On March 4, 2015, H.D. Vest Investment Securities, Inc. (“H.D. Vest”) submitted an Offer of Settlement (“Offer”) to the Securities and Exchange Commission (“SEC”) solely for the purpose of settling the SEC’s allegations that H.D. Vest violated key customer protection rules after failing to adequately supervise registered representatives who misappropriated customer funds. In addition to paying a $225,000 fine, H.D. Vest agreed to retain an independent compliance consultant to improve its supervisory controls.
H.D. Vest is a financial services firm that offers tax and financial planning advice to its customers. With its main corporate office in Texas, H.D. Vest has a nationwide network of over 4,500 independent contractor registered representatives. Most of H.D. Vest’s independent contractor registered representatives are tax professionals who operate tax businesses through affiliated businesses operating separately from the broker-dealer. This type of business is known as an outside business activity and is heavily regulated by both the SEC and the Financial Industry Regulatory Authority, Inc. (“FINRA”).
The SEC uncovered H.D. Vest’s deficient supervisory controls in the wake of wrongdoing by its representative Lewis J. Hunter (“Hunter”), a former registered representative whom FINRA barred from the industry in May 2013. The SEC alleged that between September 2010 and February 2011, Hunter fraudulently and illegally transferred approximately $300,000 from two elderly customers’ accounts to unaffiliated businesses he controlled. According to the SEC, Hunter told these elderly investors that these funds were used for investments. Hunter, however, used those funds for personal expenses and to make fraudulent dividend payments to those two elderly customers in a Ponzi-like manner. This type of fraudulent activity is commonly referred to as “selling away” and is a violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. The SEC also alleged that other H.D. Vest registered representatives misappropriated customer funds through outside business activities through entities unaffiliated with a broker-dealer and similar fraudulent selling away schemes dating as far back as December 2007 (the “relevant period”).
According to the SEC, H.D. Vest’s compliance policies and procedures were not reasonably designed and implemented to prevent or detect this type of fraudulent selling away. Typically, H.D. Vest’s registered representatives operated their securities and other businesses through a business that is unaffiliated with the broker-dealer and paid expenses for the businesses through an account under that business’s name. However, H.D. Vest did not establish procedures governing reviews of these unaffiliated business accounts from which representatives paid their business expenses. Specifically, even though H.D. Vest knew that the many of its registered representatives operated their securities business through their unaffiliated businesses, H.D. Vest had no policies and procedures in place to review third-party disbursements from customer brokerage accounts and detect selling away activity. Had H.D. Vest had such policies in place during the relevant period, the SEC contends that Hunter’s selling away activity would have been detected and prevented.
The SEC alleged that H.D. Vest’s compliance policies and procedures with respect to the supervising unaffiliated business activities of its registered representatives were deficient in other area as well. For example, Section 17(a) of the Exchange Act and Rule 17a-4(b)(4) promulgated thereunder, requires registered broker-dealers to preserve all email communications relating to their business that are made to the public. However, the SEC alleged that H.D. Vest allowed its registered representatives to communicate with customers using non-H.D. Vest e-mail accounts, so long as investment-related communications were copied or forwarded to H.D. Vest. During the relevant period, H.D. Vest registered representatives communicated with customers from outside email accounts, yet failed to forward these messages to H.D. Vest. As a result, H.D. Vest could not preserve these communications and failed to maintain all required business-related e-mails under Rule 17a-4(b)(4).
Additionally, Rule 15c3-3, promulgated under Section 15(c)(3) of the Exchange Act, requires, among other things, that broker-dealers perform calculations to determine the amount of funds that must be maintained in a special reserve account for the exclusive benefit of customers. Rule 15c3-3 is intended to protect customer funds and securities in the possession of broker-dealers. When H.D. Vest determined that it owed money to customers due to its registered representatives’ selling away activities, it should have made a reserve formula calculation and accounted for any requisite reserve bank account deposit under Rule 15c3-3. However, H.D. Vest failed to comply with Rule 15c3-3 by failing to perform the required reserve formula calculations or maintain cash and/or qualified securities in a reserve bank account for the customers to whom it owed money.
Finally, as a result of failing to establish procedures and controls reasonably designed to detect and prevent the selling away activities of Hunter and other registered representatives, H.D. Vest failed to adequately supervise its representatives within the meaning of Section 15(b)(4)(E) of the Exchange Act in that it failed to detect violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder.
If you have any questions about selling away or believe that your broker may engaged in improper outside business activities with your account, please contact Lax & Neville LLP today at (212) 696-1999 to schedule a consultation.