Managers of Bayou Hedge Funds Charged with Fraud
9.29.2005 The SEC filed a civil injunctive action against Samuel Israel III of New York and Daniel E. Marino of Connecticut, the managers of a group of hedge funds known as the Bayou Funds. The SEC has requested that the court freeze the defendants' assets and appoint a receiver to marshal any remaining assets for the benefit of defrauded hedge fund investors. In addition, the United States Attorney for the Southern District of New York announced that it has filed criminal fraud charges against Israel and Marino.
The SEC alleges in its complaint that from 1996 through 2005, investors deposited over $450 million into the Bayou Funds and a predecessor fund. During that period, Israel and Marino defrauded current investors, and attracted new investors, by grossly exaggerating the Bayou Funds' performance to make it appear that the Bayou Funds were profitable and attractive investments, when in fact, the Funds had never posted a year-end profit. The SEC's complaint further alleges that, in furtherance of their fraud, Israel and Marino concocted and disseminated to the Bayou Funds' investors periodic account statements and performance summaries containing fictitious profit and loss figures and forged audited financial statements in order to hide multimillion dollar trading losses from investors.
Please click http://www.sec.gov/news/digest/dig092905.txt for a copy of the press release about the administrative action.
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CFTC Charges Managers and Accounting Firm of Bayou Funds with Fraud
9.29.2005 The CFTC filed a complaint in the United States District Court for the Southern District of New York alleging misappropriation and fraud involving Connecticut hedge fund manager Bayou Management, LLC, its principals, Samuel Israel III and Daniel E. Marino, and Richmond Fairfield Associates, Certified Public Accountants PLLC.
Like the SEC administrative action discussed above, the CFTC�s complaint alleges that the Bayou Funds� manager misappropriated investor funds, acquired funds through false pretenses, engaged in unauthorized trading, and misrepresented material facts to actual and prospective investors, including the rates of return the Bayou Funds earned, the value of assets under management, and the existence and identity of the accounting firms that had purportedly audited the hedge funds. The conduct is alleged to violate the Commodity Exchange Act�s anti-fraud and false reporting provisions and certain CFTC regulations.
Unlike the SEC action, the CFTC�s complaint also charged the hedge funds� accountant with violations.
Please click http://www.cftc.gov/opa/enf05/opa5121-05.htm for a copy of the press release announcing the administrative action.
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CFTC Proposes Rule Clarifying Definition of Commodity Trading Adviser by Adding Definition of Client
9.28.2005 The CFTC proposed an amendment to Rule 1.3(bb) that would define the term �client� of a commodity trading advisor (CTA). The CFTC stated that this action would clarify inconsistencies in the CFTC�s regulations concerning the advisees of CTAs.
The proposed definition would include clients to whom a CTA provides personalized trading advice as well as clients to whom a CTA provides nonpersonalized trading advice. Such nonpersonalized advice would include, among other things, standardized advice provided by newsletters, seminars, tutorials, periodicals, computer software, Internet Web sites, voicemail recordings, e-mails, and facsimiles. The definition also would cover advice provided over a period of time pursuant to a subscription.
Please click http://www.cftc.gov/foia/comment05/foi05--005_1.htm to access a copy of the press release announcing the motion.
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Adviser Charged with Fraud
9.28.2005 The Massachusetts federal district court entered a preliminary injunction and asset freeze against Rajeev Johar in connection with a fraud action filed by the SEC against Entrust Capital Management, Inc., an investment advisory firm based in Worcester, Massachusetts, and its principal Amit Mathur.
The SEC alleged that beginning in October 2000, Entrust, through Mathur and Johar, raised more than $16 million from approximately twenty investors. The complaint alleges, however, that Entrust, Mathur and Johar dissipated nearly all of their clients� assets through undisclosed trading losses in Entrust�s brokerage accounts, unauthorized use of investor funds to support Entrust�s operating expenses, and blatant misappropriation of client funds for personal use.
The SEC�s complaint also alleges that Entrust, Mathur and Johar transferred at least $1 million in investor funds to AMR Realty. AMR Realty allegedly has no legitimate interest in those funds and that it should not be allowed to retain them.
Please click http://www.sec.gov/litigation/complaints/comp19396.pdf to access a copy of the administrative order.
