The Order also found that the supervisor of the employees, failed to:
- review the trading activities engaged in by the employees on behalf of their customers; and
- follow up and investigate these red flags, even though he was aware of
correspondence received from the mutual funds seeking to restrict market
timing trading.
Please click http://www.sec.gov/litigation/admin/33-8556.pdf for a copy of the administrative action.
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PUTNAM SETTLES MUTUAL FUND SHELF-SPACE CASE
3.23.2005 Putnam Investment Management, LLC (Putnam) settled an SEC enforcement action charging that Putnam failed to adequately
disclose to the Putnam Funds’ Board of Trustees and the
Putnam Funds’ shareholders the conflicts of
interests that arose from its arrangements with broker-dealers for
increased visibility within the broker-dealers' distribution systems.
The SEC found that from at least January 1, 2000 through December 31, 2003, Putnam directed brokerage commissions on the Putnam
Funds’ portfolio transactions to broker-dealers for “shelf space” or
heightened visibility within their distribution systems. Putnam Retail
Management Limited Partnership (PRM), the Putnam Funds' distributor and
an affiliate of Putnam, had entered into arrangements (Preferred
Marketing Arrangements) with over 80 broker-dealers whereby the broker-
dealers provided services designed to promote the sale of the Putnam
Funds. Approximately twenty of those broker-dealers were paid in cash,
while over sixty broker-dealers received directed brokerage commissions
from the Putnam Funds' portfolio transactions. All of these
arrangements were based primarily upon negotiated formulas relating to
gross or net fund sales and/or the retention of fund assets.
When Putnam directed fund brokerage commissions to broker-dealers in
connection with the Preferred Marketing Arrangements, its affiliate,
PRM, did not use its own assets to pay for the services obtained under
these arrangements. Because the financial results of these entities
along with other affiliates were combined within consolidated financial
statements, the entire Putnam organization benefited from the use of
fund assets to defray such expenses. Putnam did not adequately disclose
this potential conflict of interest to the Putnam Board and the Putnam
Shareholders.
As part of the settlement, Putnam will pay a penalty of $40 million,
which will be distributed to the Putnam Funds.
Please click http://www.sec.gov/litigation/admin/ia-2370.pdf for a copy of the administrative action.
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CITIGROUP SETTLES MUTUAL FUND SHELF-SPACE CASE
3.23.2005 Citigroup settled a mutual fund shelf-space case brough by the SEC. Citigroup is a registered broker-dealer which offers
retail brokerage services under the trade name of Smith Barney. The SEC found that from January 1, 2002, through July 31, 2003,
Citigroup failed to disclose adequately certain material facts to its
customers in the offer and sale of mutual fund shares. First, Citigroup
failed to fully disclose to its customers material information regarding
its revenue sharing program, known as the Tier Program. Under the Tier
Program, approximately 75 mutual fund complexes made revenue sharing
payments to Citigroup in exchange for access to or “shelf space” within
Citigroup’s retail brokerage network. In fact, Citigroup offered and
sold only the funds of those mutual fund complexes which participated in
the Tier Program. Citigroup also provided additional benefits to those
mutual fund complexes which made higher revenue sharing payments. These
benefits included increased access to branch offices, greater agenda
space at sales meetings, and visibility in Citigroup’s in-house
publications and broadcasts. This practice created a conflict of
interest which Citigroup failed to adequately disclose to its customers.
The second disclosure failure related to Citigroup’s sale of Class B
shares of mutual funds in amounts aggregating $50,000 or greater.
Citigroup recommended and sold Class B shares of mutual funds to certain
customers who, depending on the amount of the investment and the holding
period, generally would have obtained a higher overall rate of return
had they purchased Class A shares instead. These customers could have
benefited had they purchased Class A shares because they could have
qualified for breakpoints beginning at the $50,000 level.
Please click http://www.sec.gov/litigation/admin/33-8557.pdf for a copy of the administrative action.
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ADVISER/BROKER-DEALER CHARGED WITH MISAPPROPRIATINg CLIENT ASSETS
3.17.2005 The SEC filed a complaint in the
United States District Court for the District of Massachusetts against
T. Gene Gilman, Steven A. Gilman, and companies
they operated alleging that they conducted an offering fraud and
misappropriated approximately $14 million of investor proceeds. The
complaint alleges that between December 1998 and October 2003, G. Gilman
and his son, S. Gilman, solicited approximately $20 million from 40
people who invested funds with Arbor Securities, Ltd., an unregistered
broker dealer and investment adviser located in Needham, Mass.
