Undetected Error Results in SEC Enforcement Case
To err is human. To allow errors to continue undetected, however, is to invite an SEC enforcement proceeding.
Although it involved a brokerage firm that sponsored a mutual fund wrap program, the SECís January 25 case against Vertical Capital Partners is one of those wonderful "get-religion" kinds of cases, worth a read by CCOs of all stripes.
It all began back in August 2002, when a low-level employee at Vertical was instructed to input client mutual fund trades. Unfortunately, however, the clerk didnít enter the trades quite right: Although clients had been told that they would purchase funds at NAV, and would not pay sales loads or commissions, the clerk did not realize that she needed to go to a dropdown menu on the trade entry screen and select the "NAV" price option for this to occur.
Trade after trade, the clerk made the same error. And trade after trade, clients were erroneously charged loads on their mutual fund purchases.
SEC examiners discovered the error two years later, during an exam. By that point, the firmís clients had been overcharged $530,048 in sales loads.
The SEC alleged that the firm, and the registered rep who was responsible for managing the wrap accounts, committed fraud by negligently failing to detect the error. Specifically, the SEC alleged that the rep and her supervisor received "commission runs" and other types of periodic information that should have tipped them off that the wrap clients were incorrectly paying sales loads.
For example, the supervisor allegedly was provided with "cover sheets" that indicated that the rep began receiving monthly payouts in connection with the wrap program after August 2002. Previously, however, she had received only quarterly payouts, reflecting quarterly management fees. The supervisor "did nothing to investigate this change, nor did he do anything to ensure that the gross fees appearing on the cover sheets were correct," said the SEC. "Instead, he merely checked the arithmetical accuracy of the calculations included on the cover sheets and then approved the payout."
The SEC brought counts against Vertical under Section 206(2) of the Advisers Act and Rule 10b-10 under the Exchange Act. It also asserted that the rep caused Verticalís violations of these provisions.
A Section 206(2) violation "does not require a finding of scienter and may be established by a showing of negligence," noted the Commission.
To settle the matter, Vertical agreed to hire a compliance consultant to review its policies and procedures in the areas of trade processing, compensation of registered representatives, and the training of registered and unregistered staff. The firm was ordered to cease and desist from future violations, but was not censured or ordered to pay a civil money penalty. The firm had previously reimbursed affected clients, and as part of the settled action, agreed to additionally reimburse interest on the improperly charged amounts.