Saturday, September 5, 2009
The SEC's Office of inspector General posted on its website the entire 477-page report of its investigation into why the SEC never uncovered the Madoff ponzi scheme despite numerous red flags and warnings over the years. From the introuction:
The Report of Investigation (ROI) includes the following sections: (a) the 1992 investigation of Avellino & Bienes and the related examination of Madoff (Section I); (b) the circumstances surrounding the 2000 and 2001 complaints presented to the SEC by Harry Markopolos (Markopolos) (Section II); (c) the Office of Compliance Inspections and Examinations (OCIE) Washington, D.C. examination of Madoff triggered by a May 2003 complaint from a Hedge Fund Manager (Section III); (d) the Northeast Regional Office (NERO) examination of Madoff that arose out of an internal complaint found in April 2004 during a routine examination of an SEC registrant (Section IV); (e) the Enforcement investigation of Madoff based upon Markopolos’ 2005 complaint (Section V); (f) a discussion of whether there was any improper influence by senior-level officials at the SEC upon the examinations and investigations of Madoff and the effect that Madoff’s stature had on the SEC’s conduct of its examinations and investigations of Madoff (Section VI); (g) an analysis of the allegation that former OCIE Assistant Director Eric Swanson’s relationship with Shana Madoff impacted the SEC’s examinations of Madoff (Section VII); (h) a summary of the due diligence efforts undertaken by private parties who determined that Madoff was not a wise investment and a comparison with the methods utilized by the SEC in its examinations and investigations(Section VIII); (i) the extent of reliance by potential investors with Madoff on the fact that the SEC conducted examinations and investigations of Madoff in making investment decisions; (Section IX); (j) a summary of all the additional complaints that the SEC received regarding Madoff, or any of his firms or related entities (Section X); and (k) a description of all the additional examinations that the SEC conducted of Madoff or his firms (Section XI).
The OIG also intends to issue separate audit reports that analyze the findings of this ROI and make concrete and specific recommendations to both the Office of Compliance Inspection and Examinations (OCIE) and the Division of Enforcement for improvements in their operations based upon the findings in this ROI. We also intend to issue a third audit report analyzing why Madoff was not subjected to an OCIE Investment Adviser (IA) examination after he was forced to register as an investment adviser in 2007.
Friday, September 4, 2009
Judge Scheindlin's opinion in Abu Dhabi Commercial Bank v. Morgan Stanley & Co. Download AbuDhabiCommercialBank(S.D.N.Y. Sept. 2, 2009) is receiving a great deal of press, and deservedly so. Two institutional investors brought a class action to recover losses stemming from the liquidation of notes issued by a SIV and sued eight defendants, including two rating agencies, Moody's and S&P. The court recognized that it is "well-established" that the First Amendment protects rating agencies, subject to an "actual malice" exception, from liability arising out of their issuance of ratings and reports because their ratings are considered matters of public concern. Nevertheless, the court found that the rating agency is not afforded the same protection where its ratings were disseminated only to a select group of investors. Accordingly, the agencies' First Amendment argument was rejected because the ratings were provided in connection with a private placement to a select group of investors.
The court also rejected the argument that the ratings are nonactionable opinions instead of actionable misrepresentations, since plaintiffs adequately pled that the agencies did not genuinely or reasonably believe that the ratings were accurate and had a basis in fact.
I have a great deal of difficulty understanding how rating agencies can assert the First Amendment to escape liability for ratings that they produce and sell; we might as well say that issuers' statements in prospectuses are protected by the First Amendment. It's good to see at least a small chink in the armor.
