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Author: Todd Cipperman

Fund Manager Did Not Conduct Adequate Investment Due Diligence

A formerly-registered fund manager was fined and censured for failing to conduct sufficient due diligence on underlying investments, which resulted in significant losses for the funds.  The fund manager invested $4 Million in a Norwegian trading strategy that promised repayment plus $40 Million in interest.  The fund manager represented that he conducted significant due diligence and that his financial advisers approved the investment.  In fact, the fund manager’s due diligence consisted of several phone calls and some Google searches.  Also, his lawyer, accountant, and fund administrator counseled further due diligence before investing. 

It is unclear how much due diligence is enough, but an investment that promises a 1000% return likely requires more than a few phone calls.  When financial professionals recommend a losing investment, they bear the burden of proving that their recommendations and due diligence satisfied their fiduciary and/or suitability obligations. 

Marketplace Lender Fined $3 Million for Overstating Returns Due to Coding Errors


A marketplace lender agreed to pay a $3 Million fine for overstating returns because of coding errors.  The SEC asserts that the firm’s legacy coding omitted charged-off loans from historical performance calculations once the charged-off loans were sold to a third party.  According to the SEC, the firm knew as far back as 2014 that its legacy code had significant issues but failed to fix the code affecting the return calculations.  The firm used the inflated returns in client reporting and marketing. 

As firms implement FinTech and RegTech, they cannot simply set it and forget it.  Compliance, operations, and IT personnel must work together in real time to ensure that systems reflect current regulatory requirements.  Technology is a great tool, but it is not the complete answer to regulatory compliance. 

SEC Commissioner Questions Informal Staff Guidance

SEC Commissioner Hester Peirce recently criticized unpublished staff guidance that operates as de facto legal precedent without going through a process that ensures transparency and accountability.  Referring to the securities regulatory framework as a “compliance minefield” where the wrong move can be a “matter of professional life or death,” Ms. Peirce questioned the propriety of informal staff positions about specific products or types of businesses.  She characterized sub rosa staff guidance as secret law that binds firms without legislative authority, effective oversight, or consistency. 

We agree that unpublished staff guidance can result in industry favoritism and (perceived) unfairness.  The next question is how the SEC addresses Ms. Peirce’s very legitimate concerns. 

Firm’s Weekly Email Reviews Were Not Adequate According to FINRA

FINRA censured and fined a broker-dealer for inadequate email reviews.  Although the firm, through its President/CCO, conducted weekly reviews, FINRA charges that the firm’s random sampling and lexicon-based reviews were not sufficient given the firm’s size and risk areas.  The firm used 24 search terms provided by its email provider, but FINRA asserts that the search terms did not reflect a meaningful assessment of risk areas and resulted in a large number of false positives.  FINRA faults the firm for failing to change the email reviews “[d]espite the obvious indications that the firm’s lexicon system was not reasonably designed.”  FINRA also criticizes the firm’s Written Supervisory Procedures for omitting specific email review procedures. 

Just doing email reviews isn’t enough.  A firm must conduct effective email reviews that can statistically assess whether supervised persons are complying with the securities laws.  We call this “compliance alchemy” i.e. the appearance of compliance without the implementation of adequate procedures and testing.

SEC Warns About Failures to Protect Personal Information

The SEC’s Office of Compliance Inspections and Examinations has published a Risk Alert calling out advisers and broker-dealers for their failures to protect personal information.  Based on deficiencies identified over the last 2 years, the SEC found failures related to privacy notices, policies and procedures, and physical safeguards.  The SEC faulted registrants for failing to deliver initial and annual privacy notices or for delivering notices that did not accurately reflect policies and procedures.  The SEC found firms that completely failed to adopt policies and procedures by simply restating the Safeguards Rule.  Other firms either adopted weak policies and procedures or failed to properly implement them.  Some common deficiencies included unsecure laptops, unencrypted emails, inadequate training, insufficient control of third-party vendors, inadequate incident response plans, and shared login credentials.  OCIE states that the Risk Alert is intended “to assist advisers and broker-dealers in providing compliant privacy and opt-out notices, and in adopting and implementing effective policies and procedures for safeguarding customer records and information.” 

Compli-pros should ensure the annual testing program includes the privacy notice process and the implementation of policies and procedures to avoid the highlighted issues.  It may make sense to combine the testing with the required cybersecurity assessment. 

