Category: CCO Liability

Enforcement cases against a Chief Compliance Officer always catch my attention. The latest to catch my eye is against A.G. Morgan Financial Advisors, LLC (“AGM”) of Massapequa, New York, AGM’s owner Vincent J. Camarda, and AGM’s former Chief Compliance Officer James McArthur.

The SEC Commissioners and senior Division of Examination staff have usually stated three circumstances that lead to CCO liability:

1. when the CCO is affirmatively involved in misconduct;
2. when the CCO engages in efforts to obstruct or mislead the Commission; or
3. when the CCO exhibits “a wholesale failure to carry out his or her responsibilities”

AGM, Mr. Camarda and Mr. McArthur got involved with an unregistered securities offering with a lending company called Complete Business Solutions Group, that was doing business as Par Funding. The company was making short term loans to small businesses that were supposed to be secured by receivables. Par Funding was raising capital by selling unregistered securities in the form of promissory notes. Nothing illegal as long as the firm and its agents are following the the private placement rules.

According to the SEC compliant, Mr. McArthur was actively involved in the selling of the Par Funding securities to the AGM clients. This would put the nature of the SEC CCO action into the exception 1: affirmatively involved in the misconduct. (And still its CCO.)

In this case I’m not sure why Mr. McArthur is identified in the complaint as “its former Chief Compliance Officer”. There is no mention of him acting in a compliance role in the complaint. According to the firm’s website and the firm’s Form ADV filing, Mr. McArthur is also the firm’s president.

As for the alleged wrongdoing, AGM was also a client of Par Funding. The firm owed par as much as $750,000 at times and some which was personally guaranteed by Mr. Camarda. The Securities and Exchange Commission accuses AGM of telling investors that it was a safe investment, while failing to disclose that his company AGM was in debt to Par Funding and that Mr. Camarda was a guarantor on that debt to Par Funding. The SEC claims that existence of the debt was a material conflict that should have been disclosed to the AGM investors and failing to disclose the existence of the debt was a breach of fiduciary duty under the Investment Advisers Act. AGM was apparently paying down its debt to Par Funding by selling the promissory notes.

The SEC also claims that the sale of promissory notes did not fit any exemption from registration. It’s a little light on that claim. It at least three instances, the complaint notes that the respective investor had completed an “Accredited Investor Questionnaire.” It does reference a television commercial for the investment, so that could be a general advertisement in violation of the private placement rules.

Of course, the main problem was that the Par Funding investments were duds. Par Funding ended up in receivership. It’s under investigation for illegally selling securities. From news reports, Par Funding engaged in some shading lending practices, poor underwriting and had some shady characters under its employ. Investors lost money.

Sources:

• SEC Charges New York-Based Investment Adviser and Its CEO and Former Chief Compliance Officer with Securities Violations
• SEC Complaint
• SEC Charges Long Island Firm With Fraud In Connection With $500M Securities Offering
• Par Funding founder says he expects to face criminal charges — and soon
• Par Funding defendants settle with SEC, will repay money in $500 million investment fraud

Cases against Chief Compliance Officers catch my attention. Jack Cook is the Chief Compliance Officer of Princeton Alternative Funding. He is in the crosshairs of the Securities and Exchange Commission.

The SEC Commissioners and senior OCIE staff have usually stated three circumstances that lead to CCO liability:

1. when the CCO is affirmatively involved in misconduct;
2. when the CCO engages in efforts to obstruct or mislead the Commission; or
3. when the CCO exhibits “a wholesale failure to carry out his or her responsibilities

Mr. Cook served initially as Princeton’s chief operating officer and chief compliance officer. He eventually became CEO. Even though Mr. Cook had no experience in Princeton’s alternative lending space.

The SEC accuses Mr. Cook, of creating and disseminating materially false statements to investors and potential investors that misrepresented the management of the Princeton. Mr. Cook also concealed the significant role that a principal, Mr. Burgess, who had recently been convicted of tax fraud, played in managing Princeton and its investment.

