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Items of interest to investment advisers are constantly updated. Bookmark this page to read up-to-the-minute news and important regulatory changes!

IA Charged with Inadequate Controls to Prevent Insider Trading

On February 4, 2020, the Commission announced settled charges against registered investment adviser Cannell Capital, LLC (CCL) of Alta, Wyoming for not having policies and procedures reasonably designed to prevent the misuse of material nonpublic information.

According to the SEC's order, CCL specializes in investing in the securities of thinly-traded companies with little or no analyst coverage. To understand these securities, it frequently communicated with issuer insiders and others who had access to material nonpublic information. The order finds that from 2014 through October 2019, CCL failed to follow its written policies and procedures by not maintaining a reasonably designed list of securities that members, officers, and employees and their family household members were prohibited from trading after the firm came into possession of potential material nonpublic information.

The order also finds that CCL's written policies and procedures were not reasonably designed to prevent misuse of material nonpublic information because they did not address any business-specific risks and lacked any guidance regarding when trading in securities should be restricted.

The order finds that CCL violated Section 204A of the Investment Advisers Act of 1940 by failing to establish, maintain, and enforce policies and procedures reasonably designed to prevent the misuse of material, nonpublic information. Without admitting or denying the findings in the SEC's order, CCL consented, to the entry of a cease-and-desist order, a censure, and a $150,000 civil penalty. [Please
login to the IA Act UnwrappedTM Releases Database to view Release No. IA-5441 In the Matter of Cannell Capital, LLC.]   Top 

Agencies Propose Changes to Modify “Covered Funds” Restrictions of Volcker Rule

Five federal financial regulatory agencies have invited public comment on a proposal to modify regulations implementing the Volcker rule’s general prohibition on banking entities investing in or sponsoring hedge funds or private equity funds – known as “covered funds.”

Since the regulations implementing the Volcker rule were finalized in 2013, the rule has created compliance uncertainty and imposed limits on certain banking services and activities that the Volcker rule was not intended to restrict.  To address these concerns, the agencies simplified requirements for the proprietary trading restrictions in November 2019.  Today’s proposal would modify the restrictions for banking entities investing in, sponsoring, or having certain relationships with covered funds.

In particular, the joint agency proposal would improve and streamline the covered funds portion of the rule, address the treatment of certain foreign funds, and permit banking entities to offer financial services and engage in other permissible activities that do not raise concerns that the Volcker rule was intended to address.

The proposed changes were jointly developed by the Federal Reserve Board, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission.

Comments will be accepted until April 1, 2020.   Click HERE to access the proposing release.

Media Contacts:

Federal Reserve - Eric Kollig     202-452-2955
CFTC - Office of Public Affairs 202-418-5080
FDIC - Julianne Fisher Breitbeil 202-898-6895
OCC - Bryan Hubbard             202-649-6870
SEC - Office of Public Affairs  202-551-4120
Top 

 

SEC Charges Portfolio Manager and Advisory Firm with Misrepresenting Risk in Mutual Fund

The SEC announced charges against a New York-based investment adviser for misleading investors about the management of risk in a mutual fund. Catalyst Capital Advisors LLC (CCA) and its President and Chief Executive Officer, Jerry Szilagyi, agreed to pay a combined $10.5 million to settle the charges.  The SEC also filed a complaint in federal district court in Madison, Wisconsin, against Senior Portfolio Manager, Edward Walczak, for fraudulently misrepresenting how he would manage risk for the fund.

The SEC's settled order against CCA and Szilagyi finds that, although CCA told investors that it abided by a strict set of risk parameters for the Catalyst Hedged Futures Strategy Fund, it breached those parameters and failed to take the required corrective action during a majority of the trading days between December 2016 and February 2017. As alleged, the fund lost hundreds of millions of dollars – approximately 20% of its value – from December 2016 through February 2017 as markets moved against it.  The SEC's complaint against Walczak alleges that he told investors that the fund employed a risk management strategy involving safeguards to prevent losses of more than 8%, when in fact no such safeguards limited losses and Walczak did not otherwise consistently manage the fund to an 8% loss threshold.

"Fund managers must be truthful and transparent when describing their risk management procedures," said C. Dabney O'Riordan, Co-Chief of the SEC Enforcement Division's Asset Management Unit.

Daniel Michael, Chief of the Division's Complex Financial Instruments Unit, added, "Here, CCA's misrepresentations, and Walczak's alleged departure from his stated approach to managing risk, deprived investors of accurate information about an important aspect of the fund's management."

The SEC's order finds that CCA violated the antifraud provisions of the federal securities laws, and that Szilagyi was a cause of CCA's violations and failed reasonably to supervise Walczak. Without admitting or denying the findings, CCA and Szilagyi agreed to be censured, to cease and desist from future violations, and to certain undertakings as described in the order. CCA agreed to pay disgorgement of $8,176,722 plus prejudgment interest of $731,759, and a civil penalty of $1,300,000. Szilagyi agreed to pay a civil penalty of $300,000. The payments will be placed in a fair fund for distribution to affected investors. The SEC's complaint against Walczak alleges that he violated the antifraud provisions of the federal securities laws and seeks a permanent injunction, disgorgement of ill-gotten gains, and a civil penalty. In parallel action, the Commodity Futures Trading Commission (CFTC) today announced settled charges against CCA and Szilagyi, and a district court action against Walczak. [Please
login to the IA Act UnwrappedTM Releases Database to view Release No. IA-5436 In the Matter of Catalyst Capital Advisors, LLC and Jerry Szilagyi.]  Top 

OCIE Publishes Observations on Cybersecurity and Resiliency Practices

The SEC’s Office of Compliance Inspections and Examinations (OCIE) has issued examination observations related to cybersecurity and operational resiliency practices taken by market participants.

The observations highlight certain approaches taken by market participants in the areas of governance and risk management, access rights and controls, data loss prevention, mobile security, incident response and resiliency, vendor management, and training and awareness. The observations highlight specific examples of cybersecurity and operational resiliency practices and controls that organizations have taken to potentially safeguard against threats and respond in the event of an incident.

“Data systems are critical to the functioning of our markets and cybersecurity and resiliency are at the core of OCIE’s inspection efforts,” said SEC Chairman Jay Clayton.  “I commend OCIE for compiling and sharing these observations with the industry and the public and encourage market participants to incorporate this information into their cybersecurity assessments.”

“Through risk-targeted examinations in all five examination program areas, OCIE has observed a number of practices used to manage and combat cyber risk and to build operational resiliency,’ said Peter Driscoll, Director of OCIE.  “We felt it was critical to share these observations in order to allow organizations the opportunity to reflect on their own cybersecurity practices.” 

