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Unregistered Adviser Barred From Industry for Marketing Misrepresentations

 

The SEC fined an unregistered investment adviser and barred its principal from the industry for making false representations in marketing materials primarily to professional athletes.  The SEC asserts that the adviser, which terminated its SEC registration in 2008 but continued to market its investment advisory services through 2018, baldly lied about its assets under management, clients, management, and employees.  The firm emailed its misleading brochure to over 80 prospects over a 12-month period and included a cover email that also included significant misrepresentations.  The SEC alleges violations of the Advisers Act’s antifraud rules.

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.

Fund Sponsor Violated Private Offering Rules

The 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. 

Self-Reporting ICO Forced to Offer Rescission to All Investors

The sponsor of an initial coin offering agreed to offer full rescission of proceeds raised in order to settle SEC charges that the firm engaged in an unregistered securities offering.  The sponsor raised $12.7 Million by issuing digital tokens in exchange for Ether as part of its efforts to raise funds to further develop its internet security product.  The tokens would serve as currency for a peer-to-peer network that would allow participants to access additional bandwidth in the event of a cyber-attack.  As part of its marketing, principals suggested that the value of the tokens should rise as the network expanded.  The SEC maintains that this “reasonable expectation of a future profit” satisfied the Howey test and that, therefore, the tokens were “securities” and the offering constituted an unregistered securities offering.  The SEC did not impose a civil penalty because the firm self-reported. 

We don’t think that the SEC has a slam-dunk case that ICOs are securities offerings.  In fact, some courts have opined that the SEC must specifically prove that each ICO is in fact a securities offering.  Until the courts offer some specific guidance, ICO sponsors should observe the securities laws to avoid a crippling enforcement action. 

SEC Cancels Internet RIA Registration for Failure to Launch


The SEC 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 period. 

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.    

Adviser Falsely Claimed SEC Registration Eligibility

The SEC barred from the industry the principal of a registered investment adviser for falsely claiming SEC registration eligibility.  In his initial Form ADV filing, the respondent claimed over $500 Million in assets under management, but the SEC asserts the firm managed no assets.  A year later, the respondent claimed a Wyoming principal place of business and assets under management in excess of $25 Million.  The SEC maintains that the firm operated from New York and had assets less than $5.4 Million.  In both years, the respondent electronically signed the Form ADV “under penalty of perjury.”

The SEC does not look kindly on advisers that lie on Form ADV to claim registration eligibility.  The regulator already supervises over 13,000 advisers that legally qualify for federal registration. 

FBI Takes Down Unregulated Non-U.S. Swaps Dealer

 

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.

SEC Halts Crypto Hedge Fund Offering for Failing to Register

 

The manager of a crypto hedge fund offered its investors rescission and agreed to pay a $200,000 fine for failing to comply with the securities.  The SEC argues that the fund, which invested in digital assets, was “engaged in the business of investing, holding, and trading certain digital assets that were investment securities.”  Consequently, the offering, which did not comply with Regulation D’s private offering safe harbors, should have been registered under the Investment Company Act.  The SEC charges violations of the registration provisions of the Securities Act and the Investment Company Act as well as the antifraud rules.  This case is the SEC’s first enforcement action against a crypto hedge fund manager for failing to register under the Investment Company Act.

OUR TAKE:  Most significant is the SEC Enforcement Division taking the position that a fund that invests in digital assets is subject to the securities laws.  It remains to be seen whether others will challenge that position in the courts.

 

Adviser Lacked Required AUM to Register with the SEC

The SEC fined and suspended the principal of a defunct investment adviser for falsely claiming SEC registration eligibility.  The firm claimed that it had at least $25 Million in assets under management through 2011 and then suddenly claimed it had at least $100 Million assets under management following passage of the Dodd-Frank in 2012.  The SEC asserts the firm had no basis for claiming SEC registration eligibility because it did not have the purported assets under management.  The SEC also alleges violations of the custody rule arising from the firm’s role as a private fund manager.

OUR TAKE: Lying to the SEC about registration eligibility is more than mere marketing puffery.  It can prompt a public enforcement action.  Make sure you have records to support the claimed assets under management.

https://www.sec.gov/litigation/admin/2018/ia-4875.pdf

SEC Official Questions Registration Exemption for ETF Index Providers

The SEC’s Director of the Division of Investment Management, Dalia Blass, questioned whether ETF index providers should continue to claim a blanket exemption from investment adviser registration.  Ms. Blass, acknowledging an exemption for publishers of broad-based indexes, asked whether providers of more narrow indexes should register as investment advisers especially where such providers create indexes for a single fund or take significant input from the fund sponsor.  Ms. Blass cautioned “against assuming that the status of a provider can be determined based simply on its characterization as an index provider” and encouraged fund sponsors and index providers to “refresh your analysis if you are looking at a bespoke or narrowly focused index.”  Ms. Blass also advised funds to consider disclosure implications of narrow indexes.

OUR TAKE: As a result of Ms. Blass’s speech, index providers should expect some hard questions from fund counsel and independent directors’ counsel as the lines blur between index creation and investment recommendations.

https://www.sec.gov/news/speech/speech-blass-2018-03-19

RIA’s Affiliate Private Fund Manager Wrongly Claimed Registration Exemption

The SEC censured and fined a fund manager and its principal and barred the principal from serving as a chief compliance officer for incorrectly claiming exemption from Advisers Act registration and its requirements.  The SEC contends that the principal, which managed a registered investment adviser, created an affiliate to manage two private funds and then claimed an exemption from registration because the funds had less than $150 Million.  The SEC maintains that the affiliate was required to register because it was under common control with the registered adviser and shared office space, employees and technology.  The SEC alleges that the private fund adviser hoped to avoid the custody rule’s audit requirements and compliance requirements.  The SEC cites Section 208(d) of the Advisers Act, which prohibits a person from doing indirectly any act which would be unlawful if done directly.

OUR TAKE: This case has significant implications for larger organizations.  If a firm operates a registered investment adviser affiliate, the SEC, based on this action’s reasoning, would prohibit the firm from claiming an exemption registration for an unregistered fund manager under the same roof.  The SEC is using the regulatory flexibility to integrate advisers under one Form ADV as a regulatory weapon to force registration on otherwise exempt affiliates.