The case seems to fall squarely in circumstance 1. Mr. Cook was clearly involved in the wrongdoing. The liability is not coming from his role in compliance. The SEC is accusing Mr. Cook of being the person creating the misstatements, approving the misstatements and conveying the misstatements to investors and in marketing to potential investors.

Of course there were smoking gun emails about the involvement of Mr. Burgess in the management of Princeton.

Burgess instructed them to “[b]e careful with too much transparency as it will bite you in the ass.” He later added, “I am also NOT suggesting you lie, but don’t volunteer unless you are ask[ed] the direct question.” He then noted his apparent belief that “[y]ou cannot trust anyone, period, and good deeds do not go unpunished. He [the investor] will jerk you around on future investments, just to continue to get info out of you.” To underscore his concern, Burgess added, “I will bet you my left nut (and I like my nuts) that this [investor] comes after us and uses your words to get us. Don’t let that happen.”

Less than a minute after sending this email, Burgess replied to all with a single sentence stating, “Also, delete these emails please.”

Sources:

• SEC Charges Private Fund Manager, Consumer Credit Company, and Three Individuals with Fraudulently Raising Over $73 Million from Investors
• SEC Complaint
• CCO Charged in SEC Fraud Case

Rule one following a regulatory examination is to implement the changes you told the regulators you said you would. GGHC failed to do so and it was the CCO’s fault. Then the CCO did the worst thing in compliance.

GGHC was duly registered as a broker-dealer and an investment adviser. It used both transaction based fees and annual fees for different accounts.

“As disclosed in its new account documents, GGHC “uses an aggressive growth style of investing . . . . [which] results in significant fluctuations and at times will result in significant losses in the short term.” GGHC also discloses that this type of investment style may involve active portfolio changes and therefore a high turnover, and as a result, the effective annual fee GGHC charges its advisory clients is often higher than the fees charged by comparable advisers. GGHC discloses commissions charged on each of its trades in trading confirmations provided to its clients, either as a separate line item or embedded in the price of the relevant security.”

Churn is a concern with the accounts using the transaction fee model. During a FINRA exam, the regulator wanted GGHC to beef up its review of cost-to-equity ratio and turnover ratios. GGHC agreed and amended its procedures to review cost-to-equity ratios monthly, document the reviews and escalate all accounts with a cost-to-equity ratio above 6%.

The firm amended its procedures but didn’t conduct the reviews. None of the accounts with cost-to-equity above 6% was escalated.

The SEC came in the following year for an examination. As you would expect, the SEC examiners focused on the cost-to-equity reviews. Rather than admit that she didn’t conduct the reviews, the CCO lied and produced doctored documents.

The exam resulted in a referral to enforcement. The CCO also sent doctored documents to the enforcement lawyers lying about the reviews. The CCO was finally subject to sworn testimony and admitted to altering the documents by whiting out the as of date and making later handwritten annotations.

Bad actions. Bad result for the firm and the CCO. The firm got hit with a $1.7 million fine and the CCO got barred.

Sources:

• SEC Order against Gilder Gagnon Howe and Bonnie Haupt

Cases imposing liability against compliance offices catch my attention. An Illinois court just imposed a fine on the former chief compliance officer of The Nutmeg Group, a registered investment adviser and fund manager. David Goulding had previously agreed to be barred from association with any investment adviser.

David Goulding must have thought things would go differently when his father promoted him at his financial advisory firm from a part-time administrative capacity to the full-time role as the chief compliance officer. The Nutmeg Group had $32 million in assets under management. Mr. Goulding was going to make money…

It’s not clear whether he knew that his father had been convicted of conspiracy to defraud the United States, mail fraud, and illegal transportation of currency in connection with a tax evasion and money laundering scheme that lead to him serving six months in prison and suspension from the practice of law for four years.

As you might expect, things were bad at Nutmeg. Nutmeg did not have complete records of investments, lacked books and records required by law, and had no internal controls to prevent violation of the Investment Advisers Act. Fund assets were commingled with firm assets. Of course, this lead to improper valuations and inaccurate reporting to investors. Assets were improperly transferred.

As the new CCO, Mr. Goulding could fix this?… No.

