Compliance September 23, 2011

SEC Charges Quant Manager With Fraud

The Securities and Exchange Commission (SEC) has charged the co-founder of institutional money manager AXA Rosenberg with securities fraud.
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The SEC says that Barr M. Rosenberg concealed a significant error in the computer code of the quantitative investment model that he developed and provided to the firm’s entities for use in managing client assets.  According to the SEC’s order instituting administrative proceedings against Rosenberg, he learned of the error in June 2009 but directed others to keep quiet about it and not fix it immediately.

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Rosenberg denied the existence of any significant errors in the model during an October 2009 board meeting discussion about its performance. AXA Rosenberg disclosed the error to SEC examination staff in late March 2010 after being informed of an impending SEC examination. However, the error was not disclosed to clients until April 2010, causing them $217 million in losses, according to the SEC.

Rosenberg has agreed to settle the SEC’s charges by paying a $2.5 million penalty and consenting to a lifetime securities industry bar. The SEC previously charged AXA Rosenberg and its affiliated investment advisers, and they agreed to pay $217 million to harmed clients plus a $25 million penalty.

“Rosenberg chose concealment over candor, and in doing so selfishly served his interests over those of his clients,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.

According to the SEC’s order, Rosenberg created the model, oversaw research projects to improve and enhance it, and exercised significant authority throughout the AXA Rosenberg organization. The material error in the model’s computer code disabled one of its key components for managing risk and affected the model’s ability to perform as expected. According to the SEC, clients raised concerns about this underperformance, and Rosenberg knew about and discussed these concerns with others at AXA Rosenberg. “But instead of disclosing and correcting the error immediately, Rosenberg directed others to conceal the error and declined to fix the error,” according to the SEC. 

(Cont...)

The SEC's order found that due to Rosenberg's misconduct, AXA Rosenberg and its affiliated investment advisers misrepresented to clients that the model's underperformance was attributable to factors other than the error, and inaccurately stated that the model was controlling risk correctly. Rosenberg's instructions to delay fixing the error caused additional client losses.

In its order, the SEC found that Rosenberg willfully violated anti-fraud provisions of the Investment Advisers Act of 1940, Sections 206(1) and 206(2). Without admitting or denying the SEC's findings, Rosenberg consented to the entry of an SEC order that:

  • requires him to cease and desist from committing or causing any violations and any future violations of these provisions;
  • orders him to pay the $2.5 million penalty;
  • and bars him from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization and prohibits him from serving as an officer, director or employee of a mutual fund.
Data & Research September 23, 2011

Know When to Hold ‘Em…

In a recently published paper, law firm Sutherland Asbill & Brennan poses the question: when should broker/dealers and advisers play it safe or tough it out when facing litigation from the SEC or FINRA? 
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When advisers are faced with the possibility of litigating against the Securities and Exchange Commission (SEC) or the Financial Industry Regulatory Authority (FINRA), many often decide to settle right away, rather than dragging the case into timely and costly litigation.  However, after examining cases dating back to 2005, Sutherland Asbill & Brennan explains in its paper that sometimes, “swinging for the fences” is the right decision.    

The paper, “Swinging for the Fences: An Analysis of Whether Broker-Dealers and Registered Representatives Should Litigate Against the SEC or FINRA,” uses a baseball metaphor throughout, arguing that just as a batter sometimes swings and sometimes doesn’t, advisers need to do the same.  To see whether advisers should adopt an aggressive approach at the plate, the firm has conducted a study of litigated disciplinary proceedings brought by FINRA against broker/dealers, registered representatives, and associated persons since 2005.  The firm also analyzed administrative proceedings brought by the SEC since 2008.

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Of the 237 charges that were litigated by the SEC and FINRA and resulted in SEC initial decisions or FINRA Hearing Panel decisions during fiscal years 2009 and  2010 (October 2008 through September 2010), B/Ds and individuals succeeded in getting approximately 13% of the charges dismissed.

For advisers going up against FINRA, the numbers of cases winning a dismissal are shrinking, however. Approximately 7.6% of charges were dismissed, although they had slightly greater success during FY 2010 (8.6%) compared with FY 2009 (7%). Both years represent declines from FY 2008 when FINRA respondents succeeded in getting 15% of the charges dismissed.

Those going up against the SEC had a relatively high success rate during the period (approximately 28%), which was greater than in FY 2008 (approximately 19%).

The firm contends that “many broker-dealers, registered representatives, and associated persons fear going up to the plate and litigating against regulators because regulators are well-funded, have often spent months or even years investigating the conduct, have their own procedural rules, and have an employee of the regulator serve as a judge. Respondents fear that litigating in “the house that the regulators built” gives the SEC and FINRA a competitive advantage.”  But sometimes, it pays for advisers to litigate, rather than settle.

Sometimes, of course, advisers are dealt monetary penalties. When SEC and FINRA respondents were found to be liable for one or more charges, 33% of the time the SEC Administrative Law Judge (ALJ) or FINRA Hearing Panel imposed lower monetary sanctions than those sought by the regulators. This is a notable change from FY 2008, when respondents succeeded in obtaining lower monetary sanctions 60% of the time.

The law firm also looked at the prevalence of suspension times, the outcomes of appeals, time spent in litigation, and the effect of having counsel representation.  The paper is available here. 

 

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