Real Estate Investments: Don’t Fail to Supervise Fund Managers
There’s no substitute for effective and implemented supervision policies and procedures, particularly if those being supervised are remotely located – as one adviser and its director of compliance discovered after settling a case with the SEC.
Boston-based Signator Investors and its director of compliance, Gregory Mitchell, who also had supervisory responsibilities, last month settled charges with the Commission over allegations that they failed to properly supervise two fund managers in the company’s Maryland office. Those alleged supervision failures led to a collective civil money penalty of $465,000 – considerably more than proper supervision procedures would have cost.
"If you accept the SEC findings, the case against Signator and Mitchell involved a very dangerous combination – inadequate procedures and a failure to follow the procedures that did exist," said Sidley Austin partner Mark Borrelli. "The fact that the alleged fraud continued for 14 years and involved more than 100 clients of the adviser was most likely a factor in the SEC’s decision to bring the action against the adviser and the supervisor."
But it was not the only SEC action in the matter.
The underlying fraud
Also last month, the SEC settled charges with the individuals and the real estate investment firm that Signator and Mitchell were responsible for supervising. John Glover and Sherman Hill, both managing members at Maryland-based real estate investment firm Colonial Tidewater Realty Income Partners, were alleged to have defrauded at least 125 investors out of approximately $13.5 million from May 1998 through May 2012, according to the SEC’s complaint to the U.S. District Court for the District of Maryland.
Many of the investors were co-members of Glover’s church, the agency said. "Glover lied to unsuspecting members of his close-knit religious community and preyed upon the trust they placed in him as their registered representative," said Sharon Binger, director of the SEC’s Philadelphia Regional Office.
In addition to his position with Colonial Tidewater, Glover was an investment adviser representative and a registered representative at Signator’s Maryland office, and allegedly also solicited Signator clients to invest in Colonial Tidewater – hence the failure-to-supervise allegations. Cory Williams, also a registered representative and adviser representative at Signator’s Maryland office who had formerly been Glover’s business partner, on August 13 also separately settled fraud charged through an agency administrative proceeding.
Colonial Tidewater, Glover and Hill, as part of their settlement, consented to the appointment of a receiver to take control of Colonial Tidewater and agreed to monetary penalties. Colonial Tidewater agreed to pay more than $594,000 in disgorgement and interest, plus a civil money penalty of $725,000; Glover agreed to be barred from the securities industry, pay more than $904,000 in disgorgement and interest, plus a $450,000 civil money penalty; and Hill agreed to pay a $75,000 civil money penalty. Williams, in his separate settlement, agreed to be barred from the securities industry, pay more than $104,000 in disgorgement and interest, plus pay a civil money penalty of more than $94,000.
The attorney representing Glover chose not to comment after being contacted, and the attorneys representing Hill, Signator and Mitchell did not respond to a voice mail or email seeking comment. An attorney representing Williams could not be located. Funds collected from all the parties will go into a fair fund for the injured investors, the SEC said.
The supervision allegations
Signator and Mitchell, Binger said, "failed to conduct the thorough reviews necessary to catch Glover and Williams in the act of defrauding investors." Specifically, the SEC, in its settlement with the two, alleged that:
Signator and Mitchell "failed to identify and prevent the alleged fraud conducted by Glover and Williams;"
Signator lacked policies and procedures governing "consolidated reports," which it said "could be used to combine all of a client’s financial holdings in a single report." This was significant considering the agency’s claim that Glover, without Signator’s knowledge, "inserted clients’ Colonial Tidewater holdings into the consolidated reports to create the false impression that Colonial Tidewater was a Signator-approved investment when it was never authorized for sale by Signator representatives."
Mitchell, rather than follow the policies and procedures that Signator had, "routinely allowed Glover and Williams to select client files for his review or he provided them a pre-selected list of names of client files to be reviewed, enabling them to remove all references to Colonial Tidewater investments before Mitchell reviewed the records." The SEC charged that Mitchell continued to do so, even after being notified "on multiple occasions" by Signator’s supervision department that he was not conducting client file reviews in accordance with Signator’s policies and procedures. Mitchell was then told on two different occasions, in May 2011 and in November 2011, that he was following incorrect procedures, the agency said, noting that "despite agreeing to change his practice" after the May 2011 warning, "Mitchell did not."
"Beginning in January 2009, … Mitchell was responsible for supervising Glover and Williams," the SEC said in its administrative order instituting the settlement. "Had Mitchell reasonably implemented Signator’s policies and procedures regarding client file reviews, the fraud likely would have been detected."
"The case illustrates the perils of not conducting truly random reviews," said Borrelli. "The less that employees know about what you will review, and when you will review it, the better."
Borrelli also noted that the supervisor was not in the same office with the employees alleged to have been involved in the fraudulent scheme and only visited once or twice per month. "While it is not necessarily a problem to have a supervisor in a different office, advisers may want to put extra controls in place when supervising employees that do not share an office with their supervisor," he said.
"While the adviser had policies in place requiring a supervisor to review the individual representative’s customer files, the SEC alleges that the supervisor did not follow those policies, allowing the alleged fraud to go undetected for years," said Zaccaro Morgan partner Nicolas Morgan. The SEC’s decision to file an enforcement action "demonstrates the agency’s continued emphasis on requiring investment advisers and brokers to establish and implement policies and procedures necessary to ensure an investment approval process and sufficient supervisory oversight to reduce the risk investors will be misled."
The SEC did credit Signator with taking remedial efforts, noting that in March 2013 it hired a consultant to conduct a comprehensive review of its supervisory systems. "With the assistance of the consultant, Signator has reviewed, evaluated and enhanced its supervisory and compliance systems, including by instituting formal training and written policies and procedures concerning the creation, use and review of [consolidated] reports," the agency said.
Signator in 2014 also eliminated a manual entry function from the system that created these reports. That function allowed financial representatives to manually add information into the consolidated reports, which the SEC suggested Glover and Williams did to add information about Colonial Tidewater for clients. The two allegedly then removed that information from those reports that were going to be reviewed.