Registration and Regulation of Investment Advisers

Increased regulation, and a push for more regulation by FINRA and the States is causing brokers and small firms to move the to investment advisory side of the business. While regulations are going to change here too, there are benefits to the adviser registration, rather than dealing with FINRA. More>>>

How BofA Used Merrill To Bully the Government

Some members of Congress and others have accused federal regulators of pressuring Bank of America into going through with its merger with Merrill Lynch. But records suggest it was the bank, not regulators, doing the bullying. Law.com has an analysis of this view of the issue. More>>>

EXCERPT: 'The Madoff Chronicles'

If you simply can't get enough Madoff, ABC News correspondent wrote a book which examines the personal and business life of the Madoff Family. More>>>

Due Diligence Failure Leads to SEC Enforcement Action?

Did a failure of due diligence cause a broker to assist a fraud? The SEC has charged Detroit-area stock broker Frank Bluestein with fraud, alleging that he lured elderly investors into a $250 million Ponzi scheme.

The complaint reflects that the broker was a top salesman for the Ponzi scheme, raising $74 million from more than 800 investors over a 5 year period. The broker is not charged with running the Ponzi Scheme. In fact, he is charged with not knowing enough about what he was selling - the Commission alleges that he failed to conduct proper due diligence on the investments that he was selling, and thus breached his fiduciary duty to his clients.

There is a whole lot more to the allegations than a simple failure to do due diligence, but we are seeing more and more noise, and some cases, from the Commission regarding the failure of firms and brokers to conduct proper due diligence on the investments that they are presenting to their clients. The work is not being properly performed, or it is being farmed out to third party "due diligence" firms who are not doing their jobs.

The last thing a firm or broker needs to be named in a SEC proceeding alleging misrepresentations that arise from a failure to perform due diligence and therefore becoming an unwitting participant in a fraudulent scheme.  The SEC's press release is here, the securities fraud complaint is here.

Due Diligence Failure Leads to SEC Enforcement Action?

Did a failure of due diligence cause a broker to assist a fraud? The SEC has charged Detroit-area stock broker Frank Bluestein with fraud, alleging that he lured elderly investors into a $250 million Ponzi scheme.

The complaint reflects that the broker was a top salesman for the Ponzi scheme, raising $74 million from more than 800 investors over a 5 year period. The broker is not charged with running the Ponzi Scheme. In fact, he is charged with not knowing enough about what he was selling - the Commission alleges that he failed to conduct proper due diligence on the investments that he was selling, and thus breached his fiduciary duty to his clients.

There is a whole lot more to the allegations than a simple failure to do due diligence, but we are seeing more and more noise, and some cases, from the Commission regarding the failure of firms and brokers to conduct proper due diligence on the investments that they are presenting to their clients. The work is not being properly performed, or it is being farmed out to third party "due diligence" firms who are not doing their jobs.

The last thing a firm or broker needs to be named in a SEC proceeding alleging misrepresentations that arise from a failure to perform due diligence and therefore becoming an unwitting participant in a fraudulent scheme.  The SEC's press release is here, the securities fraud complaint is here.

Trouble Brewing for Small Broker-Dealers?

Trouble Brewing for Small Firms?

Having spent the last 25 years representing small and mid-sized brokerage firms, I completely understand the issues facing these firms. It always seems that FINRA and the SEC fail to pay attention to the ramifications of their rules and regulations on the smaller firms when new regulations are considered.

Those concerns are coming to the forefront again, as the latest economic crisis generates calls for additional rules and regulatory overhaul. SIFMA has taken notice, and is speaking out.

E. John Moloney, the chairman of SIFMA’s small firms committee provided written testimony to the House Committee on Small Business this week, and spoke to On Wall Street magazine afterwards. Moloney, who is the president and chief executive officer of Moloney Securities Co., said that Congress and regulators need to be mindful of unintended consequences in their zeal for regulatory reform.

There are any number of proposals that could negatively impact the small broker-dealer, and Moloney hit a few. He addressed the issue of pre-dispute arbitration agreements, which the NASAA has suddenly decided is a terrible way to resolve disputes. (See my post on their latest position on the topic here). Moloney’s point is that before the use of such agreements are prohibited; the entire process must be examined. As I noted in my discussion, arbitration is often the best way to protect the consumer, as it is not only faster than a traditional court proceeding, it is less expensive.

