SEC Sends Message That Branch Managers Must Be Vigilant To Protect Investors

By James Eccleston

recent enforcement action by the Securities and Exchange Commission (SEC) clearly sends the message that branch managers at financial services firms must be vigilant in supervising their financial advisers in order to protect investors. A branch manager who fails to do so will face sanctions. Let's consider the recent matter involving Banc of America Investment Services, Inc. ("BAI") and its branch manager, Virginia Holliday.

Preliminarily, financial services firms must supervise employees through effective, established policies and procedures that reasonably are designed to detect and prevent violations of the securities laws. In addition, firms are required to conduct ongoing monitoring and review of activities to ensure that supervisory systems and procedures are adequate. Branch managers in particular must reasonably discharge their duties. When a branch manager suspects that an adviser is engaging in improper activity, he or she must respond reasonably. For example, the SEC has found that a branch manager cannot discharge his or her supervisory obligations merely by relying upon the unverified representations of the advisers being supervised. That is because, "Red flags and suggestions of irregularities demand inquiry as well as adequate follow-up and review."

This enforcement action - an order instituting administrative proceedings, making findings and imposing remedial sanctions - arose out of BAI's and Holliday's failure reasonably to supervise Brent Lemons, a former BAI financial adviser. Between May, 2005 and May, 2007, Lemons was able to misappropriate $1.3 million from BAI customer accounts primarily by liquidating their variable annuities, and all during the time in which BAI had placed Lemons on "heightened supervision."

Lemons' fraudulent scheme took advantage of the manner in which customers' annuity holdings typically are reported. That is, unless annuity providers have made special arrangements, annuity holdings normally do not appear on a customer's monthly statement from the financial services firm (here, BAI). Instead, customers typically receive statements showing their annuity holdings directly from the annuity providers themselves.

Accordingly, to perpetrate his scheme, the SEC found that Lemons typically faxed notices to annuity providers directing them to liquidate all or a part of his customers' annuities and then to deposit the proceeds in the customers' bank accounts. Lemons then withdrew the cash from the customers' bank accounts using pre-signed withdrawal slips. Lemons then convinced Bank of America tellers to give him the funds.

To hide his scheme, the SEC found that Lemons provided his customers with manually prepared statements (sometimes handwritten) which falsely summarized their holdings. Again, because certain variable annuities were not listed on his customers' monthly account statements from BAI, Lemons "was able to mislead his customers about the true value of their annuities though his manually prepared statements."

The SEC found several problems with respect to the way BAI, and Holliday in particular, failed to supervise Lemons. First, Lemons had been the subject of four customer complaints at his former firm, prior to BAI. Yet, apart from soliciting his responses to those customer complaints and receiving a customer questionnaire about those complaints prepared by the former firm, Holliday did nothing else. She failed, for example, to seek additional information or attempt to corroborate Lemons statements to her.

Second, the SEC faults Holliday for not complying with BAI's policies and procedures with respect to the review of incoming correspondence and the review and approval of outgoing correspondence. In fact, the SEC found that Holliday "neither reviewed the Tyler branch office's mail or faxes nor inquired about the Tyler branch office's correspondence procedures with the branch office employees who handled correspondence." Consequently, "she did not discover that the Tyler branch office only sent some of Lemons' incoming and outgoing correspondence to the OSJ [supervisor] for review."

Third, Holliday failed to recognize the importance of the first two customer complaints that were received while Lemons was placed on heightened supervision. The SEC notes that if an adviser at BAI receives a customer complaint while on heightened supervision, the branch manager is required to determine an appropriate course of action, including termination of employment. However, the SEC found that Holliday failed to re-evaluate whether or not to terminate Lemons.

Fourth, with respect to the first complaint, the SEC determined that Holliday failed to reasonably investigate it. The SEC wrote that while Holliday agreed to review the complaint, and claimed to have reviewed documents, she failed to review certain other documents and, more importantly, failed to notice the similarity between the complaint that she was reviewing and the four other complaints that Lemons had received from his former firm.

Fifth, the SEC likewise found that Holliday failed to reasonably investigate a second complaint about Lemons. The SEC emphasized that at the time of these two complaints, Lemons had succeeded in misappropriating only approximately $250,000 from his customers, and that reasonable supervision could have detected the fraudulent scheme.

The SEC order censures and fines BAI for its supervisory failures. Owing to the egregious supervisory failures of Holliday, the SEC orders that she be barred from association in any supervisory capacity (subject to reapplication after one year). This sanction deservedly is severe. Hopefully, it will send a message to branch managers that they must be vigilant to protect investors.

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About the Author:
James J. Eccleston is the president of Eccleston Law Offices, P.C. The Chicago-based firm represents investors and advisers nationwide in securities and employment matters. 312-332-0000 www.EcclestonLaw.com.