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.
In its 2017 fiscal report, the SEC’s Enforcement Division cites individual accountability as one of its core enforcement principles. The report expresses the Enforcement Division’s view that “individual accountability more effectively deters wrongdoing.” Since Chairman Clayton took office, the SEC has charged an individual in more than 80% of standalone enforcement actions. The report notes that it can be more expensive to pursue individuals, but “that price is worth paying.” The report notes a modest decrease in filed enforcement actions and recoveries since 2016: 754 vs. 784 cases (excluding municipal cases) and $3.8 Million vs. $4 Million in total money ordered.
OUR TAKE: “Just because you’re paranoid doesn’t mean they aren’t after you.” (Joseph Heller) The data and the explanation imply that the SEC will prioritize prosecuting individuals, even if the money ordered is smaller than in institutional actions, because of the fear and deterrent effect. If financial executives need another reason to engage a best-in-class compliance program, how about protecting yourselves from a career-ending enforcement action?
An unregistered investment adviser/fund manager and its principals agreed to pay over $1 Million in disgorgement, fines and interest for engaging in conflicted transactions that were not properly disclosed. The SEC accuses the respondents of using fund assets to invest in a company that the principals controlled and then buying out the ownership interest at a loss, all without consent of the limited partners or any relevant disclosure. The SEC also asserts that the respondents engaged in undocumented personal loans and payment of overhead expenses in contravention of the fund’s disclosure documents and limited partnership agreement. Although the firm (which had less than $25 Million in AUM) was not registered, the SEC argues that it engaged in investment advisory activities, owed the fund and its investors a fiduciary duty, and, therefore, violated the Advisers Act’s antifraud rules.
OUR TAKE: Just because you are not eligible (or fail) to register as an investment adviser, does not mean that the Advisers Act does not apply. In fact, most of the antifraud provisions apply to unregistered and state-registered advisers, thereby allowing the SEC to assert its enforcement jurisdiction.
The North American Securities Administrators Association (NASAA), the organization of state securities regulators, reported that state securities regulators imposed $914 Million in restitution, fines and penalties in 2016, as compared to $766 Million in the prior year. In its Enforcement Report, NASAA also reported significant increases in criminal penalties including incarceration and probation. The number of investigations and administrative actions also increased especially against investment advisers, which, according to NASAA, may be due to “heightened state interest in individuals and firms who have transitioned from broker-dealer registration to investment adviser registration in recent years.” NASAA also reported significant information sharing with federal regulators.
OUR TAKE: Over the last several years, the state securities regulators have expanded examinations and enforcement along with the SEC and FINRA, making it much more difficult for any adviser or broker-dealer to avoid regulatory scrutiny. It’s worth noting that many state securities regulators have criminal enforcement authority.
An investment adviser was indicted in part for making a false declaration in a court proceeding by lying to the SEC during a sworn deposition. The deposition occurred during an enforcement case that alleges that the adviser defrauded retirees by lying about account balances, falsifying documents, and creating false wires. According to the SEC, the adviser lied in a deposition about providing false documents to investors.
OUR TAKE: Once a formal enforcement proceeding commences, any misstatements under oath can lead to criminal proceedings for perjury or lying to a regulator. It’s always wise to ensure that the lawyer defending the enforcement action has sensitivity to the possible criminal prosecution implications. An enforcement action may results in fines and industry bars, but criminal proceedings could result in jail time.
FINRA imposed nearly double the fines on the industry in 2016, assessing $173.8 Million in fines as compared to $93.8 Million in 2015, according to its annual report. The increase in fines helped FINRA report over $57 Million in net income versus a $39 Million loss last year, even though operating income was lower in 2016. FINRA also ordered another $27.9 Million in restitution. FINRA uses fines collected for “capital expenditures and regulatory projects.”
OUR TAKE: Most of the financial regulators use their enforcement powers to collect funds to support their activities. Rather than encourage this financial incentive to bring cases, policy-makers should consider other alternatives such as third party compliance reviews or user fees.
In recent testimony about the SEC’s proposed 2018 budget, Chairman Jay Clayton emphasized enforcement and examination activities. Mr. Clayton noted that 50% of requested budget resources will go to enforcement and examinations. He said that the SEC is on track to deliver a 20% increase in adviser examinations and plans a further 5% increase. He noted that the staff will put a special focus on cybersecurity efforts. Mr. Clayton also committed to continue the SEC’s “vigorous enforcement efforts to investigate and bring civil charges” including critical areas such as “investment professional misconduct.”
OUR TAKE: It appears that the Clayton SEC will continue the examinations and enforcement focus of the Mary Jo White SEC. The more things change, the more they stay the same.
The SEC fined and permanently barred a former broker-dealer chief compliance officer for violating a prior 5-year bar by consulting with the BD on FINOP matters including financial statements and FOCUS filings. The SEC accuses the respondent from executing a consulting agreement on the day after he resigned to comply with the prior bar. According to the SEC, the respondent “continued to run the day-to-day operations” for the next 3 years and maintained a BD email account.
OUR TAKE: There is a special place in the basement of the SEC Enforcement Division with wall photos of recidivists. The SEC staff will show no quarter to those that violate enforcement settlements.
The U.S. Supreme Court has ruled that the SEC cannot seek disgorgement with respect to ill-gotten gains received more than 5 years ago. A unanimous Court held that disgorgement is a “penalty” under the statute of limitations because (i) the SEC brings public cases not intended to remedy individual harm and (ii) disgorgement is imposed for punitive and deterrent purposes. The Court rejected the SEC’s argument that disgorgement is used for restitution because disgorgement orders often exceed the defendant’s gains. The Court has previously held that SEC penalties are also subject to the 5-year statute of limitations.
OUR TAKE: The Supreme Court significantly constrains the SEC’s enforcement power to demand huge settlements based on multi-year violations. The SEC will have to move more quickly to investigate and file.
Acting SEC Chairman Michael Piwowar strongly supports the SEC’s use of enforcement as the mechanism to ensure fair capital markets that enable economic growth. In a recent speech, he said that “appropriate enforcement efforts” including a willingness to “assess penalties where appropriate and take back proceeds of fraud from the bad guys” facilitate capital markets by ensuring a fair and level playing field, thereby lowering the cost of capital. He also advocated for enforcement as the best way for regulators to focus “limited resources on a risk based approach to addressing the problems in the market, in contrast to burdensome and ultimately futile attempts to regulate away the problems.” Mr. Piwowar also believes in complete and transparent disclosure but cautions against overregulation that impedes capital formation.
OUR TAKE: It does not appear that the new SEC administration will pull back from its heavy enforcement agenda that dominated the last several years. If anything, Mr. Piwowar suggests a greater enforcement push coupled with lesser regulation and enhanced disclosure.