Today aggrieved investors with smaller claims are able to retain attorneys to represent them, precisely because of the lower cost of arbitration. If pre-dispute arbitration agreements are banned, not only will consumers be able to opt-out of arbitration, brokers and firms will be able to do so as well. The end result: consumers who cannot afford to prosecute their claims in court will have no recourse at all, and “would likely result in a complete denial of justice for individuals with smaller claims” in Moloney’s words.

On Wall Street’s story contains more detail regarding the issue and SIFMA’s concerns, and is available here.

Friday Q&A - LLCs for Independent Reps

Question: I recently went independent and intend to operate my business as an LLC. We setting up the relationship with my BD, they insist that all the paperwork will be in my name and not the LLC. Is this normal? How do I protect myself from liability?

Answer: The reason the BD insists on having the registration and agreements with you rather than your LLC is simple – securities regulations require it. Firms are not permitted to pay compensation to unregistered persons or entities. Your LLC is not registered, YOU are registered, and therefore the paperwork is with you, not the LLC.

As to liability, first, an LLC will not protect you from liability to your clients should they sue you for negligence or fraud. That is what insurance is for, and a corporate entity does not provide protection from your own wrongful conduct. You can insulate yourself from other liabilities, such as rent, premises liability, vendor suits and all non-work related hazards by using the LLC. Set up the LLC as you would for any other business, and pay the LLC a fee for rent, phones, etc. from the check that you receive from the BD.

All of the legal caveats apply, this is not legal advice. If you need assistance with this give us a call.

SEC Alleges Pump and Dump Scheme Involving ConnectAJet. com Stock

From The Securities Law Prof Blog:

The SEC announced today that on September 18, 2009, it sued several individuals and entities, alleging that the defendants implemented a scheme to funnel ConnectAJet.com, Inc. shares into the public market at great profit to themselves when no registration statement was filed or in effect.

According to the complaint, ConnectAJet.com, Inc., of Austin, Texas, issued 30 million shares of stock in an illegal, unregistered offering to certain penny stock promoters, including Testre LP and Verona Funds LLC, companies owned and controlled by Page, a resident of Malibu, California. To pump up demand for the stock, Cantu and ConnectAJet.com, Inc. launched a nationwide advertising campaign, issued false press releases and published misleading web content. The complaint further alleges that the press releases falsely stated that ConnectAJet.com. Inc. had created a real-time, online booking system for private jet travel. Testre LP, Verona Funds LLC, and an entity owned by Martin M. Cantu, Firenze Funds, LLC, then allegedly sold their stock into the public market at grossly inflated prices for millions of dollars in profits. Fayette, of Sarasota, Florida, allegedly facilitated the scheme by liquidating ConnectAJet.com, Inc. shares on behalf of multiple clients.

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A Tax on Cadillac Health Plans May Also Hit the Chevys

This is just outrageous. Senator Max Baucus is proposing to put a "luxury tax" on companies who provide the most expensive health insurance policies to their workers. Unfortunately, Senator Bacus is pegging that tax at policies that cost more than $21,000 a year.

The NYT does a great analysis of this outrageous proposal, but misses the mark. Most business owners in New York and New Jersey with small groups pay more than $21,000 a year for their policies. I do. In fact, I had to increase our deductibles because my new health insurance policy was going to cost $30,000  a year! I have the basic 40/40 coverage, with $40 co pays, no dental, no eyeglasses, I pay for hospitalization on a daily basis for 5 days, etc. It is certainly not a cadillac policy. It is a policy for a small group of employees.

And you are going to increase my cost by 35%? Are you out of your mind? More>>>

A Tax on Cadillac Health Plans May Also Hit the Chevys

This is just outrageous. Senator Max Baucus is proposing to put a "luxury tax" on companies who provide the most expensive health insurance policies to their workers. Unfortunately, Senator Bacus is pegging that tax at policies that cost more than $21,000 a year.

The NYT does a great analysis of this outrageous proposal, but misses the mark. Most business owners in New York and New Jersey with small groups pay more than $21,000 a year for their policies. I do. In fact, I had to increase our deductibles because my new health insurance policy was going to cost $30,000  a year! I have the basic 40/40 coverage, with $40 co pays, no dental, no eyeglasses, I pay for hospitalization on a daily basis for 5 days, etc. It is certainly not a cadillac policy. It is a policy for a small group of employees.

And you are going to increase my cost by 35%? Are you out of your mind? More>>>

SEC Files Insider Trading Charges Only 5 Days After the Trade!