According to the complaint, the Gilmans funneled investor proceeds to
their personal use through Financial Links, Inc., a registered broker-
dealer controlled by G. Gilman but headquartered in Raleigh, N.C.
The complaint alleges that G. Gilman represented he would establish
individual brokerage accounts for customers at Arbor Securities, an
alleged offshore brokerage firm operated from his office in Needham,
Mass., and would use clients’ funds to trade in the stocks of publicly
traded U.S. companies. Instead of establishing the individual accounts
and investing customer funds as represented, G. Gilman and S. Gilman
commingled and transferred the funds into several foreign and domestic
bank and brokerage accounts in the names of Arbor Securities, including
accounts at Financial Links. From those accounts, S. Gilman transferred
customer funds to himself, to G. Gilman, and to private companies
controlled by G. Gilman.
Please click http://www.sec.gov/litigation/litreleases/lr19144.htm for a copy of the administrative action.
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NASD FINES INSURANCE COMPANY IN FIRST VARIABLE ANNUITY MARKET TIMING CASE
3.16.2005 The NASD fined Jefferson Pilot Variable Corporation, a broker-dealer, $325,000 for failing to have an adequate supervisory system in place to prevent market timing and excessive trading in the sub-accounts of its variable universal life insurance policies. NASD found that, despite having an electronic system ostensibly designed to recognize and block sub-account transfers in excess of policy limits, Jefferson Pilot failed to determine whether the system was functional. Given the firm's exclusive reliance on this system to monitor sub-account transfers, such follow-up and review was essential in the NASD's view.
As a result of this failure, 292 policyholders were permitted to exceed the 20-transfers-per-policy-year limit described in the prospectus.
Separately, NASD fined another affiliate, Jefferson Pilot Securities Corp. (JPSC), also of Concord, $125,000 for failing to retain all e-mail communications of its registered persons.
Please click http://www.nasd.com/web/idcplg?IdcService=SS_GET_PAGE&ssDocName=NASDW_013566&ssSourceNodeId=5 for the NASD news release about the case.
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MSRB PROPOSES AMENDMENTS TO MUNICIPAL SECURITIES SOLICITATION RULES
3.15.2005 The Municipal Securities Rulemaking Board (MSRB) has proposed amendments to Rule G-38, which regulates the solicitation of municipal securities business. The amendments would prohibits brokers, dealers and municipal securities dealers from paying persons who are not affiliated with the dealers for soliciting municipal securities business on their behalf. Affiliated persons to whom payments for solicitations are permitted consist of partners, directors, officers and employees of dealers or of affiliated companies of such dealers. Solicitation is defined as a direct or indirect communication with an issuer for the purpose of obtaining or retaining municipal securities business.
Please click http://ww1.msrb.org/msrb1/whatsnew/2005-16.asp for a copy of the proposal.
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SEC ADOPTS MUTUAL FUND REDEMPTION FEE RULE
3.11.2005 The SEC adopted Rule 22c-2 under the Investment
Company Act of 1940. The rule requires:
- the board of directors
(including a majority of independent directors) of most registered
investment companies (funds) to either approve a redemption fee of up to
2% or determine that imposition of a redemption fee is not
necessary or not appropriate for the fund. The proceeds of the
redemption fee must be paid to the fund itself; and
- funds to enter into written
agreements with their financial intermediaries (such as broker-dealers
and retirement plan administrators) under which the intermediaries must,
upon request, provide funds with certain shareholder identity and
trading information and carry out certain instructions from the fund.
The redemption fee is
intended to allow funds to recoup some of the direct and indirect costs
incurred as a result of short-term trading strategies, such as market
timing. The inquiry requirement will enable funds to obtain the information that they
need to monitor the frequency of short-term trading in omnibus accounts
and enforce their market timing policies.
The SEC requested additional comment to obtain further views on whether it
should establish uniform standards for redemption fees charged under the
rule.
The new rule iseffective on May 23, 2005. The compliance date of
the rule is October 16, 2006.
Please click http://www.sec.gov/rules/final/ic-26782.pdf for a copy of the adopting release in PDF format.
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COURT FINDS AGAINST FINANCIAL PLANNER IN FRAUD CASE
3.9.2005 The U.S.
District Court for the Western District of Pennsylvania, entered a final
judgment against Bryan James Hawes, a financial planner and investment
adviser, for violating the antifraud provisions of the federal
securities laws. In its complaint, the SEC alleged that Hawes, individually and
through entities he controlled, through an egregious abuse of trust and
fraudulent dealings, misappropriated at least $1.2 million from
investors whose assets he purported to manage.