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First National CCOutreach Seminar to be in November
9.26.2005 The SEC announced that its first CCOutreach Program National Seminar for mutual fund and investment adviser Chief Compliance Officers (CCOs) will be held on November 8, 2005, in Washington, D.C. The SEC stated that the CCOutreach program aims to protect investors by enhancing communication and coordination with CCOs and helping CCOs do their vital jobs.
The National Seminar follows a series of regional seminars held by OCIE staff. The regional seminars focused on the �nuts and bolts� of the examination process. The National Seminar will include panel discussions with SEC staff and CCO representatives on the latest policy developments relevant to CCOs and will address questions raised at the regional seminars and elsewhere.
The meeting will be held from 9 a.m. until 4:45 p.m., November 8, 2005, at the SEC�s headquarters, 100 F Street, NE, Washington, D.C. 20549. Attendance is limited to 500, with CCOs given priority on a first-come, first-served basis. The Seminar will also be webcast at www.sec.gov.
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State Street Failed to Transfer Redemption Fees to Mutual Funds
9.23.2005 The SEC sanctioned State Street Bank for improperly transferring redemption fees. The SEC found that, during the period April 2002 through April 2003, State Street Research & Management Company (SSRM) improperly transferred $156,128 in redemption fees it collected in connection with short-term trading in the State Street Research International Equity Fund to its affiliated distributor instead of paying such fees to the Fund as required by the Fund's prospectus.
According to the SEC, SSRM transferred the redemption fees to its affiliated distributor because, as SSRM knew or should have known, SSRM utilized a computer system that inaccurately treated the redemption fees as contingent deferred sales charges. By this conduct, the SEC order finds that SSRM willfully violated Section 206(2) of the Advisers Act.
The SEC required SSRM to cease and desist from committing or causing any violations and any future violations of Section 206(2) of the Advisers Act; censured SSRM; and required SSRM to pay a civil penalty in the amount of $300,000.
Please click http://www.sec.gov/litigation/admin/ia-2435.pdf to access a copy of the administrative order.
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NASD President Speaks at SIA Mutual Fund Reform Conference
9.23.2005 Mary Shapiro spoke about the regulation of mutual funds and the intermediaries that sell them at the SIA Mutual Fund Reform Conference. She reviewed various task forces.
The Task Force's Phase One report, which was issued in November 2004, recommended better disclosure of soft-dollar arrangements and portfolio transaction costs, narrowing the Section 28(e) safe harbor, and preserving the use of soft dollars for both for third-party and proprietary research. On September 28, 2005, the SEC agreed to publish for comment new interpretive guidance that would narrow the Section 28(e) safe harbor, but preserve the ability of money managers to pay for third-party research with soft dollars.
A second report by the Task Force developed a prototype point of sale document - the Profile Plus-that describes key features of a fund. Like the SEC proposal, the Profile Plus would include expenses and dealer conflicts, but also would summarize information about the fund's investment strategies, risks, performance and other significant features.
Ms. Shapiro also spoke about breakpoints, the Omnibus Task Force, and future initiatives.
Please click http://www.nasd.com/web/idcplg?IdcService=SS_GET_PAGE&ssDocName=NASDW_015070&
ssSourceNodeld=1346 for a copy of the speech.
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Adviser Charged with Inadequate Disclosure
9.21.2005 The SEC issued a order against Springer Investment Management, Inc. (SIM) and its president Keith W. Springer. The SEC found that SIM which is based in Sacramento, California and Springer misrepresented the performance of the hedge fund, the Apollo Fund. The SEC also found that SIM failed to update disclosures of Springer�s prior disciplinary history SIM was required to make as an investment adviser. Without admitting or denying the SEC�s findings, SIM and Springer have agreed to pay a civil penalty of $50,000 to settle the SEC�s charges.
According to the SEC, as the rest of the hedge fund�s publicly traded investments declined in value, SIM bolstered the fund�s overall performance by inflating the value of its stock in a struggling, privately-held Internet company that constituted the fund�s largest holding. Notwithstanding the dramatic decline in the price of publicly-traded Internet stocks during the early 2000s, SIM continued to value the Internet company�s shares at several times the price the fund had paid for them.
In addition, the SEC found that SIM failed to update SIM�s Form ADV, a form investment advisers are required to file with the SEC, to disclose the status of Springer�s appeal with the SEC regarding a prior disciplinary matter.
