Home » Compliance Blog » Archives for January 2017

Month: January 2017

Best of the Web – December 2016

Best of Web

“How did it get so late so soon? Its night before its afternoon. December is here before its June. My goodness how the time has flewn. How did it get so late so soon?” (Dr. Seuss)

 

Welcome to the December 2016 BOTW.  Was it the end of a year or the end of an era?  Only time will tell.  But, the regulatory world just keeps rolling along.  A former SEC counsel at K&L Gates offers his views on a federal fiduciary standard for private funds.  Drinker Biddle untangles insider trading. Sadis offers advice on sub-adviser performance marketing.   The only foolproof strategy is knowledge.

 

A Federal Fiduciary Standard under the Investment Advisers Act of 1940: A Refinement for the Protection of Private Funds (K&L Gates)

http://www.hblr.org/2016/12/a-federal-fiduciary-standard-under-the-investment-advisers-act-of-1940-a-refinement-for-the-protection-of-private-funds/

 

Do You Think the Second Circuit’s Decision in United States v. Newman is a Game Changer for Hedge Funds? Not So Fast. (Drinker Biddle)

http://www.drinkerbiddle.com/-/media/files/insights/publications/2016/12/hansen_carr_investment-lawyer_dec-2016.pdf

 

How Investment Managers Can Advertise Sub-Adviser Performance Without Violating SEC Rules (Sadis & Goldberg)

http://www.sglawyers.com/wp-content/uploads/2016/12/Article-Hedge-Fund-Law-Report-Dan-Viola-Dec-1-2016-00314538x9ED28.pdf?lbisphpreq=1

 

SEC Staff Issues Guidance on Fund Fee Structure Disclosures (Dechert)

https://info.dechert.com/10/7866/december-2016/sec-staff-issues-guidance-on-fund-fee-structure-disclosures(2).asp

 

Simons Says: New York Proposed Cybersecurity Regulations (Focus One)

http://focus1associates.com/simons-says-new-york-proposed-cybersecurity-regulations/

 

Regulation FD: From an Investment Management Perspective (Mayer Brown)

https://www.mayerbrown.com/files/News/26612fcb-c0b3-40a4-a4cd-ec07d3c7d610/Presentation/NewsAttachment/6e4dc08e-6cc7-456d-9bd3-efe9ba0fb841/IL_1216_Pershkow.pdf

 

CFTC Amends Regulations Regarding CPO Financial Reports (Cordium)

http://www.cordium.com/briefing/cftc-amends-regulations-regarding-cpo-financial-reports/

 

Recent CFTC Rule Changes That Affect Hedge and Private Equity Fund Managers (Schulte, Roth & Zabel)

https://www.srz.com/resources/recent-cftc-rule-changes-that-affect-hedge-and-private-equity.html

 

EU Update: The Latest Developments on Brexit, MAR, and MiFID II (Morgan Lewis)

https://www.morganlewis.com/~/media/files/publication/outside%20publication/article/investmentlawyer-eu-update-jan2017.ashx?la=en

 

The New UK Corporate Offence of ‘Failure to Prevent the Facilitation of Tax Evasion’: Implications for Fund Managers and Investors (Skadden)

https://www.skadden.com/insights/new-uk-corporate-offence-failure-prevent-facilitation-tax-evasion-implications-fund-manager

Large Wrap Sponsor Pays $18.3 Million for Compliance Problems in Business Sold 8 Years Ago

mousetrap

A large dually registered adviser/broker-dealer agreed to pay over $18 Million to settle charges that it overbilled clients in a wrap program that it sold off in 2009, although it maintained an interest through 2013.  The SEC charges that the respondent overbilled clients by failing to (i) input lower negotiated fees into its system, (ii) track transferred accounts, (iii) rebate prepaid fees after termination; (iv) benefit investors when rounding, and (v) track lower rates when switching platforms.  The SEC faults the firm for failing to implement adequate compliance policies and procedures (Rule 206(4)-7) that would have required sample testing to discover the over-billing.  The SEC also charges violations of the books and records rule (204-2) because the respondent could not locate over 83,000 advisory contracts.

OUR TAKE: Selling or terminating a business line does not cut off regulatory liability for prior events.  Also, this case is a good example of how overbilling could occur and how to test for irregularities.

http://www.sec.gov/litigation/admin/2017/34-79882.pdf

Top 5 Regulatory Alerts – December 2016

Top 5

Here are our Top 5 Regulatory Alerts for December 2016, ranked by significance.  We have also included the Top 5 most read Alerts (other than Best of the Web and Top 5).

