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Category: Disclosure

SEC Fines and Bars Fund Manager in Series Trust

The SEC fined and barred the portfolio manager of a registered mutual fund for failing to disclose to the Board and shareholders significant changes in investment strategy.  The fund operated as part of a platform series trust sponsored by a third party fund administrator that was responsible, along with the Board, for compliance oversight, although each adviser was responsible its own tailored compliance program.  As the SEC alleged, the PM altered the fund’s strategy and began investing the vast majority of assets in derivatives, which ultimately led to the fund’s demise.  Although the PM did ask for permission to invest in derivatives, he did not disclose that engaging in derivatives and short selling would become the principal investment strategy.    The SEC also accuses the respondent with failing to properly disclose the changes in investment strategy in the prospectus and shareholder reports and for causing the series trust’s Investment Company Act violations.

OUR TAKE: The SEC has wrestled with the allocation of compliance responsibility between series trust sponsors and boards and the underlying managers.  In this case, the SEC targets the manager for failing to ensure proper disclosure.  It is unclear at this writing whether the SEC will also charge the series trust or its board.


SEC Prosecutes De-Registered Adviser for Prior Compliance Failures

The SEC fined a deregistered investment adviser and barred its former principal for multiple compliance failures involving double dipping, Form ADV disclosures, fee rebates, and misrepresentations.  The respondents recommended that clients invest in private funds in which the principal held ownership and managerial interests.  Although the SEC acknowledges that clients knew about the conflict, the firm failed to list and describe the conflicts on Form ADV.  The SEC also charges the firm with multiple compliance program failures including inadequate policies and procedures and failing to conduct annual testing of the compliance program.

OUR TAKE: There is no such thing as declaring regulatory bankruptcy: the SEC’s long arm won’t let a firm engage in wrongdoing and then simply de-register to avoid consequences.    Compli-pros should also note that disclosure alone will not always cure significant conflicts of interest, such as fee double dipping for advisory services along with underlying products. 


Large Private Equity Firm to Pay $12.8 Million for Accelerated Portfolio Monitoring Fees

A large private equity firm agreed to pay over $12.8 Million in disgorgement, interest and fines for taking accelerated monitoring fees arising from the sale, IPO, and exit from portfolio companies.  The PE firm disclosed in the PPM that it would receive portfolio monitoring fees and disclosed in LP reports and the ADV that it received accelerated fees.  Nevertheless, the SEC faults the respondent for failing to disclose the accelerated fees before LPs committed capital and failed to submit the accelerated fees to the LP committee for approval.  The SEC accuses the firm of engaging in undisclosed conflicts of interest and failing to implement an adequate compliance program.

OUR TAKE: The SEC has attacked PE fees and expenses including portfolio monitoring fees, broken deal expenses, overhead costs, and consulting fees.  To avoid these issues, PE firms may want to re-think their business models and include all fees and expenses in a higher management fee and carried interest.


Dual-Hat Principal/CCO Ignored SEC’s Compliance Deficiencies

The SEC has commenced enforcement proceedings against a fund manager and its principal/CCO for ignoring exam deficiencies about its compliance program and other violations.  The SEC examined the respondents in 2010 and 2014 and noted several compliance deficiencies, which the SEC asserts the respondents ignored.  The SEC charges the dual-hatted principal with failing to perform any work on the compliance program, adopting a stock manual that was not properly tailored to the business, or conducting any compliance review.  The SEC also faults the respondents for charging compliance costs to the funds.  The SEC additionally charges undisclosed conflicts of interest, misrepresentations, and valuation issues.

OUR TAKE: The SEC doesn’t always give you a second chance to fix cited deficiencies.  But when they do and you don’t, expect an enforcement action.  Also, this is another example of the failure of the dual-hatted CCO model, where an executive ignored his compliance responsibilities.  Penny wise and pound foolish.


RIA/BD Failed to Disclose Mark-Ups and 12b-1 Fees

The SEC has commenced enforcement proceedings against a dually registered adviser/broker-dealer and its CEO/CCO principal for taking undisclosed commissions and 12b-1 fees on discretionary accounts.  The SEC’s complaint avers that the respondent sold inventory securities, acquired at a discount as part of the selling syndicate, to clients at a mark-up.  The SEC alleges that the firm never obtained the required informed consent.  The SEC also charges the firm for taking mutual fund 12b-1 fees without telling clients.

OUR TAKE:  A principal transaction with a client requires an adviser fiduciary to obtain specific client consent following disclosure of all relevant information.  The SEC continues its crackdown on any form of revenue sharing received by advisers with respect to their fiduciary clients.


