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Saturday, December 16 2017

SEC Brings Churning Case Against Registered Representatives of New York Broker-Dealer

For the third consecutive quarter, the Security Exchange Commission has filed charges of excessive trading. On December 6, the SEC announced that it had charged two New York-based broker-dealer representatives, Zachary Berkey and Daniel Fischer, with violating anti-fraud provisions of the federal securities laws. The former Representatives of Four Points Capital Partners (“Four Points”) are accused of having utilized a high-cost, in-and-out trading strategy that resulted in large commissions for themselves and significant losses for their customers.

According to a complaint filed by the Commission, the trading activity in question “all but doomed any possibility of even a minimal profit for their clients” and, in fact, resulted in total losses of more than $567,000. While their clients were losing, Berkey and Fischer raked in a combined $181,000 in commissions. According to the SEC, “Berkey and Fischer often charged commissions on losing trades as well as profitable trades,” and thus the two men “had every incentive to keep buying and selling.” On average Berkey and Fischer only held customer positions for 30.6 and 14.3 days respectively. Due to the high cost of investment strategy, accounts managed by Berkey and Fischer would have needed to see an increase in value of nearly 58.19% and 70.26% percent, respectively, before customers would see any profit. For seven of the eleven accounts at issue, costs exceeded the average equity in the account.

FINRA Rule 2111 requires, in relevant part, that broker-dealers and associated persons “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through reasonable diligence of the firm or associated person to ascertain the customer’s investment profile.” Berkey and Fischer, however, had only very limited discussions with customers regarding customer financial condition and needs, and account opening-documents sent to the customers were uniformly pre-populated to indicate “Speculation” and/or “Aggressive” as the investment profile. Meanwhile, “these customers, despite what was reflected on their pre-filled account documents, had low or moderate risk tolerance.” Risk tolerance aside, the SEC makes itself clear—the costs of the in-and-out trading strategy were such that Berkey and Fischer had “no basis to believe that [it]…would be suitable for anyone [emphasis added].”

Despite having no reasonable basis for their recommendations, Berkey and Fischer, “implicitly represented to each customer” that they did have a reasonable basis for recommending the strategy. Furthermore, the churning scheme involved withholding material information, such as the costs and fees associated with the frequent transactions. Thus, in addition to disregarding their duty to make suitable investment recommendations, Berkey and Fischer violated federal securities laws that broadly prohibit fraud.

In September 2016, Four Points and the Montana Commissioner of Securities and Insurance (“CSI”) entered into a Consent stipulating that Four Points failed to implement written supervisory policies and procedures necessary “to monitor Berkey for alleged excessive trading.” The CSI cited Four Points failure to supervise even though the Broker Dealer had previously provided Berkey and Fischer with a FINRA Regulatory Notice that plainly outlined the representative’s obligation to make suitable investment recommendations. For its part, Four Points had to pay $5,000 fine, along with $61,000 in restitution, and agree to withdraw its Montana Registration.
Daniel Fischer has consented to a final judgment that will require him to disgorge all ill-gotten and pay an additional $160,000 civil penalty. Berkey’s case will proceed in federal district court.

If you are a Broker-Dealer or Investment Adviser and with concerns about whether your investment advice is compliant or you would like to know more about protecting your firm from employee misconduct, please call us at 888.302.4594 or email us and we will be happy to assist.