Thursday, September 3, 2009
The Treasury Department posted on its website a policy statement, "Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms." According to the statement,
The global regulatory framework failed to prevent the build-up of risk in the financial system in the years leading up to the recent crisis. Major financial institutions around the world had reserves and capital buffers that were too low; used excessive amounts of leverage to finance their operations; and relied too much on unstable, short-term funding sources. The resulting distress, failures, and government bailouts of these firms imposed unacceptable costs on individuals and businesses around the world. Going forward, global banking firms must be made subject to stronger regulatory capital and liquidity standards that are as uniform as possible across countries. Today the Treasury Department set forth the core principles that should guide reform of the international regulatory capital and liquidity framework to better protect the safety and soundness of individual banking firms and the stability of the global financial system and economy.
On September 1, 2009, the SEC filed a civil complaint against three individuals and three entities alleging that between February 2004 and June 2007, they engaged in an unregistered distribution and sale of over 21 billion shares of Universal Express Inc. (USXP) formerly located in New York City, New York. The defendants raised approximately $34 million from their sales to public investors. The defendants are Doyle Scott Elliott of Holmes Beach, Florida, Scott Elliott Inc. of Bradenton Beach, Florida, Robert Weidenbaum of Coral Gables, Florida, CLX Associates, Inc. of Miami, Florida, and Michael Xirinachs and Emerald Asset Advisors LLC of Melville and Dix Hills, New York respectively.
The complaint alleges that Elliott and Xirinachs entered into private agreements to obtain shares of Universal Express for themselves or their respective companies, Scott Elliott Inc. and Emerald Assets Advisors, at a substantial discount to the current market price. Xirinachs also served as an investment adviser to an offshore entity, North Atlantic Resources Ltd., and obtained shares of Universal Express at a substantial discount for that entity. Weidenbaum entered into an arrangement for CLX to be paid in shares of Universal Express stock purportedly for consulting services. However, each of the defendants immediately sold the shares they had obtained directly from Universal Express without filing a registration statement providing information about their distribution of the shares to public investors. The complaint alleges the defendants’ unregistered distribution of shares to the public and failure to provide accurate information about the company, which is required in a registration statement, created a substantial risk of loss to investors.
The defendants are charged with violating the securities registration provisions of Sections 5(a) and (c) of the Securities Act of 1933. The Commission seeks permanent injunctions against all defendants, disgorgement of ill-gotten gains, and civil penalties. The Commission also seeks penny stock bars against all defendants. The Commission previously sued Universal Express, Inc. for violating the securities registration provisions. See SEC v. Universal Express, Inc. et al, 04 Civ-02322 (GEL), (LR-18636 Mar. 24, 2004).
The SEC settles another backdating case, this one involving The Hain Celestial Group, Inc. ("Hain"), a Melville, New York natural foods company. The SEC's complaint, filed in federal court in Brooklyn, New York, alleges that from at least 1998 to 2002, Hain fraudulently backdated stock options granted to Company officers, directors, and employees. After media inquiries and analyst reports regarding its stock option practices in mid-2006, Hain's current CFO conducted a limited internal review of selected grants. At the time, Hain did not retain outside counsel to review its historical option practices and did not conduct a forensic review of e-mails or accounting records. Subsequently, Hain's current CFO and the company made statements during September and November 2006 that the company had carefully reviewed its historical stock option grants and found nothing improper.
After being contacted by the SEC staff in mid-2007, Hain formed a group of independent directors and retained outside counsel and other experts to conduct a detailed review of its stock options practices. In January 2008, Hain restated its historical financial statements as a result of this review. Hain re-measured 48 grants and recorded $20.5 million of compensation expense. Twenty-one of the 48 re-measured grants, representing approximately 3.7 million options and $13.2 million of compensation expense, were issued between 1998 and 2002.
Without admitting or denying the SEC's allegations, Hain consented to a permanent injunction against violations of Section 17(a) of the Securities Act of 1933, Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), and 14(a) of the Securities Exchange Act of 1934, and Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13, and 14a-9 thereunder. The settlement is subject to court approval. The Commission took into account the cooperation that Hain provided the Commission staff during its investigation.
