Supervision Efforts Should Keep Up with Rapid Growth; “One Offs” Cause Regulatory Headaches, and CCO Gets Harsh Lesson for Faking Records: Lessons Learned from SEC


Lessons Learned

SEC Nails Interactive Brokers for Repeatedly Failing to File Suspicious Activity Reports. The importance of having a strong supervision and anti-money laundering programs was evident in recent regulatory actions taken against Interactive Brokers LLC (“Interactive”). Interactive grew rapidly from 2013 to 2018 becoming one of the larger electronic broker-dealers in the United States. However, with that growth Interactive failed to put in place the necessary resources and to implement programs for properly surveilling hundreds of millions of dollars in wire transfers and to identify and investigate suspicious activity. Among other things, this resulted in Interactive failing to file suspicious activity reports for certain microcap securities trades or to properly supervise employee’s handling of customer accounts. As a result, Interactive was fined a total of $38 million by regulators (FINRA $15 million, SEC $11.5 million, CFTC $11.5 million). The firm also had to pay an additional $706,214 in disgorgement related to the CFTC settlement. Contributed by Doug MacKinnon, Senior Compliance Consultant.

National Financial Services Fails with Regard to Its Underwriting Activities. As compliance consultants, we are often concerned when a client engages in certain business activities on an occasional or “one-off” basis. Why? Because those areas are ripe for mistakes, and sometimes big ones. The activity may not seem significant and the firm may fail to properly consider the associated risks. Often, the activity is not covered in the firm’s written compliance and supervisory procedures. As a result, the activity falls under the radar and continues unmonitored until… This case offers a perfect example.

Over a twelve-year period, National Financial Services (“NFS”) failed to satisfy its prospectus delivery obligations to investors in connection with five “at-the-market delayed shelf offerings” of FuelCell Energy, Inc. During that time, NFS sold over 70 million shares of the issuer’s common stock, raising over $148 million without delivering final prospectuses. With shelf offerings, the issuer is permitted to file a registration statement with the Commission that includes a “base prospectus” that omits some of the offering-specific information required in a final prospectus (e.g., type of security, manner and timing of distribution, and nature and terms of agreements with underwriters, dealers and agents). When selling off-the-shelf securities, the issuer must file a final prospectus that discloses the required offering information that was excluded from the base prospectus. In the case of FuelCell, no final prospectuses were ever prepared, filed, or delivered. As it turns out, the trading desk that conducted these sales did not generally engage in underwriting activities. In addition, NFS did not have policies and procedures to monitor the activities, or prevent, detect, or address the violations. Making the situation worse, once aware of the situation, NFS failed to take timely or effective corrective action to prevent further violations.

It is imperative that your compliance program identifies and addresses all business activities of your firm. Firms should pay particular attention to the policies and procedures addressing those activities that represent a small portion of revenue as these areas are often overlooked, until… Contributed by Rochelle A. Truzzi, Managing Director.

Career Ends in Disgrace for CCO that Faked Records. Bonnie Haupt was the CCO and part-owner of Gilder Gagnon Howe & Co., LLC (GGHC), a dually registered investment adviser and broker-dealer, who has been barred from the industry and personally fined $45,000. Her crime? Failure to follow policies and procedures. GGHC was examined by FINRA in late 2016. FINRA found that because the firm actively traded client accounts and was paid on a commission basis, GGHC needed to better supervise its trading activity. GGHC responded by adopting a process for the CCO to review turnover rates in client accounts monthly, and to escalate accounts that exceeded a 6% cost-to equity ratio to the firm’s managing members. The SEC came onsite for an exam in late 2017 and asked to see these reviews. The CCO produced reports that she altered by using white-out to cover up the dates the reports were printed and by making hand-written notes to make it look like she had reviewed them earlier.

The SEC’s order does not say why these reviews were not performed. But the lessons learned are not new. First, if you tell a regulator that you are going to do something, do it. Second, do not adopt policies and procedures that you cannot implement. The SEC enforces the compliance manual as if it were law, so make sure you can live up to the promises you make. Third, do not fake records. It is better to admit the wrong-doing than to try and cover it up. The SEC hates devious behavior and will punish it much more forcefully than neglect of duty. Contributed by Jaqueline M. Hummel, Partner and Managing Director.

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Photo Credits: Photo by David Edkins on Unsplash

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