Recently, an investment portfolio manager was barred by the SEC from working in the securities industry for at least five years. His crime was in misleading his company’s chief compliance officer about personal trades that he had made and concealing his failure to report them. It was reportedly a first for the SEC and if it becomes a trend, then it should be used as a club by compliance officers of companies under SEC jurisdiction to compel cooperation during internal investigations. It might also dictate who hires outside counsel for those inquiries.
On August 27, 2013, Reuters reported that the portfolio manager of a Colorado investment firm had been barred from the securities industry because he had forged documents and misled his company’s chief compliance officer in order to conceal his failure to report hundreds of personal trades. The portfolio manager, Carl Johns, was employed by Colorado-based Boulder Investment Advisers, LLC and an affiliate, Rocky Mountain Advisers, LLC.
The SEC said Johns failed to report 640 personal securities trades to his compliance officer or to get advance clearance – as required by federal securities laws – before making each of them. According to the SEC, at least 91 of Johns’ trades involved securities held by funds managed or acquired by his employer. Johns made his own trades despite being aware that the company code of ethics restricted him from trading in securities that were also traded in the funds he helped manage, the SEC said.
After Boulder Investment Advisers’ CCO began to look into Johns’ trades for improprieties, the manager concealed them in periodic internal reports by altering company records, including trade confirmations and brokerage statements. He later tried to hide his misconduct by creating documents that purported to be the required pre-trade approvals. When the CCO found irregularities in his personal securities transaction reports, Johns told the officer that he closed some of the brokerage accounts in question, all the while continuing to use them for trading. He also altered paper copies of brokerage account statements to falsely show that his trading was in compliance, according to the SEC.
The Reuters story indicated that Johns’ debarment was the first that the SEC has imposed for violations of a securities industry rule that prohibits misleading a chief compliance officer or obstructing the officer’s duties.
17 CFR 270.38a-1 provides for the compliance practices and procedures of certain investment companies such as Boulder Investment Advisers and Rocky Mountain Advisers. It further provides for the prohibition of undue influence at subsection (c), stating that:
“No officer, director, or employee of the fund, its investment adviser, or principal underwriter, or any person acting under such person’s direction may directly or indirectly take any action to coerce, manipulate, mislead, or fraudulently influence the fund’s chief compliance officer in the performance of his or her duties under this section.”
The CCO’s range of duties are not defined by the rule, but have now clearly been interpreted by the SEC to include conducting internal investigations. That the government has now used a violation of this provision to justify the debarment sanction – and presumably will again – should be seen s a valuable new tool by which CCO’s can compel cooperation by probe targets and witnesses.
Usually, only the threat of suspension, demotion, or termination gets employees talking. The hush-hush nature of internal probes even lessens – to a degree – the pain of getting fired for non-cooperation. After all, getting another job is not nearly as difficult in any industry in which the dirty laundry of an internal investigation – including even the players’ identities – is not commonly washed in public. Reminding targets and witnesses of the industry-wide nature of the debarment penalty for 17 CFR 270.38a-1(c) transgressions is a club that CCOs-as-investigators ought to now swing to secure target and witness cooperation.
They also ought to see that it be employed by outside investigators under an agency theory. Although outside counsel are most often brought in as investigators by the Audit Committee or Board, perhaps it is time to consider having the CCO be the client. As designates of that office, it would seem logical that the SEC would treat attempts to manipulate or mislead outside counsel in the same fashion as it did the CCO himself or herself in Johns. This would be a powerful weapon in the arsenal of outside investigators who depend on getting cooperation from those within the company they are probing.