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.
Lying to the regulators in public filings to qualify for exemptions will lead to big trouble. Ordering rescission is the Big Kahuna of enforcement penalties because it involves returning all proceeds with interest in addition to fines and usually an ongoing cease and desist order. Act deliberately when filing that Form D or making those Rule 144 representations.
An exempt reporting adviser is still subject to several provisions of the Advisers Act, including its fiduciary and anti-fraud rules. We recommend that ERAs implement a legitimate compliance program to avoid a firm-ending regulatory action like this one.
The SEC fined a now-defunct fund manager for ignoring its compliance obligations. The SEC charges that the firm never delivered audited fund financials within 120 days as required by the custody rule (206(4)-2). Although the firm did hire an auditor, the firm never received an opinion that the financials were prepared in accordance with GAAP. Instead, the audit firm issued reports stating that it was unable to express such an opinion. In addition, the SEC charges the firm with violating the compliance rule (206(4)-7) because the principal, who also served as the Chief Compliance Officer, failed to adopt and implement policies and procedures and disregarded his obligation to conduct annual compliance reviews.
When you register as an investment adviser, you subject yourself to the full panoply of substantive regulation imposed by the Investment Advisers Act. To comply and continue as a going concern, you need to hire a competent Chief Compliance Officer to help you meet the regulatory requirements. Otherwise, you may end up either in your next career or in jail.
Just because you do not register with the SEC does not mean that you are exempt from its antifraud rules. Section 206 applies to any statement made by an investment adviser, whether registered or unregistered, that could defraud any client or prospective client.
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.
cancelled the adviser registration of a purported internet investment adviser
because the registrant failed to launch its website in the three years since registering.
The registrant filed as an RIA under
the internet adviser exception whereby an adviser without assets under
management is eligible to register if the adviser provides advice exclusively
through an interactive website. The
adviser registered in May 2015 and still has not launched its website due to personal
events and product complexity. The
registrant argued that the internet adviser exception allows a grace period for
development. The SEC concedes that an
internet adviser may be allowed some leeway beyond 120 days (the stated time
period for new advisers), but three years is “well over any reasonable grace
period.” Additionally, the SEC places
the burden on the adviser to demonstrate “substantial efforts and progress
toward developing an interactive website” in order for the Commission to
exercise discretion to allow registration beyond the initial 120-day
This decision states for the first time that internet advisers may get more than 120 days to launch so long as they can demonstrate significant progress. The SEC will grant a grace period, but three years is too long.
An FBI sting operation ensnared an unlawful non-U.S. based securities dealer that offered securities-based swaps without registering. The Austrian-based defendant operated an internet-based platform that offered contracts for difference, which operated as securities-based swaps based on publicly-traded U.S. equity and indexes. An undercover FBI agent opened an account with nothing more than a username and a password and traded CFDs with bitcoin. The platform served as the counterparty and collected the bid-ask spreads. The SEC charges the platform with failing to register the securities offering and the platform as a broker dealer. The SEC also asserts that the CFDs were required to be traded on a registered securities exchange.
OUR TAKE: We love innovation and technology. However, when you apply new technologies to a highly regulated industry, you must follow the same rules as everybody else. Trading in securities with U.S. persons implicates the whole panoply of U.S. securities regulation including the regulation of the offering, the parties, and the venue. Also, never assume that law enforcement or the regulators won’t find you. Your competitors and clients have an interest in helping the investigators find those who are cutting regulatory corners.