SEC Investment Guideline Case Sends Tough Enforcement Message
If you are aware of problems at your firm, speak up loudly and speak up fast ó or risk being sued by the SEC yourself.
Thatís the message sent in a very tough enforcement case settled earlier this month against William Belko, formerly a portfolio manager at Advanced Investment Management (the Pittsburgh-based firm went out of business in early 2003).
Why was the case so tough? Consider how you might handle the following situation:
Letís say you are a senior portfolio manager at a mid-sized advisory firm. You discover that positions in some of your firmís client accounts exceed stated percentage limits in their investment guidelines. Which of your colleagues was responsible for the over-exposure? Because of the way the accounts are managed, itís immediately obvious to you: a portfolio manager who also happens to be your firmís CEO and majority shareowner. Youíve worked with this individual for nearly a decade.
You bring the matter to his attention immediately. He assures you that he will fix the problem.
After a few weeks, however, you see that the accounts remain over-exposed. Concerned, you again raise the issue with your colleague. In fact, you do so on several occasions. Each time, he assures you that he will remedy the situation.
But he doesnít. In fact, you see that your colleague has veered even farther from the clientsí stated mandates. Turns out, heís making leveraged bets, apparently in the hopes that he will recoup past investment losses in the accounts. Unfortunately, the bets donít pan out and your firmís clients lose millions.
At this point, itís been two and a half months since you discovered the problem. You want to do the right thing, so you announce your resignation and call your firmís outside counsel to alert them to the problem.
You did the right thing, right?
Wrong, according to the SEC.
It appears that you personally should have drafted letters to each of your firmís clients informing them of what was going on. You also should have personally ensured that any monthly account statements going out the door accurately reflected the clientsí positions.
At least thatís one way to read the Belko case. "As portfolio manager, senior vice president and second-highest ranking officer and shareholder, and director, Belko had a duty to AIM clients to provide full and fair disclosure of all material facts to AIM clients about the unauthorized trading," said the SEC. "Belko knowingly, or at least recklessly, made misstatements and omissions of material facts by failing to ensure the monthly account statements sent to clients disclosed the excessive exposure and by failing to otherwise inform clients about the improper trading after becoming aware of it . . . ."
Belko was charged with Securities Act and Exchange Act fraud, as well as aiding and abetting his firmís fraud under the Advisers Act. To settle the SECís case, Belko agreed to a nine-month suspension and agreed to pay a $50,000 civil money penalty. Belko also promised to cooperate with the SEC in any related investigations.
Jeff Thomas Allen, the portfolio manager who allegedly caused the AIM client accounts to violate their percentage restrictions, also settled SEC fraud charges, agreeing to pay a civil money penalty of $175,000. Related charges against the firmís equity trader remain outstanding and are subject to a pending civil action.
Is it realistic to expect a portfolio manager to proactively notify firm clients of his bossís mismanagement? Isnít resignation and handing the matter over to outside counsel sufficient?
"Once somebody in Belkoís position knows that the firm has caused exposure that they havenít disclosed, he then has to act reasonably," said SEC associate director Dan Hawke. "Given the knowledge he had, he was in a position to prevent further harm," he said. "We want people, when they see misconduct happening, to act responsibly and put themselves in the position of the clients: What would the client expect? The client would want them to make it stop, and if they canít, to tell the client so they can take decisive action."
Hawke analogized the situation to that of the legal duty to rescue. "You canít do it halfway," he said. "Once you start down the road, youíve got a duty to make sure that the concerns you raised are vindicated."
Belko, through his attorney, declined to comment.