 

OCIE conducts examinations of SEC-registered investment advisers, investment companies, broker-dealers, self-regulatory organizations, clearing agencies, transfer agents, and others. It uses a risk-based approach to examinations to fulfill its mission to promote compliance with U.S. securities laws, prevent fraud, monitor risk, and inform SEC policy.  [Please login to the IA Act UnwrappedTM Examination Tools Database/2020 Information to view OCIE's Cybersecurity and Resiliency Observations.]  Top 

 

OCIE Announces 2020 Examination Priorities

On January 7, 2020, OCIE announced its 2020 examination priorities. OCIE publishes its examination priorities annually to enhance the transparency of its examination program and to provide insights into its risk-based approach, including the areas it believes present potential risks to investors and the integrity of the U.S. capital markets.

“OCIE’s 2020 examination priorities identify key areas of risk, both existing and emerging, that we expect self-regulatory organizations (SROs), clearing firms, investment advisers and other market participants to identify and mitigate. I applaud OCIE’s thoughtful, strategic and efficient focus, which is critical to the fulfillment of the SEC’s mission and our service to Main Street investors,” said SEC Chairman Jay Clayton.

“As markets evolve, so do risks and potential harm to investors. OCIE continually works to adjust its examination focus areas to target these risks and publishes its annual priorities to communicate where we see the potential for increased risk and related harm. We hope that this transparency helps firms evaluate and improve their compliance programs, which ultimately helps protect investors,” said OCIE Director Pete Driscoll.

OCIE’s 2020 examination priorities are:

Retail Investors, Including Seniors and Those Saving for Retirement – OCIE will continue its focus on the protection of retail investors, including the various intermediaries that serve and interact with retail investors and the investments marketed to, or designed for, retail investors. Examinations in these areas will include reviews of disclosures relating to fees, expenses, and conflicts of interest.

Market Infrastructure – OCIE will continue its focus on entities that provide services critical to the functioning of our capital markets, including clearing agencies, national securities exchanges, alternative trading systems, and transfer agents. Particular attention will be focused on the security and resiliency of entities’ systems.

Information Security – OCIE will continue to prioritize cyber and other information security risks across the entire examination program.

Focus Areas Relating to Investment Advisers, Investment Companies, Broker-Dealers, and Municipal Advisors
– OCIE will continue its risk-based examinations for each type of these registered entities. In particular, examinations of registered investment advisers (RIAs) will focus on RIAs that have never been examined, including new RIAs and RIAs registered for several years that have yet to be examined. These examinations will include RIAs advising retail investors as well as private funds.  Investment company examinations will focus on mutual funds and exchange-traded funds, the activities of their RIAs, and the oversight practices of their boards of directors. Broker-dealer examinations will focus on issues relating to the preparation for and implementation of recent rulemaking, along with trading practices. Municipal advisor examinations will include review of registration and continuing education requirements and municipal advisor fiduciary duty obligations to municipal entity clients.

Anti-Money Laundering Programs – OCIE will continue to review for compliance with applicable anti-money laundering (AML) requirements, including whether entities are appropriately adapting their AML programs to address their regulatory obligations.

Financial Technology (Fintech) and Innovation, Including Digital Assets and Electronic Investment Advice – OCIE recognizes that advancements in financial technologies, methods of capital formation and market structures, as well as registered firms’ use of new sources of data (often referred to as “alternative data”), warrant ongoing attention and review. OCIE also will continue to identify and examine SEC-registered firms engaged in the digital asset space, as well as RIAs that provide services to clients through automated investment tools and platforms, often referred to as “robo-advisers.”

FINRA and MSRB – OCIE will continue its oversight of the Financial Industry Regulatory Authority (FINRA) by focusing examinations on FINRA’s operations, regulatory programs, and the quality of FINRA’s examinations of broker-dealers and municipal advisors. OCIE will also continue to examine the Municipal Securities Rulemaking Board (MSRB) to evaluate the effectiveness of its operations and internal policies, procedures, and controls.

The published priorities for FY 2020 are not exhaustive and will not be the only areas OCIE focuses on in its examinations, risk alerts, and investor and industry outreach. While the priorities drive OCIE’s examinations, the scope of any examination is determined through a risk-based approach that includes analysis of a given entity’s history, operations, services, products offered, and other risk factors.

The collaborative effort to formulate the annual examination priorities starts with feedback from examination staff who are uniquely positioned to identify the practices, products, services and other factors that may pose risk to investors or the financial markets. OCIE staff also takes into account input and advice from the Chairman and other Commissioners, staff from other SEC divisions and offices, and other federal financial regulators. [Please
login to the IA Act UnwrappedTM Examination Tools Database/2020 Information to view the full text of OCIE's 2020 Examination Priorities publication.] Top 


SEC Proposes to Codify Certain Consultations and Modernize Auditor Independence Rules


The Commission announced that it is proposing amendments to codify certain staff consultations and modernize certain aspects of its auditor independence framework.  The proposed amendments would update select aspects of the nearly two-decade-old auditor independence rule set to more effectively structure the independence rules and analysis so that relationships and services that would not pose threats to an auditor’s objectivity and impartiality do not trigger non-substantive rule breaches or potentially time consuming audit committee review of non-substantive matters. 

“The proposed amendments are based on years of Commission staff experience in applying our auditor independence rule set and respond to recent and longer term feedback received from a wide range of market participants,” said Chairman Jay Clayton.  “The proposal is consistent with the Commission’s long-recognized view that an audit by an objective, impartial, and skilled professional enhances both investor protection and market integrity, and, in turn, facilitates capital formation.  In practice, the proposed amendments also would increase the number of qualified audit firms an issuer could choose from and permit audit committees and Commission staff to better focus on relationships that could impair an auditor’s objectivity and impartiality.”

Since the initial adoption of the auditor independence framework in 2000 and revisions in 2003, there have been significant changes in the capital markets and those who participate in them.  The proposed amendments primarily focus on fact patterns presented to Commission staff through consultations that involve a relationship with, or services provided to, an entity that has little or no relationship with the entity under audit, and no relationship to the engagement team conducting the audit.  In these scenarios (including the examples outlined below), the staff regularly observes that the audit firm is objective and impartial and, as a result, does not object to their continuing the audit relationship with the audit client.  

The public comment period will remain open for 60 days following publication of the proposing release in the Federal Register. [Please
login to the IA Act UnwrappedTM Releases Database to view proposing Release No. IA-5422 Amendments to Rule 2-01, Qualifications of Accountants.]

