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Month: February 2019

IT Firm Pays Over $25 Million for Bribing Foreign Officials; Execs Charged


An IT outsourcing firm agreed to pay over $25 Million in disgorgement, interest and penalties for violating the Foreign Corrupt Practices Act by paying bribes to Indian government officials to build facilities there.  The SEC and the Department of Justice have also charged the firm’s President and Chief Legal Officer with approving and facilitating the transactions.  According to the SEC, Indian officials demanded bribes to grant construction permits, and the firm approved and arranged such payments through a third-party contractor.   The SEC alleges that the firm hid the bribes by falsifying construction change orders.  The SEC charged the company on the legal theory of respondeat superior whereby the company is responsible for the actions of its senior executives.

Firms doing business outside the United States must create compliance infrastructure to prevent employees at any level from paying bribes.  Violations of the FCPA carry severe civil and criminal penalties. 

Best of the Law Firms – February 2019 edition

Welcome to the February 2019 edition of the Best of the Law Firms.  In this feature, we recommend some of the best recent articles and analyses authored by top investment management lawyers.  These articles offer a more comprehensive review of the issues that we address in our daily “Our Take” alerts. 

The best law firms cranked out some great articles during the last several weeks, perhaps feeling a post-holiday burst of energy.  Paul Hastings offers a great overview of the esoteric world of Section 13 and Section 16 filings.  Morgan Lewis addresses best execution issues when recommending mutual fund share classes.  Dechert tries to discern the future of Brexit.  There were also some great pieces on co-investments from Pepper Hamilton, political and lobbying activities from K&L Gates, and a CFTC survey from WilmerHale.

SEC Reporting Obligations Under Section 13 and Section 16 of the Exchange Act (Paul Hastings)

When Best Execution Isn’t Best: Mutual Fund Share Class Selection (Morgan Lewis)

Brexit Manoeuvres: Potential Implications of a “Hard Brexit” for Fund Managers: A UK Perspective (Dechert)

Common Considerations and Complications of Co-Investments (webinar) (Pepper Hamilton)

Involuntary Termination of Investment Adviser: The Nuclear Option (Perkins Coie)

Fund Boards Are Not Immune to Activists (Skadden)

A Guide to Political and Lobbying Activities (K&L Gates)

A Year to Remember for Business Development Companies (Mayer Brown)

2018 CFTC Year-In-Review (WilmerHale)

Artificial Intelligence in Financial Services: Tips for Risk Management (Kramer Levin)

Preparing for the Next Generation of Actively Managed ETFs (Thompson Hine)

Securities Cases That Will Matter Most In 2019 (Willkie Farr & Gallagher)

Dual-Hat CCO and Weak Supervision Allowed Rogue Trader to Harm Clients

FINRA faulted a firm’s supervisory structure and unqualified Chief Compliance Officer for failing to prevent its CEO/Head Trader from engaging in a scheme that inflated bond prices to the detriment of clients.  FINRA alleges that the Trader engaged in pre-arranged trades with a third-party broker dealer to inflate and deflate bond prices to enrich both parties and circumvent an agreement with a client that capped bond commissions at 15 basis points.  FINRA asserts that the firm failed to supervise the trading and that the CCO did not have the “requisite qualifications, experience and training” to properly supervise the trading activities.  In addition to paying restitution and a fine, the firm hired a dedicated CCO that was not also working for an affiliated bank.

Broker-Dealers and advisers must abandon the dual-hat compliance model, the practice of naming a non-regulatory professional with multiple executive roles.  Firms must retain a competent and dedicated Chief Compliance Officer either by hiring a full-time employee or by retaining the services of an industry-recognized outsourcing firm. 

SEC Cancels Internet RIA Registration for Failure to Launch


The SEC cancelled the adviser registration of a purported internet investment adviser because the registrant failed to launch its website in the three years since registering.  The registrant filed as an RIA under the internet adviser exception whereby an adviser without assets under management is eligible to register if the adviser provides advice exclusively through an interactive website.  The adviser registered in May 2015 and still has not launched its website due to personal events and product complexity.  The registrant argued that the internet adviser exception allows a grace period for development.  The SEC concedes that an internet adviser may be allowed some leeway beyond 120 days (the stated time period for new advisers), but three years is “well over any reasonable grace period.”  Additionally, the SEC places the burden on the adviser to demonstrate “substantial efforts and progress toward developing an interactive website” in order for the Commission to exercise discretion to allow registration beyond the initial 120-day period. 