Wow, this has got to be a record. The SEC announced today that it charged Richardson, Texas resident Reza Saleh with insider trading around the public announcement of Dell Inc.'s tender offer for Perot Systems earlier this week.

The trades occurred between September 4 and September 18 OF THIS YEAR! Just 5 days ago.

The press release says that the "overwhelming evidence in this case allowed the SEC to move quickly." That must be some mound of evidence. I am involved in insider trading investigations where the trades took place years ago.

Maybe the Madoff Mess has a silver lining afterall. An Enforcement Division that has the resources to move quickly?  More>>>

What the SEC Might Look Like If It Did Its Job

Bloomberg's Susan Antilla has an interesting article on the SEC. While I am not an advocate of putting investors in control of the SEC, which would undoubtedly do more harm than good, the idea of removing the Enforcement Division and putting it into the Justice Department deserves some consideration. More>>>

SEC About Face on BofA Suit

After having its questionable settlement with Bank of America rejected by the Court, the SEC has now said that it will press its case that Bank of America Corp. misled investors, and said additional claims may be added.

“We will vigorously pursue our charges against Bank of America and take steps to prove our case in court,” the agency said yesterday in a statement, a week after U.S. District Judge Jed Rakoff set trial for February. The SEC said it will use the pretrial process to obtain information and “determine whether to seek the court’s permission to bring additional charges.”

Are we supposed to forget that the Commission agreed to settle the claims in an agreement that was of questionable merit, and did not include any individual defendants? More>>>

SEC Proposes Flash Order Ban

A flash order enables a person who has not publicly displayed a quote to see orders less than a second before the public is given an opportunity to trade with those orders. Investors who have access only to information displayed as public quotes may be harmed if market participants are able to flash orders and avoid the need to make the order publicly available. The SEC has proposed proposed a rule amendment that would prohibit the practice of flashing marketable orders.

A flash order gives market insiders a head-start on trading, and non-public pricing information. While the practice is legal, there has been no word on why this has been permitted. More>>>

Citi to Sell Smith Barney?

The Street is reporting that Citi CEO Vikram Pandit said the company will eventually sell its remaining stake in the Smith Barney joint venture entered into this summer with Morgan Stanley. More>>>

NASAA Pushes to Abolish Mandatory Arbitration

I really am not picking on them, but one more part of today's NASAA story.

The organization of state securities regulators have also raised the "mandatory arbitration is not fair" refrain again. The NASAA incoming president, Denise Voight Crawford is pushing to end mandatory arbitration in the securities industry. Since mandatory arbitration in the securities industry is a creation of the regulators, it is an interesting position for a regulator to take.

Keep in mind, it is the NASD that created mandatory arbitration in the brokerage industry, without a word of protest from the state regulators for some 30 years that brokers have been forced to arbitrate disputes with customers and their employers. The use of arbitration clauses in customer agreements followed the NASD's lead, and individual brokers, as well as customers, are forced to arbitrate their disputes with the firms and each other.

Various publications are quoting the incoming NASAA president as saying “The harmful effects of mandatory arbitration have been well-documented in numerous studies. Both houses of Congress have responded with legislation that would prohibit the use of mandatory arbitration clauses in a wide range of consumer services, including securities. No further studies are necessary.”

I am not sure what studies she is referring to. Sure, there are plenty of studies about the harmful effects of mandagory arbitration in consumer contracts and credit card contracts, but I am not aware of any study that has shown harmful effects of securities arbitration, which is a completely different and highly regulated process.

But that brings us back around to the original problem. If mandatory arbitration is so awful, why do the securities regulators continue to force brokerage firm employees to arbitrate their disputes with their customers and their employers? Is the NASAA taking the position that the FINRA rule requiring brokers and firms to arbitrate with customers and each other should be abolished?  More>>>

NASAA Power Grab With a Punch

As referenced earlier today the NASAA is pushing hard to regain its power and authority over the financial industry, and isn't being shy about it. We wrote eabout their push to increase the ceiling for state registered investment advisers from $25 million to $100 million, which will put financial regulation back at least a decade.

In another story today, the NASAA actually took a shot at its fellow regulators. The incoming NASAA president is quoted as saying, referring to the current financial collapse - "While this catastrophe was the result of many failures, I am very proud to say that a failure of state securities regulation was not one of them. In the last few years, it has been state and provincial securities regulators who have been at the forefront of investor protection. Our record demonstrates clearly that we have the will and ability to regulate."

