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Author: Todd Cipperman

Large IA/BD Fined $8 Million for Failing to Implement Suitability Procedures

The SEC fined a large IA/BD $8 Million because it failed to implement compliance policies and procedures for the sale of single-inverse ETFs.  Following warnings from FINRA and SEC OCIE staff, the respondent adopted policies and procedures requiring (i) every client to sign a Client Disclosure Notice and (ii) a supervisor to review all recommendations for suitability.  However, over a 5-year period thereafter, the SEC maintains that 44% of clients did not sign a Disclosure Notice and most did not undergo adequate supervisory reviews.  Consequently, the firm made several unsuitable recommendations including to retirement account clients.  The SEC cites violations of the Adviser’s Act’s compliance rule (206(4)-7), which requires advisers to adopt and implement policies and procedures reasonably designed to ensure compliance with the Advisers Act.

OUR TAKE: The SEC will severely punish recidivists who were notified of deficiencies during a prior exam.  In this case, the IA/BD specifically undertook to fix the identified suitability concerns but failed to implement those policies, thereby allowing the violative conduct to continue.


Hedge Fund Misused Inside Information from Affiliate’s Research Department

An investment bank was fined and censured for failing to enforce information barriers between its research department and an affiliated hedge fund managed by the bank’s CEO.  The investment bank maintained policies and procedures related to the misuse of material nonpublic information, including a restricted list applicable to the bank’s employees.  However, the restricted list did not stop the hedge fund from making 126 trades in restricted list securities over a 6-month period.  In response to deficiencies raised during an SEC examination that occurred before the unlawful trading, the hedge fund adopted policies and procedures that applied the restricted list, required physical barriers, instituted email monitoring, and restricted information flow.  The SEC alleges that the hedge fund failed to enforce those policies.

OUR TAKE: Compliance means more than a drafting unused policies and procedures.  It means actually enforcing those policies to prevent unlawful conduct.  This firm likely incurred the enforcement action because it told the SEC that it had fixed the problem by adopting policies and procedures but then ignored implementation.


Family Office Seeks Exemption to Avoid RIA Registration

A single family office is seeking an exemption from investment adviser registration even though it may manage a pooled investment vehicle with more than 100 holders.  The family office wants to open a pooled vehicle to more than 100 family members to avoid family conflict, but such a vehicle would be deemed a “client” under the Advisers Act, thereby requiring the family office to register.  The family office argues against registration because of pre-Dodd-Frank precedent and the policy rationale underlying the registration requirements.

OUR TAKE: The publication of the application generally precedes approval unless somebody objects.  This application is good news for family offices who often must artificially contort their structures to avoid registration.   It is also good news that the SEC will accept no-action and exemptive precedents that pre-date Dodd-Frank.


General Counsel Awarded $7.9 Million for Wrongful Whistleblower Termination


A jury awarded a terminated General Counsel $2.9 Million in compensatory damages and $5 Million in punitive damages for wrongful termination due to his whistleblower activities.  In a key ruling, the Court (USDC for Northern District of California) ruled not to exclude evidence provided by the GC that his former employer claimed was privileged under California professional rules.  The Court held that federal law preempted the more stringent state law and that federal common law governing privilege applied to his Sarbanes-Oxley Act whistleblower retaliation claim.  The GC had raised Foreign Corrupt Practices Act compliance concerns.

OUR TAKE: While we sympathize with the plaintiff in this case, the broader policy of piercing lawyer-client privilege may result in limiting the role of in-house counsel.  Because the court can discard privilege, senior management and outside counsel may be less likely to include in-house lawyers in more sensitive matters.

Jury Verdict


Investment Consultant Lied about Code of Ethics Compliance


The SEC censured and fined an investment consultant and its principal $700,000 for lying about gifts received from recommended investment managers and performance information.  The respondent’s marketing material claimed that neither the firm nor its principals took “so much as a nickel” from any investment manager.  However, the firm’s Code of Ethics permitted gifts over $100 with pre-approval and under $100 without.  The SEC asserts that personnel in the firm received tickets to the Masters Golf Tournament and other smaller gifts over a 4-year period, even where such gifts violated the Code of Ethics but the firm never imposed discipline.  The SEC also accuses the firm of marketing hypothetical and back-tested performance without sufficient disclosure or backup.

