Securities Law Blog

The Securities and Exchange Commission today announced that it has obtained an asset freeze and other emergency relief to protect investors whose funds were at risk due to fraudulent misconduct at North American Clearing, Inc., a Longwood, Fla., based general securities and clearing brokerage firm. The SEC's complaint alleges that the defendants' fraud began earlier this year, when North American Clearing began experiencing severe financial problems. To ease its financial difficulties, North American Clearing secured a bank loan using customer securities as collateral. To comply with the federal securities laws and remain in operation, North American Clearing increased its reserves in an account it maintained for the benefit of customers, which limited funds available to North American Clearing to meet its daily operating expenses. According to the SEC's complaint, on several occasions in March and April 2008, North American Clearing improperly sold customer money market funds as a means of temporarily freeing up funds that it then used to pay for daily operating expenses. The SEC's complaint also alleges that on May 13, 2008, the defendants manipulated North American Clearing's processing system to overstate net customer money market purchases. This enabled North American Clearing to illegally withdraw more than $3 million from the reserves it was required to maintain for the benefit of customers.

For more information on this subject contact securities attorneys, Michaels, Ward & Rabinovitz, LLP.

The Financial Industry Regulatory Authority (FINRA) unveiled four new regulatory proposals earlier this month. The overall aim of the measures is to consolidate NASD and New York Stock Exchange rules into one FINRA rulebook, but included are several changes to rules governing net capital requirements for member firms, supervisory roles and documentation. Proposed Rule 4110(a) would allow FINRA's executive vice president to require greater net capital requirements for clearing and carrying member firms. The authority to do is based upon broad language terminology such as "protecting investors" or "in the public interest." However, FINRA does note in its proposal that, historically, a provision such as this, akin to NYSE Rule 325(d), has this has been rarely utilized. "FINRA anticipates that it would apply [Rule 4110(a)] in similar circumstances," it notes. FINRA also proposes that firms be unable to reduce their member's equity in levels that exceed 10% of the firm's excess net capital, unless FINRA gave it the green light to do so. Proposed Rule 4110(c) (2) would apply only to carrying, clearing and (k)(2)(i) firms. FINRA also proposes that firms "must maintain discretionary accounts," a change aimed at making the rule self-limiting, it says. The SEC has proposals that could limit the legal liability of broker-dealers maintaining discretionary accounts, FINRA says in Regulatory Notice 08-25. Customer complaint records would have to be preserved for a period of four years, up from the current three, and member firms would be prohibited from drawing upon a customer's checking or savings account without "that person's expressed writing authorization," says proposed Regulatory Notice 08-25. That same notice also proposes that customer signatures would be required to be kept for three years following the date it expires, and amends the requirements concerning signatures of registered representative responsible for accounts. In an odd twist in these days of identity fraud, rather than requiring firms to maintain the signature of the registered rep, it would instead require the firm maintain "the name of the associate person" responsible for the account. The most targeted proposal concerns the bank-related securities activities of so-called dual employees. Now, unless FINRA had written assurances are in place, dual employees would be prohibited from engaging in investment banking or securities business at a bank. And where a producing manager's revenue levels rose past a certain threshold, proposed Rule 3110(b)(6) would prohibit supervisory personnel from supervising their own activities and reporting. The compensation or continued employment of these managers could not be determined by someone they are supervising. As for its Investor Education initiative, or proposed Regulatory Notice 08-26, FINRA appears to have skirted the issue of adding levels of consumer protection. FINRA's Proposed Rule 2267 includes requiring member firms to serve customers with a new batch of where-to-go disclosures, including the web address for FINRA's "BrokerCheck" program, on an annual basis. But this is simply an update based on the old NASD Rule 2280. Perhaps the most far-reaching change expressed is a proposal that Rule 2267 would now apply to member firms that conduct a "limited business with customers," including mutual fund distributors and direct participation programs.

For more information on this subject contact securities attorneys, Michaels, Ward & Rabinovitz, LLP.