 

Top 5 Regulatory Alerts – December 2016

  1. SUPREME COURT EXPANDS INSIDER TRADING LIABILITY (12/8/16)
  2. ETF SPONSOR WILL PAY $20 MILLION TO SETTLE CHARGES IT OVERSTATED PERFORMANCE (12/5/16)
  3. HEDGE FUND MANAGER CHARGED WITH CONCEALING LIQUIDITY CRISIS (12/20/16)
  4. BD FINED $16.5 MILLION FOR UNDER-RESOURCING AML COMPLIANCE (12/6/16)
  5. PRIVATE EQUITY FIRM FAILED TO OBTAIN APPROVAL FOR CO-INVESTMENTS (12/15/16)

 

Most Read – December 2016

  1. BD FINED $16.5 MILLION FOR UNDER-RESOURCING AML COMPLIANCE (12/6/16)
  2. SEC ENFORCEMENT DIRECTOR STRESSES INDIVIDUAL LIABILITY IN FCPA CASES (12/12/16)
  3. SEC IMPOSES $1.4 MILLION FINE FOR WHISTLEBLOWER RULE VIOLATIONS (12/21/16)
  4. FINRA FINES 12 FIRMS $14.4 MILLION FOR FAILING TO MAINTAIN DATA IN PROPER ELECTRONIC FORMAT (12/23/16)
  5. PRIVATE EQUITY FIRM FAILED TO OBTAIN APPROVAL FOR CO-INVESTMENTS (12/15/16)

Adviser Faces Criminal Prosecution for Cherry-Picking

white collar criminal

A state-registered adviser faces civil and criminal charges for cherry-picking trades in a manner that benefitted him over clients.  The SEC asserts that the respondent, the adviser’s Managing Partner and Chief Compliance Officer, placed omnibus trades before earnings announcements and then allocated the trades after the announcement such that profitable trades were allocated to his personal account and unprofitable trades were allocated to clients.  The SEC alleges that the respondent unlawfully made $1.3 Million in profits on more than 200 trades.  In addition to violations of the Advisers Act’s fiduciary provisions, the SEC also alleges violations of Section 10 and Rule 10b-5 for fraud in the sales of securities.  The respondent has been barred from the industry and faces monetary penalties as well as criminal prosecution.

OUR TAKE: The SEC has brought many cherry-picking cases with similar facts (See e.g. In re Hartshorn).  However, the SEC, by alleging violations of Section 10 and Rule 10b-5, opened the door for criminal prosecution.  This legal theory could potentially transform any alleged breach of fiduciary duty into a criminal case.

https://www.sec.gov/litigation/complaints/2017/comp-pr2017-32.pdf

Personal Loan Results in Industry Bar for PE Fund Manager

iou

The SEC fined and barred from the industry the principal of a private equity real estate manager for taking unauthorized personal loans from the funds his firm managed.  FINRA uncovered the loans during an exam when FINRA staff found discrepancies between bank statements and the firm’s general ledger.  Although the respondent repaid the loans, the SEC asserts potential harm to investors because the borrowed funds were not available to make investments as described in the offering documents.

OUR TAKE: The SEC will come down hard on conflict-of-interest transactions where fund managers use invested assets as a personal piggy bank.  And, the chance of getting caught is much higher in this environment where examiners will check financial records and other transaction data.  In this case, the respondent lost his entire business because of an $85,000 loan.

https://www.sec.gov/litigation/admin/2017/33-10291.pdf

Executing Broker to Pay $22.6 Million for Misrepresenting Order Filling Process

hidden ball

A large executing broker agreed to pay $22.6 Million to settle charges that it misled broker-dealers clients about the mechanism for filling orders.  The SEC charges that the executing broker claimed that it would deliver best price but, instead, used two algorithms that capitalized on price discrepancies that often benefitted the respondent.  An SEC official warned, “We are focused on the execution of retail orders and encourage investors to ask brokers, and brokers to ask internalizers, how they are determining best prices for retail orders.”

OUR TAKE: This case looks like a disconnect between the front office and the back office.  It appears that the folks talking to clients did not understand how the firm actually filled orders.  “Don’t let the facts ruin a good story” is a recipe for an enforcement action.

 http://www.sec.gov/litigation/admin/2017/33-10280.pdf

The Friday List: 2017 Examination Priorities

the list

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

Within the last 2 weeks, the SEC OCIE staff and FINRA published their 2017 examination priorities letters (see SEC letter here and FINRA letter here).  If past is prelude, the regulators will fulfill their promises to examine the highlighted areas.  Also, the regulators have advised compliance staff to spruce up procedures and testing in these areas.  We did a breakdown of the two letters and offer our view of the most significant priorities.

