2 HOUSTON-BASED INVESTMENT ADVISORY FIRMS CHARGED BY SEC FOR MAKING TRANSACTIONS WITHOUT NOTIFYING CLIENTS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 
SEC Announces Charges Against Two Houston-Based Firms for Engaging in Thousands of Undisclosed Principal Transactions

The Securities and Exchange Commission today announced charges against two Houston-based investment advisory firms and three executives for engineering thousands of principal transactions through their affiliated brokerage firm without informing their clients.

One of the firms — along with its chief compliance officer — also is charged with violations of the “custody rule” that requires firms to meet certain standards when maintaining custody of client funds or securities.

In a principal transaction, an investment adviser acting for its own account or through an affiliated broker-dealer buys a security from a client account or sells a security to it.  Principal transactions can pose potential conflicts between the interests of the adviser and the client, and therefore advisers are required to disclose in writing any financial interest or conflicted role when advising a client on the other side of the trade.  They must also obtain the client’s consent.

The SEC’s Enforcement Division alleges that investment advisers Parallax Investments LLC and Tri-Star Advisors engaged in thousands of securities transactions with their clients on a principal basis through their affiliated brokerage firm without making the required disclosures to clients or obtaining their consent beforehand.  Parallax’s owner John P. Bott II and Tri-Star Advisors CEO William T. Payne and president Jon C. Vaughan were collectively paid more than $2 million in connection with these trades.

“By failing to disclose principal transactions and obtain consent, Parallax and Tri-Star Advisors deprived their clients of knowing in advance that their advisers stood to benefit substantially by running the trades through an affiliated account,” said Marshall S. Sprung, co-chief of the SEC Enforcement Division’s Asset Management Unit.

According to the SEC’s orders instituting administrative proceedings, Bott initiated and executed at least 2,000 undisclosed principal transactions from 2009 to 2011 without the consent of Parallax clients.  In each transaction, Parallax’s affiliated brokerage firm Tri-Star Financial used its inventory account to purchase mortgage-backed bonds for Parallax clients and then transferred the bonds to the applicable client accounts.  Bott received nearly half of the $1.9 million in sales credits collected by Tri-Star Financial on these transactions.

According to the SEC’s orders, Payne and Vaughan initiated and executed more than 2,000 undisclosed principal transactions from 2009 to 2011 without the consent of Tri-Star Advisor clients.  Tri-Star Financial similarly used its inventory account to purchase mortgage-backed bonds for Tri-Star Advisor clients and then transferred the bonds to the applicable client accounts.  Payne and Vaughan together received nearly half of the $1.9 million in gross sales credits collected by the brokerage firm on these transactions.

The SEC’s Enforcement Division further alleges that Parallax failed to comply with the custody rule that requires firms to undergo certain procedures to safeguard and account for client assets.  Parallax served as an adviser to a private fund Parallax Capital Partners LP.  The custody rule required Parallax to either undergo an annual surprise exam to verify the existence of the fund’s assets, or obtain fund audits by a PCAOB-registered auditor and deliver the financial statements to investors within 120 days after the fiscal year ends.  Although Parallax obtained an audit of PCP in 2010, it failed to retain a PCAOB-registered auditor and failed to deliver the financial statements on time.

According to the SEC’s orders, Parallax chief compliance officer F. Robert Falkenberg was aware of the 120-day deadline, but failed to take any steps to ensure that Parallax complied.  Even after Falkenberg and Bott learned that the fund’s auditor was not registered with the PCAOB, they retained him to perform the 2010 audit and issue financial statements to investors.

According to the SEC’s orders, Parallax allegedly violated the principal transaction, custody, and compliance provisions of the Investment Advisers Act of 1940, and Bott allegedly aided, abetted, and caused the violations.  Falkenberg allegedly aided, abetted, and caused Parallax’s custody and compliance violations.  Tri-Star Advisors allegedly violated the principal transaction and compliance provisions of the Advisers Act, and Payne and Vaughan allegedly caused the violations.

The SEC’s investigation was conducted by R. Joann Harris and Asset Management Unit member Barbara L. Gunn of the Fort Worth Regional Office.  The SEC’s litigation will be led by Jennifer Brandt.

SEC SANCTIONS 3 INVESTMENT ADVISORY FIRMS FOR PROBLEMS WITH COMPLIANCE PROGRAMS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION

The Securities and Exchange Commission today sanctioned three investment advisory firms for repeatedly ignoring problems with their compliance programs.

