Articles Tagged with Broker Dealers 2

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On January 11, the Office of Compliance Inspections and Examinations (OCIE) of the SEC announced its 2016 Examination Priorities (“Priorities”). To promote compliance, prevent fraud and identify market risk, OCIE examines investment advisers, investment companies, broker-dealers, municipal advisors, transfer agents, clearing agencies, and other regulated entities. In 2016, OCIE will continue to rely on the SEC’s sophisticated data analytics tools to identify potential illegal activity.

This year, private fund advisers should pay attention to the following OCIE Priorities:

  • Side-by-side management of performance-based and asset-based fee accounts: controls and disclosure related to fees and expenses
  • Cybersecurity: testing and assessments of firms’ implementation of procedures and controls
  • High frequency trading: excessive or inappropriate trading
  • Liquidity controls: potentially illiquid fixed income securities – focus on controls over market risk management, valuation, liquidity management, trading activities
  • Marketing / Advertisements: new, complex, and high risk products, including potential breaches of fiduciary obligations
  • Compliance controls: focus on repeat offenders and those with disciplined employees

Highlights for other market participants:

  • Never-Before-Examined Investment Advisers and Investment Companies: focused, risk-based examinations will continue

  • Broker-Dealers

    :

    • Marketing / Advertisements: new, complex, and high risk products and related sales practices, including potential suitability issues
    • Fee selection / Reverse Churning: multiple fee arrangements – recommendations of account types, including suitability, fees charged, services provided, and disclosures
    • Market Manipulation: pump and dump; OTC quotes; excessive trading
    • Cybersecurity: testing and assessments of firms’ implementation of procedures and controls
    • Anti-Money Laundering: missed SARs filings; adequacy of independent testing; terrorist financing risks
    • Registered representatives in branch offices – focus on inappropriate trading
    • Retirement Accounts: suitability, conflicts of interest, supervision and compliance controls, and marketing and disclosure practices
  • Public Pension Advisers: pay to play, gifts and entertainment
  • Mutual Funds and ETFs: liquidity controls – potentially illiquid fixed income securities
  • Immigrant Investor Program: Regulation D and other private placement compliance

For additional details, visit the SEC’s Examination Priorities for 2016. Please call an Investment Funds and Investment Management Attorney to discuss your firm’s risk areas.

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U.S. Investment advisers, other financial services providers, and pooled investment vehicles – private and public funds – involved in certain cross-border transactions must file.

Background

The U.S. Department of Commerce’s Bureau of Economic Analysis (“BEA”) is conducting its next five-year “Benchmark Survey of U.S. Financial Services Providers and Foreign Persons” on Form BE-180. The survey is mandatory and collects data on cross-border trade and financial services transactions of U.S. financial services providers, including investment advisers and other asset managers, broker-dealers and banks. BE-180 covers cross-border purchase and sales transactions that occurred or were charged during the U.S. reporter’s 2014 fiscal year. BE-180 is one of a series of benchmark surveys[1] measuring international trade transactions and collecting data for use in various economic studies.

Who Is Required to Report

Each U.S. individual and entity that is a “financial services provider” and meets the reporting requirements must file form BE-180. Financial services providers include investment advisers and their pooled vehicles such as hedge funds, private equity funds, pension funds, mutual funds and real estate funds, and broker-dealers.[2]

Filing Thresholds

The reporting requirement applies to each U.S. individual or entity that is a financial services provider with (i) either[3] sales or purchases directly with non-U.S. individuals or entities in excess of $3 million or more on a consolidated basis during the 2014 fiscal year, or (ii) sales or purchases directly with non-U.S. individuals or entities of less than $3 million, that were notified by the BEA about the survey. Any U.S. individual or entity that is notified by the BEA about the survey but has no transactions of the types of services covered must complete pages 1-3 of the survey.

Reportable Transactions

Reportable financial transactions include investment management and advisory services, brokerage services, underwriting, custodial services, credit-related services, securities lending, and electronic funds transfer services – transactions involving cross-border payments, such as advisory or sub-advisory fees, brokerage commissions, custodial fees and securities lending fees.