 

10 Most Significant 2017 Examination Priorities

 

  1. Suitability:  The SEC expressed significant concern about mutual fund share classes and wrap programs.  FINRA will look at rep training as well as over-concentration of high-risk products.
  2. Cybersecurity: Each of the SEC and FINRA specifically highlighted cybersecurity.  They will review information security, data storage formats, password controls, physical security, and service provider oversight.
  3. Bad Brokers: Both the SEC and FINRA will target firms that retain and/or hire recidivist brokers.  The regulators will review supervision as well as hiring and training practices.
  4. Senior Investors: Both regulators will focus on sales practices to, and products for, senior investors.   The regulators are concerned with suitability especially related to high-yield products, target-date funds, and variable insurance products.
  5. Public Plans: The OCIE staff will scrutinize how advisers to public pension plans fulfill their fiduciary duties.  The staff also plans to examine pay-to-play practices.
  6. Branch Offices: Both regulators will examine how firms supervise branch locations.  These exams will include reviews of marketing, client communications, and outside business activities.
  7. Anti-Money Laundering:  Both the SEC and FINRA expressed continued concern about AML compliance.  They will test suspicious activity reporting, independent testing, automated trading, money movement, and foreign currency transactions.
  8. Robos: The SEC will focus on compliance programs, suitability, data protection, and algorithm oversight.
  9. ETFs: The SEC wants to ensure compliance with exemptive relief conditions.  The staff also promised reviews of the creation/redemption processes and sales practices.
  10. Private Funds: The SEC staff expressed concern about the private fund industry including conflicts of interest, disclosure and fees.

Large Asset Manager Pays $340,000 Fine because Separation Agreements Violated Whistleblower Rule

whistleblower-retaliation

The SEC fined a large asset manager $340,000 because it added provisions to its separation agreements prohibiting employees who received severance payments from collecting whistleblower awards.  The SEC contends that the respondent added the provisions after the SEC adopted the Dodd-Frank rule prohibiting any action that could impede a potential whistleblower.   The SEC imposed the fine even though the respondent voluntarily changed the language and even without any evidence that any employee was actually impeded or that the respondent ever sought to enforce the restrictions.  An SEC official faulted the firm for taking “direct aim at our whistleblower program by using separation agreements that removed the financial incentives for reporting problems to the SEC.”

OUR TAKE: Registrants must immediately review and revise confidentiality and separation agreements to strike any potentially violative language.

https://www.sec.gov/litigation/admin/2017/34-79804.pdf

SEC Fines 10 Firms for Violating Anti-Pay-to-Play Rule

pay to play

The SEC fined 10 advisory firms over $650,000, ranging from $30,000 to $100,000, for accepting compensation to manage city or state pension funds within 2 years of a disqualifying campaign contribution.  The SEC alleges that the firms violated the anti-pay-to-play rule (206(4)-5) by failing to observe the 2-year timeout after a designated covered associate makes a campaign contribution to a candidate who could influence manager selection.  An SEC official explained, “The two-year timeout is intended to discourage pay-to-play practices in the investment of public money, including public pension funds.”

OUR TAKE: The anti-pay-to-play rule is strict liability i.e. the SEC does not need to show that the campaign contribution actually resulted or contributed to the decision to grant the mandate.

https://www.sec.gov/news/pressrelease/2017-15.html

Large Adviser Fined $13 Million for Predecessors’ Compliance Breakdowns

merger

A large investment adviser agreed to reimburse clients and pay a $13 Million penalty for compliance breakdowns related to fee billing, custody, and books and records.  According to the SEC, over a 15-year-period, the respondent overbilled clients because of coding and administrative errors included in predecessor firms’ billing systems.  The SEC faults the firm for failing to test and uncover the over-billing when it integrated the systems.  The SEC also accuses the respondent of violating the custody rule’s surprise audit requirement by failing to properly identify the accounts subject to audit.   Also, the SEC faults the firm’s books and records practices for failing to retain client agreements.  The SEC cites violations of the Advisers Act’s custody rule (206(4)-2), compliance rule (206(4)-7), and books and records rule (204-2).

OUR TAKE: Integrating operations following a combination should trigger compliance due diligence into the prior firm’s policies and procedures. Also, firms should include compliance due diligence as part of the acquisition process.

https://www.sec.gov/litigation/admin/2017/34-79794.pdf