to Rothstein.  Moreover, the Financial Crimes Enforcement Network (FinCen), an arm of the U.S. Department of Treasury, is the administrator of the Bank Secrecy Act that has the authority to assess civil monetary penalties against domestic financial institution.  FinCen hit TD Bank with a $37.5 million fine for the BSA failures that contributed to Rothstein’s fraud.

In an unusual move, the SEC, which does not regulate national banks, nonetheless has brought an enforcement action against TD Bank for violating various sections of the Securities Act in connection with its role in the Rothstein fraud.  For example, the SEC charged TD Bank with violating Section 17(a)(2) of the Act, which prohibits any person, in the offer or sale of any security, from obtaining money or property by means of any untrue statement or omission of material fact.  The agency also charged the bank with violating Section 17(a)(3), which prohibits any person, in the offer and sale of any security, from engaging in any transaction, practice or course of business that operates as a fraud or deceit upon the purchaser.

TD Bank chose not to fight the SEC’s charges.  Rather, it entered into a settlement with the Commission that agreed to entry of a cease-and-desist order and a civil monetary penalty of $15 million, in addition to the separately assessed FinCen penalty.  Additionally, TD Bank had to agree that, with regard to any lawsuit against it by a victim of Rothstein’s fraud, the bank would not argue for or benefit from any offset or reduction of any award of compensatory damages as a consequence of its payment of the civil penalty to the SEC.

While the SEC’s action stands alone as an important enforcement matter, it portends a welcome and broader effort by U.S. Regulators to aggressively pursue all those who are responsible for the mushrooming number of massive schemes to defraud that are devastating untold numbers of investors.