Articles Tagged with Enforcement

Published on:


As we have previously reported, the Securities and Exchange Commission (“SEC”) has taken a significantly heightened interest in whether people who engage in certain promotional activities on behalf of issuers of securities should be subject to regulation as a broker dealer.  The David Blass speech of April 5, 2013 put hedge fund general partners on notice that certain sales practices undertaken by hedge fund personnel may require registration as a broker dealer.  The SEC has recently followed up this guidance with enforcement action.

On May 15, 2014, the SEC  charged a Tiburon, California based securities salesman for selling millions of dollars in oil-and-gas investments without being registered with the SEC as a broker-dealer or associated with a registered broker-dealer.  The defendant, Behrooz Sarafraz, agreed to settle the SEC charges by paying disgorgement of his commissions, prejudgment interest, and a penalty for a total of more than $22 million.

According to the SEC’s complaint filed in federal court in San Francisco, Sarafraz acted as the primary salesman on behalf of TVC Opus I Drilling Program LP and Tri-Valley Corporation, which were based in Bakersfield, California.   From February 2002 to April 2010, these companies raised more than $140 million for their oil-and-gas drilling venture.  While Sarafraz was raising money for these entities, he was not associated with any broker-dealer registered with the SEC.  The SEC also alleged that Sarafraz worked full-time locating investors for the Opus and Tri-Valley oil-and-gas ventures.  He described the investment program to investors and recommended they purchase Opus partnership interests or securities of Tri-Valley and its affiliated entities.  In return, Sarafraz received commissions that ranged from seven to 17 percent of the sales proceeds that he and members of a sales network generated.  The SEC alleges that Opus and Tri-Valley paid Sarafraz approximately $18.3 million in sales commissions.  He paid approximately $1.9 million to others as referral fees and kept the remaining $16.4 million for himself.

For the two companies for which Sarafraz raised money, this could be just the beginning of the process.  If investors have lost money or would otherwise seek to unwind these transactions, it is possible that the investors could sue the companies and Sarafrax for rescission.  Typically, in a rescission recovery case, the plaintiffs who purchased through the unregistered broker can receive the higher of the current market price of the price that they originally paid for the securities.  Hedge funds and other private companies that use solicitors should take note.

The SEC also charged New York-based Rafferty Capital Markets with illegally facilitating trades for another firm that was not registered as a broker-dealer as required under the federal securities laws.  According to the SEC’s order instituting settled administrative proceedings, Rafferty agreed to serve as the broker-dealer of record in name only for approximately 100 trades in asset-backed securities that were actually introduced by the unregistered firm.  While Rafferty held the necessary licenses and processed the trades, it was the unregistered firm that managed the business.  Five of the firm’s employees became registered representatives with Rafferty but they performed their work in the offices of the unregistered firm, which retained sole authority over their trading decisions and determined their compensation.  Rafferty had no involvement in the trading or compensation decisions while the registered representatives executed the trades through Rafferty’s systems on behalf of the unregistered firm.  Based on the agreement, Rafferty kept 15 percent of the compensation generated by these trades and sent the remaining balance to the unregistered firm.

The SEC’s order found that Rafferty willfully violated Federal securities laws and also willfully aided and abetted and caused the unregistered broker-dealer’s violation of the registration provisions of the Securities Exchange Act.  Rafferty consented to a cease-and-desist order that censures the firm and requires the disgorgement of $637,615 as well as payment of $82,011 in prejudgment interest and a $130,000 penalty.  This case should serve as a cautionary tale for hedge fund and other private fund managers that seek to hire sales people who construct sham arrangements with a broker dealer in order to appear to be in compliance with the broker dealer registration provisions.  Expect more of these types of action from the SEC in the near future.

Published on:


Written by: Jay B. Gould, Michael G. Wu and Jessica M. Brown

In January, 2010, the Securities and Exchange Commission (“SEC”) announced its Enforcement Cooperation Initiative (“Initiative”), which provided the SEC with the ability to offer certain individuals or entities immunity or other preferential treatment in exchange for information about illegal activities and/or cooperation with the SEC in connection with SEC enforcement actions. These techniques, such as cooperation and immunity agreements, or deferred and non-prosecution agreements were adopted by the SEC as a result of their effectiveness against organized crime investigations and the then recent hires by the SEC from the U.S. Attorney’s Office which regularly employs those tools. 

For a full description of the types of agreements in which the SEC may enter with an enforcement target or other “person of interest,” see the 2013 Enforcement Manual HERE.  Since the Initiative began, the SEC has entered into thirteen cooperation agreements, three deferred prosecution agreements and four non-prosecution agreements. See those agreements on the Initiative website HERE.

On November 12, 2013, the SEC announced its first deferred prosecution agreement with an individual. Scott Herckis (“Herckis”) had brought to the attention of the SEC certain fraudulent activities at the Heppelwhite Fund LP, where he acted as fund administrator through his financial and accounting services firm, SJH Financial, LLC. With the information and materials provided by Herckis, the SEC was able to bring an enforcement action against fund manager Berton Hochfeld for misappropriating over $1.5 million from the fund and overstating performance. The harmed Heppelwhite investors have since been granted a $6 million distribution by a federal judge.