FACT SHEET - Amendments to Rule 2-01, Qualification of Accountants

Highlights


The Commission proposed amendments designed to modernize certain auditor independence requirements.  Many of the current independence requirements have not been updated since their initial adoption in 2000 and amendments in 2003.  Since that time, the Commission and our staff have, through several consultations per year, continued to learn about the application of our independence rule set and the efficiency and effectiveness of our independence requirements as market conditions and industry practices have changed.  The proposed amendments to Rule 2-01 are designed to respond to these changes, reflect the SEC staff’s experience administering the independence requirements, and incorporate consideration of the recent and longer term feedback received from the public.

Aspects of Current Rules that Do Not Impact Audit Firm Objectivity and Impartiality

The following examples, based, in part, on the SEC staff’s consultation experience, help to illustrate some of the concerns with the current rules that the proposals would address.

Example 1 – Student Loans

Audit Firm has an audit partner based in Atlanta who continues to pay his student loans taken to attend college before starting his career at Audit Firm.  A different audit partner in Atlanta audits the lender that provided the student loan, a large student loan company that originates thousands of student loans.  Under the current rules, the student loan of the audit partner who is not part of the audit would still lead to an independence violation for the audit engagement of the lender.

Example 2 – Portfolio Companies

Assume Company X is a U.S.-based portfolio company of Fund F.  Fund F invests in various companies around the globe, perhaps dozens or even hundreds, including Company X.  Audit Firm A is the auditor of Company X.  Also assume that two of Audit Firm A’s global network affiliates provide the services discussed below to two separate portfolio companies of Fund F.  Call them Company Y and Company Z.  Further assume that Company Y and Company Z have no relation to each other or to Company X except for the fact that Fund F is invested in each Company.  To add practical context, further assume that:

•    An Australian affiliate of Audit Firm A provides limited staffing services to a healthcare portfolio company based in Australia – Company Y – for a short-period of time to meet a resource need.

•    A Spanish affiliate of Audit Firm A provides payroll services for a lodging (hotel chain) portfolio company based in Spain – Company Z – for a short-period of time.

Also assume that Company X has its own separate governance structure that is unrelated to Company Y or Z, and Company Y and Z are not material to Fund F.  Under the current auditor independence rules, if Company X registers with the SEC (e.g., by conducting an IPO), Audit Firm A would not be independent of Company X as a result of the services provided to either Company Y or Z.  This is the case regardless of whether, as the SEC staff has observed in similar situations, these limited services at immaterial portfolio companies (Companies Y and Z) have no impact on the entity under audit in any way and do not impact the objectivity and impartiality of the auditor in conducting the audit for Company X.

The intent of the proposed amendments to the auditor independence rules is to avoid requiring Company X, under these and similar circumstances, to (1) replace Audit Firm A with another audit firm, (2) wait to register with the SEC for up to three years after termination of the services provided to Company Y and Company Z, or (3) make a determination, likely in consultation with Commission staff and/or the audit committee, that the rule violation did not impair the auditor’s objectivity and impartiality.

In some situations, the existing audit firm cannot be replaced as a practical matter because all other qualified audit firms have themselves provided services or established other relationships with portfolio companies of Fund F that triggered a breach of our independence rule.  The issue of the independence rule set affecting auditor choice is brought home by this example and has increased significantly as the asset management industry has grown, investments have become more global and the global audit services ecosystem has consolidated and become more specialized.

The hypothetical scenario described above is based directly on SEC staff’s experience over the past decade.  For the 12-month period ending September 30, 2019, the SEC staff has conducted a number of consultations in which this fact pattern, or one similar to it, was raised to the SEC staff by the registrant’s audit committee and its auditor, and the SEC staff, under such circumstances, did not object to the auditor’s and the audit committee’s conclusion that the auditor’s objectivity and impartiality would not be impaired.  SEC staff has provided similar feedback in these types of scenarios over the past decade.

Proposed Amendments to Rule 2-01

The proposed amendments would, if adopted:

•    Amend the definitions of affiliate of the audit client, in Rule 2-01(f)(4), and Investment Company Complex, in Rule 2-01(f)(14), to address certain affiliate relationships, including entities under common control;

•    Amend the definition of the audit and professional engagement period, specifically Rule 2-01(f)(5)(iii), to shorten the look-back period, for domestic first time filers in assessing compliance with the independence requirements;

•    Amend Rule 2-01(c)(1)(ii)(A)(1) and (E) to add certain student loans and de minimis consumer loans to the categorical exclusions from independence-impairing lending relationships;

•    Amend Rule 2-01(c)(3) to replace the reference to “substantial stockholders” in the business relationship rule with the concept of beneficial owners with significant influence;

•    Replace the outdated transition and grandfathering provision in Rule 2-01(e) with a new Rule 2-01(e) to introduce a transition framework to address inadvertent independence violations that only arise as a result of merger and acquisition transactions; and

•    Make certain miscellaneous updates.

What’s Next?


The public comment period will remain open for 60 days following publication of the proposing release in the Federal Register.  Top 

 

SEC Proposes to Modernize Regulation of the Use of Derivatives by Registered Funds and Business Development Companies

The SEC has voted to propose a new rule designed to enhance the regulation of the use of derivatives by registered investment companies, including mutual funds, exchange-traded funds (ETFs) and closed-end funds, as well as business development companies. The proposed rule would provide an updated and more comprehensive approach to the regulation of funds’ derivatives use.

“The Commission’s proposal recognizes the extensive changes that have taken place in our capital markets and the fund industry over the past several decades, including the importance of derivatives in effective portfolio management,” said SEC Chairman Jay Clayton. “Funds frequently use derivatives to gain exposure to certain asset classes more efficiently and to mitigate risks, but in certain cases derivatives can heighten risks to investors and markets, including risks related to leverage. By standardizing the framework for funds’ derivatives risk management, the proposal would benefit investors, funds and our markets, including by providing for more-effective risk management across funds and enhanced investor protections.”

The Investment Company Act limits the ability of registered funds and business development companies to obtain leverage, including by engaging in transactions that involve potential future payment obligations. Leverage is commonly thought of in terms of purchasing securities with borrowed funds. However, derivatives, such as forwards, futures, swaps and written options, can also create future payment obligations. The proposed rule would permit these funds to use derivatives that create such obligations, provided that they comply with certain conditions designed to protect investors.