While it is nice to pat yourself on the back, stepping on your fallen colleagues to gain an advantage is not the way most folks do business. Particularly when the pats on the back are not deserved.

While no one would claim that the state regulators were responsible for the financial crisis, they certainly missed some important parts of that collapse. Lets not forget that most, if not all of the state regulators who comprise the NASAA had regulatory authority over Madoff, Lehman, Bear Stearns and Merrill Lynch. Each had the ability, and dare I say some had the obligation, to review the books and records of each of those firms.

I am not suggesting that they should have conducted full audits of the firms, heck I will even give them a pass on missing all of these issues that were under their jurisdiction. Let's face it, they simply do not have the funds or staff to meet their obligations. But they do have the statutory authority, to oversee brokerage firms that are operating in their states. It is therefore disingenuous for their president to now say "everyone else missed the boat, we didn't and we could do it better."

We spent years attempting to consolidate the regulatory nightmare that is known as securities regulation. Giving new powers, and new jurisdiction to 50 regulators is not the way out of the financial crisis - unless of course the plan is to put the brokerage firms and investment advisory firms out of business under a bureaucratic nightmare of duplicative filings, fees, audits, examinations and enforcement proceedings.

Cuomo Subpoenas BofA Board

The Merrill Bonus issue at Bank of America is not going away. InvestmentNews is reporting that the New York Attorney General's office subpoenaed five members of BofA's board of directors as part of an investigation into the bank's acquisition of Merrill Lynch & Co.

According to the article, the board members are expected to be questioned about what they knew regarding the mounting losses and bonus payments at Merrill ahead of the deal's completion on Jan. 1. More>>>

The Power Grab Continues

It seems like everyone is trying to gain power and control using the Madoff Mess as a justification. The North American Securities Administrators Association (the state securities commissioners) is pushing for authority over all investment advisors who manage less than $100 million in assets.

Today they only have authority over those with less than $25 million in assets, and if this power grab is successful, it will be one giant step backwards for the securities industry and the investing public. We spent decades attempting to consolidate regulators so that large national firms did not have to deal with 50 state regulators. The move to divide investment managers into state vs. SEC registrations was part of that consolidation process. The $25 million dollar cut off left the smaller RIAs with the states. Since smaller RIAs only need to register with a handful of states, that division made sense.

By increasing their jurisdiction there will be a significant increase in RIAs who need to be state registered, and those RIAs will have to register in all 50 states, and make filings in all 50 states, and comply with the rules and regulations in all 50 states. Not only do the states have different rules and filing requirements, the cost of maintaining registrations will increase dramatically.

At the same time, the SEC is simply not going to be able to oversee all of the new RIAs if pending legislation passes. The SEC has clearly demonstrated its inability to oversee the regulated entities that it is currently responsible for. If we are going to have meaningful regulation of investment advisers, a new entity needs to be created, similar to FINRA, or the SEC needs significantly more staffing and funding. Turning the regulation over to 50 state regulators will be a nightmare, one that we finally removed years ago.

One of the Richest Men in the US Can't Afford an Attorney

There is something wrong with this picture. Texas financier R. Allen Stanford was reported to be worth approximately 2 billion dollars before his arrest on securities fraud charges. Yesterday, the court appointed a public defender to represent him, because he cannot afford an attorney.

How is it that a billionaire does not have money to pay an attorney? The government has seized all of his assets and apparently will not release any funds for Stanford to retain counsel.

I don't have a perfect solution to this problem, but something is wrong when the government can accuse (not convict) a citizen of a crime, and seize all of his assets to that he cannot afford to have an attorney represent him. I am sure that the public defender will do as good a job as he or she can, but a public defender's office is not equipped to  defend a 7 billion dollar fraud case.

Without doing the research, it seems to me that this must be a constitutional violation here. The man has been accused of committing a crime, he has not been convicted, and no one has established that all of his assets are the proceeds of the alleged crime. How does the court justifiy the seizure of all of a defendant's assets on the filing of an accusatory instrument?
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SEC Announces Distribution of Gabelli Fund Disgorgement

The Distribution Plan provides for distribution of the disgorgement, prejudgment
interest, and penalties totaling $16 million paid by Gabelli Funds LLC plus any
accumulated interest, less any federal, state or local taxes on the interest.
The Distribution Plan provides that the calculation of amounts to be distributed
to investors will be based on records of Gabelli Funds LLC and records obtained
from third-party intermediaries. Accordingly, the funds are not being distributed
according to a claims-made process. The Distribution Plan provides for the
distribution of the monies to eligible investors in the Gabelli Global Growth
Fund to compensate them for losses resulting from market timing.

