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Month: December 2019

Top 5 Regulatory Alerts – Q4 2019

Here are our Top 5 Regulatory Alerts for Q4 2019 (October-December), ranked by significance.  We have also included the Top 5 most read Alerts.

Top 5 Regulatory Alerts – Q4 2019


 Most Read – Q4 2019


Adviser Radio Host Charged with Misleading Advertising Practices


The SEC charged an investment adviser with using his radio show and other advertisements to mislead investors.  The adviser advertised that he had been selected to host the radio show, when, according to the SEC, he actually paid to host and broadcast the show.  He also claimed to hold a fictitious “Qualified Retirement Advisor” designation.  The SEC also accuses the adviser of intentionally concealing his significant disciplinary history by failing to deliver Form ADV and using internet search suppression consultants to hide his background.  As alleged, the adviser also failed to disclose compensation arrangements and conflicts of interests.  The principal, who also served as the firm’s Chief Compliance Officer, is also charged with operating a compliance program with insufficiently tailored policies that the firm failed to implement.

Now that the SEC has proposed a new investment adviser advertising rule, we expect that OCIE and Enforcement will step up review of how advisers comply.  The new rule prohibits any misleading or unsubstantiated statements, which would include marketing hype not grounded in specific facts. 

A Review of My 2019 Predictions

Every year, I offer my predictions on what will happen in the investment management regulatory world.  (I will publish my 2020 predictions next Friday.)  For 2019, I went 4-4-2 (ties for predictions that were mostly correct).  Last year, I went 8-2, which suggested I needed to stretch a bit more this year.  Over the last 5 years, I have gone 26-19-5 (4-6 in 2017, 4-3-3 in 2016 and 6-4 in 2015).  Below are the predictions I made in early January and how they turned out:

A Review of My 2019 Predictions

The SEC will propose a comprehensive adviser marketing/advertising ruleThe SEC proposed a comprehensive new investment adviser advertising rule in November.  The SEC has proposed broadening the definition of “advertising” and requiring standardized performance.  (1-0)

The SEC will re-propose the broker best interest standard.  I predicted that the SEC would propose a best interest standard short of an adviser fiduciary standard.  The SEC went one step further by actually adopting a heightened Regulation Best Interest that is not quite a fiduciary standard.  (2-0)

The Enforcement Division will bring several significant cases alleging violations of the solicitor rule.  There were several solicitation cases alleging violative facts such as failure to deliver proper disclosures.  (3-0)

The SEC will liberalize the private offering rules.  After publishing a broad concept release in June, the SEC’s December proposal would expand the definition of “accredited investor.”  (4-0)

OCIE will examine at least 20% of advisers.  OCIE examined only 15% of advisers this year. Even if you annualize results because federal workers were furloughed a month, they didn’t get to 20%.  It still remains an OCIE goal (4-1).

The SEC will bring significant cases against independent fund directors.  I am unaware of any significant cases against independent fund directors this year, other than the usual glut of hopeless 36(b) cases.  Regardless, there is some industry concern that the SEC will begin to scrutinize directors who approve questionable revenue sharing practices.  (4-2)

The SEC will allege securities fraud in secondary market private equity transactions.  There have been cases alleging secondary market fraud, but those cases have not been widespread in the PE market. With the surge in secondary market transactions this year, this prediction may be a year early.  We’ll call it a push. (4-2-1)

The SEC will approve a registered crypto fund.  It didn’t happen, although most of the industry remains hopeful.  The Division of Trading and Markets did allow a pilot program to test the use of a distributed ledger system for securities settlement.  Baby steps.  (4-3-1)

The Supreme Court will decide that digital tokens are not securities and that an ICO is not a securities offering.  This didn’t specifically happen, but, perhaps more surprising, the SEC’s Division of Corporation Finance allowed an initial coin offering without registration on the grounds that the underlying digital tokens were not securities.  If the SEC will concede this point, the issue may not reach the high court.  I am taking a tie on this one.  (4-3-2).

The SEC will expand the whistleblower program.  Despite recommending changes in 2018, the SEC never took action to expand the program in 2019.  Maybe, this comes up again next year.  (4-4-2)

Investment Advisers Included as Accredited Investors in SEC Proposal


The SEC has proposed expanding the definition of “accredited investor” to include investment advisers and licensed professionals, among other new categories.  The SEC did not propose changing or indexing the $200,000 income or $1,000,000 net worth test.  The proposal includes the estimated 13,400 SEC-registered investment advisers and approximately 17,500 state-registered advisers in the definition of accredited investors, but the proposal does not include exempt reporting advisers.  The proposal also includes financial professionals who have their Series 7 or 65 licenses.  Additional new categories include knowledgeable employees of private funds, certain family offices, and a catch-all category for entities owning at least $5 Million in investments.

This proposal is a good start, but we urge the SEC to go further.  The income and net worth tests unduly restrict lower net worth, but knowledgeable, individuals from investment opportunities, while failing to protect  wealthy, but unsophisticated investors. Rather than the income and net worth tests, the SEC should consider knowledge, background and financial sophistication as litmus tests for accredited investor.  We believe that the burden should be on the investor to make representations, upon which an issuer could rely, to determine whether s/he is sophisticated enough.  Alternatively, the SEC could develop a financial quiz that potential investors would have to complete before becoming accredited. 

