Home » Compliance Blog » Archives for June 2017

Month: June 2017

Lack of Compliance Infrastructure Costs Private Equity Firm and Principals

The SEC fined a private equity firm and its principals, and barred the former CFO/CCO from the industry, for engaging in multiple conflicts of interest transactions with the funds.  According to the SEC, prohibited transactions included (i) borrowing from the funds, (ii) failing to make capital contributions, and (iii) using false bookkeeping adjustments to hide transactions.  The transactions violated the LPA and were not properly disclosed in capital call notices or financial statements.  In addition to anti-fraud and books and records violations, the SEC charged violations of the compliance rule (206(4)-7) because the compliance manual did not address conflicts of interest including control by the two principals and related party transactions.  As part of the settlement, the firm hired a new CCO, a new general counsel, a new CFO, and an independent compliance consultant.

OUR TAKE: Hiring a competent CCO before the SEC arrived would likely have avoided the enforcement action and the resulting damage to the firm’s business and reputation.  It appears that the principals had no sensitivity to the regulatory environment in which they were operating.

https://www.sec.gov/litigation/admin/2017/ia-4721.pdf

Top 5 Regulatory Alerts – May 2017

Here are our Top 5 Regulatory Alerts for May 2017, 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 – May 2017

  1. FIDUCIARY RULE GOES LIVE ON JUNE 9 WITHOUT SPECIFIC COMPLIANCE REQUIREMENTS (5/25/17)
  2. SEC WARNS ADVISERS AND BROKER-DEALERS TO PROTECT AGAINST RANSOMWARE (5/18/17)
  3. FINRA POSTS SOCIAL MEDIA AND DIGITAL CONTENT GUIDANCE (5/10/17)
  4. WRAP SPONSOR PAYS $97 MILLION FOR INADEQUATE DUE DILIGENCE (5/11/17)
  5. CCO BARRED AND FINED $250,000 FOR AML COMPLIANCE BREAKDOWNS (5/9/17)

 

Most Read – May 2017

  1. SEC WARNS ADVISERS AND BROKER-DEALERS TO PROTECT AGAINST RANSOMWARE (5/18/17)
  2. CCO BARRED AND FINED $250,000 FOR AML COMPLIANCE BREAKDOWNS (5/9/17)
  3. MUTUAL FUND MANAGER FINED AND BARRED FROM INDUSTRY FOR INVESTMENT, DISCLOSURE, AND FEE VIOLATIONS (5/30/17)
  4. WRAP SPONSOR PAYS $97 MILLION FOR INADEQUATE DUE DILIGENCE (5/11/17)
  5. FINRA POSTS SOCIAL MEDIA AND DIGITAL CONTENT GUIDANCE (5/10/17)

SEC Chairman Re-Commits to Examinations and Enforcement

In recent testimony about the SEC’s proposed 2018 budget, Chairman Jay Clayton emphasized enforcement and examination activities.  Mr. Clayton noted that 50% of requested budget resources will go to enforcement and examinations.  He said that the SEC is on track to deliver a 20% increase in adviser examinations and plans a further 5% increase.  He noted that the staff will put a special focus on cybersecurity efforts.  Mr. Clayton also committed to continue the SEC’s “vigorous enforcement efforts to investigate and bring civil charges” including critical areas such as “investment professional misconduct.”

OUR TAKE:  It appears that the Clayton SEC will continue the examinations and enforcement focus of the Mary Jo White SEC.  The more things change, the more they stay the same.

https://www.sec.gov/news/testimony/testimony-fiscal-year-2018-budget-request

BD and Principal Punished for Failing to Observe Information Barriers (Again)

A broker-dealer and its principal were censured and fined for failing to observe information barriers intended to safeguard material nonpublic information contained in research reports.  According to the SEC, notwithstanding the BD’s written supervisory procedures, (i) the principal and other employees engaged in active personal trading without pre-approval, (ii) the firm failed to observe information barriers between research and sales, (iii) employees disseminated material information such as price targets to existing and prospective customers, and (iv) the firm failed to prevent trading ahead of research reports or decisions to commence coverage.  FINRA had previously cited the firm about similar issues.  The SEC alleges violations of Section 15(g) of the Exchange Act, which requires broker-dealers to establish and enforce policies and procedures to prevent the misuse of material nonpublic information.

OUR TAKE: The SEC will bring an enforcement action based on issues raised by other regulators (e.g. FINRA) but not adequately remediated.  The regulators will throw the book at recidivists.  (see e.g. In re Morgan Stanley).

https://www.sec.gov/litigation/admin/2017/34-81025.pdf

Investment Adviser Sentenced to 2 Years in Prison for Cherry-Picking Trades

An investment adviser was sentenced to 2 years in prison plus another 2 years of supervised release for engaging in an illegal cherry-picking scheme that favored his personal accounts over his clients.  He was also ordered to pay $1.3 Million in restitution.  The SEC charged that the adviser used omnibus accounts and allocated trades at the end of the trading day.  The SEC has not yet imposed civil penalties, which will likely include a significant financial penalty and an industry bar.