Reportable data include the transactional counterparty’s location by country and the relationship between the U.S. reporter and its counterparty (i.e., foreign affiliates or unaffiliated foreign persons). You may have easy access to some of the required data (such as through your administrator or internal accounting systems). However, as with the other BE forms, obtaining some of the required information may involve additional legwork and cooperation with cross-border counterparties, which should be considered in meeting the deadlines.

Filing Deadline and Extensions

The BEA has granted automatic extensions to the original October 1 filing deadline, as follows:

File no later than November 1, 2015 if:

  • You were notified of the BE-180 survey by BEA and have a BE-180 identification number below 140012490.
  • You were NOT notified of the BE-180 survey by BEA and do NOT have a BE-180 identification number.

File no later than December 1, 2015 if:

  • You were notified of the BE-180 survey by BEA and have a BE-180 identification number above 140012490.

Additional extensions to each filing deadline will be granted by the BEA if a request is submitted by November 1, 2015 as instructed by the BEA.

Penalties

Failure to file a required report can lead to civil and criminal penalties.

Confidential Treatment

Like it is the case with the other BE forms, information reported on BE-180 is confidential and may be used for only analytical or statistical purposes.

Sources

Form BE-180 is available online here.

Instructions for new filers are available here.

Form instructions are available here.

FAQs regarding the BE-180 benchmark survey are available here.

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[1] See our alerts and articles on other BEA survey forms here.

[2] Additional entities included in the definition are commercial banking entities, bank holding companies, financial holding companies, savings institutions, check cashing and debit card issuing entities, underwriters, investment bankers, providers of securities custody services, insurance carriers, insurance agents, insurance brokers, and insurance services providers.

[3] The $3 million threshold applies to purchases and sales separately, and must be reported on separate schedules to the BE-180. Consequently, a U.S. reporter, for example, that only exceeds the threshold for sales but does not reach the threshold for purchases, is only required to complete the schedule relating to sales.

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Chair Mary Jo White’s opening remarks on July 15 kicking off the annual broker-dealer compliance outreach program drew a parallel between the goals and work of the SEC and those of compliance professionals. Ms. White acknowledged the challenges and hardship that compliance professionals face, the critical importance of their role to investors and the integrity of the markets. Her acknowledgment comes after the upset that compliance professionals experienced when BlackRock’s CCO was found personally liable and slapped with a civil penalty. (See our previous post regarding BlackRock’s censure and its compliance officer’s personal liability.) Ms. White’s assurance that “it is not our intention to use our enforcement program to target compliance professionals” was hedged by her statement that “we must, of course, take enforcement action against compliance professionals if we see significant misconduct or failures by them.”

Ms. White named the following examination priorities: fee structures; suitability; order routing conflicts; recidivist representatives; microcap activity; excessive trading; transfer agent activity; and issues of importance to retail investors and investors saving for retirement.

Read more of Chair Mary Jo White’s opening remarks at the Compliance Outreach Program for Broker-Dealers HERE.

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The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (“OCIE”) recently released its annual examination priorities.  In 2015, OCIE will focus on three primary “themes” involving broker-dealers, investment advisers and transfer agents:

  1. Retail Investors – OCIE will look at important matters for retail investors and investors preparing for retirement including whether the products, advice, services and information being offered to them is consistent with current laws, rules and regulations;
  2. Market-Wide Risks – this is a broad theme which focuses on structural risks and trends involving whole industries or multiple firms; and
  3. Data Analytics – OCIE continues to increase its ability to analyze large amounts of data to identify registrants that may be conducting illegal activity.

Retail Investors – Advisers to retail investors and investors saving for retirement will be scrutinized by the SEC in 2015. The OCIE will assess fee selection where the adviser offers a variety of fee arrangements as well as reverse churning. Further, where advisers recommend moving retirement assets from employer-sponsored plans into other investments or accounts, OCIE will examine whether the sales practices used were improper or misleading. OCIE will also be reviewing the suitability of complex or structured products and higher yield securities and how well representatives in branch offices are being supervised by the home office.  The SEC may have an interesting opportunity to demonstrate whether it is serious in going after those who target seniors.