These conditions include adopting a derivatives risk management program and complying with a limit on the amount of leverage-related risk that the fund may obtain, based on value-at-risk. A streamlined set of requirements would apply to funds that use derivatives in a limited way. The proposed rule would also permit a fund to enter into reverse repurchase agreements and similar financing transactions, as well as “unfunded commitments” to make certain loans or investments, subject to conditions tailored to these transactions.

Certain registered investment companies that seek to provide leveraged or inverse exposure to an underlying index—including leveraged ETFs—would not be subject to the proposed limit on fund leverage risk but instead would be subject to alternative requirements under the Commission’s proposal. These funds would have to limit the investment results they seek to 300% of the return (or inverse of the return) of their underlying index (i.e., three times leveraged). Sales of these funds also would be subject to proposed new sales practices rules. Under these new rules, a broker, dealer, or investment adviser that is registered with the Commission would have to exercise due diligence in approving a retail customer or client’s account to buy or sell shares of these funds, as well as shares of exchange-listed commodity or currency pools that have similar investment strategies. These proposed new rules are designed to help ensure that retail investors in these products are limited to those who are capable of evaluating their characteristics—including that the funds would not be subject to all of the leverage-related requirements under the proposed rule applicable to registered investment companies generally—and the unique risks they present.

The proposal will be published on SEC.gov and in the Federal Register. The comment period for the proposal will be 60 days after publication in the Federal Register.

FACT SHEET


Use of Derivatives by Registered Investment Companies and Business Development Companies; Required Due Diligence by Broker-Dealers and Registered Investment Advisers Regarding Retail Customers’ Transactions in Certain Leveraged/Inverse Investment Vehicles

Highlights


The Commission voted to propose new rules, and rule and form amendments, designed to provide an updated, comprehensive approach to the regulation of funds’ use of derivatives and certain other transactions. Proposed new rule 18f-4, an exemptive rule under the Investment Company Act of 1940 (the “Act”),would permit mutual funds, exchange-traded funds (“ETFs”), registered closed-end funds, and business development companies (collectively, “funds”)to enter into derivatives transactions and certain other transactions notwithstanding the restrictions under section 18 of the Act.

The Commission also proposed new sales practice rules—rule 15l-2 under the Securities Exchange Act of 1934 and rule 211(h)-1 under the Investment Advisers Act of 1940—designed to address specific considerations raised by certain leveraged or inverse funds and exchange-listed commodity or currency pools (“leveraged investment vehicles”). In connection with these proposed new rules, the Commission proposed to amend rule 6c-11 under the Act to allow certain leveraged or inverse ETFs to operate without obtaining an exemptive order.

Finally, the Commission proposed new reporting requirements and amendments to certain disclosure forms.

Proposed Rule 18f-4 Under the Investment Company Act

The development of staff guidance and industry practice on an instrument-by-instrument basis, together with growth in the volume and complexity of derivatives markets over past decades, has resulted in situations in which different funds may treat the same kind of derivative differently, based on their own view of our staff’s guidance or observation of industry practice. Where there is no specific guidance, or where the application of existing guidance is unclear or applied inconsistently, funds may take approaches that may not address the purposes and concerns underlying section 18.

Proposed rule 18f-4 would impose a uniform set of conditions and provide certain exemptions from the Act. The conditions include the following:

Proposed Sales Practice Rules and Amendments to Rule 6c-11

The proposed sales practice rules would establish a set of due diligence and approval requirements for broker-dealers and SEC-registered investment advisers with respect to trades in shares of certain leveraged investment vehicles.

Under the proposed rules, a firm would have to exercise due diligence in determining whether to approve a retail customer or client’s account to buy or sell leveraged investment vehicles. A broker-dealer or investment adviser could only approve the account if it had a reasonable basis to believe that the customer or client is capable of evaluating the risks associated with these products.

The proposed amendments to Investment Company Act rule 6c-11 would permit certain leveraged or inverse ETFs to rely on rule 6c-11. The Commission proposed to rescind the exemptive orders previously issued to the sponsors of leveraged or inverse ETFs in connection with any adoption of the proposed amendments.

Reporting Requirements


The proposal would require a fund to report confidentially to the Commission on a current basis on Form N-LIQUID (to be renamed “Form N-RN”) if the fund is out of compliance with the VaR-based limit on fund leverage risk for more than three consecutive business days. The proposal also would amend Forms N-PORT and N-CEN to require funds that are currently required to file these forms to provide certain information regarding a fund’s derivatives exposure and, as applicable, information regarding the fund’s VaR. This information would be publicly available.

Review of Relevant Staff Guidance

In view of the proposal’s updated, comprehensive approach to the regulation of funds’ derivatives use, the Commission proposed to rescind a 1979 General Statement of Policy (Release 10666), which provides Commission guidance on how funds may use certain derivatives and derivatives-like transactions in light of section 18’s restrictions. In addition, staff in the Division of Investment Management is reviewing its no-action letters and other guidance addressing funds’ use of derivatives and other transactions covered by proposed rule 18f-4 to determine which letters and staff guidance, or portions thereof, should be withdrawn in connection with any adoption of the proposal.

What’s Next?
The proposal will be published on SEC.gov and in the Federal Register. The public comment period will remain open for 60 days after publication in the Federal Register.

The Commission also approved for use two short-form tear sheets to gather information. Funds are encouraged to submit additional feedback on proposed rule 18f-4 in light of their current risk management practices. Broker-dealers and investment advisers are encouraged to submit additional feedback on the proposed sales practice rules. While any commenter could use these tear sheets, they are particularly aimed at smaller funds, advisers, and broker-dealers, and are designed to help these smaller entities provide feedback on how the proposal would affect them. [Please
login to the IA Act UnwrappedTM Release Database to access Proposing Release No. IA-5413 Use of Derivatives by Registered Investment Companies and Business Development Companies; Required Due Diligence by Broker-Dealers and Registered Investment Advisers Regarding Retail Customers’ Transactions in Certain Leveraged/Inverse Investment Vehicles]   Top 

New Frequently Asked Questions on Form CRS

The staff of the Division of Investment Management and the Division of Trading and Markets have prepared responses to questions about Form CRS and expect to periodically update responses to additional questions.  These responses represent the views of the staff of the Division of Investment Management and the Division of Trading and Markets.  Replies to questions under the new FAQs include  Relationship Summary Format and Delivery Requirements. [Please
login to the IA Act UnwrappedTM Regulatory Database Rule 204-5:Delivery of Form CRS to access the new questions and answers.]   Top 

SEC Revokes Registration of Adviser Engaged in $60 Million Fraud

The SEC has revoked the registration of New York-based investment adviser International Investment Group LLC (IIG), which the Commission recently charged with securities fraud for hiding losses in its flagship hedge fund and selling at least $60 million in fake loan assets to clients.