OUR TAKE: When we reported this case back in January, we noted that the SEC included 10b-5 charges to allow for criminal prosecution.   Apparently, this strategy was successful as the defendant faces 2 years behind bars.

https://www.sec.gov/litigation/litreleases/2017/lr23867.htm

CFP Board Proposes Fiduciary Standard

The CFP Board has proposed a broad fiduciary standard in its new Code of Ethics and Standards of Conduct.  The proposed fiduciary standard requires a CFP professional to exercise a duty of loyalty, which requires placing the client’s interests above those of the CFP or his/her firm, avoiding or fully disclosing conflicts of interest, and acting without regard to personal or firm financial interests.   The new Code requires disclosure of all conflicts of interest such that a client can provide informed consent.    Comments on the proposed Code are due on August 21.

OUR TAKE: Whether or not the DoL or the SEC moves ahead with a fiduciary standard, the CFP Code would apply a best interest standard to many of the high-end planners carrying the CFP designation.  The fiduciary genie appears to be out of the lamp.

https://www.cfp.net/docs/default-source/for-cfp-pros—professional-standards-enforcement/2017-proposed-standards/final-standards-for-public-comment.pdf?sfvrsn=2

Form ADV FAQs Impact Cross-Border Investment Managers

The SEC’s Division of Investment Management has released additional Form ADV FAQs that affect cross-border investment managers.  The staff advises that non-U.S. investment funds, including UCITs or their equivalent, should be classified as “pooled investment vehicles” when describing assets.  Also, a non-resident GP or managing agent of a relying adviser must file Form ADV-NR.  The FAQs also broadly define “borrowings” for purposes of whether an adviser engages in borrowing transactions on behalf of clients, explain social media disclosure, and clarify that the new Form supersedes SEC no-action relief with respect to relying advisers.

OUR TAKE: The SEC continues to take an extra-territorial regulatory approach to any cross-border adviser that must register in the U.S.

https://www.sec.gov/investment/im-info-2017-04.pdf

Former CCO Fined and Barred for Life for Circumventing SEC Order

 The SEC fined and permanently barred a former broker-dealer chief compliance officer for violating a prior 5-year bar by consulting with the BD on FINOP matters including financial statements and FOCUS filings.  The SEC accuses the respondent from executing a consulting agreement on the day after he resigned to comply with the prior bar.  According to the SEC, the respondent “continued to run the day-to-day operations” for the next 3 years and maintained a BD email account.

OUR TAKE: There is a special place in the basement of the SEC Enforcement Division with wall photos of recidivists.  The SEC staff will show no quarter to those that violate enforcement settlements.

https://www.sec.gov/litigation/admin/2017/34-80884.pdf

Clearing Broker Charged with Failing to File SARs

 The SEC instituted enforcement proceedings against a clearing broker for failing to file required Suspicious Activity Reports as required by the Bank Secrecy Act.  Although the broker-dealer had appropriate Written Supervisory Procedures, the firm failed in practice to implement its compliance program.  The firm filed nearly 2000 SARs that omitted necessary descriptive information, failed to file follow-up SARs with respect to another 1900 transactions, and did not file 250 SARs within the required time frames.  The SEC claims that the deficient SARs “facilitated illicit actors’ evasion of scrutiny by U.S. regulators and law enforcement.”

OUR TAKE: The BSA is no joke.  Failure to file SARs can result in crippling fines (up to $25,000 per failed SAR) and land you in jail.  It should be Chapter 1 of a broker-dealer’s compliance program.

https://www.sec.gov/litigation/complaints/2017/comp-pr2017-112.pdf

Supreme Court Limits SEC Disgorgement

The U.S. Supreme Court has ruled that the SEC cannot seek disgorgement with respect to ill-gotten gains received more than 5 years ago.   A unanimous Court held that disgorgement is a “penalty” under the statute of limitations because (i) the SEC brings public cases not intended to remedy individual harm and (ii) disgorgement is imposed for punitive and deterrent purposes.  The Court rejected the SEC’s argument that disgorgement is used for restitution because disgorgement orders often exceed the defendant’s gains.  The Court has previously held that SEC penalties are also subject to the 5-year statute of limitations.

OUR TAKE: The Supreme Court significantly constrains the SEC’s enforcement power to demand huge settlements based on multi-year violations.  The SEC will have to move more quickly to investigate and file.

https://www.supremecourt.gov/opinions/16pdf/16-529_i426.pdf