OUR TAKE: Closed-end funds that rely on tender offers for investor liquidity must ensure strict compliance with the arcane and voluminous tender offer rules. As the market for more esoteric products grows, the SEC will use the tender offer rules to ensure full and fair disclosure.
OUR TAKE: Without proper disclosure and consent, a transaction that benefits the fund sponsor or its principals will violate the Advisers Act’s fiduciary duty whether or not the investors suffered any harm. This case also highlights the perils of the CCO dual-hat model whereby a senior executive with a pecuniary interest also serves as the Chief Compliance Officer, thereby avoiding independent scrutiny.
OUR TAKE: It appears that the firm failed to implement a monitoring system to ensure that the trading desks observed information barriers. How firms ensure the protection of material nonpublic information should be part of the annual testing program.
The SEC fined an adviser and its principal for failing to timely refund prepared advisory fees to terminating clients and for neglecting to disclose its failing financial condition. When two of the firm’s financial advisers left the firm and forwarded 63 client termination letters, the respondent declined to refund fees paid at the beginning of the quarter, claiming that it would not accept electronic signatures, notwithstanding the firm’s written policies. The SEC also asserts that the firm suffered from chronic cash shortages late in every quarter because it received its fees at the start of the quarter. The SEC faults the firm for failing to disclose its deteriorating financial condition including its default on several loans and its negative net worth and insolvency. Item 18.B. of Form ADV requires discretionary advisers to “disclose any financial condition that is reasonably likely to impair your ability to meet contractual commitments to clients.”
OUR TAKE: As economic circumstances change, advisers should consider whether they need to make Item 18 disclosure, especially if creditors declare a default on outstanding loans. Unlawfully withholding client funds turns financial problems into regulatory actions.
OUR TAKE: We have found the staff to be fairly reasonable if a firm misses the deadline by a few days because of an unusual event such as a hard-to-value security or a change in auditors. When you consistently ignore a regulatory requirement and fail to make changes, the Enforcement Division will treat you as a regulatory recidivist and proceed accordingly.
OUR TAKE: The SEC will take punitive action against firms that fail to preserve regulatory records, whether or not the firm acted with bad intent. We recommend creating a regulatory records chart to serve as reference for all employees. Also, firms should create a policy and related procedures governing how it will ensure all employees comply with regulatory requests.
A portfolio manager of an activist investment firm failed to disclose a $3 Million personal loan to the CEO of a company in which he invested. The portfolio manager made the loan, according to the SEC, to secure the CEO’s support for his election to the Board as part of a broader initiative to exert control over the company. The SEC asserts that the portfolio manager violated his fiduciary duty to his clients by concealing his personal interest and that the investment manager failed to file a Schedule 13D (indicating more than passive investment). Also, the SEC faults the adviser for failing to implement a reasonable compliance program because the policies and procedures “did not discuss conflicts of interest more broadly in sufficient depth so as to capture and train employees to recognize other violative conduct not specifically identified.”
OUR TAKE: Because portfolio managers are often treated like the rock stars of investment management, compli-pros must implement heightened supervision to protect against reckless actions that will ultimately hurt the firm. Procedures should include reviews of investment decisions, due diligence about personal dealings, reviews of transactions outside the ordinary course, and training all employees how to identify unlawful activity.