sponsor of a private fund agreed to disgorge its management fees for soliciting
investors without a pre-existing, substantive relationship. The SEC accuses the fund sponsor and its
principal with engaging in a public solicitation through a website and media
interviews. The respondents had filed a
Form D Notice of a private offering. The
alleged public solicitation violated Section 5 of the Securities Act, which
requires a registration statement before engaging in a public offering. During the unlawful offering, the value of the
fund declined 62%, which amounted to over $300,000. The Order notes that the principal had no
prior securities industry experience. The SEC declined to impose further
penalties because of the respondents’ financial condition.
Most securities professionals know that you cannot raise capital in a private offering unless the offeror can document a pre-existing relationship with potential investors. However, as FinTech and the securities markets intersect, the neophytes may not realize that they are tripping over the regulatory wires. This respondent is lucky that the SEC didn’t order full rescission of the offering and the refund of the amount lost.
It is a HUGE warning sign when a fund manager fails to deliver audited financial statements, regardless of the ostensible reasons for delay. What may be most shocking is that this firm engaged in unlawful conduct for at least 11 years until the SEC uncovered wrongdoing during a routine OCIE exam in 2018.
Three CCS professionals – Jocelyn Dalkin, Jason Ewasko and Bridget Garcia – recently attended the IA Watch’s 21st Annual IA Compliance: The Full 360° View East conference in Washington. If you were unable to attend, you should review their summary of the most significant sessions including Dan Kahl’s summary of Enforcement Priorities, a top panel’s views on SEC rulemaking, and more specialized sessions on cybersecurity and custody. If you want more information, feel free to contact Jo, Jason or Bridget
SEC has proposed an overhaul of the registration and offering rules for business
development companies and closed-end funds. The proposal provides for a shelf registration
for funds with a public float of at least $75 Million and a more flexible
offering and communications scheme for Well-Known Seasoned Issuers with a
public float over $700 Million. The proposal
would allow interval funds to pay registration fees based on the issuance of
shares rather than paying an estimate at registration. The proposed new rules would change
disclosure rules to follow operating companies, utilizing Form 8-K for significant
events and management discussion of fund performance in annual reports. A 60-day comment period will begin upon
These changes are long overdue. The current rules shoehorn BDC and closed-end funds into the mutual fund regulatory regime, resulting in some unintended regulatory consequences. While we’re sure that industry pros will debate the specifics of the proposal, it’s hard to argue that the SEC shouldn’t revamp the rules.
SEC’s Investment Management Division Director, Dalia Blass, anticipates that
the Division will soon recommend changes to the adviser marketing and solicitation
rules. In her annual speech to the Investment
Company Institute membership, Ms. Blass also announced initiatives for a
summary shareholder report, updates to the valuation guidance, modernization of
the offering rules for business development companies and closed-end funds, and
changes to the rules for funds’ use of derivatives. Additionally, Ms. Blass wants the Division to
finalize the proposed ETF and fund-of-funds rules. She has also asked the staff to begin an
outreach to small and mid-sized fund sponsors about regulatory barriers. She announced that the Division is
considering the formation of an asset management advisory committee to solicit diverse
viewpoints on critical issues.
We applaud the reinvigorated Investment Management Division for tackling some of the thornier problems that have faced the industry for many years. For instance, the marketing rules haven’t changed for decades despite revolutionary change in the financial services industry.
A private fund and CDO manager agreed to pay over $400,000 to settle charges that it facilitated an illegal cross-trade that benefitted one client over another. The SEC alleges that the firm sold securities held by its CDO client to its private fund at an artificially low price because the respondent failed to obtain required third-party bids. Instead, the SEC asserts, based on a record of a phone conversation, that the firm asked friendly firms to provide false bids with assurances that they would not have to purchase the securities. The private fund ultimately sold the securities at a significant profit. The SEC also charged the firm’s Chief Operating Officer (who was fined and barred from the industry) for arranging the transactions and personally benefitting through his investment in the private fund.
Firms should avoid client cross-trades. One side will always benefit, which gives rise to conflict of interest and favoritism allegations. A fiduciary on both sides of a transaction may not be able to cure the conflict with any amount of disclosure.
broker-dealer was fined and censured for failing to act against a longtime broker
charged with participating in pump-and-dump transactions. The SEC faults the firm for ignoring red flags
including emails outlining the illegal activity, FINRA arbitrations, and
customer complaints. One supervisor
explained that he did not act more aggressively because the broker worked at
the firm for 30 years and her business partner was a partial owner of the firm.
The SEC asserts that the firm’s supervisory system “lacked any reasonable
coherent structure to provide guidance to supervisors and other staff for
investigating possible facilitation of market manipulation.” The SEC also maintains that the firm “lacked
reasonable procedures regarding the investigation and handling of red flags.”
Reasonable policies and procedures must do more than simply restate the law and the firm’s commitment to comply with the law. The compliance manual or WSPs must specifically describe HOW a firm will prevent and address regulatory misconduct.
Firms that take revenue sharing from fund companies should consult counsel about their self-reporting options. Also, whether or not your firm self-reports, you should undertake the review of all relevant disclosure that the SEC has mandated.
fined a large broker-dealer $2 Million for under-resourcing its compliance
function, thereby allowing unlawful short-selling. As the firm’s trading activity increased, the
firm continued to rely on a primarily manual system to monitor compliance with
Regulation SHO’s requirements. The
handful of employees tasked with monitoring trading requested more resources as
their 12-hour workdays could not adequately surveil the activity of 700 registered
representatives. FINRA alleges that the
firm routinely violated Regulation SHO by failing to timely close-out
positions, illegally routing orders, and failing to issue required
notices. As part of the settlement, the broker-dealer
also agreed to hire an independent compliance consultant.
TAKE: Firms need to track business activity to ensure that compliance and operations
infrastructure keep up with the business.
A good metric is whether the firm spends at least 5% of revenues on compliance
infrastructure including people and technology.
The SEC will offer no quarter to RIAs who ignore their basic compliance responsibilities. At a bare minimum, firms must appoint a dedicated and qualified CCO, adopt tailored policies and procedures, annually test the program, and generally attempt to comply with the Advisers Act. The initiation of proceedings, rather than a settled order, suggests that the SEC intends to pursue aggressive penalties.