A copy of the Distribution Plan may be obtained from the Commission's website http://www.sec.gov.

NYAG Seeks to Question BofA Lawyers on Merger

In a move that has the potential to impact the attorney-client privilege, New York Attorney General Andrew Cuomo asked Bank of America Corp. to allow his office to question the institution's lawyers in its ongoing probe into last year's merger with Merrill Lynch. Cuomo's office said it cannot adequately explore whether to bring charges against Bank of America officers because of the bank's "indiscriminate invocation of the attorney-client privilege. More>>>

Fuld on Lehman's Anniversary

The demise of Lehman Brothers is coming up on an anniversary, and Reuters spoke to the man who led Lehman at the time - Richard Fuld. Most will recall that Fuld was blamed for the downfall of Lehman, and was then humiliated before a Congressional panel last October. He was told by one politician that he was the designated "villain" of the day and screamed at by protesters who called for him to be jailed. Reuters found him at his home in Idaho.  More>>>

SEC Charges Biotech Company With Fraudulently Hyping Stem Cell Breakthrough

The SEC has filed charges CellCyte Genetics Corporation its former CEO, and its former Chief Scientific Officer for falsely telling investors that the company's cutting-edge stem cell technology had been proven successful and was headed for human trials. More>>>

Stifel to sell 1.2 million shares in offering

Stifel Financial Corp. said Wednesday it plans to launch a public offering of 1.2 million shares of common stock. According to a regulatory filing, the company plans to use the proceeds from the offering for general corporate purposes. The company will have 29.8 million shares outstanding after the offering. More>>>

What Next? Performance Fees for SEC Staffers?

Sen. Charles Schumer intends to propose legislation that would allow the SEC to keep any fines it levies against wrongdoers and to pocket the $1.5 billion in transaction and other fees it is expected to collect for the fiscal year that begins Oct 1, 2009. This is the first we are hearing of such a proposal, but it sounds like a huge potential problem for the Commission, and one that it does not need.

Self funding is a great idea, if implimented correctly, and having the SEC keep its filing fees, or a portion of those fees to fund its operations is probably sound fiscal policy. But once you start giving them the fines and penalties, you open the doors for conflicts, potential conflicts, or simply perceptions of conflicts. The SEC is having enough image problems these days.  More>>>

SEC Asset Freeze in $32 Million Scheme

The SEC announced fraud charges and obtained an order freezing assets of the defendants of an alleged investment scheme that the Commission alleges defrauded investors of $32 million dollars. According to the press release, the SEC alleges that Sidney S. Hanson and his wife Charlotte M. Hanson solicited investors at church gatherings and in other face-to-face meetings, persuading them to cash out their retirement funds and invest in so-called private loan agreements that the Charlotte couple offered through a dozen companies they controlled (collectively, Queen Shoals Entities). Through their Web site and a widespread sales force of at least 45 "consultants," the Hansons falsely promised investors that the investment contracts they were offering would generate them yearly returns ranging from 8 to 30 percent, and that their funds would be safe in a diversified portfolio of treasury bills, precious metals, and foreign currency.

Returns of 8 to 30% a year? Investors need to spend some more time conducting due diligence to avoid spending much more time with their securities attorney pursuing their losses. Most securities attorneys will conduct a due diligence review of an investment BEFORE you make the investment. They will do it afterwards as well, when attempting to retrieve your money, but it costs quite a bit more. More>>>

SEC Files Another Ponzi Scheme Complaint

Ponzi schemes have become a popular topic at the SEC these days. Hardly a week goes by without the Commission announcing charges against someone for running a Ponzi scheme.

While it is well known that bull markets will disguise losses, bad investments and even frauds, it is interesting to note that most of these schemes have been operating for years, at least according to the SEC's allegations. We know that Madoff ran his Ponzi scheme for decades, in the latest complaint the Commission alleges that a Brooklyn man ran a $40 million Ponzi scheme since 1999.

Similar to Madoff, from reading the complaint is appears that the operation was at one time a legitimate one. The complaint alleges that in 1999 the defendant stopped investing his investor's funds and began using incoming investor money to repay existing investors. The Commission also alleges that the defendant diverted investors' fund for his own use, purchasing real estate in his own name, paying expenses of another business entity and to support his lifestyle.


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