This decision states for the first time that internet advisers may get more than 120 days to launch so long as they can demonstrate significant progress.  The SEC will grant a grace period, but three years is too long.    

Execs Face Up to 5 Years in Prison for Lying to SEC

Two former employees of a biotech have pleaded guilty to criminal charges of obstructing an SEC investigation.  The Justice Department accuses one of the defendants with testifying falsely before the SEC about his manipulative purchases and sales of the OTC-traded biotech.  The other employee is accused of providing a back-dated document to the SEC with the intent to obstruct the SEC’s investigation.  The two defendants face prison sentences of up to 5 years for obstructing an agency proceeding. 

Although the SEC only has civil enforcement powers, it can (and will) bring in the Justice Department if you lie to SEC investigators.  Better to take your civil medicine (fine or industry bar) than to wind up a guest of the state. 

FINRA Allows Limited Use of Pre-Inception Index Performance Data with Intermediaries

FINRA has issued an interpretive letter allowing a broker-dealer to use pre-inception index performance data to market index-based registered funds to institutional investors including intermediaries.  To use pre-inception data, the index must be developed according to “pre-defined rules that cannot be altered” except under extraordinary conditions, and the member firm may only disseminate the data to institutional investors including intermediaries that will not use the information with their retail clients.  FINRA imposes several conditions including (i) the data includes no less than 10 years of performance information, (ii) the material shows the impact of the deduction of fees and expenses, (iii) the material includes actual fund performance, and (iv) the firm includes extensive disclosure including the reasons why the data would have differed from actual performance during the period.  FINRA previously allowed pre-inception performance data to institutional investors other than intermediaries with the same conditions.

The change here is allowing broker-dealers to provide the information to intermediary financial advisers and putting the burden on the intermediaries to prevent use directly with their retail clients.    Regardless, we recommend against using hypothetical backtested performance data because of SEC concerns as well as the significant regulatory and disclosure limitations. 

PE Firm Bought Insurance Company Clients and Sold Them Over-Valued Illiquid Assets

The SEC barred and censured the principal of a private equity firm for using his position to mislead advisory clients, sell them over-valued assets, and loot the funds.  The SEC accuses the respondent of acquiring insurance companies, entering into investment management agreements, and then selling over-valued illiquid assets (e.g. paintings, private company venture interests) to the insurance companies to siphon off the general funds.  The respondents did not reveal that the valuation agent for the illiquid assets was an affiliated company controlled by the principals. 

This case has all the features of an advisory fraud: illiquid assets, conflicts of interest, an affiliated valuation agent, and individuals with questionable backgrounds.  It is a cautionary tale for investors, compli-pros, and regulators about how far wrongdoers will go to pursue their illicit intents. 

Non-U.S. Adviser Lied on Form ADV

The SEC censured and barred from the industry the principal of a non-U.S.-based investment manager for making false Form ADV statements.  The SEC charges the firm with falsely claiming (i) to have over $100 Million in assets under management, (ii) to have retained a nationally recognized auditor and prime broker for its funds, and (iii) a principal place of business in the United States, which was only a virtual office.  The SEC alleges that the Form ADV statements violated the antifraud rules of both the Securities Act and the Investment Advisers Act.  The SEC asserts jurisdiction because the respondents used interstate electronic communications to further the fraud.  The SEC claims proper venue because the defendants maintained a virtual office in New York. 

Form ADV is a securities law filing that gives rise to antifraud liability for misstatements.  The regulators will not overlook untruths as innocent marketing exaggerations.  Hire a lawyer or compli-pro to help prepare an accurate Form.   

FINRA Wants Firms to Self-Report Unsuitable 529 Plan Recommendations

FINRA announced its 529 Plan Share Class Initiative, a program allowing firms to avoid fines by self-reporting unsuitable share class recommendations to 529 Plan customers.  FINRA questions the suitability of no-load, higher-fee share class recommendations where the beneficiary has more than 6 years until drawing on the account (e.g. where the beneficiary is less than 12 years old).  According to FINRA, no-load share classes tend to exceed the aggregate costs of front-end load, lower-fee share classes after six years.  Member firms have until April 1, 2019 to self-report the issues uncovered and how they intend to remedy violations and pay restitution to harmed customers.  FINRA warns that the 529 Plan Share Class Initiative will not absolve individuals accused of violating MSRB rules. 

At the very least, member firms should review their 529 Plan recommendations to see if they have exposure and then take action to remediate.  Because of the broader implications of an enforcement action and individual liability, we recommend consulting counsel about whether to self-report.