On February 5, 2015, SEC Commissioner Luis A. Aguilar and Investor Advocate, Rick A. Fleming, gave speeches at The American Retirement Initiative Winter Summit about advocating for investors saving for retirement and protecting elderly investors from financial exploitation.

Under the umbrella theme of “retail investors,” the OCIE will be assessing alternative investment companies and the focus of the exams will be (i) liquidity, leverage and valuation; (ii) the way the funds are marketed; and (iii) the internal controls, staffing, funding and empowerment of boards, compliance and back-offices. Mutual funds with material exposure to interest rate increases will be reviewed by OCIE to ensure they have the appropriate compliance policies and procedures and trading and investment controls in place to prevent their disclosures from being misleading and to be sure their investment and liquidity profiles are consistent with the fund’s disclosures.

Assessing Market-Wide Risks – The OCIE will focus in 2015 on structural risks and trends that involve whole industries or multiple firms. In collaboration with the Division of Trading and Markets and the Division of Investment Management, the OCIE will monitor the largest asset managers and broker-dealers. Through a risk-based approach, the OCIE will conduct annual examinations of all clearing agencies that have been designated systemically important. Furthering the OCIE’s 2014 efforts to examine the cybersecurity preparedness of registrants, 2015 will see a continuation of the initiative and an expansion of the initiative to include transfer agents. OCIE will also be looking into whether firms are giving priority to trading venues due to credits or payments for order flow, thus violating their best execution duties.

Data Analytics – The OCIE has made strides in developing data analytics that it can use to identify and examine firms and other registrants that may be engaged in fraudulent or illegal activity. The examination initiatives the OCIE will be using data analytics to examine include recidivists, microcap fraud, excessive trading and anti-money laundering.

Other Initiatives – Along with the primary themes discussed above, the SEC will continue to examine never-before examined investment advisers and newly registered municipal advisers. Advisers to private equity funds can expect to have their fees and expenses examined as a result of OCIE’s observed high rates of deficiencies. In addition to examining proxy advisory service firms, OCIE will also look at investment advisers’ compliance with their fiduciary duty to vote proxies on their investors’ behalf.

Advisers and broker-dealers should always be prepared for an SEC examination and ensure all written policies and procedures are in place and regularly audited for efficacy and compliance. Should you be subject to an examination, any deficiencies noted by the SEC should be addressed and rectified in a timely manner.

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On February 3, 2015, the Securities and Exchange Commission (“SEC”) released two publications addressing cybersecurity at advisory and brokerage firms. The first publication, a Risk Alert, relays the findings from the examinations of more than 100 investment advisers and broker-dealers and focuses on how they: (i) establish cybersecurity policies, procedures and oversee the processes; (ii) identify cybersecurity risks; (iii) protect information and networks; (iv) identify and address the risks associated with funds transfer requests, remote access to client information and third-party vendors; and (v) detect activity that is unauthorized.  The SEC’s Office of Investor Education and Advocacy released the second publication which provides tips for investors to better safeguard their online investment accounts. Their recommendations include using a strong password and a two-step verification process.

The SEC’s recent examinations found 93% of examined broker-dealers and 83% of examined investment advisers have adopted cybersecurity policies, though, whereas 89% of the broker-dealers periodically audit compliance with the policies, only 57% of investment advisers conduct periodic cybersecurity compliance audits.  The SEC continues to place high importance on cybersecurity and every broker-dealer and investment adviser should ensure they have adequate written policies and procedures in place and test them periodically.

