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VC Manager Failed to Register as Investment Adviser

 

The SEC has commenced proceedings against the principal of a venture capital fund manager for failing to properly register as an investment adviser under state law.  The Connecticut securities regulator entered a final order alleging failure to register the fund manager as an investment adviser under Connecticut law and making false representations about the success of the funds.  The action led to criminal proceedings to which the respondent entered guilty pleas.  Now, the SEC has begun proceedings to implement federal civil penalties under the Advisers Act.

Avoiding required registration will not long go unnoticed.  Eventually, the state securities regulators or the feds will find you.  Your risk goes up exponentially if an aggrieved client has lost money or a competitor raises eyebrows. 

FINRA Plans Review of Regulation BI Compliance Among Other Examination Priorities

 FINRA plans to examine firm compliance with new Regulation Best Interest, Form CRS and related SEC guidance and interpretations during the upcoming year, according to its 2020 Risk Monitoring and Examination Priorities Letter.  FINRA will review whether firms have implemented procedures and training, whether their reps observe the best interest standard of care, how the firm guards against excessive trading, and the extent to which firms identify and address conflicts of interest.  Other significant priorities include sales practices and supervision (especially complex products, variable annuities, private placements, mark-ups/downs, and senior investors), trading authorization, best execution, TRACE reporting, and cybersecurity.

It is notable that FINRA intends to prioritize Regulation BI in the first year.  Usually, the regulators give some time for firms to put operations in place before conducting regulatory sweeps for compliance with new laws and regulations.      

Barred Adviser Lied to Investors about Track Record, Credentials and Performance

 

The SEC has commenced proceedings against a barred investment adviser for fraudulent statements made during a note offering.  The SEC alleges that the respondents concealed a barred adviser’s disciplinary history and industry bars by entering into a bogus operating agreement showing a 5% ownership interest when he had a 50% stake.  The other partner to the venture had little to no securities experience.  The SEC accuses the respondents of lying to investors to induce them to purchase promissory notes with their self-directed IRA accounts.  The respondents allegedly lied about performance, safety, track record, and credentials.

This is exactly why the industry needs an active regulator.  Only by ridding the industry of (alleged) liars and thieves like this can the investment industry instill confidence in the regulators, the clients, and the lawmakers.  Ultimately, strong regulation facilitates growth as evidenced by the $20 Trillion in assets in registered funds and ETFs, the most regulated investment products on the planet. 

CFP Task Force Calls for Significant Enforcement and Governance Reform

 

The Independent Task Force on Enforcement created by the Certified Financial Planner Board of Standards has issued a report that heavily criticizes the CFP’s enforcement program and related governance structure.  The Task Force concludes that the CFP Board’s enforcement program is “not reasonably designed to ensure CFP certificants are held to an appropriate level of compliance.”  The Task Force recommends that the CFP retain a dedicated Director of Enforcement, increase resources devoted to enforcement, undertake periodic audits, and enforce penalties.  The Task Force also recommends several governance reforms. The CFP Board commissioned the Task Force to address gaps between public expectations and the actual operations of the enforcement program.

 

We laud the CFP Board for commissioning this Task Force to issue a public report this critical.  However, this Report will cause big problems for the CFP Board and the industry.  The CFP Board must take action to create a credible enforcement program or risk a diminution of its public perception.  The industry can now expect the involvement of yet another supervisory body that can conduct audits and impose penalties.    

SEC Enforcement Division Hits New High with $4.3 Billion in Monetary Penalties in Fiscal 2019

 

The SEC Enforcement Division ordered over $4.3 Billion in monetary penalties for the fiscal period that ended September 30, thereby setting a modern record, according to its 2019 annual report.  Total penalties exceeded amounts ordered during each of the prior four years.  The SEC also brought 826 total actions and 526 standalone actions, surpassing totals for 2015, 2017 and 2018 and nearly equaling the 868 cases filed in 2016.   The most cases (191; 36% of total) were brought against investment advisers and investment companies.  The Enforcement Division continues to prioritize charging individuals (69% of cases) and to pursue referrals to law enforcement (400 investigations).  The SEC also imposed 595 bars and suspensions.  The Co-Directors lauded the Division: “By any measure, we believe the Division had a very successful year.”