The following are Mr. Goulding’s failing qualifications:

• No training, experience, or knowledge of the securities industry
• Never worked for a broker/dealer, investment company, or investment fund
• No experience communicating with investors
• No experience performing or assisting in the valuation of an investment fund
• No experience with the compliance responsibilities of an investment adviser
• Education consists of an undergraduate degree in philosophy with a minor in political science.
• Worked as a personal trainer and in marketing for a health club and Border Books prior to joining the firm.

The court thought “[t]o be blunt, the evidence suggests David literally had no idea what he was doing or what he was getting himself into when he decided to go work for Nutmeg.” (p.16 of Memorandum Opinion and Order)

In the process of some attempt to fix things, he helped perpetuate the wrongdoing at Nutmeg. He sent misleading statements to investors that served to further Nutmeg’s improper activities.

Just his luck after becoming CCO, the firm was subject to examination three months later. That exam quickly uncovered the serious problems at Nutmeg.

Mr. Goulding’s defense was that he did not receive financial benefit from the fraud. That benefit went to his father who agreed to disgorge his profits, plus pay a penalty. David ended up disgorging half his salary as CCO.

Under the SEC’s three prong approach, Mr. Goulding hit the first prong by participating in the fraud. You could argue that he may not even have fully understood what he was doing was wrong. The court found that Mr. Goulding had aided and abetted Nutmeg’s primary violations of the Investment Advisers Act. (p.16 of Memorandum Opinion and Order)

Was this a matter of bad timing? If Mr. Goulding had more time as CCO could he have fixed the problem? Did his father put someone unqualified in the position to help with the fraud? My guess: yes, no, yes.

Sources:

• Memorandum Opinion and Order
• SEC Obtains Judgment Against Former Chief Compliance Officer of Investment Adviser
• SEC Complaint against Nutmeg and Principals
• SEC Order barring David Goulding
• Federal Court Rules that Chief Compliance Officer Lacked the Necessary Qualifications

The New York City Bar is looking out for compliance officers. It published a comprehensive report on liability for financial firm compliance officers and ways the regulators can do a better job relating to compliance officers.

“Financial firm compliance officers serve as essential gatekeepers to prevent, detect, and remediate violations of laws, regulations, and internal policies and rules.  Because of their role, compliance officers are inherently at risk of becoming subject to regulatory investigations and personal liability.  While the intent of such investigations and liability risks may be to strengthen the “gatekeeper” function, they can also discourage appropriate activity by compliance officers, isolate compliance officers from other business processes, or, at the extreme, lead individuals to leave compliance roles for fear of bearing liability for the misconduct of others.  “

The Report makes four proposals for regulators to consider:

1. Release formal guidance articulating specific factors guiding discretion on charging decisions against chief compliance officers.
2. Communicate greater detail on the conducting of inspections and investigations of chief compliance officers in existing methods of informal guidance, through providing greater detail in enforcement action releases, or in other public communication methods.
3. Create an ex ante method of communication between compliance officers and regulatory staff.
4. Create an ongoing advisory group between regulators and the compliance community to discuss areas of mutual concern.

I’ve complained about item 1 several times. On one hand, regulators state the factors that would put a CCO in danger of liability. Then on the other hand, the enforcement actions completely ignore those factors or come up with new ones. Those two hands are writing different stories.

The SEC Commissioners and senior OCIE staff have usually stated three circumstances that lead to CCO liability:

1. when the CCO is affirmatively involved in misconduct;
2. when the CCO engages in efforts to obstruct or mislead the Commission; or
3. when the CCO exhibits “a wholesale failure to carry out his or her responsibilities

But then you get enforcement actions like the one against Thaddeus North which upheld liability of a CCO because he “failed to make reasonable efforts to fulfill the responsibilities of his position.” That’s not one of those three.

The Report starts off with the proposition that increased CCO liability and uncertainty about the scope of liability may deter people from taking compliance positions. See, e.g., Court E. Golumbic, “The Big Chill”: Personal Liability and the Targeting of Financial Sector Compliance Officers, ; Emily Glazer, The Most Thankless Job on Wall Street Gets a New Worry, WALL ST. J. (Feb. 11, 2016); Dawn Causey, Who Should Have Personal Liability for Compliance Failures?, A.B.A. BANKING J. (Aug. 17, 2015).