After Herckis became aware of the fraudulent scheme, his actions and omissions enabled the scheme to continue for many months, yet without his cooperation and information, the scheme may have gone undetected. The deferred prosecution agreement provides for sanctions and penalties against Herckis for his role in the fraud but no further action will be taken against him for his violations, provided he does not violate the terms of the agreement.  This leaves industry participants pondering what further action the SEC would have taken against Herckis had he not cooperated and what the value of a deferred prosecution agreement might really be. Click HERE to read the Herckis deferred prosecution agreement.  

The SEC and federal prosecutors are continuing to explore alternative approaches to penalize companies and their principals for what they consider egregious securities law violations. In the recent criminal proceeding of SAC Capital Advisors LP (“SAC”), prosecutors considered whether criminal charges under the Racketeer Influenced and Corrupt Organizations Act (“RICO”) would be appropriate. RICO allows for criminal charges, with substantial penalties, against the leader of an organization for acts that they ordered others to commit. Traditionally RICO has been successfully used against organized crime figures.  Federal prosecutors have taken the position that RICO may also be successfully used against the leaders of a legal entity, which could greatly increase the potential personal liabilities that an executive may face.  Although the SEC has now incorporated certain enforcement techniques used by criminal prosecutors, the SEC can only bring civil actions against alleged wrongdoers, but it can, and with increasing frequency does, refer cases over to the Justice Department for criminal prosecution.

Published on:

Written by Peter J. Chess

On November 30, 2011, FINRA and the SEC’s Office of Compliance Inspections and Examinations (OCIE) released a National Exam Risk Alert on effective procedures and policies for broker-dealer branch inspections. This follows other recent guidance for broker-dealers regarding the Market Access Rule and reasonable investigations in Regulation D Offerings, in addition to recent FINRA sanctions against broker-dealers related to Regulation D Offerings.

Under Sections 15(b)(4)(E) and 15(b)(6)(A) of the Exchange Act, the SEC can impose sanctions on any firm or any person that fails to reasonably supervise someone subject to supervision that violates the federal securities laws. A broker-dealer can defend such a charge with a showing of effective procedures and policies designed to prevent and detect potential violations.

The National Exam Risk Alert jointly released on November 30 by FINRA and the OCIE (“November 30 Alert”) concerns broker-dealer branch inspections which are required by the Exchange Act and FINRA rules. Examination staff have observed that firms that execute these inspections well typically:

  • tailor the focus of branch exams to the business conducted in that branch and assess the risks specific to that business;
  • schedule the frequency and intensity of exams based on underlying risk;
  • engage in a significant percentage of unannounced exams selected based on both risk analysis and random selection;
  • deploy sufficiently senior branch office examiners to conduct the examinations; and
  • design procedures to avoid conflicts of interest with examiners.

The November 30 Alert also lists typical findings about firms with deficiencies in their inspection process, including the utilization of generic examination procedures for all branch offices; the use of novice or unseasoned branch office examiners; the performance of “check the box” inspections; and, the lack of adequate procedures and policies.

The November 30 Alert is the second such Alert released this quarter by the OCIE. On September 29, 2011, OCIE released a National Exam Risk Alert  (September 29 Alert) regarding the master/sub-account structure and potential risks of noncompliance for broker-dealers with the recently adopted Rule 15c3-5 (the Market Access Rule).

The Market Access Rule requires broker-dealers to have a system of risk management control and supervisory procedures reasonably designed to manage the financial, regulatory and other risks of the business activity associated with providing a customer or other person with market access. Deficiencies in risk management control and supervisory procedures raise significant regulatory concerns with respect to money laundering, insider trading, market manipulation, account intrusions, information security, unregistered broker-dealer activity, and excessive leverage.

Recent FINRA Enforcement Actions Against Broker-Dealers

On September 29, 2011, FINRA also announced it had sanctioned another eight firms and ten individuals and ordered restitution totaling more than $3.2 million due to violations related to private placements. FINRA previously announced similar sanctions against broker-dealers in April 2011, and the most recent announcement brings the total to ten firms and seventeen individuals sanctioned by FINRA since April for involvement in problematic private placements.

The sanctions stem from a variety of issues uncovered by FINRA related to firms selling private placement offerings, including the lack of a reasonable basis for recommending the offering; failure to conduct a reasonable investigation of the offering; failure to have adequate supervisory systems in place; failure to conduct adequate due diligence of offerings; lack of reasonable grounds regarding the suitability of the offering for customers; and, lack of reasonable grounds to allow registered representatives of firms to continue selling the offerings, despite numerous “red flags.”

These sanctions follow FINRA’s release of a Regulatory Notice in April 2010 (“April 2010 Notice”) regarding the obligation of broker-dealers to conduct reasonable investigations in Regulation D, or private placement, offerings. The April 2010 Notice provided guidance on many of the issues at the heart of the recent sanctions by FINRA related to private placements. The April 2010 Notice noted that broker-dealers had many requirements triggered by private placement offerings, including: a duty to conduct a reasonable investigation concerning the security and the issuer’s representations about it; a duty to possess reasonable grounds to recommend transactions that are suitable for the customer; and, other specific responsibilities that could be triggered based on specific factors with each transaction.