Please click http://www.sec.gov/litigation/admin/ia-2434.pdf to access a copy of the administrative order.
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Legg Masson Charged with Improperly Processing Mutual Fund Share Orders
9.21.2005 Legg Mason Wood Walker, Incorporated (Legg Mason) a registered broker-dealer headquartered in Baltimore, Maryland, consented to the entry of an SEC order that censures Legg Mason, and orders Legg Mason to cease and desist from violations of the charged provisions, comply with certain undertakings, and pay a $1,000,000 civil penalty.
The SEC found that from at least September 1, 2002, through October 19, 2003, Legg Mason�s flawed mutual fund order processing system enabled Legg Mason registered representatives to process more than 18,000 mutual fund orders after 4:00 p.m., ET, and receive the current day�s net asset value (NAV) without regard for the time the orders were placed. Hundreds of these orders were either received by Legg Mason after 4:00 p.m. or were the result of discretionary investment decisions made by Legg Mason registered representatives after 4:00 p.m. As a result of this conduct, Legg Mason willfully violated Rule 22c-1(a) under the Investment Company Act, which requires trades to be placed by customers before 4:00 p.m., ET, to receive that day�s NAV.
The SEC found that Legg Mason had minimal written procedures governing the timing and pricing of mutual fund orders and, instead, relied almost exclusively on its mutual fund order entry system to block any orders from being processed after 4:00 p.m., regardless of their time of receipt. However, since 1997, Legg Mason�s system had been failing to block certain trades processed by Legg Mason registered representatives after 4:00 p.m. Although the violative trading was not the result of any improper agreements between Legg Mason personnel and their customers, this practice had the potential to affect shareholders in the mutual funds sold by Legg Mason. Shareholders in the mutual funds could have been harmed through dilution of their share values if Legg Mason personnel attempted to capitalize on post-market information by processing mutual fund orders after hours based on stale prices.
The SEC order further found that Legg Mason failed to make and keep certain required books and records and therefore willfully violated Section 17(a)(1) of the Exchange Act and certain rules thereunder. Legg Mason did not maintain records relating to the original time of order entry for mutual fund transactions for three years as required by Rule 17a-4 of the Exchange Act and failed to maintain records reflecting the time it received mutual fund orders from customers for several months after May 2, 2003, the effective date of an amendment to Rule 17a-3 of the Exchange Act.
Please click http://www.sec.gov/litigation/admin/34-52478.pdf to access a copy of the administrative order.
Pennsylvania Adviser Charged with Custody Violation
9.15.2005 The SEC charged CMS Fund Advisers, Inc. (CMS), a registered investment adviser located in Philadelphia, Pennsylvania., and Joseph W. Lutes, a financial officer and a principal of the firm. CMS provides advisory and administrative services to limited partnerships offered and controlled by the firm, and has over $1 billion in assets under management. Without admitting or denying the Commission�s findings, both CMS and Lutes consented to the sanctions imposed by the SEC.
The SEC found that CMS willfully violated Section 206(4) of the Investment Advisers Act and Rule 206(4)-2 thereunder (custody rule) when it failed to perform annual custody verifications of client funds and securities from 2001 through March 2004. The custody rule, as then in effect, required investment advisers that had custody of client funds and securities to retain an independent auditor to conduct surprise custody verifications of such funds and securities at least once during each calendar year. The SEC found that, for the years 2001 through 2004, CMS had custody of client funds and securities but failed to perform the required annual custody verifications.
The SEC also found that he aided and abetted CMS� violations of Section 206(4) of the Advisers Act and Rule 206(4)-2. From January 2002 forward, Lutes was the senior CMS officer responsible for ensuring the completion of the custody verifications. The SEC found that Lutes knew at the time CMS advised the SEC staff of a proposed compliance plan that the custody verifications could not be completed as represented.
The SEC ordered CMS to cease and desist from committing or causing any violations and any future violations of Section 206(4) of the Advisers Act and Rule 206(4)-2 thereunder, and to pay a civil penalty in the amount of $115,000.
Please click http://www.sec.gov/litigation/admin/ia-2430.pdf for a copy of the administrative order.
