Alert February 15, 2011

SEC Settles with Broker-Dealer over Failure to Supervise Registered Representatives to Prevent Securities Act Violations In Connection with Offer and Sale of Mutual Fund Shares

The SEC issued an order settling administrative proceedings that it proposed to bring against a registered broker-dealer regarding the broker-dealer’s failure to supervise its registered representatives with a view to preventing their violations of Section 17(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”), in connection with their offer and sale of shares in the Reserve Yield Plus Fund (the “Fund”).  Section 17(a)(2) of the Securities Act prohibits the offer or sale of securities by means of any untrue statement of material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.  Section 15(b)(4)(E) of the Securities Exchange Act of 1934, as amended requires broker-dealers to supervise reasonably, with a view to preventing violations of the federal securities laws, persons subject to their supervision. 

In its order, the SEC found that from approximately January 18, 2007 through September 16, 2008, the broker-dealer’s representatives mischaracterized the Fund as a money market fund, as safe as cash, or as an investment with guaranteed liquidity.  The SEC further found that although the broker-dealer developed training materials and procedures to train its representatives specifically regarding the Fund, the broker-dealer did not have a system to implement such procedures that was reasonably designed to prevent and detect misrepresentations or omissions by the broker-dealer’s representatives in their offer and sale of Fund shares.  According to the SEC’s findings, the broker-dealer had no system to ensure that representatives actually received the training from their managers and understood the materials, and the broker-dealer did not take adequate steps, such as providing additional training, refresher courses or continuing education on the Fund, to ensure that its representatives understood the Fund.  In determining to accept the broker-dealer’s settlement offer, the SEC considered the remedial efforts voluntarily undertaken by the broker-dealer to make improvements to its supervisory system.  As part of the settlement, without admitting or denying any wrongdoing, the broker-dealer agreed, among other things, to pay to all current and former account owners who purchased Fund shares at the broker-dealer during the relevant period (and who continue to hold shares as of date of the order) $0.012 for each share of the Fund held by such customers, an amount which is expected to total approximately $10 million.  The SEC did not impose any civil money penalty against the broker-dealer but reserved the right to do so in the future if the SEC’s Division of Enforcement believes that the broker-dealer has not complied with its undertakings as set forth in the order.