FROM: SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., May 2, 2013 — The Securities and Exchange Commission today charged the gatekeepers of a pair of mutual fund trusts with causing untrue or misleading disclosures about the factors they considered when approving or renewing investment advisory contracts on behalf of shareholders.
Some trusts are created as turnkey mutual fund operations that launch numerous funds to be managed by different unaffiliated advisers and overseen by a single board of trustees. The federal securities laws require all mutual fund directors to evaluate and approve a fund's contract with its investment adviser, and the funds must report back to shareholders about the material factors considered by the directors in making these decisions. The SEC Enforcement Division's Asset Management Unit has been taking a widespread look into the investment advisory contract renewal process and fee arrangements in the fund industry.
An SEC investigation that arose from an examination of the Northern Lights Fund Trust and the Northern Lights Variable Trust found that some of the trusts' shareholder reports either misrepresented material information considered by the trustees or omitted material information about how they evaluated certain factors in reaching their decisions on behalf of the funds and their shareholders. The trustees and the trusts' chief compliance officer Northern Lights Compliance Services (NLCS) were responsible for causing violations of the SEC's compliance rule, and the trusts' fund administrator Gemini Fund Services (GFS) caused violations of the Investment Company Act recordkeeping and reporting provisions.
The firms and the trustees have agreed to settle the SEC's charges.
"Determining the terms of the investment advisory contract, especially compensation of the adviser, is one of the most critical duties of a mutual fund board," said George S. Canellos, Co-Director of the SEC's Division of Enforcement. "We will aggressively enforce investors' rights to accurate and complete information about the board's process and decision-making."
The five trustees named in the SEC enforcement action are: Michael Miola of Arizona, Lester M. Bryan of Utah, Anthony J. Hertl of Florida, Gary W. Lanzen of Nevada, and Mark H. Taylor of Ohio.
According to the SEC's order instituting settled administrative proceedings, the Northern Lights trusts included up to 71 mutual fund series from January 2009 to December 2010, most of which were managed by different advisers and sub-advisers. The trustees conducted 15 board meetings during that time period, and made decisions about 113 advisory and 32 sub-advisory contracts during what's known as the 15(c) process. Section 15(c) of the Investment Company Act requires fund directors to request and evaluate information that is reasonably necessary to evaluate the terms of any contract for an investment adviser of a registered investment company.
The SEC's order found that some boilerplate disclosures related to the 15(c) process that were included by GFS in some fund series shareholder reports contained untrue or misleading information. For example, one disclosure claimed that the trustees had considered peer group information about the advisory fee, however no such data had been provided to the trustees. Other disclosures misleadingly indicated that the fund's advisory fee was not materially higher than its peer group range, when in fact the fee was nearly double the peer group's mean fee or even higher. GFS failed to ensure that certain shareholder reports contained the required disclosures about the trustees' evaluation process and failed to ensure that certain series within the trusts maintained and preserved their 15(c) files.
The SEC's order also found that certain mutual fund series did not follow their policies and procedures for the trustees' approval of the investment advisers' compliance programs. Fund boards are required to approve the policies and procedures of service providers to a fund, including its adviser. The policies and procedures of each series within the Northern Lights trusts stated that the trustees could approve the compliance program of each series' investment adviser based on their review of an adviser's compliance manual or based on a summary provided by NLCS that familiarized them with the salient features of the compliance program and provided a good understanding of how the program addressed particularly significant compliance risks. Rather than following this process, the trustees' approval of the advisers' compliance programs was based primarily on their review of a brief written statement prepared by NLCS saying that the advisers' compliance manuals were "sufficient and in use" and a verbal representation by NLCS that such manuals were adequate.
"These violations make clear that turnkey mutual fund arrangements can pose significant governance concerns, and trustees must be vigilant in ensuring that the funds they oversee meet their disclosure, compliance, reporting, and recordkeeping obligations," said Marshall S. Sprung, Deputy Chief of the SEC Enforcement Division's Asset Management Unit.
The SEC's order finds that GFS caused violations of Sections 30(e) and 31(a) of the Investment Company Act and Rules 30e-1 and 31a-2(a)(6); NLCS and the trustees caused violations of Rule 38a-1(a)(1) under the Investment Company Act; and the trustees caused violations of Section 34(b) of the Investment Company Act. Without admitting or denying the SEC's findings, GFS and NLCS each agreed to pay $50,000 penalties, and the firms and trustees agreed to engage an independent compliance consultant to address the violations found in the SEC's order. They agreed to cease and desist from committing or causing any violations and any future violations of those provisions.