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Oppenheimer Settles Revenue Sharing Charges
9.14.2005 The SEC entered a cease and-desist order against OppenheimerFunds, Inc. (OFI) and Oppenheimer Funds Distributor, Inc. (OFDI) (collectively Oppenheimer), the investment adviser and principal underwriter and distributor affiliated with the Oppenheimer Funds Complex, finding that Oppenheimer, without proper disclosure, used brokerage commissions � which are fund assets � on trades executed for some of the Funds to reduce OFDI�s revenue sharing obligations with certain broker-dealers.
The SEC found:
- Between January 1, 2000 and June 2003, and in the case of approximately 25 broker-dealers, OFDI, instead of exclusively using cash from its own resources, used approximately $15.8 million worth of brokerage commissions to reduce cash payments under revenue sharing arrangements. OFDI�s payments for revenue sharing in some cases resulted in placement on certain broker-dealers� �preferred lists� of mutual funds, increased access to brokers� registered representatives, placement on the brokers� websites, and participation in broker conferences, among other things.
- OFI failed to disclose the practice of using brokerage commissions to reduce cash payments under revenue sharing arrangements. By reducing some revenue sharing payments with the Funds� brokerage commissions, OFI permitted its subsidiary, OFDI, to avoid an expense that OFDI otherwise would have incurred. OFI had an obligation to fully and fairly disclose this practice to the Fund Boards, so the Fund Boards could determine if it was in the best interest of Fund shareholders.
- OFI violated Section 206(2) of the Investment Advisers Act, Sections 15(c) and 34(b) of the Investment Company Act, and Section 17(d) of the Investment Company Act, and Rule 17d-1 thereunder. OFDI aided and abetted and caused OFI�s violations of Section 206(2) of the Advisers Act, and Section 17(d) of the Investment Company Act, and Rule 17d-1 thereunder.
- In May 2004, OFI voluntarily paid to the Funds approximately $15.8 million, which represented the gross amount of brokerage commissions that had been used to reduce revenue sharing cash payments. In recognition of this prior payment, as well as Oppenheimer�s voluntary cessation of the practice of directed brokerage, and its cooperation with the SEC staff, the SEC did not order Oppenheimer to pay disgorgement of approximately $12.45 million � OFDI�s net benefit, prejudgment interest of approximately $1.4 million, or a civil penalty.
The SEC censured OFI and OFDI; ordered OFI and OFDI to cease and desist from committing or causing any violations and any future violations of the provisions listed above; and ordered OFI and OFDI to comply with certain remedial undertakings.
Please click http://www.sec.gov/litigation/admin/34-52420.pdf for a copy of the administrative order.
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Compliance Date for Broker Exemption Under the Investment Advisers Act Extended
9.12.2005 The SEC issued a release extending the compliance date for rule 202(a)(11)-1(b)(2) and (b)(3) under the Investment Advisers Act of 1940 from October 24, 2005, until January 31, 2006.
Rule 202(a)(11)-1 addresses the application of the Investment Advisers Act of 1940 to broker-dealers offering certain types of brokerage programs. Paragraph (b)(2) of the addresses the circumstances under which a broker-dealer providing financial planning services would be deemed to be an investment adviser under the Advisers Act. Paragraph (b)(3) of the rule provides that a broker-dealer with investment discretion would be deemed to be an investment adviser under the Advisers Act.
The American Council of Life Insurers, the Securities Industry Association and the Financial Services Institute Inc. each filed a petition for rulemaking seeking an extension of the compliance date for one or both of paragraphs (b)(2) and (b)(3) of rule 202(a)(11)-1. The Commission considered the petitions along with letters submitted opposing the petitions.
Please click http://www.sec.gov/news/digest/dig091205.txt to access a copy of the press release announcing the administrative action.
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Regulation B Extended
9.9.2005 The SEC issued an order further extending until September 30, 2006, the compliance dates for banks with respect to certain broker registration requirements contained in the Gramm-Leach-Bliley Act (GLBA). The SEC 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.�
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 SEC 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 SEC 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 September 30, 2005.
In June 2004, the SEC proposed to revise and replace the Interim Rules with Regulation B. The SEC extended the exemption from the definition of �broker� until September 30, 2006. This will give the SEC time to consider fully comments received on Regulation B and to take any final action on the proposal as necessary, including consideration of any modification necessary to the proposed compliance date.
Please click http://www.sec.gov/news/press/2005-130.htm to access the release delaying the implementation of the regulation.
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