Joint Agency Release on Improving Privacy Notices
3.31.2006 The Federal Reserve Board of Governors, FDIC, FTC, NCUA, OCC, and OTS issued a report on improving financial privacy notices for consumers. The report explores alternatives for financial privacy notices that would be easier for consumers to read, understand, and use than many of the notices consumers currently receive from financial institutions. The report's findings indicate that it is possible for financial privacy notices to include all of the information required by law in a short document that consumers can readily understand. The report fully describes the extensive research that underlies these findings and the development of a prototype simplified privacy notice.
According to the report, consumers are overwhelmed by complex information, and simplification of financial privacy notices enhances consumers' ability to understand the notices and make informed choices about the use of their personal information.
Please click http://www.ftc.gov/privacy/privacyinitiatives/ftcfinalreport060228.pdf to access a copy of the report.
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3.29.2006 Lori Richards, Director of the SEC's Office of Compliance Inspections and Examinations, spoke in New York at the SIA’s "Anti-Money Laundering in 2006: It's the 'Total Mix" conference.
She stated that SEC examiners are finding that some firms of different sizes and types may not be looking at their whole business–-on an enterprise-wide basis—when crafting and implementing their AML programs. In particular, examiners have identified issues regarding the coverage of branch offices, outsourced activities and new business activities.
Ms. Richards noted that suspicious activity monitoring, detection and reporting is the cornerstone of AML programs and, as a result, it receives a fair amount of attention from SEC examiners.
Finally, she stated that training is an essential, required part of every AML program. Examiners will consider whether the substance of the firm's training program is appropriately customized to the firm's business model and risk profile. Also companies will be asked to provide copies of training materials and to provide indications that employees attended the training.
Please click http://www.sec.gov/news/speech/spch032906lar.htm for a copy of the speech.
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SEC Commissioner Speaks on Proposed Point-of-Sale Rule
3.29.2006 Roel Campos, one of the SEC’s Commissioners, spoke at the National Association of Securities Professionals 1st Annual Legislative Symposium in Washington, D.C. In the speech, he suggested that it might be better to require broker-dealers to communicate specified point-of-sale information by telephone to customers purchasing mutual funds than only to give customers notice that the information is posted on the Internet. He further described the possibility of using the Internet "as part of a layered approach by which all investors are informed of the existence of revenue sharing and other conflicts at the point of sale, and interested investors can use the Internet to see quantitative information about the payments that broker-dealers receive from fund families."
Commissioner Campos noted that “even the most idealized prospectus cannot specify the full range of costs that an investor can expect to incur, based on his or her particular investment, the way that brokers can.” In his view, prospectuses cannot identify fees or compensation arrangements that are unique to the brokerage firm, “including payments that particular brokerage firm may receive by special arrangements, and brokerage's own arrangements for compensating its sales personnel.”
Campos stated that point-of-sale disclosure can alert investors to three key conflicts of interest:
- "does the brokerage receive special compensation for selling the fund, such as so-called 'revenue sharing'?";
- "does the brokerage favor the sale of particular funds by paying differential compensation to their sales personnel?"; and
- "is the brokerage affiliated with the mutual fund complex?"
Campos noted that the Internet can be used to supplement that information to permit interested investors to see more details about compensation arrangements and conflicts.
Please click http://www.sec.gov/news/speech/spch032906rcc.htm to access a copy of the speech.
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SEC Expands its International Affairs Web Page
3.26.2006 The SEC Office of International Affairs has posted a new web page entitled "SEC Rulemaking and Other Initiatives: Accommodations." The page discusses individual SEC rules under the Sarbanes-Oxley Act, and exemptions or other accommodations for foreign issuers, accounting firms or other market participants.
Please click http://www.sec.gov/about/offices/oia/oia_rulemaking/accommodations.htm to access the new web page.
