Investor Lawyers Blog

SEC Cautions Mutual Funds That They May be Misdirecting “Sub-Accounting Fees” And Impacting Investor Returns

Published on: January 8, 2016 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission’s Division of Investment Management has put out a guidance on its website cautioning mutual fund directors to more closely scrutinize the money that is paid to brokers and certain other intermediaries. The warning comes following a sweep exam, which found that fees that should be going toward record-keeping and other administrative services are instead being directed toward encouraging fund sales. A number of mutual funds, brokerage firms, investment advisers, and transfer agents were examined prior to the issuance of this guidance.

SEC rules stipulate that sub-accounting fees cannot go toward finance distribution. These fees should only go toward record-keeping and shareholder services. However, there is an issue with mutual fund-maintained omnibus accounts in which all the fees can be placed together. In such instances, payments made to brokers for selling certain funds may get buried in these administrative fees.

Now, the Commission wants fund directors to watch out for fees that intermediaries selling the funds are getting for account services. It wants these directors to establish processes to assess whether a sub-accounting fee is being harnessed to increase sales. It also is calling on fund service providers and advisers to explain distribution and servicing specifics to fund directors.
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Hedge Fund News: Fund Manager Steven Cohen Not Allowed Supervisory Role Until ’18, Father & Son Get Prison Term for Fraud, & Former New Stream Capital Executives Are Permanently Barred from the Securities Industry

Published on: January 8, 2016 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission says that billionaire Steven Cohen will not be allowed to supervise funds that oversee outside money or take on a supervisory position at any brokerage firm or investment adviser firm until 2018. The temporary bar is to resolve charges accusing him of not properly supervise Mathew Martoma. The ex-portfolio manager committed insider trading while at CR Intrinsic Investors. That firm is a subsidiary of S.A.C Capital Advisors LLC, which Cohen founded.

Cohen had been barred for life from the securities industry over said violations, although he was never charged in criminal court. However, because of an appeals court ruling in another case which impacted his case, hence the revised settlement. This latest deal will have caused Cohen to be barred from managing outside money for four years. He’s already been restricted for two of those four years.

The regulator says that before Cohen will be allowed to deal with external funds again an independent counsel will have to make sure that legally adequate procedures, policies, and supervisory mechanisms are implemented so that possible incidents of insider trading in the future are detected and stopped.

The SEC’s order also said that Cohen had ignored warning signs that should have compelled him to act immediately to find out whether or not Martoma was doing something illicit. Instead, he allowed him to make trades while making similar trades in accounts that he controlled. As a result of the insider trading, Cohen’s hedge funds made money while avoiding losses of about $275M.

401(K) Plan Lawsuit Accuses Anthem of Charging Excessive Fund Feeds

Published on: January 6, 2016 | by Shepherd Smith Edwards & Kantas, LLP

Participants in Anthem Inc.’s 401(K) plan are accusing the plan’s fiduciaries of breaching their fiduciary duties under the Employee Retirement Income Security Act of 1974. They claim that the fiduciaries churned excessive administrative and investment management fees in Vanguard mutual funds. Vanguard Group is the fund’s record-keeper.

According to plaintiffs, the plan fiduciaries chose mutual fund share classes that were “high-priced” instead of equivalent ones that didn’t cost as much and were also available to the plan. As of 12/14, Anthem’s 401(k) plan offered 11 Vanguard mutual funds, including Institutional and Admiral share classes: Vanguard target-date collective investment trust funds, a fund offered by Touchstone Investments, funds by Artisan Partners, and an Anthem common stock fund. The lawsuit claims that each fund in the plan charged fees excessive to what Anthem could have gotten elsewhere with funds that were comparable.

The Anthem 401(k) fund participants also contend that Vanguard was paid excessive fees for record-keeping related services from ’10-’13, which was when the plan paid about $80-$94/participant for record keeping through revenue-sharing and hard-dollar fees. It wasn’t until 9/13 that the cost was reduced to a flat yearly fee of $42/participant.

The plaintiffs argued that a reasonable fee’s “outside limit” for this particular plan should have been no higher than $30. The class-action securities case also claims that instead of including a stable value fund in the plan, there was a money market fund that generated returns that were “microscopic.”

Shareholder Files Against REIT Over $41M Puerto Rico Hotel Loan Write-Down

Published on: January 5, 2016 | by Shepherd Smith Edwards & Kantas, LLP

A shareholder of Resource Capital Corp. is suing the real estate investment trust (REIT) because of the way it dealt with a Puerto Rico hotel loan portfolio and a $41 million write-down that resulted last year. Plaintiff Josh Reaves says that the REIT’s directors knew there was bleak information about the deteriorating financial state of the U.S. territory way before a press release went out in August revealing there had been a $41 million write-down on a hotel mezzanine loan. The announcement caused the REIT’s stock to drop over 12% ,while erasing $55 million in market capitalization.