The SEC's investigation was conducted by Asset Management Unit members in the Denver and New York offices, including James Scoggins, Noel Franklin, John Mulhern, and Catherine Lifeso. The examination that led to the investigation was conducted by Bruce Ketter, Craig Ellis, and Phil Perrone of the Denver office.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
SEC Charges City of Victorvile, Underwriter, and Others with Defrauding Municipal Bond Investors
Washington, D.C., April 29, 2013 — The Securities and Exchange Commission today charged that the City of Victorville, Calif., a city official, the Southern California Logistics Airport Authority, and Kinsell, Newcomb & DeDios (KND), the underwriter of the Airport Authority’s bonds, defrauded investors by inflating valuations of property securing an April 2008 municipal bond offering.
Victorville Assistant City Manager and former Director of Economic Development Keith C. Metzler, KND owner J. Jeffrey Kinsell, and KND Vice President Janees L. Williams were responsible for false and misleading statements made in the Airport Authority’s 2008 bond offering, the SEC alleged. It also charged that KND, working through a related party, misused more than $2.7 million of bond proceeds to keep itself afloat.
"Financing redevelopment projects by selling municipal bonds based on inflated valuations violates the public trust as well as the antifraud provisions of the federal securities laws," said George S. Canellos, Co-Director of the SEC’s Division of Enforcement. "Public officials have the same obligation as corporate officials to tell the truth to their investors."
Elaine C. Greenberg, Chief of the SEC’s Municipal Securities and Public Pensions Unit, said, "Investors are entitled to full disclosure of material financial arrangements entered into by related parties. Underwriters who secretly line their own pockets by taking unauthorized fees will be held accountable."
The SEC alleges the Airport Authority, which is controlled by the City of Victorville, undertook a variety of redevelopment projects, including the construction of four airplane hangars on a former Air Force base. It financed the projects by issuing tax increment bonds, which are solely secured by and repaid from property-tax increases attributable to increases in the assessed value of property in the redevelopment project area.
According to the SEC’s complaint filed in U.S. District Court for the Central District of California, by April 2008, the Airport Authority was forced to refinance part of the debt incurred to construct the hangars, and other projects, by issuing additional bonds. The principal amount of the new bond issue was partly based on Metzler, Williams, and Kinsell using a $65 million valuation for the airplane hangars even though they knew the county assessor valued the hangars at less than half that amount. The inflated figure allowed the Airport Authority to issue substantially more bonds and raise more money than it otherwise would have. It also meant that investors were given false information about the value of the security available to repay them.
In addition, the SEC’s investigation found that Kinsell, KND, and another of his companies misappropriated more than $2.7 million in bond proceeds that were supposed to be used to build airplane hangars for the Airport Authority. According to the SEC’s complaint, the scheme began when Kinsell learned of allegations that the contractor building the hangars had likely diverted bond proceeds for his own personal use. When the contractor was removed, Kinsell stepped in to oversee the hangar project through another company he owned, KND Affiliates, LLC, even though Kinsell had no construction experience.
The SEC alleges that the Airport Authority loaned KND Affiliates more than $60 million in bond proceeds for the hangar project and agreed that as compensation for the project, KND Affiliates would receive a construction management fee of two percent of the remaining cost of construction. However, Kinsell and KND Affiliates took an additional $450,000 in unauthorized fees to oversee the construction and took $2.3 million in fees that the Airport Authority was unaware of and never agreed to, purportedly as compensation to "manage" the hangars. The SEC alleges that Kinsell and KND Affiliates hid these fees from the Airport Authority representatives and from the auditors who reviewed KND Affiliates’ books and records.
The SEC’s complaint alleges that the Airport Authority, Kinsell, KND, and KND Affiliates violated the antifraud provisions of U.S. securities laws and that KND violated 15B(c)(1) of the Exchange Act and Municipal Securities Rulemaking Board Rules G-17, G-27 and G-32(a)(iii)(A)(2). The complaint also alleges that Victorville, Metzler, KND, Kinsell, and Williams aided and abetted various violations. The SEC is seeking the return of ill-gotten gains with prejudgment interest, financial penalties, and permanent injunctions against all of the defendants, as well as the return of ill-gotten gains from relief defendant KND Holdings, the parent company of KND.