Private Company and CEO Misled Investors about Compliance Failures

A privately-held benefits consulting firm agreed to pay a $450,000 fine, and its former CEO agreed to pay over $500,000, for failing to disclose compliance failures during fundraising.  The SEC maintains that the firm evaded state insurance licensing laws by rigging online examination courses and allowing employees to sell insurance without required licenses.  The SEC charges that the firm violated the securities laws by failing to disclose the compliance failures when raising money from institutional investors during at least 3 financing rounds that raised over $500 Million.  The related stock purchase agreements included false representations that the company complied with applicable laws including licensing requirements.  The respondent has also faced regulatory actions by at least 40 states who have imposed more than $11 Million in sanctions.  As part of the SEC settlement, the company created a Chief Compliance Officer position.

OUR TAKE: Be very careful when claiming compliance with applicable laws in disclosure or fundraising documents.  You might want to ask your Chief Compliance Officer if any issues require more disclosure.  The SEC can use holes in your regulatory compliance as a predicate to an enforcement action for securities fraud.


Private Equity Firm Charged Overhead and Portfolio Expenses to Fund

The SEC fined and censured a private equity manager and its principals for unlawfully charging the fund both portfolio company expenses and adviser overhead expenses.  The PE manager charged the fund certain consulting expenses provided to a portfolio company without offsetting the management fee as required by the LPA.  The PE manager also charged overhead expenses including employee compensation, rent, and the costs of responding to the SEC examination/enforcement.  The SEC charges that the expenses were not authorized in the fund’s organizational or disclosure documents.  The SEC asserts violations of the Advisers Acts antifraud provisions as well as the compliance rule (206(4)-7) for failing to adopt and implement reasonable policies and procedures.  As part of its remediation, the PE firm agreed to hire a new Chief Compliance Officer.

OUR TAKE: It really is better to build a legitimate compliance infrastructure before the SEC arrives rather than in response to an enforcement action.  An ounce of compliance prevention can avoid the reputation-crushing havoc of an SEC enforcement action.


RIA Did Not Offer Lowest Share Class Available

An RIA was censured and agreed to pay disgorgement for failing to offer the lowest-fee mutual fund share classes available and failing to adequately disclose compensation paid to its affiliated broker-dealer.  The RIA recommended third party mutual funds to 403(b) and IRA clients, who directed the investments.  The SEC faults the respondent for recommending Class A shares that paid 12b-1 fess to its affiliated broker and failing to make available lower-fee institutional shares.  The SEC also cites the insufficiency of various disclosures that generally discussed payment of 12b-1 fees but failed to specifically explain that an affiliate would receive the trailers.  The SEC charges the RIA with violations of the compliance rule (206(4)-7) for failing to adopt and implement adequate policies and procedures around conflicts of interest, disclosure, and mutual fund share class selection.

OUR TAKE: We believe that the SEC wants advisers to offer the lowest share class available and refrain from accepting any form of revenue sharing compensation.  We think that the SEC will find inadequate even the most robust disclosures and procedures because of the inherent conflict of interest.


Large Custody Bank to Pay $32 Million for Undisclosed Transition Management Compensation

A large custody bank agreed to pay $32.3 Million to settle allegations that it charged undisclosed commissions and mark-ups as part of its transition management services to large plans and sovereign wealth funds.  According to the SEC, the respondent’s scheme involved bidding for transition management projects with artificially low commission schedules and then charging undisclosed mark-ups and concealing those mark-ups when reporting to clients.  The SEC’s investigation included emails and recorded conversations where internal employees (i) referred to such concealed mark-ups as a “rounding error,” (ii) committed to “make it work” internally when forced to bid at low commission rates, (iii) bragged that they would “back the truck up” when describing the undisclosed commissions, and (iv) vowed that “This can of works stays closed” when discussing their scheme.  A client’s consultant ultimately discovered the undisclosed commissions.

OUR TAKE: You do know that your emails are retained and your conversations are recorded?  Right?  The bad old ways of hoping you won’t get caught just have no place in the modern regulatory world where compliance officers, clients (and their consultants), and regulators all review sales activity and disclosure.


Adviser Tried to Conceal Loans to Parent Company

A mortgage loan adviser and its two principals agreed to pay over $9 Million in disgorgement, interest, and fines for using funds it managed to make loans to the parent of its affiliated advisers and then using straw man transactions in an attempt to conceal the loans.  The SEC maintains that the respondent funneled money to the parent company through undocumented, undisclosed, and unlawful loans made by two private funds and a registered closed-end fund.  The respondent then tried to repay the loans by laundering mortgage assets through a straw man that bought mortgage loans from one fund and then transferred them to another fund.  The misconduct was uncovered when discrepancies arose between the registered fund’s collection account and its custody account.  The SEC asserts that the respondent misled the Board and investors, thereby violating the antifraud rules as well as the compliance rule.

OUR TAKE: Making the unauthorized loans was bad enough and would have resulted in breach of fiduciary duty charges.  Trying to conceal the loans through straw man transactions led to the fraud charges, which also could have carried criminal penalties if the U.S. Attorney decided to prosecute.