Reaves says that Resource Capital should have known as early as February 2014, when Puerto Rico debt was downgraded to “junk” status, that investments on the island were at risk. Instead, he contends, the REIT did not disclose the degree to which its loan portfolio was exposed to the Puerto Rican economy, misrepresented the degree of risk the portfolio could handle, did not abide by disclosure practices as they pertain to loan impairment, did not accurately represent the portfolio’s value, and failed to have the internal controls needed to stop the risks from becoming too precarious.

In August 2015, when submitting its filing to the SEC, Resource Capital wrote that the loan’s outstanding balance was $38.1 million and moved $3 million of accrued interest to the negative column from the positive column. Because of the $41 million write-down, $31 million was lost over that quarter.

Reaves’ case is a derivatives lawsuit. He is filing it on the company’s behalf. This means that Resource is a nominal defendant. The defendants named included the REIT’s CFO David Bryant, CEO Jonathan Cohen, Chairperson Steven Kessler, and a number of its board members.
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FINRA Bars Ex-National Securities Broker Zachary Bader Over Investor Fraud Allegations

Published on: January 4, 2016 | by Shepherd Smith Edwards & Kantas, LLP

The Financial Industry Regulatory Authority is permanently barring former National Securities broker Zachary Bader from the securities industry in the wake of allegations filed by numerous investors. Bader, who was let go from the National Securities Corporation, also was previously registered with Craig Scott Capital and Brookstone Securities. According to BrokerCheck, five customer complaints and two regulatory sanctions have been brought against him.

Bader is accused of excessive trading, making unsuitable investment recommendations to at least 21 customers by advising them to put their money in the iPath S&P 500 VIX Short Term Futures ETN (VXX), showing reckless disregard of clients’ interests, improper due diligence, breach of fiduciary duty, churning, providing inadequate investment advice, and breach of contract.

iPath S&P 500 VIX Short Term (VXX)
The iPath S&P 500 VIX Short Term is an exchange-traded note. Many ETNs are only appropriate for short-term trading and/or institutional investors. For example, the VXX exposes investors to returns of certain futures contracts on the VIX Index and it is considered a bearish investment. It is not appropriate for certain equity positions. The VXX comes with very specific risks and over time will lose value as futures contracts on the VIX Index go down too.
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Puerto Rico Will Make $330M in Bond Payments, Defaults on About $37M

Published on: December 31, 2015 | by Shepherd Smith Edwards & Kantas, LLP

The U.S. Commonwealth of Puerto Rico will pay about $330 million of what it owes on general obligation bonds, while defaulting on bonds of approximately $37 million that are mostly owed to the Puerto Rico Infrastructure Financing Authority (Prifa) and the Public Finance Corp. Puerto Rico general obligation debt is constitutionally-guaranteed and some of the money to pay for that debt had been originally earmarked for bonds that do not have as strong of legal protections.

This has led to Financial Guaranty Insurance Co. and Ambac Financial Group Inc., which together insure over $860 million in Prifa bonds, sending a letter to Puerto Rico government officials. In the note, they called the redirecting of the funds illegal.

This is not the first time Puerto Rico has defaulted on bond payments owed. It missed payments last year and its government has already warned that further payments may be missed this year. The territory owes investors approximately $72 billion.

In December, the Puerto Rico Electric Power Authority (PREPA) arrived at a partial-default deal with bond insurers and creditors, reducing debt payments by almost 50% every year for the next five years. Creditors would take a 15% loss in exchange for stronger legal claims on the debt that is left. However, legislation still must be approved to finalize the arrangement.

Worries that creditors will sue has led to Puerto Rico asking the U.S. Congress to grant it bankruptcy protection so it can file for Chapter 9. One of the purposes of the latest bond payment plan is to delay these possible lawsuits while the territory buys more time to work out a deal with negotiators. And, while Democrats and the White House have asked Congress to pass legislation that would let the island restructure its debt, Republican lawmakers have thwarted those efforts. Now, many are expecting these creditor lawsuits in the coming days.
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SEC’s Report Evaluates The Definition of An Accredited Investor

Published on: December 31, 2015 | by Shepherd Smith Edwards & Kantas, LLP

The U.S. Securities and Exchange Commission (SEC) has put out a report assessing the definition of who qualifies as an accredited investor. The 2010 Dodd-Frank Act mandates that this definition be reevaluated every four years.

Accredited investors are allowed to take part in investment opportunities that are typically not available to non-accredited investors. The definition helps to identify who has the financial sophistication to get involved in such investments, as well as handle the possible risks involved in investing in hedge funds, private companies, venture capital funds, private equity funds, and other such investments.

Currently, anyone who has a yearly income over $200K or a total net worth greater than $1M is allowed to qualify as an accredited investor. (As of 2010, an investor’s main residence may no longer be included in the calculation of his/net worth.) In the report, prepared by staff from the Divisions of Corporation Finance and Economic Risk and Analysis, the Commission is asked to consider a number of suggestions, including revising the financial threshold qualifications for natural persons who meet the accredited investor definition, as well as modifying the list-based approach that allows entities to satisfy the definition. Other suggestions:

– Subject to investment limitations, keeping the current thresholds for net worth and current income as criteria for who can qualify.
– Establish new thresholds for inflation-adjusted income and net worth that are not impacted by investment limitations.
– Allow spousal equivalents to put together their money to qualify as accredited investors.
– Modify the accredited investor definition as it applies to entities by using a $5M investments test instead of a $5M assets test.

