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.
A BDC manager’s compliance failures led to nearly $4 Million in fines, disgorgement and penalties and the loss of its advisory business. The SEC charges the firm with misallocating overhead expenses to the registered Business Development Companies it managed and with overvaluing portfolio companies. The SEC maintains that the registrant used material nonpublic information about BDC portfolio companies to benefit affiliated hedge funds that it managed. In 2014, the firm had over $2.6 Billion in assets under management but withdrew its adviser registration in 2017 following the SEC enforcement action. The SEC asserts violations of the compliance rule (206(4)-7) in addition to a laundry list of other securities laws violations.
Failure to implement an effective compliance program has consequences beyond penalties and fines. The negative impact to a firm’s and its principals’ reputations could ultimately bring down the entire franchise.
OUR TAKE: Failure to implement an adequate compliance program can have real-world implications for the viability of your firm. A tight compliance program will support a more coherent operating environment that will prevent sloppy business practices that will lose clients and attract regulators.
OUR TAKE: Having policies and procedures, but taking no significant action against those who violate them, eviscerates their purpose. This compliance voodoo – the mere appearance of a compliance program – will draw the ire of the regulators.
OUR TAKE: A motivated miscreant will find the weaknesses in your compliance and supervisory system. To avoid this type of theft, a firm should prohibit any third party money movement without the review of a supervisor or compli-pro.
The SEC fined and barred from the industry an anti-money laundering compliance officer for failing to file Suspicious Activity Reports. The SEC asserts that the AML CO ignored red flags about heavy trading in low-priced securities including specific alerts provided by the clearing firm and warnings from the SEC OCIE staff. The SEC also commenced proceedings against the previous AML CO for similar failures. The Bank Secrecy Act and the firm’s Written Supervisory Procedures specifically required filing of SARs for several transactions that the respondents ignored over a 2-year period. The SEC also fined the firm and its CEO.
OUR TAKE: This firm did not have the requisite compliance “tone at the top” when 2 compliance officers and the CEO all ignored AML red flags, yet the SEC seeks to hold the compliance officers specifically accountable. Also, compliance officers should take note that they don’t escape liability for past actions when they quit a job. The SEC can still bring charges against former employees for misconduct that occurred while they acted in a compliance function.
The SEC fined a deregistered investment adviser and barred its former principal for multiple compliance failures involving double dipping, Form ADV disclosures, fee rebates, and misrepresentations. The respondents recommended that clients invest in private funds in which the principal held ownership and managerial interests. Although the SEC acknowledges that clients knew about the conflict, the firm failed to list and describe the conflicts on Form ADV. The SEC also charges the firm with multiple compliance program failures including inadequate policies and procedures and failing to conduct annual testing of the compliance program.
OUR TAKE: There is no such thing as declaring regulatory bankruptcy: the SEC’s long arm won’t let a firm engage in wrongdoing and then simply de-register to avoid consequences. Compli-pros should also note that disclosure alone will not always cure significant conflicts of interest, such as fee double dipping for advisory services along with underlying products.
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.
Every year, we offer our predictions on what will happen in the investment management regulatory world. Last year, we went 4-6 (not great on a test, but pretty good in baseball). We were right about the fiduciary rule, whistleblowers, state enforcement, and individual liability. We missed on our predictions of regulatory changes and how the industry would respond to the increased demand for bonds.
The current uncertain regulatory environment has changed our hubris to humility. Thus, it is with humble intent that we look forward to offer our 2018 predictions:
Predictions for the 2018 Regulatory Year
More states will adopt fiduciary rules. Nevada has already adopted a uniform fiduciary standard in the wake of the DoL’s delay. We expect other states (e.g. California, New York, Connecticut) to follow.
The SEC will propose a uniform fiduciary rule for retail advisers and broker-dealers. Chairman Clayton has spoken publicly about the need for the SEC to wade into the fiduciary waters. Expect a proposed rule this year.
The SEC will commence significant cybersecurity enforcement actions. The staff has done a sweep and issued guidance. We have not yet seen significant enforcement actions. We expect several this year.
There will be cases alleging C-suite wrongdoing in private equity. The SEC Enforcement Division has focused on the private equity industry for the last couple of years. Given their interest in prosecuting senior executives to deter unlawful conduct, expect a couple of big cases against private equity execs.
FINRA will bring actions against firms for hiring bad brokers. Rather than simply prosecute the brokers, FINRA will dedicate some enforcement resources to firms that fail to screen out the bad brokers, thereby making it a firm responsibility.
SEC and/or FINRA will bring cases alleging inadequate branch office supervision. Both regulators have expressed concerns about remote office supervision. Enforcement cases will ensure the industry’s attention.
The SEC will commence significant marketing/advertising cases. Seemingly out-of-the-blue, the SEC warned advisers about misleading marketing and advertising claims. We are assuming that OCIE is uncovering a lot of problems.
The SEC will propose a re-write of the custody rule. The custody rule has the right intent, but the rule itself is too open to interpretation and questions (see multiple FAQs). We think the Division of Investment Management will undertake a re-write (although maybe this is just wishful thinking.)
The SEC will propose cryptocurrency regulations. Bitcoin futures are flying high. The SEC has expressed its opinion that it should regulate cryptocurrency offerings. We expect some rules.
The SEC will re-propose the ETF rule. Plain vanilla ETFs should have a rule that allows them to proceed without an exemptive order. The SEC proposed and abandoned a rule several years ago. We anticipate that the SEC will resuscitate the effort.
OUR TAKE: The SEC doesn’t always give you a second chance to fix cited deficiencies. But when they do and you don’t, expect an enforcement action. Also, this is another example of the failure of the dual-hatted CCO model, where an executive ignored his compliance responsibilities. Penny wise and pound foolish.
OUR TAKE: You must walk the compliance walk, not just talk the compliance talk. Registered firms must implement compliance policies and monitoring, not simply adopt broad policies and procedures that sound good.