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The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) recently released its Examination Priorities for 2015.  The priorities represent certain practices and products that OCIE believes present a potentially higher risk to investors and/or the integrity of the US capital markets.  In 2015, OCIE’s priorities focus on issues involving investment advisers, broker-dealers and transfer agents and are organized into three thematic areas:

  1. Examining important matters to retail investors and investors saving for retirement, such as whether the information, advice, products and services offered is consistent with applicable law.  Specifically, OCIE has identified the following examination priorities:
  • Fee Selection and Reverse Churning – Where an adviser offers a variety of fee arrangements, OCIE will focus on recommendations of account types and whether they are in the best interest of the client at the inception of the arrangement and thereafter, including fees charged, services provided, and disclosures made about such relationships.
  • Sales Practices – OCIE will assess whether registrants are using improper or misleading practices when recommending the movement of retirement assets from employer-sponsored defined contribution plans into other investments and accounts, especially when they pose greater risks and/or charge higher fees.
  • Suitability – OCIE will evaluate registered entities’ recommendations or determinations to invest retirement assets into complex or structured products and higher yield securities and whether the suitability of the recommendations or determinations are consistent with existing legal requirements.
  • Branch Offices – OCIE will focus on registered entities’ supervision of registered representatives and financial adviser representatives in branch offices, and attempt to identify branches that may be deviating from compliance practices of the firm’s home office.
  • Alternative Investment Companies – OCIE will continue to assess alternative investment companies and focus on: (i) leverage, liquidity and valuation policies and practices; (ii) factors relevant to the adequacy of the funds’ internal controls, including staffing, funding, and empowerment of boards, compliance personnel, and back-offices; and (iii) the manner in which such funds are marketed to investors.
  • Fixed Income Companies – OCIE will determine whether mutual funds with significant exposure to interest rate increases have implemented compliance policies and procedures and investment and trading controls sufficient to ensure that their funds’ disclosures are not misleading.
  1. Assessing issues related to market risks.  Specifically, OCIE has identified the following examination priorities:
  • Large Firm Monitoring – OCIE will continue to monitor the largest broker-dealers and asset managers to assess risks at individual firms.
  • Clearing Agencies – OCIE will continue to examine all clearing agencies designated as “systemically important” under the Dodd-Frank Act.
  • Cybersecurity – OCIE will continue to examine broker-dealers and investment advisers’ cybersecurity compliance and controls and expand these examinations to include transfer agents.
  • Potential Equity Order Routing Conflicts – OCIE will assess whether firms are prioritizing trading venues based on payments or credits for order flow in conflict with their best execution duties.
  1. Analyzing data to identify and examine registrants that may be engaging in illegal activity, such as excessive trading and penny stock, pump-and-dump schemes. Specifically, OCIE has identified the following examination priorities:
  • Recidivist Representatives – OCIE will continue to try to identify individuals with a history of misconduct and examine the firms that employ them.
  • Microcap Fraud – OCIE will continue to examine broker-dealers and transfer agents that aid and abet pump-and-dump schemes or market manipulation.
  • Excessive Trading – OCIE will continue to analyze data from clearing brokers to identify and examine brokers that engage in excessive trading.
  • Anti-Money Laundering – OCIE will continue to examine firms that have not filed suspicious activity reports (SARs) or provide customers with direct access to markets of higher-risk jurisdictions.

In addition, OCIE has identified other examination priorities for 2015, including:

  • Municipal Advisors – OCIE intends to examine newly registered municipal advisors to determine whether they comply with recently adopted SEC and Municipal Securities Rulemaking Board rules.
  • Proxy Services – OCIE intends to examine proxy advisory service firms and investment advisers’ compliance with their fiduciary duty in voting proxies on behalf of investors.
  • Never-Before-Examined Investment Companies – OCIE will conduct focused, risk-based examinations of registered investment company complexes that haven’t been examined before.
  • Fees and Expenses in Private Equity – this continues to be an area that OCIE is focused on.
  • Transfer Agents – OCIE intends to examine transfer agents, particularly those involved with microcap securities and private offerings.

