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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 Manager Failed to Register as Broker-Dealer

A former fund manager was barred from the industry and faces possible fines and disgorgement for misrepresenting fees and commissions and for selling the fund without registering.  His partner previously settled with the SEC by agreeing to pay over $1.2 Million.  According to the SEC, the defendant hid the nature of the compensation received for selling the fund, which constituted transaction-based compensation requiring broker-dealer registration.  The SEC also charged the adviser with failing to register his firm as an investment adviser and with securities fraud. 

Fund managers that engage in selling efforts must register as broker-dealers unless they can take advantage of the issuer exemption (Rule 3a4-1), which prohibits the receipt of specific transaction-based compensation. 

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 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. 

https://www.sec.gov/litigation/admin/2018/ia-4836.pdf

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.