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SEC Alleges that RIA and Principal Ignored Compliance Obligations

The SEC has commenced enforcement proceedings against an adviser and its principal for disregarding its compliance obligations for over 10 years.  The SEC alleges that the firm did not even draft or adopt compliance procedures until an SEC examination commenced in 2015, 11 years after it initially registered.  The SEC also asserts that the principal named two individuals on Form ADV as Chief Compliance Officers even though neither person had responsibility for compliance, and one of the individuals did not even know that he was named as CCO.  The SEC also charges the firm with failing to conduct annual compliance reviews, comply with the custody rule, and maintain required books and records. 

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. 

Compliance Failures Cost BDC Manager $4 Million in Penalties and $2.6 Billion in Assets

 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. 

Compliance Failures Lead to Firm’s Demise

 Compliance deficiencies led to the demise of a private fund manager because of failures to enforce a consistent redemption policy, deliver audited financial statements, and file accurate Form ADVs.  According to the SEC, the firm allowed certain clients and insiders the ability to redeem before the stated 90-day redemption policy.  The firm also failed to deliver audited financials as required by the custody rule.  The SEC also cites the firm for filing inaccurate Form ADVs, including claiming SEC registration eligibility even though the firm had less than $100 Million in assets under management.  The SEC attributes the failures to the firm’s deficient compliance program which used a template manual and did not require annual compliance reviews.   

 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. 


Broker-Dealer Failed to Discipline Commission-Sharing Traders

 The SEC fined a broker-dealer $1.25 Million for failing to take sufficient disciplinary action against brokers that shared commissions in violation of firm policy.  The SEC asserts that the one broker, who ultimately became a supervisor, assigned accounts to junior traders in exchange for off-the-book kickbacks paid by personal checks.  The transactions violated the firm’s policies and procedures and books and records requirements.  Upon discovering the arrangement 13 years after it began as a result of a FINRA investigation, the firm responded by issuing a memo condemning the activity and offering the participants the opportunity to resign.  The SEC faults the firm for failing to discipline the wrongdoers.

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.


Bad Broker Costs Large RIA/BD $3.6 Million for Compliance and Supervisory Failures

The SEC fined a large broker-dealer/investment adviser $3.6 Million because its inadequate compliance and supervisory program failed to stop a broker from stealing from clients.  The broker, currently facing criminal charges, exploited a weakness in the firm’s control systems that allowed third party disbursements up to $100,000 per day based on representations that the broker received oral instructions.  According to the SEC, the broker misappropriated $7 Million from four advisory accounts.  Although the firm did have policies and procedures that included ad hoc manual supervisory reviews, the firm did not require authorization letters, call back clients to verify instructions, or record calls.

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.


SEC Prosecutes Current and Former Compliance Officers for AML Failures

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.



SEC Prosecutes De-Registered Adviser for Prior Compliance Failures

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. 


The Friday List: Our 2018 Predictions

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


  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. 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.
  8. 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.)
  9. 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.
  10. 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.

Dual-Hat Principal/CCO Ignored SEC’s Compliance Deficiencies

The SEC has commenced enforcement proceedings against a fund manager and its principal/CCO for ignoring exam deficiencies about its compliance program and other violations.  The SEC examined the respondents in 2010 and 2014 and noted several compliance deficiencies, which the SEC asserts the respondents ignored.  The SEC charges the dual-hatted principal with failing to perform any work on the compliance program, adopting a stock manual that was not properly tailored to the business, or conducting any compliance review.  The SEC also faults the respondents for charging compliance costs to the funds.  The SEC additionally charges undisclosed conflicts of interest, misrepresentations, and valuation issues.

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.


Hedge Fund Firm Failed to Stop Sharing of Confidential Information

The SEC fined and censured a hedge fund firm for failing to stop its research analyst from sharing confidential information with his wife, who ran another hedge fund.  The research analyst helped his wife start the competing firm and provided internal confidential information including investment models, research and recommendations.  In fact, holdings of the two hedge fund firms significantly overlapped.  After the respondent become aware and warned the research analyst about sharing confidential information, it failed to stop the conduct despite policies and procedures about email review and maintaining confidential information.  The SEC faults the firm for failing to supervise and for failing to implement an adequate compliance program that would effectively monitor and halt unlawful conduct.

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.