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On November 25, 2014, the Securities and Exchange Commission (the “SEC”) brought charges against a Swiss-based bank that should serve as notice to all non-U.S. banks that maintain relationships with clients who have moved to the U.S., as well as U.S.-based banks that provide services to clients who have relocated to other countries.  The SEC found that HSBC’s Swiss-based private banking arm violated U.S. securities laws by providing investment advisory and brokerage services to U.S. clients without being properly registered as either an investment adviser or a broker-dealer.  HSBC Private Bank (Suisse) agreed to admit wrongdoing and pay $12.5 million to settle the SEC’s charges in a combination of disgorgement, prejudgment interest, and penalties.

How often do financial institutions, foreign or U.S., put themselves in the position of willfully violating the securities and banking laws of other countries?  Pretty routinely, as it turns out.  By way of example, suppose you are a citizen of a European Union country with a local banking relationship.  You work for a large multi-national company that offers you a promotion, but that new job is in New York.  Not one to decline an opportunity, off you go to the Center of the Universe.  You open a new bank account at a local New York bank, but you maintain your European bank relationship because you have a consolidated banking, investment advisory and brokerage relationship there that has worked quite well for you.  The relationship manager at your European bank certainly does not want to give up the revenue stream from your lucrative relationship, particularly now that you are making so much more money and you are willing to purchase and sell stocks more frequently.  Multiply this scenario several times over and before you know it, this certain European bank is routinely providing banking, investment advisory, and brokerage services to U.S. residents without being properly registered to do so.

This same scenario can and often does play out in reverse.  A U.S. citizen moves to a foreign country and maintains his banking, investment advisory and/or brokerage relationships with a financial institution that is not qualified to do business in the client’s new country of residence and before you know it, the U.S. financial institution is in violation of the laws of the country in which its client now resides.  And, not to gratuitously pick on any particular jurisdiction, the provision of such services in some countries pourrait être criminelle.

In the case of HSBC, the SEC found that HSBC Private Bank and its predecessors began providing cross-border advisory and brokerage services in the U.S. more than 10 years ago on behalf of at least 368 U.S. client accounts and collected fees totaling approximately $5.7 million.  HSBC relationship managers traveled to the U.S. on at least 40 occasions to solicit clients, provide investment advice, and induce securities transactions.  These relationship managers were not registered in the U.S. as investment adviser representatives or licensed brokers, nor were they affiliated with a registered investment adviser or broker-dealer (or “chaperoned” by a registered U.S. broker-dealer).  The relationship managers also communicated directly with clients in the U.S. through overseas mail and e-mails.  In 2010, HSBC Private Bank decided to exit the U.S. cross-border business, and nearly all of its U.S. client accounts were closed or transferred by the end of 2011.

According to the SEC’s order, HSBC Private Bank understood there was a risk of violating U.S. securities laws by providing unregistered investment advisory and brokerage services to U.S. clients, and the firm undertook certain compliance initiatives in an effort to manage and mitigate the risk.  The firm created a dedicated North American desk to consolidate U.S. client accounts among a smaller number of relationship managers and service them in a compliant manner that would not violate U.S. registration requirements.  However, certain relationship managers were reluctant to lose clients by transferring them to the North American desk and stalled the process or ignored it altogether.  HSBC Private Bank’s internal review revealed multiple occasions when U.S. accounts that were expected to be closed under certain compliance initiatives remained open.  HSBC Private Bank admitted to the SEC’s findings in the administrative order, acknowledged that its conduct violated U.S. securities laws, and accepted a censure and a cease-and-desist order.

Foreign financial institutions, even those that have U.S. affiliates that are properly registered and regulated as banks, investment advisers, or broker-dealers should undertake a review of their client accounts to determine whether they are providing services that are in violation of applicable law.  It is possible, perhaps even likely, that even if a non-U.S. financial institution has properly registered U.S. entities, services are being provided to certain clients outside of those entities as a result of historical relationships.  U.S. banks should also determine whether they are providing financial services to relocated clients in countries that would either prohibit such services or require some form of notification or registration.  A failure to abide by the laws of non-U.S. countries could also place a U.S. institution in the position of violating certain U.S. laws that require diligence of and compliance with the laws of other countries.