Wednesday, September 2, 2009
Here are the Opening Remarks before the SEC-CFTC Joint Meetings on Regulation Harmonization
by SEC Chairman Mary L. Schapiro, held on September 2, 2009.
Stephen Luparello, FINRA Vice Chairman, also made a Statement Before the SEC/CFTC Joint Meeting on Harmonization of Regulation.
FINRA announced today that it has entered into final settlements with three additional firms to settle charges relating to the sale of auction rate securities (ARS) that became illiquid when auctions froze in February 2008. The settlements announced today are with Northwestern Mutual Investment Services, LLC, of Milwaukee, which was fined $200,000; City Securities Corporation, of Indianapolis, which was fined $250,000; and Fifth Third Securities, Inc., of Cincinnati, which was fined $150,000. All three firms agreed to initiate or complete offers to repurchase ARS sold to their customers where the auctions for the ARS had failed — approximately $103 million for Northwestern Mutual, about $13.1 million for City Securities and approximately $11.9 million for Fifth Third Securities.
FINRA's investigation found that each firm sold ARS using advertising, marketing materials or communications with its sales force that were not fair and balanced, or that failed to contain adequate disclosure of the risks of ARS, and therefore did not provide a sound basis for investors to evaluate the benefits and risks of purchasing ARS. In particular, the firms failed to adequately disclose to customers the potential for ARS auctions to fail and the consequences of such failures. FINRA's investigation also found evidence that each firm failed to establish and maintain a supervisory system reasonably designed to achieve compliance with the securities laws and FINRA rules with respect to the marketing and sale of ARS.
In the actions announced today, the firms agreed to a comprehensive settlement plan that has been applied in FINRA's previous ARS settlements. That plan includes several elements, including offers to repurchase at par ARS that individual investors and some institutions purchased between May 31, 2006, and Feb. 28, 2008. The firms have also agreed to make whole individual investors who sold ARS below par after Feb. 28, 2008.
In addition to individual retail ARS investors, the buy-back offers include non-profit charitable organizations and religious corporations or entities, trusts, corporate trusts, corporations, pension plans, educational institutions, incorporated non-profit organizations, limited liability companies, limited partnerships, non-public companies, partnerships, personal holding companies and unincorporated associations that made individual ARS purchases and whose account value did not exceed $10 million.
As part of the settlement plan, the firms also agreed to participate in a special FINRA-administered arbitration program to resolve investor claims for consequential damages - that is, damages investors may have suffered from their inability to access funds invested in ARS. The program provides for expedited arbitration proceedings paid for by the firm. The participating firm may not contest liability related to the illiquidity of the ARS holdings, nor to the ARS sales, including any claims of misrepresentations or omissions by the firm's sales agents.
In concluding these settlements, the firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
The SEC released today the REPORT OF INVESTIGATION, UNITED STATES SECURITIES AND EXCHANGE COMMISSION OFFICE OF INSPECTOR GENERAL, Case No. OIG-509, Investigation of Failure of the SEC To Uncover Bernard Madoff's Ponzi Scheme. (This is the executive summary. The entire report should be released in a few days.) Bottom line: the SEC staff was not corrupt, but incompetent. Here are some excerpts:
The OIG investigation did not find evidence that any SEC personnel who worked on an SEC examination or investigation of Bernard L. Madoff Investment Securities, LLC (BMIS) had any financial or other inappropriate connection with Bernard Madoff or the Madoff family that influenced the conduct of their examination or investigatory work. The OIG also did not find that former SEC Assistant Director Eric Swanson's romantic relationship with Bernard Madoff's niece, Shana Madoff, influenced the conduct of the SEC examinations of Madoff and his firm. We also did not find that senior officials at the SEC directly attempted to influence examinations or investigations of Madoff or the Madoff firm, nor was there evidence any senior SEC official interfered with the staff's ability to perform its work.
