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Fund Manager Barred for Misusing Soft Dollar Credits

The principal of a hedge fund manager was fined and barred from the industry, and his firm’s registration was revoked, for misusing soft dollar credits and cherry-picking trades. According to the SEC, the fund manager misused over $1.1 Million in soft dollar credits to pay such expenses as alimony to his ex-wife, inflated rent to an affiliated company, salary to an employee, and timeshare expenses. The SEC notes that such payments contradicted disclosures in the PPMs and the Form ADV. The SEC also charges the firm with engaging in an illicit cherry-picking scheme to enrich certain hedge fund clients over other clients.

We are seeing a renewed SEC interest in how firms use soft dollar credits. Although the facts of this case date back several years, this action may portend future regulatory and enforcement initiatives.

Federal Court Says that Outside Advice is Not a “Get-Out-of-Jail-Free Card”

The United States Court of Appeals for the D.C. Circuit upheld the SEC’s decision that an investment adviser failed to fully disclose mutual fund revenue sharing even if it sought and relied on the advice of outside compliance consultants. The Court found that the adviser acted negligently by failing to fully disclose the conflict of interest inherent by receiving shareholder servicing payments for investing in certain funds offered by its broker/custodian. Although the record was unclear about whether the adviser sought or relied on an outside compliance consultant’s advice, the Court decided that it didn’t matter because “any reliance on such advice was objectively unreasonable because [the adviser] knew of their fiduciary duty to fully and fairly disclose the potential conflict of interest.” The Court did, however, throw out the SEC’s claim that the adviser intentionally filed a misleading Form ADV, because the SEC failed to show that the adviser acted with the requisite intent to deceive.

As we have previously reported, this case argues in favor of seeking outside advice because it will help defend against the claim that you acted with intent, which would draw more punitive penalties. However, the Court here makes clear that relying on outside advice, even though you (should) know otherwise, will not exonerate you from claims that you acted negligently.

Name-Dropping in Offering Materials Leads to Securities Fraud Charges

The Canadian-based principal of a company formed to invest in blockchain companies and digital assets was fined and censured by the SEC for making misrepresentations while soliciting capital. According to the SEC, the respondents used slide decks and other materials that falsely claimed that four prominent blockchain individuals served as advisors to the company. The respondents boasted “access to, and unparalleled relationships with, opinion-makers, the best entrepreneurs, and the highest profile figures in the blockchain community.” The SEC maintains that these false statements helped raise $16 Million in a convertible debenture offering. The Ontario Securities Commission imposed an additional $520,000 fine following a court order whereby the principal agreed to forego his $2 Million interest in the company.

Didn’t know that name-dropping could result in securities fraud? Any misstatement arguably relied upon by investors could give rise to Section 17(a)(2) charges of offering securities by means of an untrue statement of a material fact.

Adviser Failed to Disclose Personal Financial Problems

A state registered adviser was barred from the industry for failing to disclose a personal bankruptcy on Form ADV in addition to other charges. The Colorado Securities Commissioner cited a Form ADV that contained material omissions about the respondent’s 2017 personal bankruptcy and otherwise misrepresented his qualifications. The CSC also charged the respondent with overcharging clients and intentionally concealing the misconduct. The SEC also barred the adviser from the industry.

Form ADV, Item 18.B. specifically requires investment advisers to “disclose any financial condition that is reasonably likely to impair your ability to meet contractual commitments to clients.” Item 18.C. also requires the disclosure of any bankruptcy petition during the prior 10 years. As investment advisers struggle financially, compli-pros should assess whether the firm needs to enhance its financial condition disclosure.

SEC Official Warns Firms Not to Shortchange Compliance

In a recent speech, the Director of the Office of Compliance Inspections and Examinations, Peter Driscoll, admonished firms who do not adequately resource the compliance function. Calling compliance officers “partners,” Mr. Driscoll lauded their role on the “front lines” of regulatory compliance. Mr. Driscoll said that he could not “underscore enough a firm’s continued need to assess whether its compliance program has adequate resources to support its compliance function.” OCIE is concerned “when we hear directly from industry participants and read press reports that compliance resources and budgets are being cut or are not keeping up with firms’ risk profiles.” He stressed the importance of compliance as equal to other key business lines, critical to the success of the overall business in its role to protect the trust of clients, investors, and customers.

We have observed OCIE staff specifically ask about compliance resources and spending during examinations. Based on various research studies and our own empirical experience, firms should benchmark to spend at least 5% of revenue on compliance resources including personnel and technology. Of course, the actual spending should vary depending on the complexity and size of the business.

