CCO Liability for Wholesale Failure

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A few years ago, the SEC had expressed an unwillingness to prosecute CCOs, except in three extreme circumstances:

  1. Participating in the wrongdoing
  2. Hindering the SEC examination or investigation
  3. Wholesale failure

Some of the past actions imposing CCO liability have left me uncertain that these are the correct standards.

A COO liability case that I missed does a better job of showing a case of “Wholesale failure.”

Anthony LaPeruta was the CCO of Southwind Associates of NJ Inc. (d/b/a Villafranco Wealth Management). From the facts laid out in the enforcement order, he did a bad job as CCO. Bad enough to be considered “wholesale failure” leading to a bar from acting in a supervisory or compliance capacity at any SEC registered entity.

Southwind was subject to OCIE exams in 2003, 2006 and 2013. It was the last one that lead to the enforcement action.

Southwind had hired a consultant in 2011 to review the compliance program. Based on that review, the firm published a new compliance manual. The consulatant reported 59 action items that the firm had to fix. Southwind failed to timely implement the majority of the consultant’s action items.

Custody can be tough at the margins. Southwind’s failure was not at the margins. The firm failed to have the required surprise exam for the accounts that Southwind had custody. For the pooled investment vehicles that Southwind managed, the firm failed to distribute audited financial statement to comply with the Custody Rule. When it finally did, it chose an independent accountant that was not subject to regular inspection by the PCAOB and, therefore, was not qualified to perform audits for purposes of Rule 206(4)-2(b)(4).

Southwind failed to preserve required electronic communication. One attempt was to have its IT specialist send all sent and received client communication to a Gmail account. Even if this could have worked, the firm lost access to the account when the IT specialist left the firm. Some other information was on hard drives that ended up damaged.

Southwind failed to implement privacy safeguards to comply with Regulation S-P. Sending all that email to Gmail was considered putting the information at risk.

La Peruta never engaged in any annual review of Southwind’s written policies and procedures as required by the Compliance Rule.

All of these rules violations were identified by the compliance consultant and Southwind failed to fix the problems. LaPeruta as the CCO was the one who was responsible for these problems and failing to fix them.

I would agree that this was a “wholesale failure.” The SEC failed to use this language instead it said: “LaPeruta willfully aided and abetted and caused Southwind’s violations of Sections 204(a) and 206(4) of the Advisers Act and Rules 204-2(a)(7), 206(4)-2, and 206(4)-7 thereunder and Rule 30(a) of Regulation S-P, 17 C.F.R. § 248.30(a).”

I guess that means “willfully aiding and abetting and causing” a rules violation is a wholesale failure.

Sources:

Author: Doug Cornelius

You can find out more about Doug on the About Doug page

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