CFP Task Force Calls for Significant Enforcement and Governance Reform


The Independent Task Force on Enforcement created by the Certified Financial Planner Board of Standards has issued a report that heavily criticizes the CFP’s enforcement program and related governance structure.  The Task Force concludes that the CFP Board’s enforcement program is “not reasonably designed to ensure CFP certificants are held to an appropriate level of compliance.”  The Task Force recommends that the CFP retain a dedicated Director of Enforcement, increase resources devoted to enforcement, undertake periodic audits, and enforce penalties.  The Task Force also recommends several governance reforms. The CFP Board commissioned the Task Force to address gaps between public expectations and the actual operations of the enforcement program.


We laud the CFP Board for commissioning this Task Force to issue a public report this critical.  However, this Report will cause big problems for the CFP Board and the industry.  The CFP Board must take action to create a credible enforcement program or risk a diminution of its public perception.  The industry can now expect the involvement of yet another supervisory body that can conduct audits and impose penalties.    

SEC Charges Non-Traded REIT and BDC Sponsor with Securities Fraud


The SEC has charged a non-traded REIT, its external adviser, an affiliated BDC adviser, and the principal with securities fraud in connection with misrepresentations about assets and insider transactions.  The SEC asserts that the REIT issued shares to the principal in exchange for hotels that he did not actually own.  The SEC also alleges that the principal failed to inform the BDC that he controlled a company to which the BDC made favorable loans.  The SEC alleges multiple violations of the securities laws including the anti-fraud rules and the affiliated transaction rules.

This is the kind of defendant that hurts the entire non-traded REIT and BDC industries.  It raises the bar for legitimate players to implement robust compliance, prove valuations, hire legitimate third party service providers, and retain competent officers and independent directors. 

FINRA Wants Reps to Obtain Approval Before Acting as Beneficiary/Executor/Trustee

FINRA has proposed a new rule requiring registered representatives to obtain approval from their firms any time a firm customer designates the rep as a beneficiary, executor, or trustee or grants a power of attorney.  Upon receiving written notice, the firm must implement review procedures to assess whether the designation or grant presents undue risk for the client.  FINRA believes such a rule is necessary because of the inherent conflicts of interest coupled with evidence that reps have attempted to circumvent firm prohibitions by using a friendly colleague or naming a family member.

Regardless of where FINRA lands on this rule, we recommend that compli-pros prohibit such designations in the WSPs.  FINRA correctly cites the conflicts of interest, especially with senior investors.  If reps already circumvent firm rules, how can FINRA ensure that reps will notify their firms? 

Best of the Law Firms – December 2019 edition

Welcome to the December 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 laws firms have published some extensive articles on important investment management topics.  Dechert answers all our questions about ESG investing, Thompson Hine instructs on how to convert a mutual fund into an ETF, and Sadis tackles Opportunity Zone funds.  Groom always brings the ERISA good stuff, and Winston & Strawn has the best (longest) article title of the year in its piece about digital assets.

Dechert on ESG: An Overview for Asset Managers (Dechert)

Converting a Mutual Fund to an ETF: Key Considerations (Thompson Hine)

SEC and DOL Working Together on Retirement Advice Rules (Groom)

Private Equity and Venture Capital Investment in Opportunity Zones (Sadis)

Consecutive Private and Public Offerings for Registered Funds (Seward & Kissel)

Potential Regulatory Developments for Non-Traded Closed-End Funds (Drinker Biddle)

When It Comes to Analyzing Utility Tokens, the SEC Staff’s “Framework for ‘Investment Contract’ Analysis of Digital Assets” May Be the Emperor Without Clothes (Or, Sometimes an Orange Is Just an Orange) (Winston & Strawn)

New SEC Proposal May Complicate Proxy Voting & Engagement by Advisers (Stradley Ronon)

New Rules on Cross-Border Distribution of Investment Funds in the EU (K&L Gates)

The California Consumer Privacy Act: Key Points for Private Fund Managers (Schulte Roth & Zabel)

CFP Board’s New Standard of Conduct (Eversheds Sutherland)

Preferred Clients Paid Lower Commissions in Block Trades

 The SEC censured and fined an institutional manager for charging different commission rates to different clients even though the manager combined orders in block trades.  The compliance policies and procedures required that the manager allocate execution costs on a pro rata basis when using block trading.  However, certain client agreements (or instructions) imposed a cap on commission rates.  The SEC alleges that the manager allocated commission rates up to the cap for the preferred clients and then allocated the remaining costs to the other clients, thereby causing them to incur more than their pro rata share.  The SEC charges the manager with failing to follow its own procedures.

Large institutional clients often request special treatment either directly or through “most favored nation” clauses.  Sales folks want to land these relationships and often agree to client requirements without consulting with the compliance team.  As a result, last year’s clients loses out to this year’s prospect.  A fiduciary should treat all its clients equitably. 

Adviser Ignored Board, Resulting in Huge Fund Losses


The adviser to four collective investment trusts (CITs) and its principal/PM/CEO agreed to pay over $7.6 Million in disgorgement and penalties for ignoring the CITs’ board and incurring losses due to over-concentration in a single security.  The board recognized that the CITs were overconcentrated in a single security that comprised 30% to 89% of their assets.   The board instructed the adviser to reduce the concentrations to 10%, and the adviser undertook to put a plan together.  According to the SEC, the adviser ignored the board, the CITs continued to be over-concentrated, and the CITs ultimately experienced significant losses as a result.  The board fired the adviser soon thereafter.  The CITs were sponsored by a trust company affiliated with the adviser.

A fund board, even if completely independent, has few remedies available when confronted with a fund sponsor that misleads or ignores the board.  The board can threaten to terminate the adviser (or constructively terminate by reducing fees), but that only leads to the untenable situation of a board having to find a new manager or closing the fund.  Perhaps, the U.S. fund industry should consider a European-style governance structure that includes a third party trustee that can monitor and step in if necessary.