The SEC’s complaint alleged that Hawes, through his company, falsely told certain investors that he had
purchased, as they had directed, annuity policies as investment
vehicles. The complaint further alleged that, in fact, for some
investors, Hawes never bought the policies but rather took the policy
“premium” for himself. For other investors, the complaint alleged that
Hawes initially purchased the annuities but later liquidated them
without the clients’ knowledge or authorization, keeping the proceeds
for himself. Additionally, in a separate alleged scheme, Hawes, through
FMAS, charged exorbitant and unauthorized management fees to investors
who believed he was managing their assets. Hawes then hid his fraud
from these investors by sending false account statements to the
investors showing inflated balances and omitting the unauthorized fee
deductions.
Please click http://www.sec.gov/litigation/litreleases/lr19137.htm for a copy of the administrative action.
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REGULATION S IS POSTPONED AGAIN
3.8.2005 The SEC issued an order further extending
until September 30, 2005, the compliance dates for banks with respect to
certain broker registration requirements contained in the Gramm-Leach-
Bliley Act (GLBA).
The GLBA repealed an exception from broker-dealer registration
requirements in the Securities Exchange Act of 1934 that had allowed
banks to engage in securities activities without registering as a broker
or dealer. The GLBA replaced this exception with new functional
exceptions that were to become effective May 12, 2001. On May 11, 2001,
the Commission adopted interim final rules (Interim Rules) that, among
other things, gave banks time to come into full compliance with the more
narrowly tailored exceptions from broker-dealer registration. To further
accommodate the banking industry's continuing compliance concerns, the
Commission delayed the effective date of the bank “broker” rules through
a series of orders that ultimately extended the temporary exemption from
the definition of “broker” to March 31, 2005. In June 2004, the Commission proposed to revise and replace the Interim
Rules with Regulation B.
The SEC announced that it does not expect banks to develop
compliance systems to meet the terms of the “broker” exceptions until
the SEC amends its rules. Banks have indicated that they will
need time to implement systems to ensure compliance with the new
statutory requirements regarding the definition of “broker.”
Please click http://www.sec.gov/litigation/admin/34-51219.htm for a copy of the administrative action.
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SEC TAKES EMERGENCY ACTION AGAINST HEDGE FUND
3.3.2005 The SEC filed an emergency enforcement action to halt an ongoing hedge fund fraud concerning three related hedge fund investment advisers, multiple hedge funds, a registered broker-dealer and the principals that control these entities.
The SEC's complaint alleges that from approximately 1999 to the present, the Defendants have raised at least $81 million from investors nationwide by boasting annualized returns of 125 to 150% over the last several years and by sending false account statements to investors showing similar gains. According to the complaint, the hedge funds were suffering tremendous trading losses and only about $11 million remains of the more than $81 million that investors put into the hedge funds. The complaint also alleges that:
- The defendants used phony account statements to convince investors that the hedge funds were profitable;
- Contrary to defendant’s claims of profitable returns, only about $11 million remains of the more than $81 million that investors put into the hedge funds; and
- The investment advisers and the individual defendants earned substantial fees from the hedge funds, in part from a performance commission fee that was typically 20% of the hedge funds’ profit.
- The PPMs generally prohibited the use of investor funds to pay commissions in connection with sales of limited partnership interests to Hedge Fund investors. Notwithstanding these restrictions, XL Capital paid substantial referral fees to itself based on a percentage of the net profits allocated to each investor referred to the Hedge Funds. And because XL Capital fraudulently overstated investment returns, these improper fees greatly exceed the maximum 20% incentive allocation the XL Capital Defendants were entitled to withdraw from the Hedge Funds. Indeed, because net profits for the Hedge Funds approached zero between December 2002 and November 2004, XL Capital was entitled to withdraw little or no inventive allocations from the Hedge Funds during this period.
Please click http://www.sec.gov/litigation/litreleases/lr19117.htm for a copy of the administrative action.
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SEC GRANTS NO-ACTION RELIEF FROM CERTAIN PROVISIONS OF THE CODE OF ETHICS RULE WITH RESPECT TO NON-ADVISORY PERSONNEL
3.1.2005 The SEC granted no-action relief to Prudential Insurance Company Prudential from to Rule 204A-1 under the Investment Advisers Act of 1940 if Prudential does not comply with the requirements of the Rule with respect to certain of its supervised persons who are "non-advisory personnel."