The SEC’s investigation was conducted by Robert H. Conrrad and Theresa M. Melson in the Municipal Securities and Public Pensions Unit, and Lorraine B. Echavarria, Todd S. Brilliant, and Dora M. Zaldivar of the Los Angeles Regional Office. Sam S. Puathasnanon will lead the SEC’s litigation.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Defendant in SEC Action Sentenced On Related Criminal Charges, Receives 17 Year Sentence
The Securities and Exchange Commission announced today that on April 26, 2013, Arnett L. Waters of Milton, Massachusetts, a principal of a broker-dealer and investment adviser who is a defendant in a securities fraud action filed by the Commission in May 2012, was sentenced to 17 years in federal prison in a separate criminal action for orchestrating a securities fraud and for defrauding rare coin investment customers. Waters was also sentenced to three years of supervised release and $9,025,691 in restitution and forfeiture. The criminal charges were brought by the U.S. Attorney for the District of Massachusetts. Waters' guilty plea to securities fraud and other charges occurred on November 29, 2012, and followed an earlier guilty plea by Waters in October 2012 to criminal contempt charges for violating a preliminary injunction order obtained by the Commission in its case. The Commission's Order barring Waters from the securities industry was issued on December 3, 2012.
The Commission filed an emergency enforcement action against Waters on May 1, 2012, alleging that he and two companies under his control, broker-dealer A.L. Waters Capital, LLC and investment adviser Moneta Management, LLC, defrauded investors from at least 2009-2012 by, among other things, misappropriating investor funds and spending it on personal expenses. On May 3, 2012, the Court entered a preliminary injunction order that, among other things, froze Waters' assets and required him to provide an accounting of all his assets to the Commission. On August 7, 2012, the Commission filed a civil contempt motion against Waters, alleging that he had violated the court's preliminary injunction order by establishing an undisclosed bank account, transferring funds to that account, dissipating assets, and failing to disclose the bank account to the Commission, as required by the Court's order. On August 9, 2012, the U.S. Attorney for the District of Massachusetts filed a separate criminal contempt action against Waters based on the same allegations. On October 2, 2012, Waters pleaded guilty to the criminal contempt charges, and the Court ordered him detained pending sentencing.
On December 3, 2012, the Commission barred Waters from the securities industry, based on his October 2, 2012 guilty plea to criminal contempt. The Order bars Waters from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and from participating in any offering of a penny stock, including: acting as a promoter, finder, consultant, agent or other person who engages in activities with a broker, dealer or issuer for purposes of the issuance or trading in any penny stock, or inducing or attempting to induce the purchase or sale of any penny stock.
The U.S. Attorney for the District of Massachusetts charged Waters with an array of securities fraud and other violations on October 17, 2012. On November 29, 2012, Waters pleaded guilty to sixteen counts of securities fraud, mail fraud, money laundering, and obstruction of justice. The counts of the criminal information to which Waters pleaded guilty alleged that, from at least 2007 through 2012, he used fictitious investment-related partnerships to draw in investors, misappropriate their investment money, and spend the vast majority of it on personal and business expenses and debts. Waters raised at least $839,000 from at least thirteen investors, including $500,000 from his church in March 2012. Waters also pleaded guilty to engaging in a criminal scheme to defraud clients of his rare coin business. Under this scheme, Waters defrauded coin customers out of as much as $7.8 million by selling coins at prices inflated, on average, by 600% and by inducing coin purchasers to return coins to him, on the false representation that he would sell those coins on the customers' behalf, when, in fact, he sold most or all of the coins and kept the proceeds for himself. The criminal information to which Waters pleaded guilty further alleged that he engaged in money laundering through two transactions totaling $77,000. Finally, Waters pleaded guilty to allegations that he made multiple misrepresentations to Commission staff, including that there were no investors in his investment-related partnerships, in order to conceal the fact that investor money was misappropriated in a fraudulent scheme. Waters was charged with obstruction of justice related to this conduct.
The Commission acknowledges the assistance of the United States Attorney's Office for the District of Massachusetts, the Federal Bureau of Investigation and FINRA in this matter.
FROM: U.S. DEPARTMENT OF TREASURY
Remarks by Treasury Secretary Jacob J. Lew at Meeting of the Financial Stability Oversight Council (FSOC)
As prepared for delivery
I would like to call the Financial Stability Oversight Council meeting back to order.
