SEC Charges Gatekeepers in Federal Court with Aiding and Abetting Fraud
Don’t expect the crackdown on "gatekeepers" – attorneys, accountants, consultants and other third parties that work with advisory firms – to let up any time soon, even with a new SEC chairman at the helm. The agency recently filed charges in U.S. District Court against an attorney and an accountant for allowing, if not enabling, an adviser’s alleged misappropriation of more than $9 million from a charitable foundation.
The SEC on December 22 filed a complaint in U.S. District Court for the Southern District of New York against attorney Robert Gaughran and accountant Kevin Clune. The complaint argues that the two gatekeepers aided and abetted New York City-based investment adviser Train, Babcock Advisors (TBA) and its former principal, John Rogicki, in their alleged theft against the foundation.
"While serving as a trustee of the foundation, Gaughran allegedly accepted outsized fees and ignored glaring signs of Rogicki’s theft that were apparent from the foundation’s brokerage statements and other documents that he regularly reviewed," the SEC said in a statement. "Gaughran also drafted the trust and estate papers that put Rogicki in charge of the charitable foundation and knew the size of the estate that should have flowed to the charitable foundation, but for Rogicki’s misappropriation of $9 million of its assets."
As for Clune, who performed tax work for both the estate that created the foundation and for the foundation itself, he "ignored multiple and repeated red flags revealing Rogicki’s and TBA’s fraudulent scheme," the agency said.
In addition, the SEC said, "both Gaughran and Clune were actively involved in concealing the theft by providing false information to an outside audit firm during a surprise examination of the charitable foundation that was conducted in 2014."
"If you accept the allegations in the complaint, the gatekeepers were doing far more than just providing one-off advice to the bad actors," said Faegre Baker Daniels partner Jeffrey Blumberg. "They were allegedly deeply entrenched in the situation and actively assisted in misleading other gatekeepers (like the outside audit firm) in connection with the fraudulent scheme. As a gatekeeper myself, these cases are a reminder to me that I cannot turn a blind eye to issues that present themselves when assisting my clients."
That the attorney and the accountant were allegedly participating in the fraud, rather than simply being negligent in not calling it out, is a distinction that needs to be made, said Shearman & Sterling partner Jay Baris. "The fact that they were gatekeepers is secondary to their participation in the alleged fraud."
"The complaint is a clear sign that, where lapses are viewed as sufficiently egregious, the SEC will continue to pursue gatekeepers who allow investment advisers to commit fraud under their watch," said Shearman & Sterling partner Mark Lanpher.
Violations and what’s next
In its complaint to the court, the agency charged both Gaughran and Clune with aiding and abetting Rogicki’s and TBA’s violations of Advisers Act Sections 206(1) and (2), both of which prohibit fraud; and Exchange Act Section 10(b) and its Rule 10b-5(a) and (c), which also prohibit fraud.
The SEC asks the court to permanently restrain and enjoin Gaughran and Clune from future violations, order them to disgorge all ill-gotten gains from the alleged violations, and pay civil money penalties. The defendants demanded a jury trial, and, barring a settlement between the parties, it may be months before a judgment is reached. Clune, when reached, chose not to comment.
An attorney for Gaughran said that his client cares deeply about the foundation in question and its philanthropic mission. "He too was a victim of Rogicki’s criminal fraud on the foundation and its trustees," the attorney said. "Gaughran certainly did not ‘aid and abet’ Rogicki’s fraud and he never would. The SEC’s allegations will be vigorously defended."
Advisory firm consequences
TBA separately reached its own settlement with the SEC on the same day that the agency’s complaint against the gatekeepers was filed. As a result of that settlement, the firm was censured, ordered to pay a civil money penalty of approximately $1.34 million, and disgorgement and prejudgment interest of approximately $365,000.
That’s just from the advisory firm’s administrative settlement with the agency. In October 2017, in response to criminal charges brought against him by the Manhattan District Attorney, Rogicki pleaded guilty and, in December, was sentenced to serve 30 to 90 months in prison and ordered to pay approximately $6.73 million to the foundation, of which he forfeited $2.5 million with his criminal plea, the SEC said. The agency also filed a civil injunctive action against Rogicki in October.
TBA, according to the administrative order, is in the process of "selling its assets and winding down any remaining business." The firm, which had registered with the SEC as an investment adviser in 1975, managed more than $100 million in assets, it said.
In a statement issued after the settlement was reached, an attorney representing TBA noted that TBA had conducted an internal review of Rogicki’ s client accounts. "During the course of this review, serious discrepancies were identified in one account. Train Babcock immediately engaged professional advice and further investigated the account. Additionally, the SEC was promptly informed of the matter. Throughout the past year, TBA has fully cooperated with law enforcement and regulatory authorities, including the SEC, in the investigation of this matter."
Rogicki, "in addition to his gross personal misconduct and criminal activity," the attorney said, "betrayed the trust and confidence of everyone at Train Babcock. His scheme, with the alleged assistance of two other non-Train Babcock persons, a second co-trustee and a certified public accountant, was an abhorrent abuse of his fiduciary responsibility to the Foundation as well as to the company."