As Redemption Requests Go Up, Whitebox Advisors to Liquidate Three Mutual Funds

Published on: December 30, 2015 | by Shepherd Smith Edwards & Kantas, LLP

Whitebox Advisors says it intends to liquidate its mutual funds next month following a slew of redemptions and losses this year. A spokesperson for the investment firm said that with so many people asking for their money back, the concentration risks to investors had become too high.
The three mutual funds that are closing are:

· Whitebox Tactical Opportunities Fund, which oversees $112.8M
· Whitebox Market Neutral Equity Fund, which oversees $40.25M
· Whitebox Tactical Advantage Fund, which oversees 20.3M
The news comes just weeks after Third Avenue Management shook up the equity and credit markets when it announced that it was liquidating its Focused Credit Fund (TFCVX), which is a $788.5M corporate debt mutual fund, but that distributions to investors would be delayed so as to prevent even bigger losses. Stone Lion Capital Partners has also suspended redemptions in its $400M of credit hedge funds following many redemption requests.
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Insider Trading News: SAC Capital Resolves Shareholder Lawsuit, Chinese Traders Settle SEC Charges, Another Court Turns Down Rajat Gupta’s Conviction Appeal SAC Capital Advisors Settles Insider Trading Case for $10M

Published on: December 30, 2015 | by Shepherd Smith Edwards & Kantas, LLP

SAC Capital Advisors Settles Insider Trading Case for $10M
SAC Capital Advisors has consented to pay $10M to resolve a securities case brought by shareholders of pharmaceutical company Wyeth. The plaintiffs contend that they sustained losses because the hedge fund had been insider trading in the drugmaker’s stock.

The class action securities lawsuit was brought following the arrest a few years back of Mathew Martoma, an ex-SAC Capital portfolio manager. After he was convicted last year of insider trading for using confidential outcomes of a clinical trial involving an Alzheimer’s drug, Martoma was sentenced to nine years behind bars in 2014. According to prosecutors, Martoma’s trades allowed the hedge fund to make $275M.

Other settlements have already been reached over this matter, including a $1.8B settlement with US authorities as well as a guilty plea by SAC Capital. An SAC Capital unit also settled insider trading claims involving Wyeth and Elan Corp. stock—Elan and Wyeth had been developing the Alzheimer’s drug together—for $602M.

SEC Announces Settlement with Two Chinese Traders Over Insider Trading Case
The U.S. Securities and Exchange Commission says that business associates and cousins Yannan Liu and Zhichen Zhou, who are traders in Hong Kong and China, respectively, have consented to pay over $920,000 to resolve insider trading charges. The two of them will disgorge their entire ill-gotten gains as well as pay penalties.

According to the regulator, Liu and Zhou traded Chindex International and MedAssets Inc. stocks because of nonpublic information they received about their upcoming acquisitions by private equity firms. Liu had been a private equity associate at a company that was connected to both deals.

Securities Fraud News: Barclays to Pay $13.5M For Unsuitable Fraud Transactions, Appeals Court Upholds Asset Freeze of Wyly Brothers’ Relatives, Ex-NBA Player to Get Sentence for Ponzi Scam Conviction

Published on: December 29, 2015 | by Shepherd Smith Edwards & Kantas, LLP

Barclays Capital Gets FINRA Fine for Unsuitable Mutual Fund Transactions

The Financial Industry Regulatory Authority said that Barclays Capital, Inc. (BARC) must pay over $10M in restitution plus interest to customers that were impacted by violations related to unsuitable mutual fund transactions. The self-regulatory organization said that the firm did not give certain customers the breakpoint discounts that applied. Aside from the restitution, Barclays must pay a $3.75M fine.

According to the SRO, from 1/10 through 6/15, the firm’s supervisory systems were not adequate enough to make sure that unsuitable transactions didn’t happen or that the firm’s duties related to mutual fund sales to retail brokerage clients were met. FINRA said that Barclays supervisory procedures wrongly defined a mutual fund switch as warranting three transactions within a specific period of frame. Because of this erroneous definition, the firm did not act on thousands of automated alerts warning of transactions that might be unsuitable, failed to include certain transactions for suitability review, and neglected to make sure that customesr got disclosure letters about transaction costs. Over 6,100 unsuitable mutual fund switches occurred, causing r about $8.63M in customer harm.

FINRA said that the Barclays did not give its supervisors enough guidance so that they could make sure that brokerage customers were engaging in mutual fund transactions that were suitable for their investment goals, holdings, and ability to tolerate risks. The SRO, which evaluated activities over a six-month period of time, said that 39% of mutual fund transactions were found unsuitable and customers suffered financial harm, including realized losses, of over $800K.

Also, during these five years, the firm’s supervisory system did not succeed in making sure that purchases were properly aggregated so eligible customers could get breakpoint discounts, including those involved in 100 Class A share mutual fund transactions.

By settling, Barclays is not denying or admitting to FINRA’s charges. It is, however, consenting to the entry of findings.
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