Initiated By
FINRA
Allegations
NASD RULES 2110 AND 3010: THIS MATTER INVOLVES VIOLATIONS OF NASD RULES IN CONNECTION WITH MARKET TIMING ACTIVITY EFFECTED BY TWO HEDGE FUND CUSTOMERS. THE MARKET TIMING ACTIVITY OCCURRED AS PART OF AN ARBITRAGE TRADING STRATEGY BY THE HEDGE FUND CLIENTS THAT UTILIZED FREQUENT TRADING IN THE SUB-ACCOUNTS OF VARIABLE ANNUITIES. FROM MARCH 2002 THROUGH SEPTEMBER 2003, A FINRA MEMBER FIRM ("FIRM") ACTED AS A SELLING AGENT THROUGH ITS BROKER-DEALER DIVISION, AND ENABLED THE HEDGE FUND CLIENTS TO ENGAGE IN DECEPTIVE PRACTICES REGARDING MARKET TIMING IN THE SUB-ACCOUNTS OF VARIABLE ANNUITIES THROUGH ACCOUNTS MAINTAINED AT THE FIRM. RICHARD KONST ("KONST") WAS THE GENERAL SECURITIES PRINCIPAL AT HIS MEMBER FIRM RESPONSIBLE FOR SUPERVISION OF THE FIRM'S VARIABLE ANNUITY BUSINESS. AS A RESULT OF HIS INITIAL MEETING WITH THE INVESTMENT ADVISOR TO THE HEDGE FUND CLIENTS, KONST WAS AWARE IN EARLY 2002 THAT THE HEDGE FUND CLIENTS INTENDED TO IMPLEMENT AN ARBITRAGE TRADING STRATEGY THAT UTILIZED MARKET TIMING IN THE SUB-ACCOUNTS OF VARIABLE ANNUITIES. IN THE FALL OF 2002, FROM CONVERSATIONS WITH THE FIRM'S THEN-GENERAL COUNSEL, KONST LEARNED THAT THE HEDGE FUND CLIENTS INTENDED TO USE NOMINEE AGREEMENTS THAT FAILED TO DISCLOSE THEIR OWNERSHIP OF VARIABLE ANNUITY CONTRACTS TO THE INSURANCE COMPANIES. KONST KNEW OR SHOULD HAVE KNOWN THAT INSURANCE COMPANIES MAINTAINED POLICIES SEEKING TO LIMIT EXCESSIVE TRANSFERS AMONG SUB-ACCOUNTS, AND THAT THE RELEVANT PROSPECTUSES AND OTHER MATERIALS INCLUDING SELLING AGREEMENTS STATED THAT ANNUITY PRODUCTS OFFERED THROUGH THE FIRM WERE NOT DESIGNED FOR MARKET TIMING OR EXCESSIVE TRADING. HE SHOULD ALSO HAVE KNOWN THAT THE INSURANCE COMPANIES CONSIDERED MARKET TIMING ACTIVITY TO BE PROBLEMATIC AND HARMFUL, AND THAT THE HEDGE FUND CLIENTS WERE ENGAGING IN MARKET TIMING ACTIVITY THROUGH NOMINEE AGREEMENTS. (ALLEGATIONS CONTINUED IN THE COMMENTS SECTION)
Resolution
Acceptance, Waiver & Consent(AWC)
Sanctions
Censure
Sanctions
Civil and Administrative Penalty(ies)/Fine(s)
Sanctions
Requalification
Sanctions
Undertaking
Regulator Statement
