In August 2013, FINRA announced that G. Research, Inc. f/k/a Gabelli & Company, Inc. submitted a Letter of Acceptance, Waiver and Consent in which the firm was censured and fined $1,000,000. Without admitting or denying the findings, the firm consented to the described sanctions and to the entry of findings that its Written Supervisory Procedures were not reasonably designed to achieve compliance with applicable securities laws and regulations, and NASD® and FINRA rules, with respect to private partnerships formed by firm registered representatives, and the firm did not adequately supervise the private partnerships.
The findings stated that although the private partnerships frequently offered hedge funds and funds of hedge funds, directly or indirectly, to customers, the firm did not maintain WSPs reasonably designed to provide adequate supervision regarding due diligence related to these hedge funds and funds of hedge funds. The firm’s WSPs did not provide specific guidance regarding the relative fees to be charged by the private partnerships. Private partnership investors were contractually obligated to pay additional fees to invest with an affiliated adviser through a private partnership, yet the firm’s WSPs did not provide guidance regarding offering similar investments that carry different fees, or how to balance the relative fees, benefits and detriments of closely-related investment vehicles, or the circumstances in which waivers of the affiliated adviser’s investment minimum might be sought or granted. As a result, the firm’s WSPs did not adequately consider the fees such customers were charged, or the ability of private partnership investors to seek and obtain accommodations from the affiliated adviser to invest below the stated minimum. The findings also stated that the WSPs in place were not reasonably designed to address the obligations set forth in Notice to Members 03-07 that impose obligations when members sell hedge funds and funds of hedge funds. The firm did not adequately evaluate a provision in the fund of funds’ subscription agreements that disavowed its obligation to perform due diligence on the fund manager. While the investment adviser to the fund of funds was well known to the firm, the firm should have, but did not have, the WSPs required by Notice to Members 03-07. As a result, the firm’s WSPs were defective. The findings also included that the firm failed reasonably to supervise the private partnerships by failing to enforce its own WSPs governing various aspects of the formation, operation, marketing and sale of the private partnerships, including supervisory review of sales materials. The firm’s failures to reasonably enforce its WSPs resulted in sales materials for the private partnerships not being approved by the firm prior to being used, and statements of securities held by the private partnerships not being provided to mandated firm departments. As a further result of the firm’s failure to reasonably enforce its WSPs, it did not adequately review the subscription documents for the direct investment in the fund manager through the fund of funds.
FINRA found that the firm failed to discover that its customers were being offered an investment in the fund manager even though the subscription documents did not legally obligate the private partnerships to invest solely in the fund of funds, and that the private partnerships provided investors with no legal recourse in the event the investments were not made in the fund manager as the customers instructed. Although the private partnerships did limited advertising, those communications were not approved and initialed by a registered principal prior to their use, nor were copies of them retained in a separate file that included the name(s) of the persons who prepared them. FINRA also found that the firm failed to take appropriate steps to ensure the mandated review of the sales materials occurred prior to their dissemination on behalf of private partnerships. As a result of the firm’s failure reasonably to enforce these WSPs, the private partnerships prepared advertising and sales materials that failed to comply with applicable FINRA rules. The private partnerships used items of advertising that did not comply with applicable advertising rules. Each of the noncompliant communications involved the private partnerships’ investment in the fund manager. In addition, FINRA determined that the marketing documents lacked sufficient disclosure regarding the risks of investing in the private partnerships, including potential loss of principal, concentration of investment, leverage, management fees, lack of liquidity, and conflicts of interest between the investors and the managers. Omission of these risk disclosures made the marketing documents impermissibly incomplete and unbalanced with respect to risks versus rewards.