Compliance Program Failure


The SEC slapped a fund manager and its out-sourced CCO. The main charge was engaging in undisclosed principal transactions. Beyond that obvious conflict issue, the order has some interesting statements about failures in the compliance program.

Parallax Investments, LLC, a Houston based firm, registered with the SEC as investment adviser in 2010. It also had an affiliated broker-dealer, TSF,  that was partially owned by John P. Bott, II who was the sole owner of Parallax.

According to the SEC order, Parallax would buy and sell investments through TSF and TSF would transfer the investment from its inventory account. TSF would charge a mark up and Bott, a registered representative for TSF, would receive a substantial portion of the markup as compensation.  The SEC is taking the position that those trades were principal transactions. If that is the case, then Parallax failed to obtain the consent necessary to make a principal trade with an advisory client. There is inherent conflict when the investment adviser is selling to its clients from its own account.

As a CCO, I was more focused on the compliance program failures at Parallax.

Prior to registration with the SEC, Parallax was registered in Texas. The Texas regulator issued a deficiency. Parallax at least tried to improve its compliance program and bought an off-the-shelf compliance manual.  (Okay, so it sounds like it didn’t try that hard.)

But Parallax went further and and hired a CCO, F. Robert Falkenberg who reviewed the program and suggested changes. Falkenberg had worked as an examiner for the State of California and worked for FINRA before starting his compliance consulting firm.

The order does not state it directly, but it sounds like Falkenberg acted as an out-sourced CCO.

“[Falkenberg] devoted approximately nine hours per month to Parallax’s compliance program. He did not maintain a permanent office at Parallax and delegated daily compliance tasks to other employees in his absence.”

Falkenberg did write a memo to Botts that the off-the-shelf compliance manual needed to tailored to Business operations of Parallax.  However, he never did so. He also never implemented a written code of ethics.

He really made the SEC examiners angry when he fudged the 2010 annual review.

The meta data for Falkenberg’s 2010 annual compliance memo indicates that Falkenberg created and completed the memo in approximately four hours on Friday, April 8, 2011, not February 2011. Falkenberg drafted the memo after exam staff had notified Parallax of its impending exam and just three days before exam staff was scheduled to begin field work.

Don’t lie to the SEC. That increases the chances that the examiners will push the case over to enforcement and that you will end up reading about the compliance program failures here in Compliance Building.



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