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ICI Chairman Speaks About Mutual Funds and the XBRL Technology
3.20.2006 Paul Schott Stevens, President of the Investment Company Institute (“ICI”), spoke at the Mutual Funds and Investment Management Conference in Scottsdale, Arizona, on the use of the Internet and XBRL (eXtensible Business Reporting Language) technology. He stated that the first step is to move toward providing investors with interactive data. To that end, he announced an ICI initiative to adapt XBRL - the interactive data technology promoted by the SEC to disseminate financial data for use in mutual fund disclosure.
On an unrelated topic, Stevens called on Congress, now poised to pass comprehensive pension reform, to better equip and encourage Americans to save for a secure retirement by including automatic enrollment in 401(k) plans, allowing access to professional advice, and making permanent the increased contribution levels for 401(k)s and IRAs.
Please click http://www.ici.org/new/06_mfimc_stevens_spch.html for a copy of the speech.
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SEC Posts PCAOB Rule Notice Concerning Independence, Tax Services and Contingent Fees
3.17.2006 The SEC posted a notice of the filing of a PCAOB rule change proposal relating to ethics and independence rules concerning independence, tax services, and contingent fees. A registered public accounting firm and its associated persons must be independent of the firm's audit client throughout the audit and professional engagement period.
Under proposed Rule 3521, a registered public accounting firm is not independent of its audit client if the firm, or any affiliate of the firm, during the audit and professional engagement period, provides any service or product to the audit client for a contingent fee or a commission, or receives from the audit client, directly or indirectly, a contingent fee or commission.
Under proposed Rule 3522, a registered public accounting firm is not independent of its audit client if the firm, or any affiliate of the firm, during the audit and professional engagement period, provides any non-audit service to the audit client related to marketing, planning, or opining in favor of the tax treatment of, a transaction that was initially recommended, directly or indirectly, by the registered public accounting firm and a significant purpose of which is tax avoidance.
Under proposed Rule 3523, a registered public accounting firm is not independent of its audit client if the firm, or any affiliate of the firm, during the audit and professional engagement period provides any tax service to a person in a financial reporting oversight role at the audit client, or an immediate family member of such person, with certain limited exceptions.
Finally, proposed Rule 3524 requires the audit committee to make certain approvals related to tax services.
Please click http://www.sec.gov/rules/pcaob/34-53427.pdf for a copy of the release.
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PCAOB and SEC to Host Internal Controls Roundtable
3.17.2006 On May 10, 2006, the SEC and PCAOB will host a roundtable on internal controls at the SEC's new headquarters in Washington, D.C. The purpose of the roundtable is to discuss second-year experiences with the reporting and auditing requirements of the Sarbanes-Oxley Act of 2002 related to companies’ internal control over financial reporting. The roundtable discussion will include issuers, auditors, investors, and other interested parties and will be open to the public.
Please click http://www.sec.gov/news/press/2006-22.htm to access a copy of the release announcing the roundtable.
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California Hedge Fund Charged with Concealing Trading Losses
3.16.2006 The SEC charged two managers of a San Francisco hedge fund with using an unfunded $200,000 "reserve" to conceal from investors the fund's trading losses.
According to the SEC, the value of the hedge fund, Cogent Capital Management, LLC (“Cogent”), declined by over 20% in the first three months of operation in early 2003. In response, the fund’s managers decided to form a purported “redemption reserve” of $228,000 (about 15% of the fund’s value at the time) and planned to use their own cash to fund the reserve. They then calculated the fund’s performance, obscuring the substantial trading loss by adding the $228,000 amount to the fund’s total value. The managers never disclosed this to investors, nor did they fund the $228,000 reserve at the time. Cogent’s managers then sent Cogent investors quarterly and year-end account statements that included the purported “reserve” but failed to disclose that the reserve increased Cogent’s reported performance. The statements understated the fund’s actual losses by as much as 90%. By providing Cogent investors with misleading account statements for the last three quarters of 2003, the managers caused violations of Sections 206(1) and 206(2) of the Advisers Act.