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Private equity firms were put on notice last year that they may be subject to registration as broker dealers when David Blass, head of the Division of Markets and Trading at the Securities and Exchange Commission (“SEC”), provided his insights at an industry conference.  Since that time, the SEC has published their examination priorities list, which included the presence exams of new registrants, a portion of which would review that status of private equity fund managers under the broker dealer rules.  Following up on this warning to the industry, the SEC has also targeted unregistered brokers for enforcement action.

Recently, at a speech in front of another industry group, Mr. Blass provided further guidance on how a private equity firm might structure its compensation arrangements in order to avoid the need to register as a broker dealer.  Consistent with the advice that Pillsbury has been providing private fund clients for many years, Mr. Blass warned against paying “transaction based” compensation and further suggested that if a private fund employee has “an overall mix of functions,” and sales is one aspect of those duties, it is less likely that the SEC staff would view such an arrangement as one that would require broker dealer registration.  An employee of a private fund manager would not be prohibited from being compensated on the overall success of the firm, and certainly sales of fund securities contribute to that overall success.  But tying compensation to assets raised looks like the traditional broker dealer compensation and should be avoided.

Mr. Blass indicated that the SEC is close to finalizing guidance on issues connected to private fund manager employee compensation.  However, the SEC staff has further to go before providing guidelines to the industry on the broker dealer registration issues posed by deal fees that private equity firms sometimes collect on transactions.  It is unlikely that Mr. Blass will see his initiatives through to completion, as he will soon be joining the staff of the Investment Company Institute where he will one day lobby against his former positions.

If you would like additional background on how the private fund managers came to find themselves in the gray zone of broker dealer registration as a result of paying their employees for performance, you may want to re-visit this article.

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On May 16, 2014, a federal court in Florida entered an Order finding in favor of the Commodity Futures Trading Commission (CFTC) following a trial against four Hunter Wise related companies and their owners on charges that they had fraudulently misrepresented the nature of precious metals transactions that resulted in millions of dollars in customer losses.

Hunter Wise was found to have orchestrated a multi-level marketing scheme in which so-called retail dealers served a sales function for Hunter Wise, soliciting customer accounts. The dealers advertised and claimed that they sold physical metals, including gold, silver, platinum, palladium, and copper, to retail customers on a financed basis and forwarded customer funds to Hunter Wise, whose identity was not disclosed to the customers.  Using deceptive marketing materials provided to them by Hunter Wise, the dealers claimed to arrange loans for the purchase of physical metals and advised customers that their physical metals would be stored in a secure depository.  Customers were then charged “exorbitant interest” on the purported loans and storage fees for the metal they thought they had purchased.  In fact, neither Hunter Wise nor any of the dealers purchased any physical metals, arranged actual loans for their customers to purchase physical metals, or stored physical metals for any customers participating in their retail commodity transactions.  Over 90 percent of the retail customers lost money.

Hunter Wise Commodities, LLC, Hunter Wise Services, LLC, Hunter Wise Credit, LLC, and Hunter Wise Trading, LLC and the individuals running the companies, have been ordered to pay, jointly and severally, $52.6 million in restitution to the defrauded customers and to pay a civil monetary penalty, jointly and severally, of $55.4 million, the maximum provided by law.  The CFTC charged Hunter Wise, its principals, and other related parties in December 2012.  The Court found that the principals of Hunter Wise knowingly defrauded more than 3,200 retail customers for more than 16 months, between July 2011 and February 2013, and engaged in fraudulent conduct that was “repeated, callous and blatant.”

In considering the appropriate penalties, the Court noted that the fraudulent scheme was “egregious and recurrent” and “calculated to deceive retail customers.” The Court held that the likelihood of future violations was “strong” given that Hunter Wise principals did not acknowledge any wrongdoing.  Further, the “systematic and pervasive nature” of the fraud necessitated full restitution for all customers who lost money between July 16, 2011 and February 25, 2013.

