A portfolio manager of an activist investment firm failed to disclose a $3 Million personal loan to the CEO of a company in which he invested. The portfolio manager made the loan, according to the SEC, to secure the CEO’s support for his election to the Board as part of a broader initiative to exert control over the company. The SEC asserts that the portfolio manager violated his fiduciary duty to his clients by concealing his personal interest and that the investment manager failed to file a Schedule 13D (indicating more than passive investment). Also, the SEC faults the adviser for failing to implement a reasonable compliance program because the policies and procedures “did not discuss conflicts of interest more broadly in sufficient depth so as to capture and train employees to recognize other violative conduct not specifically identified.”
OUR TAKE: Because portfolio managers are often treated like the rock stars of investment management, compli-pros must implement heightened supervision to protect against reckless actions that will ultimately hurt the firm. Procedures should include reviews of investment decisions, due diligence about personal dealings, reviews of transactions outside the ordinary course, and training all employees how to identify unlawful activity.
The sponsor of a church fund agreed to pay over $2.25 Million in returned profits, disgorgement, interest and penalties for failing to properly disclose a reserve fund created to smooth returns. According to the SEC, the Board of the fund, which was launched in 1973, created the reserve fund in 1993 as a vehicle to retain excess profits and ensure liquidity so that the fund could distribute consistent returns between 5% and 6.7%. The SEC faults the fund sponsor for failing to fully disclose that it would charge fees on the reserve fund and that redeeming investors would not receive their pro rata amounts held in the reserve fund. OCIE identified the fiduciary violations during a 2014 exam, which followed the sponsor’s registration in 2012.
OUR TAKE: The SEC appears to be most disturbed that the fund sponsor did not return client assets and double-dipped advisory fees by moving assets into the reserve fund. Private fund firms that registered after 2012 as a result of Dodd-Frank, should audit their operations to determine whether longstanding business practices run afoul of their fiduciary duties.
The SEC censured and fined a private fund manager for failing to disclose that one of its funds invested in an affiliate fund formed to help grow the manager’s business by acquiring other advisers. Although the respondent ultimately made disclosure through the fund’s financial statements, the audited financials were delivered 9 months after they were required to be delivered pursuant to the Advisers Act’s custody rule (206(4)-2). Also, the firm failed to retain an auditor subject to PCAOB inspection, as required by the Advisers Act. The SEC noted that advisory clients would not have paid any fees had they invested directly in the acquisition fund rather than through the fund in which they intended to invest, which was focused on foreign currencies.
OUR TAKE: Failure to disclose cross-transactions between affiliate funds will not go undetected. Eventually, the fund manager must deliver audited financial statements, which will require disclosure. The Advisers Act requires advance disclosure (and consent) of conflicts transactions. There is no win in kicking the disclosure down the road until financials are completed.