The SEC's complaint, filed on Nov. 21, 2019, in federal court in New York, alleges that IIG grossly overstated the value of defaulted loans in the fund’s portfolio to conceal losses in its flagship hedge fund. In an effort to continue its deception, IIG allegedly doctored the firm's records to show that the defaulted loans had been repaid and that the proceeds had been used to make new loans, when in fact there had been no repayment and the purported new loans were fake. The SEC's complaint further alleges that IIG sought to raise money to meet investor redemption requests and other liabilities by selling at least $60 million in fake trade finance loans to other clients. To deceive clients into purchasing these loans, an IIG employee allegedly had fake documentation created to substantiate the non-existent loans, including fake promissory notes and a forged credit agreement.

"This case shows that even sophisticated professional investors can fall victim to Ponzi schemes," said Daniel Michael, Chief of the SEC's Complex Financial Instruments Unit. "The revocation of IIG's registration is necessary to protect the public in light of IIG's egregious breaches of its fiduciary duty as an investment adviser."

IIG consented to a bifurcated settlement under which it is enjoined from future violations of the antifraud provisions of the federal securities laws. The judgment, which the court entered on Nov. 26, 2019, also imposes a preliminary asset freeze, but reserves the issue of any monetary relief, including disgorgement, prejudgment interest, and civil penalties, for further determination by the court upon motion of the SEC. [Please
login to IA Act UnwrappedTM to view Release No. IA-5414 In the Matter of International Investment Group, LLC]   Top 

 

2020 Renewal Program
 

The 2020 Renewal Program Calendar is now available. Preliminary Statements will be available November 11 in E-Bill. Renewal reports will continue to be available through IARD/CRD for reconciliation purposes. See the IARD Reports Quick Reference Guide for additional information.

Note: Effective with the 2020 Renewal program, the Annual IA Representative System Processing Fee will increase from $10 to $15. The Initial IA Representative System Processing Fee will also increase to $15 dollars on January 2, 2020. [Please
login to the IA Act UnwrappedTM Regulatory Database - Rule 204-1 Form ADV Amendments for more information regarding renewals.]  Top

 

Enforcement Publishes Annual Report for FY2019

The SEC's Division of Enforcement has issued its annual report for fiscal year 2019. The report details the division’s efforts and initiatives on behalf of investors, highlights several significant actions, and presents the activities of the division from both a qualitative and quantitative perspective.

“The results depicted in this report reflect the division’s focus on rooting out misconduct that can do significant harm to investors and our markets, and the focus the division places on identifying wrongdoing and taking prompt action to effectively help harmed investors,” said SEC Chairman Jay Clayton. “Across a broad array of cases, the Enforcement staff has continued to show determination, sophistication, and thoughtfulness in detecting and deterring bad conduct and crafting meaningful remedies. I thank the dedicated women and men of the division, in our home office and in our 11 regional offices, for their efforts in support of our mission and investors.”

As in prior years, the report describes the division’s efforts guided by five core principles: (1) focus on the Main Street investor, (2) focus on individual accountability, (3) keep pace with technological change, (4) impose remedies that most effectively further enforcement goals, and (5) constantly assess the allocation of resources.

“The report shows how the principles we have articulated inform our work to protect investors and ensure that the U.S. securities markets remain the safest and strongest in the world,” said Stephanie Avakian, Co-Director of the SEC’s Division of Enforcement.

In fiscal year 2019, the SEC brought a diverse mix of 862 enforcement actions, including 526 standalone actions. These actions addressed a broad range of significant issues, including issuer disclosure/accounting violations; auditor misconduct; investment advisory issues; securities offerings; market manipulation; insider trading; and broker-dealer misconduct. Through these actions, the SEC obtained judgments and orders totaling more than $4.3 billion in disgorgement and penalties. Importantly, the SEC also returned roughly $1.2 billion to harmed investors as a result of enforcement actions.

“The actions and initiatives described in the report reflect our deliberate, principled approaches to investigations, litigation, and case resolutions,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division. “We are proud of the work Enforcement staff did in enabling the SEC to punish misconduct, deter future wrongdoing, and obtain relief for harmed investors.” [Please
login to the IA Act UnwrappedTM Examination Tools Database/2019 Information to access the full report.]  Top 

 

SEC Proposes to Modernize the Advertising and Cash Solicitation Rules for Investment Advisers

The SEC has voted to propose amendments to modernize the rules under the Investment Advisers Act addressing investment adviser advertisements and payments to solicitors. The proposed amendments are intended to update these rules to reflect changes in technology, the expectations of investors seeking advisory services, and the evolution of industry practices.

“The advertising and solicitation rules provide important protections when advisers seek to attract clients and investors, yet neither rule has changed significantly since its adoption several decades ago,” said SEC Chairman Jay Clayton. “The reforms we have proposed today are designed to address market developments and to improve the quality of information available to investors, enabling them to make more informed choices.”

The proposed amendments to the advertising rule would replace the current rule’s broadly drawn limitations with principles-based provisions. The proposed approach would also permit the use of testimonials, endorsements, and third-party ratings, subject to certain conditions, and would include tailored requirements for the presentation of performance results based on an advertisement’s intended audience.

The proposed amendments to the solicitation rule would expand the current rule to cover solicitation arrangements involving all forms of compensation, rather than only cash, subject to a new de minimis threshold. They also would update other aspects of the rule, such as who is disqualified from acting as a solicitor under the rule.

The public comment period will remain open for 60 days following publication of the proposal in the Federal Register.

FACT SHEET
Investment Adviser Advertisements; Compensation for Solicitations
Nov. 4, 2019

Highlights


The Commission today voted to propose amendments to the rules that prohibit certain investment adviser advertisements and payments to solicitors, respectively, under the Investment Advisers Act of 1940 (the “Act”). Neither rule has been amended significantly since its adoption in 1961 and 1979, respectively. Since that time, the Commission and our staff have continued to learn about adviser marketing and solicitation practices, as those practices have evolved significantly with advancements in technology and the changes within the asset management industry and its investor base. The proposed amendments to Rule 206(4)-1 and Rule 206(4)-3 are designed to respond to these changes.

The Commission has also voted to propose amendments to Form ADV, the investment adviser registration form, and Rule 204-2, the books and records rule, which would reflect the changes proposed to the advertising and solicitation rules.

Proposed Amendments to Advertising Rule

The proposed amendments to Rule 206(4)-1 would replace the current rule’s broadly drawn limitations with more principles-based provisions, as described below.

