Dually Registered Adviser Found to Have Ignored Red Flags of Illicit Insider Trading

September 22, 2014

The SEC brought an enforcement action against Wells Fargo Advisors, LLC, a dually registered investment adviser and broker-dealer, for failing to implement and maintain adequate insider trading policies and procedures.


In this case, Wells Fargo Advisors did not have adequate procedures that addressed potential insider trading involving specifically material nonpublic information obtained from its customers and its advisory clients. The SEC found that this risk manifested itself in 2010 when one of Wells Fargo Advisors’ registered representatives misappropriated information from one of his customers about Burger King Holdings, Inc. (Burger King) securities, traded on the basis of that information, and tipped others including several of his Wells Fargo Advisors customers. Although a compliance group at Wells Fargo Advisors reviewed this trading after an acquisition announcement, information about the trading was not shared with senior managers or other compliance groups that were also aware of issues relating to the trading prior to the announcement.

Wells Fargo Advisors’ insider trading policies and procedures included procedures for conducting look back reviews, which stated:

Description[:] Identify select situations and review trading where there is the potential to profit or avoid losses by trading on insider information. For purposes of this review, insider information[] is defined as material, non-public information that would be important to an investor in making a decision to buy, sell or hold a security. Information would be material if its disclosure were reasonably certain to have a substantial effect on the market price of the security.

Frequency: Daily review to identify situations when profit or avoidance of loss could most likely result from trading prior to the public release of confidential information. Review of trading activity would occur when those situations have been identified.

Wells Fargo Advisors’ Retail Control Group (“RCG”), a unit in the firm’s compliance department, was designated as having primary, if not sole, responsibility for conducting the look back reviews.

In this case, the predicate insider trading violation involved Waldyr Da Silva Prado Neto (Prado), who was a registered representative and associated person of Wells Fargo Advisors in a branch office in Miami. In September 2012, the SEC charged Prado with committing insider trading in the securities of Burger King in advance of the September 2, 2010 announcement that 3G Capital Partners Ltd. (3G Capital), a private equity firm, would acquire Burger King and take it private.

The SEC alleged that Prado, who held Series 7 and 65 registrations and while an employee of Wells Fargo Advisors, misappropriated information about the acquisition from one of his brokerage customers who invested in the private equity fund 3G Capital used to acquire Burger King. The SEC alleged that Prado traded Burger King securities through his personal Wells Fargo Advisors brokerage account and that Prado tipped several of his other brokerage customers, including at least three tippees who traded Burger King securities through their Wells Fargo Advisors accounts. The Commission alleged that Prado and his tippees reaped profits of over $2 million in total from their Burger King trades, which included trading through Wells Fargo Advisors and another firm.

The SEC stated that beginning on September 2, 2010, the RCG compliance officer conducted a look back review of trading in Burger King securities at Wells Fargo Advisors before the taking private announcement, including trading by Prado and three of his customers. She determined that:

  • Prado and his customers represented the top four positions in Burger King securities firm-wide;
  • Prado and his customers bought Burger King securities within 10 days before the announcement, including on the same days;
  • The profits by Prado and his customers were at least $5,000;
  • Both Prado and Burger King were located in Miami; and
  • Prado, his customers, and the company acquiring Burger King were all Brazilian.

The compliance officer determined at the time of her review that each of these factors did not constitute “red flags” set forth in the policies and procedures that required follow up with Prado and his branch manager. Instead of taking any further steps, such as escalating the matter to her manager, the compliance officer determined there was no suspicious trading by Prado and his customers, and she closed the review with “no findings.”

The SEC noted that because the compliance officer closed the Burger King trading review with no findings, her supervisors within the compliance department were unaware that she conducted a review of trading at Wells Fargo Advisors in Burger King securities including trading by Prado and his customers. The supervisors did not become aware of that fact until September 2012, after the SEC charged Prado with insider trading.  Immediately after the SEC charged Prado with insider trading in September 2012 and the existence of the closed Burger King review came to light, the RCG manager notified her own manager that she would begin reviewing all of the compliance officer’s reviews.

At the time the compliance officer conducted the Burger King trading review, the SEC stated that unbeknownst to her, employees in the Central Supervision Unit (CSU) of Wells Fargo Advisors had reviewed concentration alerts in Burger King securities generated for Prado’s account and the account of one of his customers. The SEC found fault with Wells Fargo Advisors’ policies and procedures because they did not address how units with relevant information at the firm could coordinate. In the SEC’s view, the effect of the failure of CSU and RCG to coordinate their efforts caused Wells Fargo Advisors not to recognize red flags that its representative was engaging in insider trading in Burger King securities.

In late September 2010, the SEC stated that the anti-money laundering compliance group (AML Group) of Wells Fargo Advisors examined a $50 million wire transfer request by Prado’s customer to make his private equity investment in the Burger King acquisition. During this AML review, Prado provided to the AML reviewer copies of the offering documents dated before the public announcement concerning his customer’s investment in the private equity fund, which was later used to acquire Burger King. The AML Group, which already knew that Burger King was the subject of an acquisition by 3G Capital announced earlier in September 2010, learned from Prado that his customer was an investor in the Burger King acquisition through 3G Capital. Despite these facts, AML personnel did not question how Prado obtained the offering documents or consider whether Prado or his customers possessed or misused material nonpublic information.

The SEC concluded that Wells Fargo Advisors insider trading policies and procedures were inadequately designed. Specifically, the manner in which the policies and procedures were designed caused Wells Fargo Advisors not to recognize several red flags that its representative was engaging in insider trading in Burger King securities. Multiple units within the firm received indications suggesting that the registered representative was misusing material nonpublic information obtained from a customer to trade in Burger King securities. Because of a lack of assigned responsibility or coordination, each of these units in the SEC’s view failed to:

  • recognize the significance of those indications;
  • properly consider them; and
  • elevate those indications within their own group or communicate with other groups responsible for conducting surveillance.

Among other sanctions, Wells Fargo Advisors was ordered to pay a $5 million penalty.

Click here to access the enforcement action.


Categories

Investment Advisers