Please click http://www.sec.gov/litigation/admin/ia-2503-o.pdf for a copy of the administrative action.
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Bear Stearns Settles Market Timing Charges
3.16.2006 The SEC settled enforcement action against Bear, Stearns & Co., Inc. (BS&Co.) and Bear, Stearns Securities Corp. (BSSC) (collectively, Bear Stearns), charging Bear Stearns with securities fraud for facilitating unlawful late trading and deceptive market timing of mutual funds by its customers and customers of its introducing brokers. The SEC found that from 1999 through September 2003, Bear Stearns provided technology, advice and deceptive devices that enabled its market-timing customers and introducing brokers to late trade and to evade detection by mutual funds.
BS&Co. is an introducing broker-dealer whose customers buy and sell securities. BSSC is a clearing firm for BS&Co., other introducing broker-dealers and prime brokerage customers (i.e., hedge funds that clear trades directly through BSSC).
In 1999, BSSC established a "timing desk" to manage the increasing flow of market timing trades through BSSC. The timing desk assisted customers to enter late trades and even to cancel unprofitable trades the following day. The timing desk also advised customers and brokers on how to evade the blocks and restrictions imposed by the mutual funds and how to negotiate BSSC's own blocking system.
Bear Stearns facilitated late trading. At BS&Co., certain brokers actively facilitated late trading by knowingly processing a large number of late trades for certain of their market-timing customers. In some cases, BS&Co. brokers falsified order tickets by recording that orders which were actually received after 4:00 p.m. had been received at 3:59 p.m. or 4:00 p.m.
On the clearing side, BSSC gave introducing brokers and prime brokerage customers with mutual fund trading business direct access to its mutual fund order entry system. This system permitted users to enter orders until 5:45 p.m. and processed all trades (regardless of when they were actually received) as if they had been received before 4:00 p.m. The effect, in the case of prime brokerage customers, was to put the order entry system directly in the hands of the ultimate customer who then used the system to trade at will without an intermediary broker.
Bear Stearns also helped its market timing customers evade detection by mutual funds that did not want market timing business. Upon detecting market timing trades, mutual funds often blocked further trading by market timers by reference to the available identifying information accompanying the trade, such as the account number, registered representative (“RR”) number or branch code. To evade these blocks, BS&Co. helped its market timing customers hide their identities from mutual funds by, for example, assigning multiple account numbers to customers so that the mutual funds could not identify them as customers whose trades the mutual funds had previously blocked, or by assigning multiple RR numbers to registered representatives at BS&Co. to conceal the identity of the traders.
Pursuant to the settlement, Bear Stearns will pay $250 million, consisting of $160 million in disgorgement and a $90 million penalty.
Please click http://www.sec.gov/news/press/2006-38.htm for the press release announcing the settlment.
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Hedge Fund Settles Charges of Illegal Pipe Trading Scheme
3.14.2006 Securities fraud and related charges filed by the SEC have been settled by three New York-based hedge funds, Langley Partners, North Olmsted Partners and Quantico Partners (collectively, "Langley Partners"), and their portfolio manager, Jeffrey Thorp.
The SEC alleged that they perpetrated an illegal trading scheme to evade the registration requirements of the federal securities laws in connection with 23 unregistered securities offerings, that are commonly referred to as "PIPEs" (Private Investment in Public Equity), and engaged in insider trading.
Specifically, the SEC alleged that Langley Partners and Thorp, after agreeing to invest in a PIPE transaction, typically sold short the issuer's stock. Among other things, the SEC's complaint alleges that:
- Once the SEC declared the resale registration statement effective, Thorp used the PIPE shares to close out the short positions, a practice Thorp knew was prohibited by the registration provisions of the federal securities laws. To avoid detection and regulatory scrutiny, Thorp employed a variety of deceptive trading techniques, including wash sales and matched orders, to make it appear that he was covering his short sales with legal, open market stock purchases. In fact, the covering transactions were not open market transactions because Thorp was on both sides of the trades.