Definition of Advertisement.  The proposal would update the definition of “advertisement” so that it is flexible enough to remain relevant and effective in the face of advances in technology and evolving industry practices.  

The definition would include any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes investment advisory services or that seeks to obtain or retain advisory clients or investors in any pooled investment vehicle advised by the adviser.

The Commission proposed exclusions from this definition for:  (1) live oral communications that are not broadcast, (2) responses to certain unsolicited requests for specified information, (3) advertisements, other sales material, or sales literature that is about a registered investment company or a business development company and is within the scope of other Commission rules; and (4) information required to be contained in a statutory or regulatory notice, filing, or other communication.

General Prohibitions.  The proposed rule would prohibit the following advertising practices:  

Testimonials and Endorsements.  The proposal would permit testimonials and endorsements, subject to specified disclosures, including whether the person giving the testimonial or endorsement is a client and whether compensation has been provided by or on behalf of the adviser.

Third-Party Ratings.  The proposed rule would permit third-party ratings, subject to specified disclosures and certain criteria pertaining to the preparation of the rating.

Performance Information Generally.  The proposal would prohibit including in any advertisement: 

Performance Information in a Retail Advertisement. The proposed rule would provide additional protections for an advertisement targeted to a retail audience:  (1)requiring the presentation of net performance alongside any presentation of gross performance, and (2)requiring generally the presentation of the performance results of any portfolio or certain composite aggregations across 1-, 5-, and 10-year periods.

Internal Pre-Use Review and Approval.  In addition, the proposed amendments would require advertisements to be reviewed and approved in writing by a designated employee before dissemination, except for advertisements that are:  (1) communications disseminated only to a single person or household or to a single investor in a pooled investment vehicle; or (2) live oral communications broadcast on radio, television, the internet, or any other similar medium. 

Proposed Amendments to Solicitation Rule

The proposed amendments to Rule 206(4)-3 would largely make refinements in scope, written agreement content, and disclosure requirements, as described below.

Scope.

All Forms of Compensation.  The proposed rule would apply regardless of whether an adviser pays cash or non-cash compensation to a solicitor.  Non-cash compensation would include directed brokerage, awards or other prizes, and free or discounted services.

Private Fund Solicitors.  The proposed rule would apply to the solicitation of current and prospective investors in private funds, rather than only to the solicitation of current and prospective clients of the adviser.

Exempt Arrangements.  The proposed rule would substantially retain the current rule’s partial exemptions for (1) solicitors that refer investors for impersonal investment advice, and (2) solicitors that are employees or otherwise affiliated with the adviser.  However, these arrangements would no longer be subject to the current rule’s written agreement requirement.  The proposal would also add two new full exemptions for: (1) de minimis compensation to solicitors, and (2) advisers that participate in certain nonprofit programs.

Disqualified Solicitors
.  The proposed rule contains an expanded list of disciplinary events for which persons would be disqualified from acting as a solicitor, with a limited exception.

Written Agreement.  Under the proposed rule, an adviser that compensates a solicitor for solicitation activities would be required to enter into written agreement with the solicitor, unless an exemption applies.  The proposed rule would require that the written agreement include: (1) a description of the solicitation activities and compensation, (2) a requirement that the solicitor perform its solicitation activities in accordance with certain provisions of the Advisers Act, and (3) a requirement that solicitor disclosure be delivered to investors.  The proposed rule would eliminate the current rule’s requirements that the solicitor agree to deliver the adviser’s Form ADV brochure and perform its solicitation activities consistent with the instructions of the adviser. 

Disclosure Requirements. The solicitor disclosure required under the proposed rule would continue to highlight for investors the solicitor’s financial interest in the client’s choice of an investment adviser.  Our proposal would modify the current solicitor disclosure to include additional information about a solicitor’s conflict of interest. Our proposal would eliminate the current rule’s requirement that the adviser obtain from each investor acknowledgments of receipt of the disclosures.

Oversight of Solicitors. The proposed rule would require that the adviser have a reasonable basis for believing that the solicitor has complied with the rule’s written agreement, including complying with the solicitor disclosure requirement. This requirement would be largely the same as the current rule.

Proposed Amendments to the Books and Records Rule and to Form ADV

The proposed amendments to Rule 204-2 relate to the proposed amendments to the advertising and solicitation rules.

Finally, today’s proposal would amend Form ADV to provide additional information regarding advisers’ advertising practices to help facilitate the Commission’s inspection and enforcement capabilities.

Review of Relevant Staff Guidance

Staff in the Division of Investment Management have issued a number of no-action letters and other guidance addressing the application of the current advertising and solicitation rules.  The Commission’s release accompanying the proposed amendments includes a list of the relevant letters and guidance.  The staff is reviewing these letters to determine whether any should be withdrawn in connection with any adoption of the proposed amendments.

What’s Next? - The proposed amendments will be published on the Commission’s website and in the Federal Register.  The public comment period will remain open for 60 days after publication in the Federal Register.

The Commission also approved for use two short-form tear sheets (“feedback flyers”) to gather information. Investors are encouraged to submit additional feedback about their experiences with adviser marketing on the investor feedback flyer. Smaller advisers are encouraged to submit additional feedback about how the proposed rules would affect them on the adviser feedback flyer The feedback flyers are available on the Commission’s website. [Please
login to the IA Act UnwrappedTM Releases Database to view Release No. IA-5407 Investment Adviser Advertisements; Compensation for Solicitations]  Top

Regulatory Agencies Join the Global Financial Innovation Network

The Commodity Futures Trading Commission (CFTC), Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), and the Securities and Exchange Commission (SEC) have announced joining the Global Financial Innovation Network (GFIN).

U.S. financial regulators have taken proactive steps in recent years to enhance regulatory clarity and understanding for all stakeholders and promote early identification of emerging regulatory opportunities, challenges, and risks. Participation in the GFIN furthers these objectives and enhances the agencies’ abilities to encourage responsible innovation in the financial services industry in the United States and abroad. By promoting knowledge-sharing on innovation in financial services, U.S. members of GFIN will seek to advance financial and market integrity, consumer and investor protection, financial inclusion, competition, and financial stability. Participation in international organizations such as this helps U.S. financial regulators represent the interests and needs of the nation and its financial services stakeholders.

The agencies join 46 other financial authorities, central banks, and international organizations from around the globe that are members of the GFIN to foster greater cooperation among financial authorities on a variety of innovation topics, regulatory approaches, and lessons learned. Top 

FAQs Regarding Disclosure of Certain Financial Conflicts Related to Investment Adviser Compensation

The Division of Investment Management has published Frequently Asked Questions discussing certain compensation arrangements and related disclosure obligations arising from both the investment adviser’s fiduciary duty and Form ADV.

