Corporate executives cannot avoid accountability by claiming that they were just following orders. The SEC has maintained that senior executives have a duty to investors and the markets to stop financial wrongdoing at the companies they steward. Once charged, the SEC will often use its leverage to encourage cooperation in cases against others in the C-Suite.
Firms that take revenue sharing from fund companies should consult counsel about their self-reporting options. Also, whether or not your firm self-reports, you should undertake the review of all relevant disclosure that the SEC has mandated.
hedge fund seeding platform created by a large asset manager agreed to pay over
$2.7 Million in disgorgement, interest and penalties for over-allocating
internal expenses. The respondent
created private equity funds to invest in third party hedge fund managers. The firm then created an internal group of
employees tasked with helping hedge fund managers in which the funds invested
to attract new capital, launch products and optimize operations. Pursuant to their organizational documents,
the funds would pay up to 50 basis points for these activities. The SEC charges that the respondent allocated
all the group’s compensation expenses to the funds even though they spent a
portion of their time on activities that benefitted the fund sponsor and
unrelated to the enumerated activities.
The SEC faults the firm for failing to implement appropriate compliance
policies and procedures and for making material misstatements.
Do not charge expenses to managed funds unless the organizational and disclosure documents are absolutely clear that the funds will bear the expenses. When doing internal expense allocations, always err to the side of benefitting the fund rather than the fund manager.
We expect several enforcement actions this year based on the failure to offer the lowest mutual fund share class available. We recommend that advisers conduct an internal reviews of recommendation practices and take action to reimburse clients.
A private equity firm agreed to pay a $400,000 fine and reimburse clients for overcharging fund investors over a 16-year period. According to the SEC, the PE firm did not proportionally allocate broken deal, legal, consulting, insurance, and other expenses to co-investors and employee co-investment funds, thereby overcharging investors in their flagship funds. The SEC also accuses the firm of paying portfolio company consulting fees to co-investors, which resulted in lower fee offsets to the detriment of flagship fund investors. The firm voluntarily agreed to reimburse investors for the expenses and the fees following discovery of the misconduct during a 2016 SEC exam. The SEC charges the firm with failing to implement a reasonable compliance program as well as the Advisers Act’s antifraud rules.
If the firm had implemented a reasonable compliance program, discovered the overcharging, and reimbursed clients before the SEC uncovered the violations during an exam, it may have avoided the public enforcement action and resulting fine. Also, a reasonable compliance program may have avoided the overcharging in the first place. C-suite executives should re-think the cowboy mentality that ignores compliance until the SEC or a client makes them change. It’s much less expensive to change the oil every 5000 miles than to replace the engine if it seizes.
OUR TAKE: We have warned that the SEC does not like wrap programs. If your firm insists on operating a wrap program, we would recommend a strict policy against trading away with a non-participating broker-dealer, unless the portfolio manager can document the execution benefits on a trade-by-trade basis. Of course, the wrap sponsor must disclose the trading away information as soon as possible to participating RIAs and wrap clients.
Jocelyn Dalkin of Cipperman Compliance Services recently attended the Private Fund Compliance Forum in New York. Sponsored by Private Equity International, the forum brings together legal and compliance professionals from the biggest firms to discuss investment management regulatory issues. Keynote speaker David Sorkin (KKR) advised compli-pros to continuously monitor regulatory and business changes to adapt compliance programs in real-time. A panel of compliance experts from several large PE firms discussed how to allocate compliance responsibilities both internally and externally. Other panels considered SEC exams, regulatory priorities, and how to address conflicts of interest. Feel free to contact Jocelyn if you want more information.
Cassandra Borchers, a partner at Thompson Hine, and Todd Cipperman recently sat down to discuss the 10 most significant regulatory trends for the investment management industry. In their podcast, Todd and Cassandra discuss an investment adviser’s fiduciary responsibilities, including Regulation Best Interest and wrap programs, senior executive liability, service provider accountability, compliance programs, whistleblowers, and cybersecurity. Their conversation is based on Cipperman’s upcoming book that delves deeper into these Top 10 investment management regulatory trends. Thompson Hine LLP, a full-service business law firm with approximately 400 lawyers in 7 offices, has received numerous awards for innovation, service and expertise. Cipperman Compliance Services leads the investment management industry in providing outsourced compliance services.
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.
10 Things You Need to Know About Regulation Best Interest
Reasonable basis. A broker must have a reasonable basis that the recommendation is in the best interest of the client.
Applies to retail customers. A retail customer is defined as a person who uses the recommendation primarily for personal, family, or household purposes.
“Recommendation” remains the same. The proposal does not seek to change the definition of “recommendation,” preferring to defer to the current FINRA interpretations.
No definition of “best interest”. In 400+ pages, the SEC never defines the term “best interest” when proposing Regulation Best Interest.
More than suitability, less than fiduciary. Regulation Best Interest combines elements of the current suitability standard (e.g. suitable at time of transaction) with a few fiduciary-like elements (e.g. disclosure).
Fails to harmonize RIA and BD standards. Advocates of a uniform fiduciary standard want a single standard so that consumers are not confused by the differing standards of care applicable to advisers vs. brokers. This proposal fails to ensure a “uniform” standard.
Disclosure of conflicts of interest. The most significant new requirement is that brokers must disclose (or mitigate) conflicts of interest.
Must consider series of transactions. Expanding traditional suitability, a broker must also consider the series of recommended transactions.
Product neutrality not required. Brokers can make more money on recommended products, including proprietary products, so long as the conflict is properly disclosed and mitigated.
Regulation Best Interest is not law. Comments are due on this controversial proposal by August 7, 2018. Thereafter, we expect much debate and re-drafting before any final rule is adopted.