The OIG investigation did find, however, that the SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation of Bernard Madoff and BMIS for operating a Ponzi scheme, and that despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. The OIG found that between June 1992 and December 2008 when Madoff confessed, the SEC received six! substantive complaints that raised significant red flags concerning Madoffs hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading. Finally, the SEC was also aware of two articles regarding Madoffs investment operations that appeared in reputable publications in 2001 and questioned Madoffs unusually consistent returns.
* * *
The OIG retained an expert in accordance with its investigation in order to both analyze the information the SEC received regarding Madoff and the examination work conducted. According to the OIG's expert, the most critical step in examining or investigating a potential Ponzi scheme is to verify the subject's trading through an independent third party.
The OIG investigation found the SEC conducted two investigations and three examinations related to Madoff's investment advisory business based upon the detailed and credible complaints that raised the possibility that Madoff was misrepresenting his trading and could have been operating a Ponzi scheme. Yet, at no time did the SEC ever verify Madoff's trading through an independent third-party, and in fact, never actually conducted a Ponzi scheme examination or investigation of Madoff.
* * *
As the foregoing demonstrates, despite numerous credible and detailed complaints, the SEC never properly examined or investigated Madofi's trading and never took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme. Had these efforts been made with appropriate follow-up at any time beginning in June of 1992 until December 2008, the SEC could have uncovered the Ponzi scheme well before Madoff confessed.
SEC Chair Mary Schapiro released a statement in response, stating that "[h]is report makes clear that the agency missed numerous opportunities to discover the fraud. It is a failure that we continue to regret, and one that has led us to reform in many ways how we regulate markets and protect investors." The statement goes on to describe various SEC changes to improve examinations and investigations.
Why Did Anyone Listen to the Rating Agencies After Enron?, by Claire A. Hill, University of Minnesota, Twin Cities - School of Law, was recently posted on SSRN. Here is the abstract:
Enron was rated investment grade by Moody’s, Standard and Poor’s, and Fitch until four days before it declared bankruptcy - scarcely a ringing endorsement of the agencies’ acumen. Even before Enron, the rating agencies had come in for significant criticism. Yet many investors who lost considerable sums in the financial crisis are saying that they relied on the rating agencies. How can this reliance be reconciled with what preceded it? I argue that an adaptive trait - incorporating new data that potentially conflicts with one’s pre-existing worldview so as to preserve as much of that worldview as possible - proved to be maladaptive in this circumstance. There was a plausible story investors could tell themselves about why the rating agencies could ‘get it right’ about the complex securities at issue while having gotten it spectacularly wrong about Enron. It will be interesting to see how, and how much, the agencies’ recent failures affect investors’ beliefs and practices.
Technologies of Compliance: Risk and Regulation in a Digital Age, by Kenneth A. Bamberger, University of California, Berkeley - School of Law, was recently posted on SSRN. Here is the abstract:
Legal scholarship has been silent about a phenomenon with profound implications for governance: the automation of compliance with laws mandating risk management. Regulations - from bank capitalization rules, to Sarbanes-Oxley’s provisions on financial fraud and misrepresentation, to laws governing information privacy protection - frequently require regulated firms to develop internal processes to identify, assess, and mitigate risk. To comply, firms have turned wholesale to technology systems and computational analytics that measure and predict corporate risk levels, and 'force' decisions accordingly. In total, the third-party market for compliance-technology products, known generally as “governance, risk and compliance” (GRC) software, systems and services, alone grew to $60 billion last year, and this growth is poised to increase exponentially.
While these technology systems offer powerful compliance tools, they also generate risks of their own. They permit computer programmers to interpret legal requirements; they mask the uncertainty of the very hazards with which policymakers are concerned; they skew decisionmaking through an 'automation bias' that privileges personal self-interest over sound judgment; and their lack of transparency thwarts oversight and accountability. These phenomena played a critical role in the recent financial crisis.
