Regulatory Scrutiny Continues on Broker-Dealer Payments for Order Flow, March Madness – NCAA Players Scammed, Resources on the Latest DOL Prohibited Transaction Exemption and More: Lessons Learned and Worth Reading Update for March 2021

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Lessons Learned

Payment for Order Flow Gets Another Broker into Hot Water for Undisclosed Conflicts. The SEC found Lightspeed Trading, LLC (“Lightspeed”), formerly a registered broker-dealer, guilty of securities fraud for lying to customers and profiting from lower “market center fees” charged by its affiliate for executing trades. In 2012, Lightspeed started offering customers access to an equity trading platform that allowed them to select the exchange or trading venue for executing their orders. Unfortunately, that freedom of choice was an illusion. Lightspeed actually sent many trades to its affiliated Routing Broker, which charged Lightspeed less for the trades than the venues the customers had selected. Lightspeed charged the fees those venues advertised and kept the difference, to the tune of $300,000 over a period of seven months. The SEC required Lightspeed to repay its clients, but the firm pleaded poverty and got $100,000 of its penalty waived.

Advisers and brokers-dealers should start paying attention to the order routing practices of the firms they use to execute trades. The SEC has found a new source of conflicts of interest and will likely start including more questions in its examinations on this topic. Contributed by Jaqueline M. Hummel, Managing Director.

Multiple Disclosure Failures Lead to $18 Million Fine for Wrap Sponsor. We know that transparent disclosure is the name of the game when it comes to wrap accounts. We also know that the SEC has been laser-focused on disclosures of both 12b-1 fees and revenue sharing. A recent SEC administrative order shows us just how bad things can get when these areas aren’t diligently supervised. Pruco Securities, LLC (“Pruco”) recently settled with the SEC for failing to honor its fiduciary duty to its advisory clients that participated in one of its four wrap fee programs. Not only did the SEC find that Pruco was recommending mutual fund share classes to clients that would generate 12b-1 fees for the firm, but Pruco also failed to disclose the revenue sharing agreement it had in place with its clearing firm, which allowed the Pruco to avoid paying certain transaction fees. Pruco received revenue sharing from the same clearing firm for sales of certain bank sweep vehicles that it recommended to clients, which also went undisclosed.

Unfortunately, Pruco fell short in other areas as well. Despite Pruco’s disclosures, policies and procedures outlining periodic monitoring and review of wrap accounts to determine suitability, these procedures were not being performed. Over three years, Pruco generated more than $1.7 million in management fees as a result of maintaining 1,401 wrap fee accounts with little or no trading activity. Pruco also charged management fees contrary to its disclosures, requiring a hefty reimbursement to clients as well as updates to its wrap program brochure. Finally (and perhaps unsurprisingly given the SEC’s findings in other enforcement actions tied to 12b-1 fee), the firm violated its duty to seek best execution by recommending mutual fund share classes that charged higher expenses even though other share classes of the same funds offering a better value or performance were available. As a result of the SEC’s findings, Pruco agreed to pay $18 million in disgorgement, interest and penalties as well as a censure and cease-and-desist.

Not that we necessarily needed reminding, but the intense regulatory scrutiny placed upon the topics of 12b-1 fees, share class selection, and revenue sharing does not appear to be fading anytime soon. There is another important takeaway here, too: firms should have a plan to go beyond that important first step of identifying areas of risk. Firms should allocate appropriate and adequate resources to assess and mitigate those risks, and effective supervision should identify and address an issue before it bleeds into other areas of the firm’s business. The Pruco case is a prime example of just how important this is, and what can go wrong if not properly addressed. Contributed by Jennifer L. Cagadas, Compliance Consultant.

March Madness - RIA Bribed Agents to Recruit NCAA Player Clients. Rosedale Asset Management, LLC f/k/a Princeton Advisory Wealth Management, LLC (“PWM”) agreed to a cease-and-desist order for its participation in a widespread scheme to bribe individuals to influence NCAA amateur athletes to retain PWM as an investment adviser after they turned pro. Between February 2016 and September 2017, PWM made twenty payments totaling more than $96,000 to such individuals. Those referral payments resulted in at least five former NCAA athletes signing advisory agreements with PWM. However, at no time did PWM disclose those referral payments to the prospective clients. This conduct violated Sections 206(1), 206(2), and 206(4) of the Advisers Act and Rule 206(4)-3 thereunder. Contributed by Doug MacKinnon, Senior Compliance Consultant.

Heed the Advice of Your CCO. Advance Practice Advisors, LLC (“APA”) recently agreed to a cease-and-desist order, and its CEO, Paul C. Spitzer, agreed to pay penalties and not to act in a supervisory for allowing an individual not associated with APA to advise APA clients. The unassociated individual happened to be the father of one of its investment adviser representatives (“IAR”).

The IAR had only recently passed his series 7 and series 65 exams when he joined the firm, while his father was rejected by APA because of an ongoing FINRA investigation. Predictably, the father had an existing book of clients willing to move with him, but Spitzer informed him that he was to have ‘no formal affiliation’ with APA. However, the father continued to provide investment advice to clients on an undisclosed basis. Spitzer was responsible for overseeing the new rep and either knew or should have known that the father was servicing APA clients. For example, the father and son shared office space and phone lines, and Spitzer would often discuss topics such as advisory fees with the father. APA and Spitzer did not disclose to clients that the father was not formally associated with APA.

Six months after the hire, a new Chief Compliance Officer joined APA and expressed concerns regarding the office sharing, access to client information, and the lack of disclosures to clients about the relationship. Spitzer did not take any steps to address the CCO’s concerns. Subsequently, the CCO became aware that the son allowed his father to impersonate him on phone calls with APA’s clearing broker and recommended that APA terminate the son’s employment. Again, Spitzer ignored the CCO’s recommendations.

In addition to the lessons regarding the importance of adopting and implementing appropriate supervision policies and procedures, firms that ignore warning signs of blatant policy violations do so at their peril. A noteworthy aspect of this case is that the CCO, who was on record with advice not followed, avoided personal charges or penalties. On December 15, 2020, APA filed a request to terminate its California registration as an investment adviser. Contributed by Jeffrey C. Johnson, Compliance Consultant.

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