This case follows a CFTC “Precious Metals Fraud Advisory” alert issued in January of 2012 in which the CFTC indicated that it was aware of an increase in the number of companies offering customers the opportunity to buy or invest in precious metals.  The CFTC’s Consumer Fraud Advisory specifically warned that frequently companies do not purchase any physical metals for the customer, but instead simply keep the customer’s funds.  The Consumer Fraud Advisory further cautioned consumers that leveraged commodity transactions are unlawful unless executed on a regulated exchange.

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As we have previously reported, the Securities and Exchange Commission (“SEC”) has taken a significantly heightened interest in whether people who engage in certain promotional activities on behalf of issuers of securities should be subject to regulation as a broker dealer.  The David Blass speech of April 5, 2013 put hedge fund general partners on notice that certain sales practices undertaken by hedge fund personnel may require registration as a broker dealer.  The SEC has recently followed up this guidance with enforcement action.

On May 15, 2014, the SEC  charged a Tiburon, California based securities salesman for selling millions of dollars in oil-and-gas investments without being registered with the SEC as a broker-dealer or associated with a registered broker-dealer.  The defendant, Behrooz Sarafraz, agreed to settle the SEC charges by paying disgorgement of his commissions, prejudgment interest, and a penalty for a total of more than $22 million.

According to the SEC’s complaint filed in federal court in San Francisco, Sarafraz acted as the primary salesman on behalf of TVC Opus I Drilling Program LP and Tri-Valley Corporation, which were based in Bakersfield, California.   From February 2002 to April 2010, these companies raised more than $140 million for their oil-and-gas drilling venture.  While Sarafraz was raising money for these entities, he was not associated with any broker-dealer registered with the SEC.  The SEC also alleged that Sarafraz worked full-time locating investors for the Opus and Tri-Valley oil-and-gas ventures.  He described the investment program to investors and recommended they purchase Opus partnership interests or securities of Tri-Valley and its affiliated entities.  In return, Sarafraz received commissions that ranged from seven to 17 percent of the sales proceeds that he and members of a sales network generated.  The SEC alleges that Opus and Tri-Valley paid Sarafraz approximately $18.3 million in sales commissions.  He paid approximately $1.9 million to others as referral fees and kept the remaining $16.4 million for himself.

For the two companies for which Sarafraz raised money, this could be just the beginning of the process.  If investors have lost money or would otherwise seek to unwind these transactions, it is possible that the investors could sue the companies and Sarafrax for rescission.  Typically, in a rescission recovery case, the plaintiffs who purchased through the unregistered broker can receive the higher of the current market price of the price that they originally paid for the securities.  Hedge funds and other private companies that use solicitors should take note.

The SEC also charged New York-based Rafferty Capital Markets with illegally facilitating trades for another firm that was not registered as a broker-dealer as required under the federal securities laws.  According to the SEC’s order instituting settled administrative proceedings, Rafferty agreed to serve as the broker-dealer of record in name only for approximately 100 trades in asset-backed securities that were actually introduced by the unregistered firm.  While Rafferty held the necessary licenses and processed the trades, it was the unregistered firm that managed the business.  Five of the firm’s employees became registered representatives with Rafferty but they performed their work in the offices of the unregistered firm, which retained sole authority over their trading decisions and determined their compensation.  Rafferty had no involvement in the trading or compensation decisions while the registered representatives executed the trades through Rafferty’s systems on behalf of the unregistered firm.  Based on the agreement, Rafferty kept 15 percent of the compensation generated by these trades and sent the remaining balance to the unregistered firm.

The SEC’s order found that Rafferty willfully violated Federal securities laws and also willfully aided and abetted and caused the unregistered broker-dealer’s violation of the registration provisions of the Securities Exchange Act.  Rafferty consented to a cease-and-desist order that censures the firm and requires the disgorgement of $637,615 as well as payment of $82,011 in prejudgment interest and a $130,000 penalty.  This case should serve as a cautionary tale for hedge fund and other private fund managers that seek to hire sales people who construct sham arrangements with a broker dealer in order to appear to be in compliance with the broker dealer registration provisions.  Expect more of these types of action from the SEC in the near future.