This Article explores these developments and the failure of risk regulation to address them, and proposes specific reform measures for policymakers revisiting the governance of systemic risk. While regulators have lauded the turn to technology, they have ignored its perils. This Article argues for more activist regulator oversight backed by sanctions before disaster has occurred. But it also emphasizes collaboration in developing risk-management systems, drawing both on the granular expertise of firms and the broader vantage of administrative agencies. Most importantly, it seeks better to reflect the human decisionmaking element at both levels: to recognize the ways in which technology can hinder good judgment, to reintroduce human inputs in the decision process, and to reflect the limits of both human and computer reasoning.
The Ongoing Financial Upheaval: Understanding the Sources and Way Out, by Susan M. Wachter, University of Pennsylvania - Finance Department, was recently posted on SSRN. Here is the abstract:
The present period of financial instability is also likely to become known as the end of an era, an era of economic calm and of policy consensus on how to maintain market stability. After World War II, the federal government operated on the Keynesian principles that the right mix of spending, regulation, and interest rates could tame economic cycles and eliminate surges of unemployment. In this period, now known as the Great Moderation, we assumed we knew how to prevent economic crises, such as the recurrence of the Great Depression. However, it is clear that those principles were erroneous as the economy has entered a lesser, but still severe downturn, the Great Recession. This paper looks at the sources of the ongoing economic crisis and points to the unique role in its origins of real estate asset bubbles and mispriced credit, not only in the origin of this crisis but of many financial crises. An analysis of the data points to the role of mispriced mortgage backed securities (MBS) in the spread of aggressive mortgage products and the unwarranted price speculation that resulted in massive foreclosures. In turn, the paper addresses the source of mispriced risk in MBS as incomplete markets in real estate and non-tradability of MBS and related securities which ultimately led to the collapse of financial system, threatening global economic health. The paper also suggests corrective measures that can and should be taken to assist the short and long term recovery.
Effective December 1, 2009, FINRA is implementing increased customer margin requirements for leveraged ETFs and uncovered options overlying leveraged ETFs, in accordance with NASD Rule 2520 and incorporated NYSE Rule 431.
ETFs are typically registered unit investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. However, some ETFs that invest in commodities, currencies, or commodity—or currency—based instruments are not registered as investment companies. Unlike traditional UITs or mutual funds, shares of ETFs typically trade throughout the day on an exchange at prices established by the market. Leveraged ETFs are a subset of ETFs that are designed to generate multiples (e.g., 200%, 300% or greater) of the performance of the underlying index or benchmark they track. Some leveraged ETFs are “inverse” or “short” funds,meaning they seek to deliver the opposite of the performance of the index or benchmark they track. FINRA recently reminded firms of their sales practice obligations with respect to leveraged and inverse ETFs, including the risks caused by the fact that most of these funds are designed to achieve their stated performance on a daily basis. Leveraged ETFsmay include among their holdings derivative instruments such as options, futures or swaps. Leveraged ETFs are inherently more volatile than their underlying benchmark or index. NASD Rule 2520(f)(8)(A) and Incorporated NYSE Rule 431(f)(8)(A) permit FINRA—in response tomarket conditions—to prescribe higher initial and maintenance margin requirements. In view of the increased volatility of leveraged ETFs compared to their non-leveraged counterparts, FINRA believes higher margin levels are necessary.
The SEC settled charges that Silicon Valley technology company VeriFone Holdings, Inc. and a former finance department employee falsified the company’s accounting records which boosted gross margins and income reported to shareholders. The SEC alleged that in three consecutive quarters in 2007, the company made unsupportable alterations to its records to compensate for an unexpected decline in gross margins, overstating VeriFone’s operating income by a total of 129 percent. When the misrepresentations came to light in December 2007, the company’s stock price fell 46 percent, resulting in a one-day drop in market capitalization of $1.8 billion.
