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Month: July 2018

General Partner Fined for Violating Tender Offer Rules

 

The SEC censured and fined the General Partner of a private partnership for failing to file the required notice and response to third party tender offers.  The SEC faults the GP for failing to file a Schedule 14D-9 following the receipt of information of tender offers for more than 5% of the partnership’s interests.  The Schedule 14D-9 is the method by which investors receive information about a tender offer and management’s response.  Because no public market existed for the partnership’s interests, the failure to notify investors could have resulted in fewer investors selling their interests to the third party.

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.

 

Top 5 Regulatory Alerts – April-June 2018

 

Here are our Top 5 Regulatory Alerts for April-June 2018, ranked by significance.  We have also included the Top 5 most read Alerts.

 

Top 5 Regulatory Alerts – April-June 2018

  1. SEC PROPOSES BROKER BEST INTEREST STANDARD (4/19/18)
  2. SEC PROPOSES ETF RULE (6/29/18)
  3. INTERNET COMPANY PAYS $35 MILLION FOR FAILING TO TIMELY DISCLOSE HACK OF CUSTOMER INFO (4/25/18)
  4. SEC OFFICIAL SAYS THAT A CRYPTOCURRENCY IS NOT A SECURITY, ABSENT A SPONSORED OFFERING (6/15/18)
  5. SEC FINES 13 FIRMS FOR FAILING TO FILE FORM PF (6/4/18)

 

Most Read – April-June 2018

  1. SEC WARNS ADVISERS ABOUT FEE AND EXPENSE PRACTICES (4/13/18)
  2. BROKER-DEALER FINED FOR FAILING TO PRODUCE EMAILS (5/22/18)
  3. LAWYER CHARGED WITH PREPARING MISLEADING REGISTRATION STATEMENT (5/14/18)
  4. SEC CHARGES HEDGE FUND FIRM WITH INFLATING VALUATIONS TO SLOW REDEMPTIONS (5/10/18)
  5. FUND ADMINISTRATOR LIABLE FOR MISCALCULATING FUND NAV (4/27/18)

Private Equity Exec Barred from Industry for Personal Transaction with Portfolio Company

 A private equity firm’s managing partner, who also served as its Chief Compliance Officer, was barred from the industry and fined for failing to disclose his personal interest in a portfolio company.  The SEC alleges that the respondent caused the fund to make a loan to the portfolio company on the condition that the company used a portion of the proceeds to redeem his investment.  The SEC faults the executive for failing to disclose the transaction or to obtain consent to it from the limited partnership committee.  Neither the fund nor the investors lost money because the portfolio company ultimately sold the notes to an unaffiliated third party.

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.

 

Broker-Dealer Ignored Information Barriers for Issuer Share Repurchases

 The SEC fined a broker-dealer $1.25 Million for failing to respect required information barriers, thereby allowing the sharing of material nonpublic share buyback information with customers.  The SEC alleges that the trading desk that executed issuer share repurchase trades shared order data with another desk that disclosed the information to customers.  The head traders of the two desks shared trading intelligence including access to the order management system.  The SEC maintains that the information was material to an investment decision because third party customers could use the trade orders as indications of the financial health of the underlying issuer.   The SEC charges the firm with violating its own policies on information barriers.

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.

 

Adviser Withheld Prepaid Fees and Concealed Deteriorating Financial Condition

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.

 

Private Equity Firm Failed to Deliver Financials within 120 Days

 The SEC fined and censured a private equity firm for failing to deliver audited financial statements to limited partners within 120 days of the end of the fiscal year, as required by the custody rule (206(4)-2).  The firm missed the deadline by an average of more than 60 days in every year since it registered in 2012.  Although the staff will give a firm a pass if it misses the deadline due to “unforeseeable circumstances,” the SEC faults the PE firm for failing to make material changes to its compliance processes, thereby leading to a violation in 6 consecutive years.

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.

 

Broker-Dealer Fined $1.25 Million for Deleting Phone Calls and Inadequate Records Retention

 

The SEC fined a broker-dealer $1.25 Million for deleting recorded telephone conversations and failing to maintain books and records related to broker expenses.  The broker-dealer deleted audio files after receiving an SEC request.  The BD failed to “ensure that this litigation hold notice was distributed to the technicians in department responsible for maintaining voice recordings.”  The SEC also charges the firm with multiple failures to maintain required records of broker personal expenses and gifts and entertainment.

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.

 

Portfolio Manager Made Personal Loan to CEO to Get on Board

 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.

 

Advisers Failing Best Execution Compliance Obligations

The SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert listing the most common deficiencies cited in recent examinations of advisers’ best execution obligations.  Reviewing over 1,500 exams, the OCIE staff highlighted advisers’ failures to (i) conduct any best execution reviews, (ii) consider qualitative factors (e.g. execution capability, responsiveness), and (iii) utilize multiple brokers or to compare execution quality against other brokers.  The OCIE staff also witnessed widespread failures to fully disclose best execution practices such as client preferences and soft dollar arrangements.  The staff reports that many advisers either had inadequate policies and procedures or failed to follow them.  The staff encourages advisers “to reflect upon their own practices, policies, and procedures in these areas and to promote improvements in adviser compliance programs.”

OUR TAKE:  In its recent fiduciary interpretation release, the SEC specifically identified best execution as core to an adviser’s fiduciary obligation.  As a core obligation, it concerns OCIE that they have identified pervasive compliance failures during examinations.  Ensuring a best execution review should be part of every compliance testing program.