OUR TAKE: Code of Ethics violations are an oft-cited SEC deficiency and should be remedied upon discovery (see Common OCIE Deficiencies).  However, this firm compounded the problem by boasting about its Code of Ethics compliance in marketing materials.  We do not recommend claiming 100% compliance with any rule as part of a marketing campaign.


SEC Publishes List of Most Cited Exam Deficiencies

The SEC’s Office of Compliance Inspections and Examinations has issued a Risk Alert listing the 5 most frequently identified compliance topics: weak compliance programs, insufficient and late filings, violations of the custody rule, Code of Ethics compliance deficiencies, and books and records.  OCIE highlights specific compliance problems including untailored “off-the-shelf” manuals, weak or absent annual reviews, and failure to follow procedures.  OCIE cited Form ADV and Form PF failures including inaccurate disclosures and late filings.  Other common deficiencies include failures (i) to follow the custody rule due to lack of knowledge about its requirements, (ii) to identify access persons, and (iii) to maintain complete and accessible books and records.

OUR TAKE: Compliance with the Advisers Act is not intuitive.  It requires a thorough knowledge of the specific requirements of the statute and all its rules.  Firms must hire a regulatory professional or a compliance services firm to assist with compliance or face significant exam deficiencies or an enforcement action.


Private Equity GP Barred and Fined for Charging Undisclosed Fees

A private equity manager was barred from the industry and agreed to pay a $1.25 Million fine for taking £16.25 Million in unauthorized fees.  The respondents also agreed to reimburse the funds over $24 Million.  According to the SEC, the respondent, in its capacity as GP, invoiced the funds for real estate workout fees pursuant to an oral agreement it made with an affiliate.  The SEC asserts that the respondents needed additional cash because the financial crisis reduced their fees and increased their workload and expenses, but the LP advisory committee refused.  The SEC asserts that the purported agreement with the affiliate was never disclosed to the LPs or the auditors.  When the LPs objected to the additional fees, the respondent sued the limited partners but ultimately agreed to reimburse the funds after the SEC’s investigation commenced.

OUR TAKE: Way back when (before Dodd-Frank?), a GP may have had unfettered power to engage in conflicts of interest and assess undisclosed fees.   As a fiduciary under the Advisers Act, private equity GPs must seek approval for additional fees and fully disclose all potential conflicts.  Otherwise, they won’t be a GP for long.


SEC Staff Allows More Flexible Fund-of-Funds Structures


The staff of the SEC’s Division of Investment Management has provided no-action relief that allows open-end investment companies to invest in closed-end investment companies that hold themselves out as part of the same investment group.  Without the no-action relief, a narrow reading of Section 12(d)(1)(G) and Rule  12d1-2 of the Investment Company Act would only allow open-end funds to invest in related funds only if such funds were open-end.  In general, Section 12(d)(1) limits fund-of-funds structures, absent specific conditions, because fund-of-funds have the potential to create complex products with layered fees and conflicts of interest.

OUR TAKE: This no-action relief provides practical flexibility to create fund-of-funds structures within the same group of companies, which should save costs and avoid artificial product engineering.


SEC Uses Anti-Fraud Rules to Prosecute Unregistered Fund Manager

The SEC has charged an unregistered fund manager with stealing nearly $4 Million in client funds by commingling assets and siphoning off investment funds for personal and business expenses.  The SEC asserts that the respondents hid their nefarious activities by providing false account statements that failed to show that the assets were heavily leveraged with margin accounts.  Although the respondent was not registered with the SEC or any state, the SEC charges violations of Section 10(b) (fraud in connection with purchase/sale of securities); Section 17(a) (fraud in the offering of securities); Sections 206(1) and 206(2) of the Advisers Act (investment adviser fraud); and Rule 206(4)-8 of the Advisers Act (fraud in pooled investment vehicles).

OUR TAKE: All this talk about repealing Dodd-Frank (see Cipperman podcast) will not stop the SEC from using the anti-fraud rules against fund managers even if they are not registered.  The SEC used the anti-fraud rules to pursue private fund manager wrongdoing long before enactment of the Dodd-Frank Act (See e.g. SEC v. Lawton (2009)).