The Securities and Exchange Commission has obtained a court order to stop a $27 million Ponzi scheme involving investors in the United States, Canada, and other countries. The SEC charged Las Vegas-based Gold-Quest International and its three principals for the alleged misuse of investor funds in a scheme that promised incentives to investors who recruited “friends and family” into the system. The SEC alleged that Gold-Quest and its owners misrepresented that investor funds would be pooled and invested in foreign currency exchange trading and would generate annual profits of 87.5 percent. No investor money was actually invested in foreign currency exchange trading. According to the SEC’s complaint, Gold-Quest’s owners David M. Greene (who refers to himself as Lord David Greene), John Jenkins, and Michael McGee instead used investor funds to compensate investors who brought in new investors. Up to 88 percent of each investor’s principal was paid to the chain of promoters responsible for bringing the investor into the Gold-Quest program. Most of the remaining funds were used by Greene, Jenkins, and McGee for personal expenses. “This emergency action shows that the Commission, together with foreign securities regulators, will move swiftly to stop ongoing frauds and protect investors, both in the United States and internationally. In the type of multi-level marketing scheme alleged in our complaint, the perpetrators enlist defrauded investors as their sales force to solicit new investors from among their family and friends. By preying on the mutual trust in such relationships, the alleged perpetrators in this case were able to easily expand their network of victims, even across international borders,” said Linda Chatman Thomsen, Director of the SEC’s Division of Enforcement. “As alleged in our complaint, investors were enticed into believing that they were investing in a profitable foreign currency exchange trading program that never existed,” said Rosalind R. Tyson, Acting Regional Director of the SEC’s Los Angeles Regional Office. “This case demonstrates that the Commission will work closely with other international and state agencies to prosecute wrongdoers and protect current and future investors from further harm.” The Honorable Lloyd D. George, U.S. District Court Judge for the District of Nevada, issued an order freezing assets and appointing a temporary receiver over Gold-Quest and its affiliates. The SEC’s complaint, filed in federal court in Las Vegas, alleges that since at least mid-2006, the defendants have raised and misappropriated more than $27.9 million from more than 2,100 investors in the United States and Canada. The complaint further alleges that, undisclosed to investors, the defendants paid more than $19.1 million as returns to other investors in this Ponzi-like scheme. According to the SEC’s complaint, Gold-Quest and its owners claim they are not subject to the jurisdiction of the United States or Canada because they are members of the Little Shell Nation Indian tribe, purportedly headquartered in North Dakota. However, the Little Shell Nation is not in fact recognized as a sovereign tribe or nation. In its lawsuit, the SEC obtained an order (1) freezing the assets of Greene, Jenkins, and McGee; (2) freezing and repatriating the assets of, and appointing a temporary receiver over, Gold-Quest and its affiliates; (3) preventing the destruction of documents; and (4) temporarily enjoining Gold-Quest, Greene, Jenkins, and McGee from future violations of the antifraud provisions of the federal securities laws. The Commission also seeks preliminary and permanent injunctions, disgorgement, and civil penalties against all defendants.

For more information on this subject contact securities attorneys, Michaels, Ward & Rabinovitz, LLP.

The SEC's comment period for its proposed new Form ADV Part II recently ended. It is expected that the SEC will move quickly to finalize a new rule requiring that Form ADV Part II be in a narrative brochure written in plain English rather than the current check-the-box format. The brochure would consist of Parts 2A and 2B, which describe the Adviser's services, fees, business practices, and conflicts of interest with clients. Advisers would file their brochures electronically through the IARD system and the public would benefit by having access to these brochures through the SEC's Web site.

Brochure Items in Part 2A:
The SEC proposed 19 separate items, each covering a different disclosure topic. Much of the information that would be required in the brochure concerns conflicts between an Adviser's own interests and those of its clients. This is disclosure the Adviser already must make to clients, as a fiduciary, under the Investment Advisers Act's anti-fraud provisions. Thus, many of the proposed disclosure requirements are designed to give Advisers guidance on fulfilling their statutory disclosure obligations to clients. Part 2A would clarify that an Adviser must respond only to the items that apply to its business. The 19 items are summarized as follows:

Item 1. Cover Page - Advisers would need to disclose on the cover page of its brochure the name of the firm, its business address, telephone number, and the date of the brochure. The cover page also would include a statement that the brochure has not been approved by the SEC or any state securities authority.

Item 2. Material Changes - Advisers would need to provide clients with a summary of any material changes to their brochures since their last annual update.

Item 3. Table of Contents - The SEC is proposing a requirement that Advisers include in their brochures a table of contents detailed enough to permit clients and prospective clients to locate topics easily.