The enforcement actions arise from the agency’s Compliance Program Initiative, which targets firms that have been previously warned by SEC examiners about compliance deficiencies but failed to effectively act upon those warnings.  Had the problems been addressed, the firms could have prevented their eventual securities law violations.  The SEC Enforcement Division’s Asset Management Unit has coordinated with examiners to bring several cases since the initiative began two years ago.

The firms charged today – Modern Portfolio Management Inc., Equitas Capital Advisers LLC, and Equitas Partners LLC – have agreed to settlements in which they will pay financial penalties and hire compliance consultants.

“The Compliance Program Initiative is designed to address repeated compliance failures that may lead to bigger problems,” said Andrew J. Ceresney, co-director of the SEC’s Division of Enforcement.  “That risk materialized with these firms, whose compliance programs were not adequate to prevent misleading statements in marketing materials or inadvertent overbilling of clients.  Firms must not only have policies and procedures in place, but also need to properly implement those policies and procedures.”

Andrew Bowden, director of the SEC’s National Exam Program, added, “After SEC examiners identified significant deficiencies, these firms did little or nothing to address them by the next examination.  Firms must fix deficiencies identified by our examiners.”

Under what is known as the “Compliance Rule” (Rule 206(4)-7 of the Investment Advisers Act), investment advisers are required to adopt and implement written policies and procedures that are reasonably designed to prevent securities law violations.  The rule requires advisers to review their policies and procedures at least once a year for adequacy and effectiveness of implementation.  Advisers also must designate a chief compliance officer responsible for administering the policies and procedures.

The SEC’s order against Modern Portfolio Management (MPM) and its owners G. Thomas Damasco II and Bryan Ohm finds that they failed to correct ongoing compliance violations at the firm despite prior warnings from SEC examiners.  In particular, they failed to complete annual compliance reviews in 2006 and 2009 and made misleading statements on MPM’s website and investor brochure.  For instance, one location on MPM’s website misleadingly represented that the firm had more than $600 million in assets.  However, on its Form ADV filing to the SEC during that same time period, it reported that the firm’s assets under management were $359 million or less.

MPM, Damasco, and Ohm agreed to be censured and pay a total of $175,000 in penalties.  Damasco and Ohm must complete 30 hours of compliance training, and MPM has agreed to designate someone other than Damasco or Ohm to be its chief compliance officer.  MPM, which is based in Holland, Ohio, must retain a compliance consultant for three years.

According to the SEC’s orders against New Orleans-based Equitas Capital Advisers and Equitas Partners as well as owner David S. Thomas, Jr., chief compliance officer Susan Christina, and former owner and chief compliance officer Stephen Derby Gisclair, they failed to adopt and implement written compliance policies and procedures and conduct annual compliance reviews to satisfy the Compliance Rule.  The Equitas firms made false and misleading disclosures about historical performance, compensation, and conflicts of interest, and they inadvertently yet repeatedly overbilled and underbilled their clients.  Many of these violations occurred despite warnings by SEC examiners during examinations of the Equitas firms in 2005, 2008, and 2011.  The firms, Thomas, and Gisclair failed to disclose these deficiencies to potential clients in response to questions in certain due diligence questionnaires or requests for proposals.  Gisclair also caused Compliance Rule violations and the incorrect billing of clients at Crescent Capital Consulting LLC, an investment advisory firm that he opened in late 2010.  Gisclair inflated the amounts of assets managed by Equitas and Crescent in their Form ADV filings to the SEC, and he improperly removed and retained nonpublic personal client information when he left Equitas.

Equitas Capital Advisers and Crescent have reimbursed all overcharged clients, and Equitas Capital Advisers, Thomas, and Gisclair agreed to pay a total of $225,000 in additional penalties. The Equitas firms have agreed to censures, the Equitas firms and Crescent have hired independent compliance consultants, and the Equitas firms and Gisclair must give clients notice of the SEC enforcement actions.

The SEC’s investigation into the Equitas firms was conducted by David Neuman of the Asset Management Unit and Virginia Rosado Desilets, and was supervised by Jeffrey Finnell of the Asset Management Unit.  Examinations of the firms were conducted by Conston Casey, David Marsh, Kenny Clowers, and Mavis Kelly.  The SEC’s investigation of Modern Portfolio Management was conducted by Amy Flaherty Hartman and Jamie Davidson following examinations of the firm by Michael Esposito, Sarah Kuhn, Arthur Stoll, Louis Gracia, Steven Levine, Kiley Hamilton, Belinda Hoskins, and Maureen Dempsey of the Chicago Regional Office.