The SEC’s complaint, filed in federal court in San Jose, alleges that at the end of each of the first three quarters of 2007, internal company reports showed that gross margins would be markedly lower than previously released guidance to analysts. According to the SEC, senior management was convinced that the previous forecasts were correct and directed finance employees to figure out and fix the problem so the company could report results in line with forecasts and thereby avoid, in the words of a senior officer, an “unmitigated disaster.”
The SEC alleges that VeriFone’s former supply chain controller, Paul Periolat, then made large manual adjustments to inventory balances on VeriFone’s books each quarter, dramatically increasing both gross margins and operating income. In each of the first three quarters of 2007, the accounting adjustments allowed the company to meet its internal forecasts and guidance to investors. However, the complaint alleges that the adjustments were based on incorrect assumptions which Periolat did not take adequate steps to verify. In fact, the company’s unreported results had been correct, and Periolat’s adjustments led to VeriFone’s improper inflating of its income by over $37 million.
Without admitting or denying the Commission’s allegations, VeriFone consented to a permanent injunction against violations of the reporting, internal controls, and other provisions of the federal securities laws. Further, without admitting or denying the Commission’s allegations, Periolat consented to a permanent injunction against further violations of certain antifraud, reporting, internal controls, and other provisions of the federal securities laws, and to pay a $25,000 civil penalty.
The SEC filed a complaint yesterday in the Southern District of New York charging Golden Apple Oil and Gas, Inc. ("Golden Apple"), its former President Jay Budd, former company attorney John Briner, and Ethos Investments, Inc., with securities law violations in connection with a fraudulent scheme to inflate artificially the market for Golden Apple stock. Golden Apple was incorporated originally as CDI Developments, Inc. and subsequently underwent a series of name changes. On April 7, 2006, the Commission suspended trading in Golden Apple's securities.
The Complaint alleges that defendants Golden Apple, Budd, Briner and Ethos violated Sections 5(a) and 5(c) of the Securities Act of 1933, and that defendants Golden Apple, Budd and Briner violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10-b thereunder. The Commission is seeking permanent injunctions against all defendants, disgorgement with prejudgment interest, civil penalties, and verified accountings from Budd, Briner, and Ethos, and officer and director bars and penny stock bars against Budd and Briner.
On August 31, 2009, the SEC filed a settled insider trading action against Sarath B. Gangavarapu, a resident of Chattanooga, Tennessee. The Commission's complaint, filed in the U.S. District Court for the Eastern District of Tennessee, alleges that Gangavarapu violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder when he misappropriated material non-public information from his sister, whose husband was an executive officer at Covansys Corporation, and purchased over 54,000 shares of Covansys stock at a cost of over $1.4 million based on that information during the nine days leading up to Covansys' public announcement that it would be acquired by Computer Sciences Corporation (CSC).
The Commission's complaint alleges that throughout the month of April 2007, Covansys was in discussions with CSC and another company about their interest in acquiring it. According to the complaint, Gangavarapu spoke frequently with his sister by telephone during April 2007 and asked her questions about her husband's work activities and whereabouts. Among other things, Gangavarapu's sister told him that her husband was in meetings behind closed doors, that he was working extra hours and that he traveled twice overseas for work. The complaint alleges that on the night of April 24, 2007, after learning from her husband that Covansys' board of directors would vote the next day on which acquisition offer to accept, Gangavarapu's sister told Gangavarapu "by tomorrow, it's a relief, it will be over." According to the complaint, Gangavarapu purchased over 17,000 shares of Covansys stock at a cost of nearly $450,000 between April 17 and April 24, 2007. On April 25, 2008, the day after the telephone call from his sister, Gangavarapu purchased an additional 37,000 shares of Covansys stock at a cost of over $980,000. After the close of the stock market on April 25, 2007, Covansys and CSC publicly announced that CSC would acquire Covansys for $34 per share. The next day, the price of Covansys' stock rose 24%. According to the complaint, Gangavarapu's profits from his illegal trading totaled more than $361,761.
