Reference no: EM133211740

Jim Jansen is a dually licensed Financial Adviser with Freedom Investments. He is currently the largest producer in the Firm's New York City office. Freedom Investments is known for its large array of mutual fund and Unit Trust offerings. When Johnson joined Freedom Investments in July 2020, his customers held 1.3 million shares of NeedToKnow Inc., an up-and-coming technology company. Jansen's customers held 24 percent of the outstanding shares and 35 percent of the float, much of it on margin. During the recruiting process, Jansen told Freedom Investments about his interest in the company. The Freedom Branch Manager and Regional Director were unfamiliar with NeedToKnow but decided to hire Jansen and transfer his customer accounts to Freedom Investments without further inquiry.

Shortly after Jansen joined Freedom Investments, he began recommending NeedToKnow stock to his clients who accumulated an additional 30,000 shares over 30 days. Due to his client's significant holdings, Jansen was advised that he could not solicit purchases of additional shares of NeedToKnow stock. Jansen's clients continued to buy and sell NeedToKnow, increasing Jansen's client's holdings in the company and generating significant revenue on the frequent trading for Jansen and Freedom. All of the transactions were marked unsolicited (meaning that the purchase was the client's idea, not the registered representative's idea). Most of the trades were done on a discretionary basis, however none of Jansen's clients had completed a power of attorney form when they opened their accounts with Freedom Investments. Many of the clients were elderly with limited assets.

Jansen's trading activity appeared regularly on compliance alerts, which flagged for certain activity in customer accounts. These alerts were reviewed by Compliance and the Branch Manager. At Compliance's direction, Ralph Ryder, the Branch Manager, asked Jansen for an explanation regarding the trading in the account, including why there were so many trades marked unsolicited. He also inquired as to the high costs of the transaction-based accounts. Jansen explained that his clients all follow the stock and had called him to place the transactions. He also explained that even though he is dually licensed as an RIA, his clients had always had transactional accounts so there was no reason to consider the different account type options when the clients moved their accounts to Freedom Investments. The Manager provided this explanation to Compliance each time an alert would generate, which was at least once a week for several months.

After Jansen had been employed with Freedom Investments for nine months, the Firm received a SEC inquiry into trading in NeedToKnow. In response to the SEC inquiry, Janet Joplin (Freedom's General Counsel) through Bill Dylan (Freedom's Chief Compliance Officer) asked Jansen to explain the basis for the recommendations to purchase NeedToKnow, including whether the transactions were actually solicited or unsolicited. Jansen sent a memo to his Branch Manager, Joplin and Dylan advising them that the clients were aware of the costs, actively followed NeedToKnow stock and all of the transactions were unsolicited. Dylan provided the information to the SEC in response to its inquiry. Joplin then directed Dylan to ensure that Jansen's trades in NeedToKnow received pre-approval going forward. Dylan contacted the margin department to seek their assistance in monitoring the transactions. The Head of the Margin Department told Dylan that Jansen's client's trading in NeedToKnow stock often violated margin requirements. Dylan contacted Ryder and advised him of the restrictions and asked for his help in monitoring the transactions for pre-approval. Although the trading decreased in volume, Jansen continued to enter unsolicited orders to purchase NeedToKnow on margin without pre-approval and neither Ryder or Dylan took any action.

Freedom Investment's did not have a written policy relating to concentration levels in individual securities but based upon a prior SEC regulatory action against it many years ago, it had adopted an unwritten rule that an individual registered representative should not control more than 15% of the float of a company. The Firm has no pre-trade controls to ensure that this policy isn't violated. Although the Firm looked at cost and turnover ratios, the Firm did not monitor customer accounts for purposes of whether a fee-based account would be less costly than a transactional account. The Firm relied on the new account booklet to explain all the features of the various accounts it offered. The SEC followed up on its prior inquiry with a formal request seeking the Firm's policies and procedures relating to concentration, and recommendations/disclosures to customers. They also sought new account information for all of Jansen's clients purchasing NeedToKnow, including investment objectives and financial information, notes of communication with clients, any compliance alerts and records of supervisory review of the transactions.

Question 1

Once the SEC receives and reviews the information provided by Freedom Investments in response to the above inquiry, what are some of the possible next steps that the SEC can take as part of the investigation and enforcement process? Is Freedom Investments entitled to any information from the SEC during the investigation?

Question 2

At the same time the SEC is conducting its investigation, the Office of the Attorney General, Investor Protection Bureau (the NY State Securities regulator) decided to conduct a surprise exam of Freedom Investment's NY office. Many of the State's requests for records focused on Jansen's clients and trading in NeedToKnow, as well as Jansen's communications with clients. As part of its request, the State asked for all of Jansen's email since he joined the Firm and all telephone records (which are not required to be kept by regulation). The Firm doesn't have a centralized email archive and only keeps hard copies of monthly telephone bills that do not contain local telephone calls.

Explain the steps the Firm can take to constructively engage with the State regarding its response to this request. What are the potential consequences of not producing each category of requested records timely, or at all? Please address each category of documents in your response.

Question 3

After completing its investigation, the SEC has advised you that it is considering charges against Jansen, Ralph Ryder, Bill Dylan, Janet Joplin and Freedom Investments.

What are the possible violations of the securities rules and regulations that the SEC could charge Financial Adviser Jansen with based on these facts? Provide the name and/or a brief description of each potential rule violation and the rule number, if provided in the materials. Please respond only as to potential charges against Jansen.

Question 4

Is there any basis to charge Ryder, Dylan or Joplin with securities law violations? If so, in what capacity? Your response should address the potential liability as to each of these individuals separately. If you believe that there is a basis to charge the individual, answer yes, list the possible violations and explain why you reached that conclusion. If you do not believe that there is a basis to charge the individual with a violation, explain why you reached that conclusion. Your explanation for whether proposed charges are appropriate should be based on the requirements of the rule, any case law (if applicable) and the facts as set forth in the hypothetical.

Question 5

What are the likely charges against Freedom Investments based on the facts in the hypothetical? Do you think that the facts support a finding that Freedom Investments violated the securities laws?

Question 6

Once the SEC notifies Freedom Investments that it intends to bring charges, what are Freedom Investment's possible next steps to defend/resolve the matter?

Question 7

Freedom Investments is considering whether to resolve the regulatory matter with the SEC. What are the various factors Freedom Investments should take into consideration when deciding whether/how to resolve the regulatory matter with the SEC?

Question 8

What are the possible sanctions that the SEC can seek in an action against Freedom Investments?