(ALLEGATIONS CONTINUED)BETWEEN JULY 2002 AND SEPTEMBER 2003, THE FIRM RECEIVED AT LEAST 24 LETTERS FROM INSURANCE COMPANIES STATING THAT MARKET TIMING AND EXCESSIVE TRANSFERS AMONG SUB-ACCOUNTS BY THE HEDGE FUND CLIENTS WERE DISRUPTIVE TO THE UNDERLYING FUNDS, HARMED LONG-TERM INVESTORS AND INCREASED COSTS TO THE FUNDS. THOSE LETTERS TYPICALLY RESTRICTED THE TRADING IN ANNUITIES HELD BY THE HEDGE FUND CLIENTS, AND WHILE MANY OF THE LETTERS WERE ADDRESSED TO KONST, AS A MATTER OF FIRM POLICY , THOSE LETTERS WERE USUALLY ROUTED THROUGH ANOTHER REGISTERED REPRESENTATIVE AT THE FIRM WHO HAD ADMINISTRATIVE RESPONSIBILITIES FOR THE ACCOUNTS OF THE HEDGE FUND CLIENTS. NONETHELESS, KONST WAS THE PRINCIPAL RESPONSIBLE FOR SUPERVISING THE FIRM'S VARIABLE ANNUITY BUSINESS, AND WAS DESIGNATED AS SUCH IN THE FIRM'S WRITTEN SUPERVISORY PROCEDURES. AFTER THE INSURANCE COMPANIES NOTIFIED THE FIRM IN WRITING THAT MARKET TIMING AND EXCESSIVE TRANSFERS AMONG SUB-ACCOUNTS BY THE HEDGE FUND CLIENTS WERE DISRUPTIVE TO THE UNDERLYING FUNDS, HARMED LONG-TERM INVESTORS, AND INCREASED COSTS TO THE FUND, KONST TOOK NO ACTION TO OVERSEE OR SUPERVISE THE CONTINUED MARKET TIMING ACTIVITY THAT WAS OCCURRING THROUGH THE FIRM.
WITHOUT ADMITTING OR DENYING THE FINDINGS, KONST CONSENTED TO THE DESCRIBED SANCTIONS AND TO THE ENTRY OF FINDINGS; THEREFORE HE IS CENSURED; FINED $20,000, PAYABLE WITHIN 90 DAYS OF THE ISSUANCE OF THIS AWC; AND ORDERED TO REQUALIFY BY EXAMINATION AS A GENERAL SECURITIES PRINCIPAL WITHIN 120 DAYS OF THE DATE OF THIS AWC. IF KONST FAILS TO REQUALIFY BY EXAMINATION AS A GENERAL SECURITIES PRINCIPAL ON OR BEFORE THAT DATE, HIS REGISTRATION AS A GENERAL SECURITIES PRINCIPAL WILL BE SUSPENDED ON THAT DATE UNTIL SUCH TIME AS HE PASSES THE REQUIRED EXAMINATION. FINES PAID ON 01/04/2008.
Broker Comment
BEFORE KONST AGREED TO SUPERVISE THE VARIABLE ANNUITY BUSINESS OF THE TWO FORMER HEDGE FUND CUSTOMERS, KONST WAS INFORMED THAT THE HEDGE FUND CUSTOMERS HAD RETAINED A REPUTABLE OUTSIDE LAW FIRM TO REVIEW ALL ASPECTS OF THEIR TRADING STRATEGY, INCLUDING THE LEGALITY OF MARKET TIMING GENERALLY AND THE USE OF NOMINEE AGREEMENTS. IN ADDITION, THE FIRM'S THEN-GENERAL COUNSEL CONDUCTED INDEPENDENT RESEARCH AND REVIEWED A NOMINEE AGREEMENT THAT HAD BEEN DRAFTED BY THE OUTSIDE LAW FIRM, BEFORE ADVISING KONST AND THE FIRM THAT THE USE OF NOMINEES TO PURCHASE VARIABLE ANNUITY CONTRACTS ON BEHALF OF THE HEDGE FUND CUSTOMERS WAS LEGALLY PERMISSIBLE. ACCESS AND KONST RELIED IN GOOD FAITH ON THIS LEGAL OPINION AND BELIEVED THAT THE FORMER HEDGE FUND CUSTOMERS' TRADING STRATEGY DID NOT VIOLATE ANY OF THE SECURITIES LAWS OR NASD RULES.