I want to start by welcoming Mary Jo White to the Council. I also want to thank Elisse Walter for her hard work over the past several months.
We are meeting to discuss the Council’s annual report. I will talk more about the report in a few moments, but first I would like to take note of why continuing our work on financial reform is absolutely essential.
As we gather together today, the financial system is much more resilient than it was five years ago, and members of this Council have made a great deal of progress in building a safer system, including much progress over the last year.
The Federal Reserve issued a new framework for the consolidated supervision of large financial institutions in December.
The Securities and Exchange Commission and the Commodity Futures Trading Commission continue to fill in the remaining pieces of a new comprehensive oversight framework for derivatives that will reduce risk and increase transparency.
The Consumer Financial Protection Bureau finalized new mortgage rules that provide additional protections for borrowers.
And the FDIC continued to implement the new framework for orderly liquidation authority.
So we have made important strides over the last year, and our financial system is stronger. But, as everyone here knows, much work still remains.
Let me turn now to what is happening today.
In an executive session, we discussed the Council’s continued analysis of nonbank financial companies. It is critically important that the Council take the time to get the analysis right, and we expect to vote on designations of an initial set of nonbank financial companies soon.
The Council’s 2013 annual report released today informs the public about actions the Council has taken over the past year, developments in the financial system during that time, and the challenges ahead.
Our annual report also lays out a number of recommendations to increase the stability of our financial system. I would like to briefly highlight some of the specific areas covered in the report.
A great deal of work remains to attract private capital to our nation’s housing finance system and bolster a housing market showing signs of recovery.
We need to strengthen markets that may be susceptible to destabilizing runs and fire sales.
We need to increase our vigilance to operational risks, whether from cyberattacks or from devastating acts of nature like we saw with Superstorm Sandy.
And we must work with our foreign counterparts to reform the governance and integrity of financial benchmark reference rates like LIBOR and to consider transitions toward alternative benchmarks.
In closing, I want to thank the members of the Council and their staffs for working tirelessly to put together this year’s report and make the financial system more resilient.
And now before we begin with the presentation, I want to give the members of the Council the opportunity to make opening remarks.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Court Finds Brokerage Firm and Two Former Executives Liable for Over $2.74 Million in a Fraudulent Misappropriation Case
The Securities and Exchange Commission announced today that, on April 25, 2013, a federal court in New York found defendants Joshua Constantin and Windham Securities, Inc. jointly and severally liable for over $2.49 million and defendant Brian Solomon liable for over $249,000 in disgorgement, pre-judgment interest, and civil penalties. In addition, the court found relief defendants Constantin Resource Group, Inc. (CRG) and Domestic Applications Corp. (DAC) jointly and severally liable with Constantin and Windham for over $760,000 and $532,000, respectively, of disgorgement and pre-judgment interest.
On July 6, 2011, the SEC filed its complaint. The complaint alleged that Windham, Windham's owner and principal Constantin, and former Windham managing director Solomon fraudulently induced investors to provide more than $1.25 million to Windham for securities investments. The complaint alleged that defendants made false claims to the investors about the intended use of the investors' funds and about Windham's investment expertise and past returns. Instead of purchasing securities for the investors, the defendants misappropriated the investors' funds and then provided false assurances to the investors to cover up their fraud. The SEC's complaint charged Windham, Constantin, and Solomon with violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder. The complaint also named CRG and DAC, entities Constantin owned and/or controlled, as relief defendants. Â
On July 3, 2012, the SEC moved for summary judgment against each of the defendants and relief defendants on all of the SEC's claims. On April 2, 2013, the court issued an opinion granting the SEC's motion in its entirety and finding defendants liable for fraud. Based on the undisputed evidence, the court found that "[t]he litany of misrepresentations that Solomon and Constantin made to their clients is striking;" that Constantin "diverted [investors'] funds to his own purposes;" and that "both Solomon and Constantin provided clients with misleading documents to cover up the fraudulent nature of their investment scheme." The court concluded that permanent injunctions, disgorgement, and civil penalties were warranted against each of the defendants and that the relief defendants would be required to disgorge any assets they received through the defendants' misconduct.
On April 25, 2013, the court issued a supplemental order finding Windham, Constantin, Solomon, CRG, and DAC collectively liable for more than $2.74 million in disgorgement, pre-judgment interest, and civil penalties.
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