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Falsified Consolidated Reports Result in Frauds Against Clients
An SEC Administrative Law Judge ordered Coastal Equities and Coast Investment Advisors (the “Respondents”) to each pay a $40K fine for their failure to supervise a former executive officer who defrauded clients out of millions. In determining the fines, the SEC considered remedial acts promptly undertaken by the Respondents, the self-reporting of the conduct, and the cooperation afforded the Commission staff.
Coastal Equities has been a broker-dealer (the “B/D”) and a FINRA member since 1989. Coastal Investment Advisors, formerly known as Donnelly Steen & Co., has been a registered investment adviser (the “RIA”) since 2007. Both firms are headquartered in Wilmington, DE.
Michael Donnelly, is a former executive officer of the Respondents. For varying times from 2007 through 2014, Donnelly served as the President and CCO of both firms. He also served as an Investment Adviser Rep and as a Registered Rep. In 2016, Donnelly pleading guilty to securities fraud and wire fraud. He currently is barred from the industry and is serving a 99-month prison sentence.
THE DONNELLY FRAUD. From at least 2009 through 2014, Donnelly stole approximately $1.5 million from 12 of the Respondents’ clients. As part of his scheme, Donnelly convinced the Clients to withdraw funds from their accounts and deposited that money with the Donnelly Advisors Group, an entity he solely controlled. Donnelly had promised to invest in certain securities transactions, including high-yielding bank CDs that purportedly provided as much as 5 times the returns of other bank CDs.
In reality, the securities transactions were a complete fabrication. Instead of investing the proceeds, Donnelly deposited the clients’ checks in a Donnelly Advisors Group bank account and used the money for his own personal and business purposes.
To conceal his theft, Donnelly used an electronic system maintained by the Coastal Equities to create falsified consolidated financial reports, or “Portfolio Reports.” These Portfolio Reports were able to consolidate all the holdings of a particular client, including those held within Coastal Equities brokerage accounts and Coastal IA advised accounts - which were derived from direct systematic updates from Respondents - as well as the Client’s assets held away by outside financial institutions – which were manually entered by the financial representatives.
Donnelly manually inputted into the Portfolio Reports false information concerning the fraudulent investments, such as the fictitious high-yielding CDs, including their purported name, value and interest rate. None of Donnelly’s Portfolio Reports were subject to mandatory review by the B/D or the RIA.
The fraud unraveled in July 2014, when a client informed him that she intended to move all of her investments to a different financial institution, including several fictitious CDs that she believed she owned. Unable to transfer the non-existent CDs, and having already spent the client’s money, Donnelly stole $267,000 from another client and used that money as purported payments for the CDs. Another Coastal IA employee reported this suspicious transaction to the Chief Legal Officer who investigated the matter, which revealed Donnelly’s larger fraud. Shortly thereafter, Donnelly’s conduct was reported to the SEC and criminal authorities.
In April 2016, Donnelly was sentenced to 99 months in prison, 3 years of supervised release, and ordered to pay $2 million in restitution to his clients.
RESPONDENTS’ FAILURE TO REASONABLY SUPERVISE. The Portfolio Reports were available for use by all Respondents’ financial representatives since as early as 2009. And both firms were aware that financial representatives had the capability of manually entering data representing assets supposedly held away from the firms.
Yet, neither company implemented any policies or procedures for supervising their creation and use.
- Coastal Equities did not have any policies or procedures in place concerning consolidated reports until October 2013;
- Coastal Investment Advisors never had any procedures in place with respect to consolidated reports throughout the period of Donnelly’s fraud.
As a result of these supervisory failures, Donnelly was emboldened to carry out and perpetuate his scheme for years – knowing that the Consolidated Financial Reports, or Portfolio Reports, would falsely assure his clients that he had purchased the securities on their behalf. Had there been even a cursory review of the reports generated by Donnelly, the erroneous entries would have been detected - given the highly questionable rates of returns and securities not offered or approved by the Respondents.
The broker-dealer and the investment advisor are out $80,000, while their clients are out $2 million. WHERE'S THE JUSTICE?