The middle of the Report is a collection of enforcement actions against compliance officers in the financial sector. I’m going to go back through that collection. I didn’t see any mention of actions against compliance officers outside the financial sector. But come to think of it, I’m not sure I can recall any actions against compliance officers outside the financial sector that didn’t have the compliance officer involved in the wrongdoing.

I already mentioned the four recommendations from Part III of the Report. That regulators can fix this by getting enforcement to stick to the delineated reasons in the charges and orders against compliance officers who have gone astray.

The Report was prepared by the NYC Bar, and in partnership with the Association for Corporate Growth, American Investment Council and SIFMA.

Sources:

• Report on Chief Compliance Officer Liability in the Financial Sector
• New York City Bar Association Releases Report on Compliance Officer Liability; Makes Four Recommendations to Regulators
• Chief Compliance Officer Liability in the Financial Sector
• Report Urges Action on CCO Liability by Matt Kelly in Radical Compliance
• Thaddeus North and CCO Liability

The Securities and Exchange Commission charged Cameron G. High of Yellowstone Partners, LLP, of Idaho Falls, for fraudulently overbilling the firm’s clients and charging fees for work not performed. That amount to a total of over $11 million in excess charges from more than 100 of the firm’s clients. Mr. High faces up to 20 years in prison for wire fraud in connection with the overbilling.

The primary bad actor in the case is David Hansen, the former CEO of Yellowstone Partners. He is also on fraud charges and facing jail time.

It’s the CCO charges that caught my attention. High also held a 5% interest in Yellowstone and was a registered investment adviser representative.

According to the SEC complaint, it was Hansen who masterminded and ordered the overbilling. It was a combination of double charging and adding extra charges to the bills.

Certainly, a CCO should be subject to charges if he or she was involved in the wrongdoing. According to the complaint, and I infer from the criminla charges, Mr. High was involved in the wrongdoing.

Mr. High knew the overbilling was improper, but still followed the orders of Mr. Hansen. Hr. High also lied to clients when the overbilling was discovered and blamed it on the custodian. There was a clear pattern of bad behavior and culpability.

Sources:

• SEC Charges Former Idaho Falls Investment Adviser and Its Former Principals for Fraudulently Overbilling Clients
• SEC Complaint
• CCO Faces Jail Time for Overbilling Clients in Regulatory Compliance Watch
• Former Owner and CEO of Yellowstone Partners Investment Firm Indicted for Fraud
• FBI raids Idaho investment firm over excessive fees, firm says they have been refunded

I don’t like compliance officers being dragged into enforcement actions. If they are involved in the wrongdoing or are just a wholesale failure at compliance, I understand the desire for regulators to take aim at a CCO. The charges against Michael Cohn as a CCO are extremely bad.

Mr. Cohn was the managing director and chief compliance officer at GPB Capital Holdings. Just prior to joining GPB he was compliance examiner at the Securities and Exchange Commission.

Mr. Cohn was charged with obstruction of justice and unauthorized access of a government computer for accessing information about an investigation into GPB. While talking with GPB for the CCP job , Mr. Cohn told GPB that he had inside information about the SEC’s investigation into the firm, according to an indictment filed in the U.S. District Court for the Eastern District of New York.

According to the Department of Justice press release, Mr. Cohn accessed information on SEC servers relating to an Enforcement Division investigation into GPB.  During discussions with GPB personnel about obtaining a job there, Cohn advised them that he had inside information about the SEC’s investigation, and on several occasions he disclosed information to members of GPB’s senior management about that investigation. 

Yeah, that’s bad.

Of course, Mr. Cohn is merely charged with crimes and has not an opportunity to defend himself from the charges.

But the indictment should serve as a warning not to engage in this type of bad behavior.

Sources:

• Cohn Superseding Indictment
• Managing Director and Chief Compliance Officer of Private Equity Firm Indicted for Obstruction of Justice
• Private-Equity Firm Compliance Chief Indicted for Sharing Materials From SEC Investigation
• Former SEC investigator charged with giving insider information to firm where he sought employment