Compensation that an investment adviser, its affiliates or its associated persons receives in connection with the investments it recommends and related services it provides can result in the investment adviser having interests that conflict with those of its clients.

The Division notes that many investment advisers appear to have recognized these conflicts and have responded through practices designed to address them, including through elimination, disclosure or a combination of disclosure and mitigation. However, SEC examinations staff have observed and enforcement cases have illustrated that, in some instances, investment advisers have not appropriately addressed these conflicts of interest. [Please
login to the IA Act UnwrappedTM Examination Tools Database/2019 Information to view the full text of the Division’s publication and FAQs.]   Top 

 

SEC Announces the Formation of Asset Management Advisory Committee

The SEC has announced the formation of an Asset Management Advisory Committee formed to provide the Commission with diverse perspectives on asset management and related advice and recommendations. Topics the committee may address include trends and developments affecting investors and market participants, the effects of globalization, and changes in the role of technology and service providers. The committee is comprised of a group of outside experts, including individuals representing the views of retail and institutional investors, small and large funds, intermediaries, and other market participants.

“Asset management is a critical component of our markets and is especially important to Main Street investors,” said SEC Chairman Jay Clayton. “This committee will help the Commission ensure that our regulatory approach to asset management meets the needs of retail investors and market participants at a time when the industry is evolving rapidly. I would like to thank each of the committee members for agreeing to participate on this important committee.”

Chairman Clayton has appointed Edward Bernard, Senior Advisor to T. Rowe Price, as the initial committee Chairman. Other committee members include:


John Bajkowski, President and Chief Executive Officer, American Association of Individual Investors
Michelle McCarthy Beck, Chief Risk Officer, TIAA Financial Solutions
Jane Carten, Director, President, Director, and Portfolio Manager, Saturna Capital
Scot Draeger, President-Elect, General Counsel, and Director of Wealth Management, R.M. Davis Inc.
Mike Durbin, President, Fidelity Institutional
Gilbert Garcia, Managing Partner, Garcia Hamilton & Associates
Paul Greff, Chief Investment Officer, Ohio Public Employees Retirement System
Rich Hall, Deputy Chief Investment Officer, The University of Texas/Texas A&M Investment Management Co.
Neesha Hathi, Executive Vice President and Chief Digital Officer, Charles Schwab Corp.
Adeel Jivraj, Partner, Ernst & Young LLP
Ryan Ludt, Principal and Global Head of ETF Capital Markets and Broker/Index Relations, Vanguard
Susan McGee, Board Member, Goldman Sachs BDC Inc.
Jeffrey Ptak, Head of Global Manager Research, Morningstar Research Services
Erik Sirri, Professor of Finance, Babson College, and Independent Trustee, Natixis Funds, Loomis Sayles Funds, and Natixis ETFs
Aye Soe, Managing Director and Global Head of Product Management, S&P Dow Jones Indices
Ross Stevens, Founder and Chief Executive Officer, Stone Ridge Asset Management
Rama Subramaniam, Head of Systematic Asset Management, GTS
John Suydam, Chief Legal Officer, Apollo Global Management
Mark Tibergien, Managing Director and Chief Executive Officer of Advisor Solutions, BNY Mellon | Pershing
Russ Wermers, Dean’s Chair in Finance and Chairman of the Finance Department, University of Maryland’s Smith School of Business, and Managing Member, Wermers Consulting LLC 
Alex Glass, Indiana Securities Commissioner (non-voting)
Tom Selman, Executive Vice President, Regulatory Policy, and Legal Compliance Officer, FINRA (non-voting)


The committee will be formally established on Nov. 1, 2019 for an initial two-year term, which can be renewed by the Commission. The Commission will announce further details about the committee in the near future. Top 

SEC Charges IAs with Unlawful Proxy Voting of Client Securities

The SEC announced settled charges against two registered investment advisers, New York-based Amadeus Wealth Advisors LLC and California-based Three Bridge Wealth Advisors LLC, for the unlawful proxy voting of client securities.

The SEC's orders find that on two separate occasions in 2015, Amadeus and Three Bridge both voted client proxies notwithstanding representations in their client advisory agreements and regulatory filings with the SEC that they would not accept or exercise proxy voting authority over client securities. Both firms managed mainly retail accounts during that period. According to the SEC's orders, at the request of representatives of the same registered broker-dealer, Amadeus and Three Bridge each executed and returned to the broker-dealer letters voting proxies for numerous clients in securities of issuers affiliated with that broker-dealer. In each instance, the advisory firms cast their clients' votes in favor of the proposition at issue for the proxy being solicited on behalf of the issuer. Neither advisory firm made any disclosure to any of the clients or sought authority to vote those clients' proxies prior to executing and returning the letters to the broker-dealer. Amadeus voted client proxies without authority for a total of 20 client accounts, while Three Bridge did so for over 65 client accounts.

The SEC's orders find that Amadeus and Three Bridge violated Section 206(2) of the Investment Advisers Act of 1940 by engaging in this conduct. Without admitting or denying the SEC's findings, Amadeus and Three Bridge each consented to a cease-and-desist order and agreed to pay civil monetary penalties of $40,000 and $60,000, respectively. [Please
login to IA Act UnwrappedTM to view Release Nos. IA-5375 In the Matter of Three Bridge Wealth Advisors, LLC & IA-5374 In the Matter of Amadeus Wealth Advisors, LLC under Regulatory Database Rule 206(4)-6 Risks/Significant Cases Tab]  Top 


Cash Solicitation Rule Violations

On September 26, 2019, the SEC issued Release No. IA-5371 In the Matter of Cetera Investment Advisers LLC.  These proceedings arise out of Cetera’s violation of Section 206(4) of the Advisers Act and Rule 206(4)-3 thereunder (the “Solicitor Rule”), which prohibit a registered investment adviser from paying a solicitor a cash fee for solicitation activities unless, among other things, the solicitor furnishes the client with a separate written disclosure document identifying the solicitor and the investment adviser, describing the nature of the relationship between the solicitor and the investment adviser, and specifying the terms of the compensation arrangement.

Since at least January 2007, Cetera has paid cash fees to approximately 350 banks to, among other things, solicit investment advisory clients on behalf of Cetera. As part of this process, Cetera did not require the banks to give clients a separate written disclosure document or otherwise provide the information required under the Solicitor Rule.

