SEC Charges Advisory Firm With Fraud for Improperly Retaining Fees
The Securities and Exchange Commission today announced that an investment advisory firm in Philadelphia has agreed to pay more than $21 million to settle charges that it fraudulently retained fees belonging to collateralized debt obligation (CDO) clients.
An SEC investigation found that Taberna Capital Management did not tell CDO clients it was retaining payments known as “exchange fees” in connection with restructuring transactions. Taberna’s retention of the exchange fees was neither permitted by the CDOs’ governing documents nor disclosed to investors in the CDOs. The fees rightfully belonged to the CDOs and created conflicts of interest that Taberna failed to disclose.
The SEC also charged Taberna’s former managing director Michael Fralin and former chief operating officer Raphael Licht for their roles in certain aspects of Taberna’s misconduct.
“CDO managers have an obligation to act in the best interests of their CDO clients and communicate fairly with them. Taberna secretly diverted funds owed to CDO clients, and concealed that diversion and the conflicts it created,” said Michael J. Osnato Jr., Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit.
According to the SEC’s order instituting settled administrative proceedings:
- From 2009 to 2012, Taberna sought and retained millions of dollars in exchange fees paid by issuers of securities held by the CDOs when Taberna recommended exchange transactions to CDO clients.
- Under the terms of the CDOs’ governing documents, Taberna was not permitted to retain the exchange fees. Instead, those fees belonged to the CDOs.
- Taberna obscured its misconduct by improperly labeling the exchange fees as “third party costs incurred” in various documents. But such costs comprised only a minimal portion of the overall exchange fees.
- In quarterly reports that Taberna provided to investors, it omitted any mention of exchange fees in its detailed descriptions about the exchange transactions.
- Taberna also failed to identify the fees in Forms ADV despite an obligation to do so.
- Taberna’s decision to seek and retain exchange fees also created conflicts of interest between Taberna and the CDO clients and investors. For instance, Taberna retained fees paid in connection with exchanges but no other types of restructuring transactions, so Taberna had an incentive to steer issuers toward doing an exchange regardless of what form of restructuring might be most advantageous to the CDOs.
- Fralin was responsible for exchange negotiations and transaction documents that mischaracterized the exchange fees as compensation for third-party costs.
- Licht helped approve and supervise Taberna’s collection of exchange fees. He played a role in the drafting and review of Taberna’s materially inaccurate Forms ADV.
The SEC’s order finds that Taberna, which is a subsidiary of RAIT Financial Trust, violated Section 15(a) of the Securities Exchange Act of 1934 and Sections 206(1), 206(2), 206(4), and 207 of the Investment Advisers Act of 1940 as well as Rule 206(4)-8. Taberna agreed to pay disgorgement of $13 million, prejudgment interest of $2 million, and a penalty of $6.5 million, and will not act as an investment adviser for three years. The SEC’s order finds that Fralin violated Sections 206(2) and 206(4) of the Advisers Act and Rule 206(4)-8, and Licht violated Sections 206(2) and 207 of the Advisers Act. Fralin agreed to pay a $100,000 penalty and is barred from the securities industry for at least five years. Licht agreed to pay a $75,000 penalty and is barred from the securities industry for at least two years. Taberna, Fralin, and Licht consented to the SEC’s order without admitting or denying the findings.
The SEC’s investigation was conducted by Andrew Feller, Jeff Leasure, and David Johnson and supervised by Reid Muoio of the Complex Financial Instruments Unit.