Regardless of administration, the SEC Enforcement Division continues to set new enforcement records.  Nothing suggests any changes for the current fiscal year.  If you haven’t received the memo, it’s time to get your compliance house in order. 

FINRA’s Financials $110 Million Worse than Last Year

FINRA reported a net loss of $68.7 Million for fiscal 2018, as compared to $41.6 Million in net income for fiscal 2017, a swing of more than $110 Million in one year. Most of the change arose from losses in FINRA’s investment portfolio. Total fines imposed were down slightly – $61 Million vs $64.9 Million – although both 2017 and 2018 reflect much lower fines than the prior several years. Other regulatory revenues were up slightly.

We don’t relish the idea of a regulator that has to fill a large financial deficit, especially since it could use fines to fill some of this hole. We expect the lower fine numbers during the last 2 years to be more of an aberration.

IA Watch Compliance Conference: The CCS Summary

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

Department of Justice Allows Credit for Identifying Only Senior Execs

The Department of Justice has revised its corporate prosecution policy to allow credit to corporations that identify senior officials without identifying every individual involved.  In criminal cases, the defendant corporation must identify “every individual who was substantially involved in or responsible” for the misconduct.  In civil cases, the corporation must identify every person “who was substantially involved” to earn maximum cooperation credit.  The new policy offers prosecutors discretion over the prior policy, which according to Deputy Attorney General Rod Rosenstein, made prosecutions more difficult, time-consuming, and inefficient.  Mr. Rosenstein made clear that “pursuing individuals responsible for wrongdoing will be a top priority in every corporate investigation.”

 

 Many defense lawyers had hoped that the Rosenstein-led Justice Department would completely rescind the Yates memo, which requires the prosecution of individuals and only allows cooperation credit if companies identified the wrongdoers.  The revised policy that focuses on senior officials and those substantially involved makes practical enforcement sense but probably offers little comfort to senior executives facing off against the Department of Justice. 

CFTC Penalties Nearly Triple in Fiscal 2018

 The Commodity Futures Trading Commission, the primary commodities and derivatives regulator, imposed nearly $1 Billion in civil monetary penalties, restitution and disgorgement during the fiscal year that ended on September 30.  The CFTC Division of Enforcement imposed $947 Million in penalties, disgorgement and restitution, including $897 Million in civil penalties, a nearly threefold increase over last year’s total.  The CFTC filed 83 enforcement actions, the most since 2012, and imposed $10 Million judgments in 10 cases, a CFTC high water mark.  More than 2/3 of cases charged an individual executive, reflecting the CFTC’s priority to hold individuals accountable in part because it deters others who become “fearful of facing individual punishment.”  The CFTC has also prioritized parallel criminal proceedings, setting enforcement records for the number of cases filed in parallel with criminal prosecutors.

The CFTC’s regulatory sphere has greatly expanded with the emergence of swaps, derivatives, cryptocurrencies, and alternative hedge funds.  The CFTC, like the SEC, has ramped up its enforcement activities to historic levels.

SEC Filed 32% More Enforcement Cases Against Advisers and Funds in Fiscal 2018

 The SEC Enforcement Division filed 32% more standalone enforcement cases against investment advisers and investment companies in fiscal 2018 (through September 30), as compared to 2017.  Cases against investment advisers and investment companies (the second largest category) and broker-dealers (fourth largest) represented 35% of all standalone actions filed.  Overall, the SEC Enforcement Division brought 490 standalone cases in fiscal 2018, a 10% increase over 2017.  Excluding the municipal disclosure initiative, the Enforcement Division filed more cases than it did in 2016 and 2015, the last two years under the prior administration.  The Enforcement Division obtained $3.9 Billion in penalties and disgorgement, which is consistent with amounts obtained during the prior several years.  The Enforcement Division outlined five core principles, including a focus on individual accountability because “holding culpable individuals responsible for wrongdoing is essential to achieving our goals of general and specific deterrence and protecting investors by removing bad actors from our markets.”

 The Enforcement Division continues to pursue its active litigation agenda, especially against the investment industry.  Apparently, the Jay Clayton SEC is not much different from the Mary Jo White SEC when it comes to enforcement cases against adviser, funds, and broker-dealers.