Prudential currently provides investment advisory services to a state employee retirement plan and arranges for its registered investment advisory affiliates to make available such services to other governmental and corporate retirement plans in conjunction with retirement recordkeeping services and stable value wrap products. In addition, Prudential has a small number of institutional investment advisory clients, primarily defined benefit retirement plans, which are a legacy of broader investment advisory activities that it previously conducted. Finally, Prudential serves as an investment manager with respect to assets that are held in various types of unregistered separate accounts. An affiliate of Prudential that is a registered investment adviser acts as sub-adviser and manages the relevant separate accounts on a day-to-day basis. You state that due to these limited investment advisory activities, Prudential is required to maintain its registration under the Advisers Act.
A large portion of Prudential's personnel are non-advisory personnel who have no involvement, either directly or indirectly, in Prudential's investment advisory activities, have no access to nonpublic information about Prudential's investment advisory activities, and are involved solely in Prudential's insurance businesses. The SEC sought relief to make sure that Rule 204A-1 would not require it to subject to thousands of its supervised, but non-advisory persons, to Rule 204-1, including the requirements to provide a copy of its code to each of them and to obtain from each an acknowledgement of the person's receipt of a copy of the code.
Prudential acknowledge that the requirements of Rule 204A-1 should not apply to all of its supervised persons. It noted that the breadth of persons covered by Rule 204A-1 and Rule 204-2 by virtue of the Rules' use of the term "supervised persons." When applied to a registered investment adviser such as Prudential that primarily engages in a business other than the investment advisory business where the vast majority of whose personnel are non-advisory personnel, it imposes unduly burdensome requirements. The SEC staff therefore stated that it would not recommend enforcement action to the Commission against Prudential under these Rules if Prudential's code of ethics contains supervised persons provisions that apply to Prudential's investment advisory personnel, but not to its non-advisory personnel, and if Prudential maintains a record of written acknowledgements for its investment advisory personnel, but not for its non-advisory personnel.
Please click http://www.sec.gov/divisions/investment/noaction/pru030105.htm to access a copy of the no-action letter.
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SEC RE-OPENS COMMENT PERIOD ON PROPOSED POINT-OF-SALE RULES
3.1.2005 The SEC reopened the comment period for and requested supplemental
comments on proposed rules 15c2-2 and 15c2-3, as well as proposed amendments to Rule
10b-10 under the Securities Exchange Act of 1934, and amendments to Form N-1A under
the Securities Act of 1933 and the Investment Company Act of 1940.
On January 29, 2004, the SEC issued, and requested comment on, two proposed new rules, as well as rule amendments under the Securities Exchange Act of 1934 designed to enhance the information broker-dealers provide to their customers in connection with transactions in certain types of securities.
Proposed rules 15c2-2 and 15c2-3 would require broker-dealers to provide their customers with targeted information, at the point of sale and in transaction confirmations, regarding the costs and conflicts of interest that arise from the distribution of mutual fund shares, 529 college savings plan interests, and variable insurance products. The SEC also proposed conforming amendments to Rule 10b-10, the confirmation rule, as well as amendments to that rule to provide investors with additional information about call features of debt securities and preferred stock. Finally, the SEC proposed amendments to Form N-1A, the registration form for mutual funds, to improve disclosure of sales loads and revenue sharing payments.
Please click http://www.sec.gov/rules/proposed/33-8544.htm for a copy of the SEC release.
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OCIE DIRECTOR SPEAKS ON CURRENT COMPLIANCE ISSUES
2.28.2005 Lori Richards, Director of OCIE, the inspection arm of the SEC, spoke at the Investment Adviser Compliance Best Practices Summit: Compliance Programs: Our Shared Mission, a conference co-sponsored by the ICAA and IA Week in Washington, D.C. Ms. Richards listed four characteristics of an "activist compliance program:"
- It must be respected within the organization, and have the utmost support from the top.
- It must be well-resourced, and populated by staff with expertise.
- It must possess an attitude of skepticism. It must be creative in thinking about ways that rules could be subverted, that ethical standards can be breached.
- It must continually beware conflicts of interest - one of the most powerful being the desire to grow assets under management and the advisory fee to benefit the adviser, at the expense of the advisory client.
She ended her speech by noting that the SEC implemented what we call the "Exam HotLine." The Exam HotLine will be dedicated to receiving calls from members of the regulated community who have a complaint or a concern about an SEC examination.
Please click http://www.sec.gov/news/speech/spch022805lar.htm for a copy of the speech.
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