Day Trader Lied About Track Record

The SEC charged an unregistered day trader for lying about his trading success and misappropriating client funds. The defendant convinced clients to hire him by asserting that that he had done very well as a day trader over several years and then promised over 50% annualized returns.  Once retained, the trader did very poorly and siphoned client assets for personal expenses.  According to the SEC, he then concealed his misconduct by delivering false account statements and implementing a microcap wash sale scheme.  The defendant also faces criminal charges brought by the U.S. Attorney’s Office for the Eastern District of New York.

Lying about your investment track record constitutes securities fraud, subjecting you to civil and criminal penalties.  Do not make performance claims unless you can affirmatively support your claims with hard data. 

Charged CFO/GC Agrees to Cooperate to Avoid Big Penalty

The former Chief Financial Officer/General Counsel of a technology company settled an enforcement action which included requiring him to pay over $400,000 in disgorgement and interest. The CFO/GC avoided a civil penalty by agreeing to cooperate in a related enforcement action.  The SEC charges the CFO/GC with turning a blind eye to inflated financial statements prepared by the CEO to help sell insider shares in secondary market transactions.  The CEO recently settled charges by agreeing to pay more than $17 Million.  Although the respondent did not have a financial background, the SEC asserts that he knew or should have known that the financial statements were misleading based on internal communications with the CEO and internal accounting professionals.

Corporate executives cannot avoid accountability by claiming that they were just following orders.  The SEC has maintained that senior executives have a duty to investors and the markets to stop financial wrongdoing at the companies they steward.  Once charged, the SEC will often use its leverage to encourage cooperation in cases against others in the C-Suite.

Investment Adviser Sentenced to Over 7 Years in Prison

A financial adviser was sentenced to more than 7 years in prison and ordered to pay over $3 Million in restitution for misappropriating client funds by forging client signatures and altering account statements.  The SEC alleged that the defendant made 56 unauthorized withdrawals from client account over a five-year period.  The SEC also charged that the defendant lied to her firm and provided fake documentation to hide her activities.  The SEC charged her with violating the Advisers Act and with securities fraud.  The prison sentence arose from parallel criminal proceedings brought by the U.S. Attorney for the District of Massachusetts for wire fraud, investment adviser fraud, and aggravated identity theft.

Although the SEC does not have criminal prosecution powers, it has the discretion to refer matters to the U.S. Attorney once it uncovers securities wrongdoing.  If the DoJ can make a federal criminal case because of fraud or theft, an investment adviser can end up a guest of the state for several years. 

Fund Manager Failed to Register as Broker-Dealer

A former fund manager was barred from the industry and faces possible fines and disgorgement for misrepresenting fees and commissions and for selling the fund without registering.  His partner previously settled with the SEC by agreeing to pay over $1.2 Million.  According to the SEC, the defendant hid the nature of the compensation received for selling the fund, which constituted transaction-based compensation requiring broker-dealer registration.  The SEC also charged the adviser with failing to register his firm as an investment adviser and with securities fraud. 

Fund managers that engage in selling efforts must register as broker-dealers unless they can take advantage of the issuer exemption (Rule 3a4-1), which prohibits the receipt of specific transaction-based compensation. 

SEC Says that ICO is Not a Securities Offering


The staff of the SEC’s Division of Corporation Finance has issued no-action relief that allows an initial coin offering without registration.  The no-action relief relies on an opinion of counsel that the underlying digital tokens are not securities as well as several other conditions including (i) the sponsor will not further develop the platform, (ii) the tokens will be immediately useable and functional, and (iii) the tokens are not marketed in a manner that emphasizes their potential for increased market value.  In a companion release, the SEC Strategic Hub for Innovation and Financial Technology (FinHub) issued guidance about how to determine if an ICO is an offering of securities under the applicable Howey test.  FinHub relies heavily on whether the sponsor of the network will engage in further development of the network or digital asset so as to generate increased market value for investors. 

Up until now, the SEC has taken the position that ICOs are securities offerings, subject to the Securities Act’s registration and disclosure requirements.  This no-action letter and companion guidance suggest that the SEC may back off its aggressive position and allow the digital token world to evolve organically.  What is unclear is whether any ICO sponsor should go forward without a no-action letter.