SEC Proposes Streamlining Financial Information for Fund Acquisitions

The SEC has proposed modernizing the financial information for acquisitions and dispositions, including the acquisitions of investment companies. Proposed changes to Regulation S-X and Form N-14 include eliminating certain pro forma financial statement requirements and changing the “significant subsidiary” test. The proposal also includes specific reporting rules for investment companies rather than relying on financial statement requirements generally applicable to the acquisition of operating companies.

Revising the investment company acquisition process should facilitate legitimate transactions while ensuring that shareholders receive relevant, rather than voluminous, financial information.

Private Equity CEO Failed to Supervise CFO/CCO


A private equity firm, the firm’s CEO, and its CFO/CCO were each censured and fined for overcharging the fund, engaging in improper insider loans, and violating the custody rule.
According to the SEC, the CFO/CCO failed to properly allocate management fee offsets for certain deemed contributions, thereby overcharging the fund by about $1.4 Million. The CFO/CCO also arranged improper loans between the fund and the management company and overcharged for organizational expenses. The SEC also charges the firm with failing to deliver audited financial statements within the required 120-day period, in part because one of its auditors withdrew from the engagement. The SEC faults the CEO for failing to properly supervise the CFO/CCO as required by Section 203(e)(6) of the Advisers Act. The SEC alleges violations of the Advisers Act’s antifraud rule (206(4)-8) and the compliance rule (206(4)-7).

Senior leaders will not escape accountability by claiming reliance on subordinates. Also, private equity firms can’t use the funds they manage as their firm piggy banks. They need to implement policies and procedures about the withdrawal and use of funds.

The Friday List: 10 Things We Learned During the Spring 2019 Investment Management Conferences

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic. 

As we approach the summer months, the spring 2019 conference season draws to a close.  CCS professionals attended most of the major industry conferences and compared notes.  As we talked, we saw some major themes from all of the conferences.  We thought our clients and friends might benefit from our meta-observations. 

10 Things We Learned During the Spring 2019 Investment Management Conferences

  1. Everybody is afraid of a cyber-breach.  Every conference we attended included sessions about cyber threats and cybersecurity counter-measures.
  2. Private equity is trying to rationalize operations.  Now that PE has become part of the institutional investing landscape, GPs are searching for ways to build scale. 
  3. Compliance officers don’t have the resources to get everything done.  Boards, investors, and the regulators continue to put more work on the CCO’s desk, but senior management doesn’t always meet the increased workload with more resources. 
  4. Technology is the future.  Many firms are racing to replace all aspects of middle and back office operations with technology solutions that enhance and replace human resources. 
  5. Everybody wants ESG.  The term “ESG” was likely used by more people at more conferences than any other term.    
  6. Nobody knows exactly how non-transparent ETFs will affect the product lineup.  Some say they’re a fad.  Some say they’re a complement to existing products.  Some say they don’t make sense.  Some say they will replace all other forms of ETFs.
  7. The hot new asset classes include private credit, cryptocurrency, and cannabis.  Private credit leads with the most products, but people are really excited about cryptocurrency.
  8. The industry is consolidating.  Almost everybody predicts massive industry consolidation as the bigs absorb the smalls, and private equity provides the liquidity.
  9. Nobody knows where the fiduciary rule is going.  Even the SEC has been less than clear about its next step especially with the DoL and the states jumping in (again).
  10. The SEC is in good hands.  We saw many speeches by many SEC leaders.  Despite the political chaos in Washington, the SEC continues to operate with a steady hand through a dedicated staff.  They provided insight on priorities and rulemaking and explained their rationale on enforcement decisions.

Fund Manager Barred for Lying About Investment Strategy

A private fund manager was barred from the industry for misleading potential investors about the success of his trading strategy.  The respondent claimed to invest in a diversified portfolio of publicly-traded securities with a proprietary algorithm to limit downside risk.  Instead, he pursued a highly risky unhedged options strategy that wiped out the fund’s assets.  The SEC alleges that the respondent hid his losses by sending out false account statements and tax forms.  The SEC charged the state-registered adviser with securities fraud.  The parties agreed to additional proceedings to determine penalties and disgorgement. 

This case should be read by any potential client/investor enticed by a too-good-to-be-true investment pitch.  It is unfortunate when legitimate investment managers have to compete for business against wrongdoers who outright lie about their performance.