- In each of the transactions, Thorp made materially false representations to the PIPE issuers to induce them to sell securities to Langley Partners. As a precondition of participation in a PIPE, Langley Partners had to represent that it would not sell, transfer or dispose of the PIPE shares other than in compliance with the registration provisions of the Securities Act of 1933. This representation was material to the PIPE issuers, which, as the stock purchase agreements made clear, relied on the investors' representations in connection with qualifying for an exemption from the registration requirements for their private offering. At the time Thorp signed the securities purchase agreements, however, he intended, if he had not already done so, to distribute the restricted PIPE securities in violation of the registration provisions of the Securities Act.
- On seven occasions, Thorp also engaged in insider trading by selling the securities of PIPE issuers on the basis of material nonpublic information prior to the public announcement of the PIPEs. Thorp engaged in this conduct notwithstanding his express agreement to keep information about the PIPE confidential and/or to refrain from trading prior to the public announcement of the PIPE.
Please click http://www.sec.gov/litigation/litreleases/lr19607.htm to access a copy of the administrative action.
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Merrill Lynch Settles E-mail Case
3.13.2006 Merrill Lynch, Pierce, Fenner & Smith Inc. (“Merrill Lynch”) settled charges that the firm had systemically failed to furnish e-mails promptly to representatives of the SEC. During the relevant period, the SEC alleged that Merrill Lynch's systems, policies, and procedures designed for the prompt production and retention of e-mails were deficient and Merrill Lynch failed to ensure that it complied with its obligations as a regulated entity. Furthermore, Merrill Lynch's inability to promptly produce e-mails contradicted statements made by Merrill Lynch that its e-mail retention systems were in compliance with applicable federal securities laws. Its failure to retain certain e-mails also contradicted statements made by Merrill Lynch that its e-mail systems were retaining required e-mails.
The SEC censured Merrill Lynch and fined it $2.5 million. It also required that Merrill Lynch comply with undertakings, including the retention of an independent consultant to review Merrill Lynch's systems, policies, and procedures as they relate to compliance with the federal securities laws and rules concerning the retention and prompt production of e-mails to the SEC.
Please click http://www.sec.gov/litigation/admin/34-53473.pdf for a copy of the administrative action.
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Adviser Charged with Scalping
3.9.2006 The SEC has charged BMA Ventures, Inc., a registered investment adviser, and its president and owner, William Robert Kepler, with scalping. According to the SEC’s complaint, from January 2004 through March 2005, BMA Ventures and Kepler issued newsletters by bulk fax under names such as "OTC Premier," "Inside Wall St.," and "OTC Marquee" recommending that the recipients purchase the stock of 26 companies, virtually all of which were penny stocks. The complaint further alleged that the newsletters were fraudulent because they did not reveal that BMA Ventures was secretly selling its stock in the same companies contrary to its recommendations, a practice known as "scalping."
BMA Ventures and Kepler obtained approximately $1.9 million through this scheme. Finally, BMA improperly registered as an investment adviser with the SEC because it did not meet the conditions necessary for registration.
Please click http://www.sec.gov/litigation/litreleases/lr19606.htm to access a copy of the administrative action.
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SEC to Study Regulation of Investment Advisers and Broker-Dealers
3.3.2006 The SEC will study and issue a report on the levels of protection afforded retail customers of financial service providers under the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 and to address any investor protection concerns arising from material differences between the two regulatory regimes. The study is in response to new Rule 202(a)(11)-1 under the Advisers Act, which provides an exception from the Investment Advisers Act for broker-dealers receiving compensation other than commissions – such as fees that are fixed dollar amounts—for full-service brokerage programs that include advice about securities.
Please click http://www.sec.gov/rules/other/34-53406.pdf to access the release describing the study.
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