Conflicts At Fund Adviser Yields First SEC Whistleblower Action

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The Commission brought its first action involving the anti-retaliation provisions of the Dodd-Frank Act. It centers on an investment adviser, a broker dealer, conflicts and retaliation against a firm employee who reported the misconduct to the SEC and later informed his employer of that report. In the Matter of Paradigm Capital Management, Inc, Adm. Proc. File No. 3-15930 (June 16, 2014).

The conduct

The proceeding names as Respondents Paradigm, a registered investment adviser, and Candace King Weir, its founder, director, president and CIO. Ms. Weir also owns about 74% of C.L. King & Associates, Inc., a registered broker dealer. Paradigm advises a hedge fund.

Beginning in 2009, and continuing for the next two years, Paradigm sought to reduce the tax liability of Fund investors. A plan was implemented under which securities with unrealized losses were either sold into the open market or to a trading account at C.L. King. The trading losses were then used to offset realized gains.

During the period Paradigm engaged in at least 83 principal transactions with the broker dealer. Ms. Weir, acting as portfolio manger, made the trading decisions. After evaluating the security if she thought it might be repurchased, the shares would be sold to the trading account at the broker dealer. Approximately 47 of the transactions were with C.I. King. About 36 of the positions were repurchased. The others were sold into the open market.

Since all of the transactions between Paradigm and C.L. King were principal transactions, written disclosure was required to the Fund. The Fund did not have a board of directors to receive the disclosures and consent. Accordingly, a Conflicts Committee was established to review the transactions. It was composed of Paradigm’s COO and CFO. Paradigm’s CFO also served as the CFO of C. L. King. The Conflicts Committee thus had a conflict. This was underscored by the fact that each time the broker dealer purchased securities from the Fund, the transaction had a negative impact on its net capital.

Paradigm failed to provide effective notice of the conflicts since disclosure could not be made to the Fund and the Conflicts Committee was ineffective because of conflicts. The firm’s Form ADV Part 2A was rendered materially misleading since it failed to disclosure the CFO’s conflict.

The whistleblower

Pardigm’s former head trader voluntarily made a whistleblower submission to the Commission in March 2012 regarding the principal transactions. He continued at the firm as head trader until mid-July 2012. He then notified Ms. Weir and the COO of the broker dealer of his whistleblower report.

Subsequently, the head trader was reassigned to investigate the trades that were the subject of his report to the Commission. The report was prepared while working at home, an arrangement sanctioned by the firm. During that period the head trader was denied access to the firm’s trading and account systems. The report was complete and submitted to the firm at the end of July.

After completion of the report, Paradigm informed counsel to the head trader that the employment relationship was “irreparably damaged.” The parties tried, but failed, to work out a severance package.

In early August the head trader was directed to return to work. He was assured that his compensation would remain the same. Paradigm refused to specify his exact duties, although it was clear that he would no longer serve as head trader. Eventually he was directed to determine if the firm had engaged in any other wrongful conduct. This review was to be conducted by analyzing 1,900 pages of trading data. A request to review the electronic reports was denied. Subsequently, the head trader was tasked with consolidating multiple trading procedure manuals into one comprehensive document and proposing revisions to enhance the firm’s procedures. That assignment was the outgrowth of the head traders’ statement that firm procedures were inadequate

Additional disputed regarding his duties and the manner in which his assignments were to be conduct followed. The head trader resigned on August 17, 2012. There was no legitimate reason form removing him from the position of head trader, according to the Order. The Order alleges violations of Exchange Act Section 21F(h), and Sections 206(3) and 207 of the Advisers Act.

Settlement

To resolve the proceeding Respondents agreed to implement a series of undertakings. Those include an obligation to distribute $1.7 million to compensate certain investors in the Fund for administrative fees paid in connection with the principal transactions. Paradigm will also retain an Independent Compliance Consultant who will review and analyze firm policies and make recommendations which will be adopted.

Paradigm consented to the entry of a cease and desist order based on the Sections cited in the Order. Ms Weir consented to the entry of a similar order but based on Section 206(3) of the Advisers Act. Respondents also agreed to pay, jointly and severally, disgorgement of $1.7 million, prejudgment interest and a civil penalty of $300,000. The $1.7 million payment will be deemed satisfied by the distribution to investors in the undertakings.

 

Topics:  Broker-Dealer, Conflicts of Interest, Dodd-Frank, Investment Adviser, Retaliation, SEC, Whistleblower Awards, Whistleblowers

Published In: Civil Procedure Updates, Civil Rights Updates, Finance & Banking Updates, Labor & Employment Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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