"Mr. Rogicki has accepted full responsibility for his actions," said an attorney with the law firm representing him. "We think this is a sensible resolution of the matter and serves the interests of justice."
The underlying case
TBA provided advisory services to individuals, investment companies, pension and profit sharing plans and business entities, as well as to accounts of charitable organizations, trusts and estates, the SEC said. For these latter services, a TBA employee would take part in an arrangement in which he or she would serve as a trustee of these client accounts.
The non-profit charitable foundation involved in this case was established in 1991 by "a wealthy elderly woman" who later died. She is identified by the SEC in its court complaint and administrative order only as "Decedent Z."
"Rogicki, who had befriended Decedent Z near the end of her life, served as the president and a trustee of the foundation," the agency said. "Gaughran, Decedent Z’s lawyer before her death, served as the secretary and a trustee of the foundation," which Decedent Z funded during her lifetime and to which she left the remainder of what the SEC called her "sizable" estate. She also named Rogicki as the estate’s executor.
After Decedent Z died in 2001, Rogicki and Gaughran named TBA as the foundation’s investment adviser, "with the understanding that Rogicki would be the individual at TBA responsible for overseeing the account."
What happened, unfortunately, was that "in this fiduciary role, Rogicki funneled money to himself that had been intended for the foundation to distribute to charities," the SEC said. The agency said that this "scheme" had three parts. Specifically, it said, Rogicki:
Liquidated positions in the foundation’s TBA advisory account,
Wired the cash proceeds from the foundation’s account to a bank account set up for the Decedent Z estate, and
Transferred those funds from the Z estate to his own personal bank account.
"Between 2008 and 2016, more than 150 of these improper transfers – in amounts ranging from $15,000 to $385,000 – were made from the foundation’s TBA advisory account to Decedent Z’s estate account," the SEC said. "From approximately 2004 through April 2016, Rogicki misappropriated more than $9 million from the TAB advisory client account of the foundation."
The attorney’s role
The court complaint notes that Gaughran became Decedent Z’s estate counsel when she was 95, drafted the documents appointing Rogicki as a trustee of her trust and as executor of her estate, served in a fiduciary role as a director and one of the trustees of the foundation since 2001, and at times performed legal work for the foundation.
"In his positions as counsel for the Z estate and a trustee for the foundation, Gaughran knew or was reckless in not knowing that significantly less money was in the foundation account than should have been there and that Rogicki was misappropriating assets," the SEC said. "Despite knowing about these red flags that either must have or should have alerted him to Rogicki’s and TBA’s misappropriation, Gaughran made no effort to stop it. By failing to take any affirmative steps to stop Rogicki’s and TBA’s misappropriation, Gaughran allowed the fraud to continue."
The agency’s complaint points out that the foundation’s monthly brokerage account statements "showed consistently large withdrawals every month throughout the year," and that the portfolio appraisals "also showed large amounts being withdrawn from the account prior to year-end – in other words, at times where no charitable disbursements or other significant foundation payments should have been made."
In addition, the SEC said, when the year-end brokerage account statements and portfolio appraisals were compared to the foundation’s annual tax forms, it was "clear that an excessive amount of money was being withdrawn. . . It should have been an immediate red flag to Gaughran that the total amount of withdrawals reflected in the year-end brokerage account statements far exceeded that shown in the tax forms."
The agency alleged that Gaughran also provided a "fabricated number" to the foundation’s outside auditor that "significantly understated the foundation’s outlays" when he was specifically asked to obtain and certify the withdrawal figures in connection with a 2014 surprise examination by TBA of the foundation.
Assuming that what the SEC charges are true, why did Gaughran take these actions? He "had incentive to ignore all of these red flags, mislead the auditor, and allow Rogicki’s and TBA’s misappropriation to continue," the agency said. Specifically, according to the complaint, Gaughran "received exorbitant compensation each year from the foundation. In his capacity as a trustee, Gaughran collected more than $90,000 annually for his limited work on behalf of the foundation. In addition, Gaughran was paid in certain years as the foundation’s counsel, at times for doing exactly the same work that he performed as a trustee."
The accountant’s role
Clune, who served as the tax accountant for both the foundation and the Decedent Z estate, "knew how much money was in the estate on at least a year-end basis, and how much money should have gone to the foundation," the SEC said. "Clune also received the brokerage account statements for the foundation, which made the misappropriation scheme immediately apparent."
Beyond not taking action on red flags, the SEC alleged that Clune "directly contributed to the misleading withdrawal figures that were provided to TBA and the auditor in connection with the surprise examination." He did so by providing Gaughran with the number that did not include Rogicki’s and TAB’s misappropriations, "thus understating the foundations actual outlays by roughly $800,000," according to the complaint.
Clune’s incentive in this matter, the agency argued, was that Rogicki and the foundation were his solo practice’s primary source of income for many years. "Clune also inflated the number of hours worked on his annual invoice to the foundation to ensure that he continued receiving these exorbitant fees," the SEC said. "Total payments from the foundation and Decedent Z’s estate alone earned Clune more than $500,000. And through Rogicki’s introduction to TBA, Clune came to serve as the tax accountant to 12 TBA clients."