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SEC Prosecutes De-Registered Adviser for Prior Compliance Failures

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. 


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.


Real Estate Interests are “Securities” Triggering Fund Registration

A purported real estate investment fund violated the Investment Company Act because investments in real estate limited partnership interests and mortgage loans constituted “securities.”  A fund that invests more than 40% of its assets in securities must register under the Investment Company Act, absent an exemption (e.g. fewer than 100 investors, solely offered to qualified purchasers).  According to the SEC, the fund exceeded the 40% threshold when the real estate related securities were added to other publicly-traded stocks and bonds in which the fund invested.  The SEC also accused the fund manager and its principal of failing to fully disclose how the fund would invest.

OUR TAKE: For purposed of the Investment Company Act, the SEC applies a broad interpretation of “security” to include pooled interests in real estate, even though a direct investment in the underlying property would not be counted.  Real estate private equity firms should not assume that they can avoid registration without a deeper analysis of their investments.


SEC Offers Relief for Private Equity Holding Companies


The SEC’s Division of Investment Management has provided guidance allowing holding companies to avoid Investment Company Act registration.  Under current rule 3a-2, a bona fide holding company could be subject to registration because certain corporate events (e.g. holding cash pending a new deal, acquisition, or tender offer) would exceed permitted passive investment thresholds for more than 12-months.  The staff advises that such holding companies could begin the 12-month clock ticking upon the occurrence of the extraordinary event so long as there is a “bona fide intent to be engaged primarily in a non-investment company business, regardless of whether they operate directly or through a holding company structure.”  The SEC maintains that this relief furthers its mission of facilitating capital formation.

OUR TAKE: This is good news for private equity firms who could otherwise get caught up in the Investment Company Act’s technicalities.  Neither Congress nor the SEC likely intended such firms to register for a temporary period.


SEC Staff Provides Guidance for Adviser M&A and Reorg Transactions


The staff of the SEC’s Investment Management Division has provided guidance clarifying that, absent a change in control, an internal reorganization of an investment adviser does not require a new registration.  The staff opines that an unregistered entity that acquires the assets of an affiliate RIA need only file a succession by amendment, so long as the same parent company continues to control both entities.  The staff offered similar guidance with respect changes in jurisdiction and form of organization.  However, a change in control would require the filing of a succession by application.   In either event, the registrant must file within 30 days of the subject event.

OUR TAKE: With expected consolidation coming in the asset management sector, the staff offers practical regulatory guidance that will facilitate transactions.



Unregistered Fund Manager Still Liable for Breach of Fiduciary Duty


The SEC fined and barred the principal of an unregistered private fund manager for breaching his fiduciary duty by failing to disclose that affiliate intermediaries profited from fund transactions.  The SEC alleges that the respondent used affiliate companies as intermediaries for the buying and selling oil and gas royalty interests and that the affiliates collected significant profits.  The SEC charges the firm with failing to disclose these transactions, instead telling investors that the fund would receive the best price possible and that any affiliate transaction would be conducted at arm’s length.  Even though the fund manager was not registered, the SEC accused him of violating the Advisers Act because he engaged in advisory activities and breached his fiduciary duty of full disclosure.

OUR TAKE: Private fund managers maintain accountability for alleged breaches of fiduciary duty even if not registered.  This includes conduct that pre-dates Dodd-Frank’s registration requirements.  Also, it is unclear how much disclosure is enough to allow affiliate transactions.


Failure to Remedy Compliance Violations Costs International Bank


A large global bank admitted wrongdoing and agreed to pay a $1.6 Million penalty, in addition to $3.7 Million in disgorgement, for failing to stop its illegal practice of providing broker-dealer and investment adviser services to U.S. clients without registering.  The SEC charges the firm with servicing high-net worth private clients by having relationship managers travel to the U.S. to meet with current and prospective clients and provide advice and brokerage services.  In addition, the firm maintained brokerage accounts, executed orders, handled customer funds, and provided account statements.  According to the SEC, the firm was aware that it was violating U.S. law as far back as 2008 and adopted policies and procedures, but failed to halt its violative conduct until at least 2013.  The respondent also executed a Deferred Prosecution Agreement with the Justice Department for related conduct.

OUR TAKE:  Compliance doesn’t stop at adopting policies and procedures.  Firms must follow-through with implementation, especially after self-identifying legal violations.  Merely “talking the talk” without “walking the walk” on compliance will result in a front-page enforcement action.