Tag: CCO Failure

Lessons from Wunderlich

I don’t take pleasure from others’ failings, but I do try to learn lessons. The recent settlement between Wunderlich Securities and the Securities and Exchange Commission is full of lessons to be learned.

  • overcharged advisory clients for commissions and other transactional fees in violation of Section 206(2) of the Advisers Act
  • failed to satisfy the disclosure and consent requirements of Section 206(3) of the Advisers Act when WSI engaged in principal trades with advisory clients;
  • failed to adopt, implement and review written policies and procedures as required by Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder; and
  • failed to establish, maintain, and enforce a written code of ethics as required by Section 204A of the Advisers Act and Rule 204A-1 thereunder.

It seems some of the failings, at least according to the order was that Wunderlich hired a CCO with a background in Broker-dealer compliance, but at the same time, the firm moved from a broker-dealer model to an investment adviser model. That left the CCO in a new regulatory scheme.

Under Section 206(3) of the Advisers Act, an investment adviser must disclose to its clients in writing before the completion of each transaction that it acts as a principal. Wunderlich failed to follow this rule in over 3,00 instances according to the order. The issue is that the investment adviser can both collect a fee and realize a difference between its cost of the security and the price it’s sold to the the client. That difference in price is a conflict that needs to be managed. Wunderlich even hired a consultant to to review their operations who highlighted the principal trading problem. That still did not lead to a correction.

Wunderlich failed to have written compliance policies or a written code of ethics. That leads to the follow up failure of an annual review of the written compliance policies and procedures. Its hard to update something that is not in place. Wunderlich was using its broker-dealer manual and failed to update it to meet the requirements under the Investment Advisers Act. Once again, this failure was highlighted in a consultant’s report and the firm failed to fix the problem.

A long true lesson in compliance is when a problem is highlighted, you need to fix it. The spotlight is on the problem.

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Another CCO in Trouble

With failure, comes learning. As a compliance officer, disciplinary actions against other compliance officers can be a road map showing me what not to do. Recently, the SEC charged affiliated firms and their former chief compliance officer with failing to have adequate policies and procedures to prevent misuse of nonpublic information.

Section 204A and Rule 204A-1 make it very clear that every investment adviser must have written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information. Buckingham Capital Management Inc. and its broker-dealer parent company, The Buckingham Research Group Inc. apparently did not.

BRG and BCM’s policies and procedures were deficient in a number of ways. BRG had a written procedure to address the misuse of material, nonpublic information, but did not follow its written procedure in practice. Important compliance policies and procedures were not contained in BCM’s written policies and procedures. Further, in some instances, BCM’s written policies and procedures were so unclear that employees did not understand their responsibilities. In other instances, the practices BCM employed varied materially from its written policies and procedures. These failures led to inadequate implementation and enforcement of the firms’ written compliance policies and procedures.

That’s bad, but more likely to result in a deficiency letter than an enforcement action, assuming they were not misusing the information. The problem was that these deficiencies were discovered during a 2003 SEC examination. BCM said they would fix the problem.

Trouble

In preparation for a 2006 SEC exam,  BCM discovered it was missing more that 100 pre-approval forms for trades and that its compliance review logs for 2005 and 2006 were incomplete.

Rather than deliver incomplete records, BCM staff altered the records. This apparently angered the SEC and they moved the case from examination into enforcement.

The former CCO, Karp was censured and agreed to pay a $35,000 penalty.

Lessons

If the SEC tells you there is deficiency, fix it and make it a priority. The first thing they will look at on their next visit is the area of the deficiency. I’m still surprised that the SEC reported only 90% of deficiencies get cured.

Don’t falsify records. That will get the problem moved from the inspection side to the enforcement side of the SEC. That would be a CCO Failure. (The complaint indicates that Mr. Karp did not participate in the falsification.)

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Disciplinary Actions Against Chief Compliance Officers

The Chief Compliance Officer should be a model for employee conduct. I don’t thing there is any better way to lead and educate than to set an example.

Not all Chief Compliance Officers succeed in this role and some get subject to discipline. Here are some ways to get in trouble.

Participation in Wrongful Conduct

David A. Zwick, chief executive officer and chief compliance officer of Suncoast Capital Group, Ltd. was held liable for participating in a scheme with a salesperson he supervised to provide kickbacks to a bond trader.  In exchange for the kickbacks, Suncoast received securities transactions at prices favoring Suncoast and provided signification compensation to Zwick. He was found to have knowingly or recklessly approved fraudulent prices on Suncoast trades.

Failure to Supervise

In its release for Rule 206(4)-7 SEC Release No. IA-2204 the SEC stated:

Having the title of chief compliance officer does not, in and of itself, carry supervisory responsibilities. Thus, a chief compliance officer … would not necessarily be subject to a sanction by us for failure to supervise other advisory personnel. … Section 203(e)(6) provides that a person shall not be deemed to have failed to reasonably supervise another person if: (i) the adviser had adopted procedures reasonably designed to prevent and detect violations of the federal securities laws; (ii) the adviser had a system in place for applying the procedures; and (iii) the supervising person had reasonably discharged his supervisory responsibilities in accordance with the procedures and had no reason to believe the supervised person was not complying with the procedures.

Clearly a CCO has a role in addressing serious misconduct by employees. For an investment adviser, the CCO could be a supervisor and the failure to adequately supervise could subject the CCO to discipline for failure to supervise.

Pre-packaged policies and procedures manual

Consulting Services Group did that and failed to meet the SEC’s standards. Unfortunately for them, the pre-packaged manual did not match up to its business. They provide consulting services to mostly institutional clients. It helps them search for and select money managers, allocate assets, review performance, and design investment policies. The pre-packaged policies and procedures manual “failed to address adequately the conflicts of interest unique to CSG’s operations as a pension consultant, and many of the sections within these generic forms were completely inapplicable and irrelevant to CSG’s provision of investment advisory services to clients.” I would guess they manual they bought was designed for a retail investment adviser.

Email server

Among the things Richard Campanella was disciplined for was the failure to stop the use of non-company email. He received several emails from an employee and told him to stop using the outside email address. Even after three warnings, he field to discipline the employee. Apparently, the employee used the email extensively for business purposes. The end result was record-keeping failure.

Background checks

Westpark Capital’s Chief Compliance Officer was William Morgan. “Among other things, Morgan was responsible for maintaining and updating the Firm’s written supervisory procedures, supervising the branch office managers, performing background investigations and participating in hiring decisions, and determining whether representatives required heightened supervision and the parameters of that heightened scrutiny.” Unfortunately, the company hired some representatives who engaged in churning and made unauthorized and unsuitable trades in customer accounts.

Reporting

Tim Poulus, the Chief Compliance Officer for Olympia Asset Management, failed to report customer complaints to FINRA. (FINRA Case #2008011806301) That statistical and summary information required by NASD Rule 3070(c). The violation lead to a $10,000 fine.

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Fail is by Amboo who?