Item 4. Advisory Business - Advisers would be required to describe their advisory business, including the types of advisory services offered, whether they hold themselves out as specializing in a particular type of advisory service, and the amount of client assets that they manage.

Item 5. Fees and Compensation - Advisers would need to describe how they are compensated for providing advisory services and describe the types of other client costs, such as brokerage charges, custody fees, and fund expenses that clients may pay in connection with the advisory services provided to them by the Adviser.

Item 6. Performance Fees and Side-By-Side Management - Advisers that charge performance fees (or who have a supervised person who manages an account which charges such fees) would need to disclose this fact.

Item 7. Types of Clients - The brochure would need to describe the types of advisory clients an Adviser generally has, as well as the firm's requirements for opening or maintaining an account, such as minimum account size.

Item 8. Methods of Analysis, Investment Strategies, and Risk of Loss - Firms would need to describe their methods of analysis and investment strategies. In addition, Advisers would be required to discuss the risks clients face in following the Adviser's advice or permitting the Adviser to manage assets. Item 8 also would require specific disclosure of how strategies involving frequent trading can affect investment performance. Finally, Item 8 would require Advisers to discuss their practices regarding cash balances in client accounts.

Item 9. Disciplinary Information - Material facts about any legal or disciplinary event that is relevant to a client's evaluation of the integrity of the Adviser or its management practices would need to be disclosed.

Item 10. Other Financial Industry Activities and Affiliations - Advisers would be required to describe material relationships or arrangements they (or any of its management persons) have with related financial industry participants, any material conflict of interest that the relationships or arrangements create, and how Adviser would address the conflict. In addition, if an Adviser selects or recommends other advisers for clients, this proposed item would require Adviser to disclose any compensation arrangements or other business relationships between the two advisory firms, as well as the conflicts created.

Item 11. Code of Ethics, Participation or Interest in Client Transactions and Personal Trading - Advisers would need to describe briefly their code of ethics and to state that a copy is available upon request.

Item 12. Brokerage Practices - Advisers would be required to describe how they select brokers for client transactions and determine the reasonableness of brokers' compensation. This item also would require Advisers to disclose how they address conflicts arising from their receipt of "soft dollars," i.e., the receipt of benefits such as research in connection with the client brokerage.

Item 13. Review of Accounts - Advisers who review accounts would need to disclose how often, they review clients' accounts or financial plans and identify who conducts the review. Advisers who do not review accounts would need to disclose such. An Adviser that reviews accounts, but not regularly, would explain what circumstances trigger an account review.

Item 14. Payment for Client Referrals - Firms would be required to describe any cash or other payment that it or a related person makes for client referrals. The brochure also would disclose whether the Adviser receives any benefit, including sales awards or prizes, from a non-client for providing advisory services to clients.

Item 15. Custody - This item would reflect amendments to rule 206(4)-2 made several years ago (the investment Adviser custody rule).

Item 16. Investment Discretion - Firms with discretionary authority over client accounts would need to disclose these arrangements in their brochure, and any limitations clients may (or customarily do) place on this authority.

Item 17. Voting Client Securities - Advisers would be required to disclose their proxy voting practices.

Item 18. Financial Information - This item would require disclosure of certain financial information about the Adviser when the information is material to clients.

For more information on this subject contact securities attorneys, Michaels, Ward & Rabinovitz, LLP.

UBS AG agreed to return more than $35 million it invested in auction-rate securities for 20 towns and public agencies in Massachusetts amid a state probe of how the debt was marketed. UBS misled the public officials by buying securities that weren't a ``permissible investment'' under the state's municipal finance law, according to Attorney General Martha Coakley. Authorities are still investigating whether the firm lied to the investors about the auction-rate obligations, which may result in penalties under the state's False Claims Act, Coakley said in a news release. Under the agreement with UBS, the 20 towns and agencies will avoid losses on the more than $35 million they invested, Coakley said. The Zurich-based investment bank on March 28 said it was cutting by 5 percent the value of auction-rate securities held for its customers to reflect the debt's diminished worth and illiquidity after the market for the bonds collapsed. ``UBS's action today will allow these entities to recover these frozen funds,'' Coakley said. Bank spokeswoman Karina Byrne said in a statement that the agreement applies ``only to the circumstances of this specific case under Massachusetts law.'' She declined to elaborate.

For more information on this subject contact securities attorneys, Michaels, Ward & Rabinovitz, LLP.