Without admitting or denying the allegations in the complaint, Gangavarapu has consented to the entry of a final judgment permanently enjoining him from further violations of the antifraud provisions of the Exchange Act and ordering him to pay disgorgement of his ill-gotten gains in the amount of $361,761.56, prejudgment interest of $46,408.12 and a civil penalty of $361,761.56.
The SEC charged David A. Souza and his company, D.A. Souza Investments, LLC for conducting a fraudulent investment scheme that targeted a Redding, California church community. In a nine-month period during 2007 and 2008, according to the SEC's complaint, Souza raised more than $1 million from approximately 28 investors by touting his supposedly phenomenal skill in investing. Souza allegedly took advantage of investors' trust by appealing to their religious faith with slogans such as "Where Business Is Moral and the Miraculous Is Routine."
In reality, the SEC's complaint alleges, Souza never invested any of the money he received from investors. Instead, he diverted most of the investors' money to expenditures designed to create the false appearance of a successful business operation. Souza used another portion of the money to pay certain investors fictitious high returns in the style of a Ponzi scheme, and he used the remainder to pay his personal living expenses.
The SEC's complaint charges Souza and D.A. Souza Investments, LLC with violations of the antifraud and registration provisions of the federal securities laws under Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933; Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; and as to Souza, Sections 206(1), 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. The complaint seeks civil injunctive relief and disgorgement of ill-gotten gains from each defendant, and civil penalties from Souza.
FINRA announced that in separate enforcement actions, it has permanently barred two brokers for running multi-million-dollar Ponzi schemes that victimized a wide range of investors — including elderly individuals, mentally and physically impaired individuals, church members and even family friends.
FINRA barred Oren Eugene Sullivan, Jr., of Rock Hill, SC, for misappropriating approximately $3.7 million in a decades-long Ponzi scheme involving more than 30 clients — including 15 widows, two Alzheimer's victims and an individual with developmental impairments. At least eight of the affected clients were over 80 years old and another four were over 70 years of age. Numerous victims considered Sullivan a close family friend. Sullivan was a registered representative of NYLife Securities.
FINRA also barred William Walter Spencer, Sr., of Franklin, TN, who "borrowed" nearly $2 million from elderly members of his church and from customers of his employing broker-dealer, Wiley Bros. — Aintree Capital, LLC.
Tuesday, September 1, 2009
SEC Chair Mary Schapiro released an open letter to the CEOs of broker-dealer firms warning that compensation arrangements could provide improper incentives for registered representatives to engage in abusive sales conduct and reminding them of the firms' supervisory responsibilities. Here is the letter in full:
Recent press articles have reported that some broker-dealer firms may be engaging in a vigorous recruiting program for broker-dealer registered representatives. Reports suggest some firms are offering substantial inducements to potential registered representatives, including large up-front bonuses and enhanced commissions for sales of investment products, In light of these reports, I want to remind broker-dealer firms and their CEOs of the significant supervisory responsibilities you have under the federal securities laws to oversee broker-dealer activities, particularly with respect to sales practices.
Certain forms of potential compensation may carry with them enhanced risks to customers. Some types of enhanced compensation practices may lead registered representatives to believe that they must sell securities at a sufficiently high level to justify special alTangements that they have been given. Those pressures may in tum create incentives to engage in conduct that may violate obligations to investors. For example, if a registered representative is aware that he or she will receive enhanced compensation for hitting increased commission targets, the registered representative could be motivated to chum customer accounts, recommend unsuitable investment products or otherwise engage in activity that generates commission revenue but i's not in investors' interest
I therefore encourage broker-dealer firm CEOs and their fellow supervisors to be particularly vigilant in ensuring that sales practices are closely monitored and that investor interests are carefully considered in the sale of any security or other investment product.
I also encourage firms and their CEOs to ensure that, in the event a firm's sales force
expands, the firm's supervisory and compliance infrastructure retains sufficient size and '