In the first such action brought under its Dodd-Frank anti-retaliation enforcement power, the SEC entered into a settlement order with Paradigm Capital Management, Inc. (Paradigm), a registered investment adviser, and its majority owner Candace King Weir (Weir).2 The order finds that Paradigm and Weir retaliated against a Paradigm employee who reported to the SEC alleged improper principal transactions between a hedge fund client of Paradigm and an affiliated broker-dealer. The enforcement action provides insight into what the SEC viewed as a flawed conflict resolution process, and underscores its commitment to creating meaningful incentives for individuals to report violations of the securities laws to federal authorities.
The settlement order indicates that, as part of a trading strategy to reduce the tax liability of the hedge fund’s investors, Paradigm caused the fund to sell securities to a proprietary trading account controlled by C.L. King & Associates, Inc. (C.L. King), a broker-dealer owned by Weir. Because Weir controlled both Paradigm and C.L. King, these transactions required prior written disclosure to and the consent of the fund under Section 206(3) of the Investment Advisers Act of 1940, as amended (the Advisers Act). However, Weir also held a controlling interest in the fund’s general partner and, accordingly, any written disclosure to her (as the owner of the general partner) was insufficient and, according to the SEC, she could not provide effective consent to the principal transactions.
To address the structural conflict of interest, Paradigm had established a conflicts committee to review and approve principal transactions on behalf of the fund, but one of the committee’s members was also the Chief Financial Officer of C.L. King (the affiliated broker-dealer) who, in that capacity, was responsible for monitoring the transactions’ impact on the broker-dealer’s net capital. The SEC found that the conflicts committee was itself conflicted, and accordingly Paradigm failed to provide effective written disclosure to the fund and failed effectively to obtain the fund’s consent to the principal transactions in violation of Section 206(3) of the Advisers Act. The SEC also alleged that Paradigm failed adequately to disclose the conflict in its Form ADV in violation of Advisers Act Section 207.
In March of 2012, Paradigm’s head trader provided information about the principal transactions to the SEC. Several months later, the trader informed Paradigm and Weir that he had advised the SEC of potential securities law violations stemming from these transactions. The settlement order indicates that, immediately thereafter, Paradigm and Weir “engaged in a series of retaliatory actions” against the trader that included “removing him from his position as head trader,” “changing his job function from head trader to full-time compliance assistant, stripping him of his supervisory responsibilities, and otherwise marginalizing him.” The SEC alleged that these adverse employment actions violated Section 21F(h) of the Exchange Act, which prohibits an employer from discriminating against a whistleblower in the terms and conditions of his or her employment because of any lawful act done by the whistleblower in providing information to the SEC.