As a result, Cetera’s clients were not informed of the extent of the banks’ financial interest in the clients’ choice of Cetera as an investment adviser and did not have all of the information that would enable them to evaluate the solicitor’s recommendation. By paying cash fees for solicitation activities and not ensuring that advisory clients received the required disclosures, Cetera violated the Solicitor Rule.
[Please login to IA Act UnwrappedTM to view Release No. IA-5371 In the Matter of Cetera Investment Advisers LLC under Regulatory Database Rule 206(4)-2 Risks/Significant Cases.]  Top   
 

SEC Orders IA to Return Nearly $1.5 Million to Clients Harmed by Share Class Selection Disclosure Violations

On September 30, 2019, the Commission announced that dually-registered investment adviser and broker-dealer Founders Financial Securities, LLC has agreed to settle charges that it invested clients in more expensive mutual fund share classes, which provided the firm with financial benefits, without disclosing this conflict to clients. The settlement includes a distribution to harmed investors.

The SEC's order finds that Maryland-based Founders purchased, recommended or held for advisory clients mutual fund share classes that charged 12b-1 fees instead of available lower-cost share classes of the same funds for which the clients were eligible. Those 12b-1 fees were then passed on to Founders, or used to offset amounts due from Founders for the cost of client custody services. This practice created a conflict of interest that the firm did not adequately disclose to clients.

In addition, the order finds that Founders breached its duty to seek best execution for its clients by investing them in mutual fund share classes with 12b-1 fees rather than available lower-cost share classes of the same funds. According to the SEC's order, Founders also failed to adopt and implement written policies and procedures designed to prevent these violations.

The SEC's order finds that Founders violated the antifraud provisions of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder. Without admitting or denying the SEC's findings, Founders will pay disgorgement of $1,246,133, prejudgment interest of $229,332, and a civil penalty of $140,000. Founders has agreed to distribute $1,475,465 to harmed investors. Founders also consented to a censure and the entry of a cease-and-desist order from committing or causing further violations of these provisions of the federal securities laws.  [Please
login to IA Act UnwrappedTM to view Release No. IA-5397 In the Matter of Founders Financial Securities, LLC]  Top 

SEC Charges Hedge Fund Adviser and Top Executives With Fraud

 

The SEC has charged SBB Research Group, LLC, a Chicago-area hedge fund adviser and its two top executives with a multi-year fraud that inflated fund values.  According to the SEC's complaint, SBB Chief Executive Officer Samuel Barnett founded the firm in 2010 while still in college, raised millions from friends and family members, and invested almost exclusively in structured notes. The complaint alleges that as SBB sought outside investors, Barnett and Chief Operating Officer and Chief Compliance Officer Matthew Aven promised prospective investors that they would use "fair value" when recording investments. Instead, they used their own valuation model to artificially inflate the value of the structured notes.

 

As a result, SBB misstated the funds' historical performance and overcharged investors approximately $1.4 million in fees. According to the complaint, once the valuation issues were uncovered by SEC exam staff, the defendants took steps to conceal their fraud from investors and SBB's auditor. The complaint alleges that when SBB hired an outside valuation firm in 2016, performance for its flagship fund was slashed, and SBB surreptitiously credited investors for the overcharged fees but did not disclose the underlying problem.

 

"Investors rely on investment advisers to accurately value assets and disclose fund performance," said Daniel Michael, Chief of the SEC Division of Enforcement’s Complex Financial Instruments Unit. "As alleged in the SEC's complaint, SBB, Barnett, and Aven intentionally manipulated valuation models to deceive current and prospective investors."

 

The SEC's complaint, filed in the U.S. District Court for the Northern District of Illinois, charges the defendants with violations of the antifraud provisions of the federal securities laws and seeks permanent injunctions and civil penalties.  Top 

 

SEC Orders an Additional 16 Self-Reporting Advisory Firms to Pay Nearly $10 Million to Investors
Orders Firm That Did Not Self-Report to Pay $300,000 Penalty for Disclosure Failures

The SEC announced settled charges against 17 investment advisers for disclosure failures regarding their mutual fund share class selection practices. The firms include 16 advisers that self-reported as part of the Division of Enforcement’s Share Class Selection Disclosure Initiative and one adviser that did not self-report and was ordered to pay a $300,000 civil penalty.

As part of the initiative announced on Feb. 12, 2018, the Division of Enforcement agreed that for eligible firms that self-reported by the deadline, the Division would recommend standardized settlement terms to the Commission, including that the Commission not impose a civil penalty. On March 11, 2019, the Commission instituted actions against 79 advisers that participated in the initiative, ordering the payment of over $125 million in disgorgement and prejudgment interest to investors. Today, the Commission issued orders against 16 additional advisers that self-reported as part of the initiative, bringing the total amount ordered to be returned to investors to over $135 million. The Commission did not order a civil penalty as to any of those self-reporting firms.

The Commission today also charged Mid Atlantic Financial Management Inc., which was eligible to self-report as part of the initiative but did not. The Commission found that Mid Atlantic, whose affiliate received 12b-1 fees, failed to fully disclose the conflicts arising from its selection of more expensive mutual fund share classes for clients when lower-cost share classes for the same fund were available. Among other things, the SEC ordered Mid Atlantic to pay over $1 million in disgorgement and prejudgment interest. Unlike the firms that self-reported as part of the initiative, however, the Commission also ordered Mid Atlantic to pay a $300,000 civil monetary penalty.

“Today’s actions reaffirm the benefits to advisers and their clients for self-reporting as part of the Initiative,” said C. Dabney O’Riordan, Co-Chief of the Asset Management Unit. “They also demonstrate the Commission’s commitment to holding advisers accountable for selecting more expensive investments that eat away at their clients’ investment returns without proper disclosure.”

The SEC’s orders find that the 16 self-reporting firms violated Section 206(2) of the Investment Advisers Act of 1940, and ordered that they are censured, that they cease and desist from future violations, that they pay disgorgement and prejudgment interest totaling nearly $10 million and that they comply with certain undertakings, including returning the money to investors. As to Mid Atlantic, the SEC’s order finds that it violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder, and ordered that it is censured, that it cease-and-desist from future violations, that it pay disgorgement and prejudgment interest totaling over $1 million and a $300,000 civil penalty, and that it comply with certain undertakings, including returning the money to investors.  Top 

Two BMO Advisory Firms Pay Over $37 Million to Harmed Clients for Failing to Disclose Conflicts of Interest

Two BMO advisers have agreed to pay over $37 million to settle charges regarding their failure to tell clients about certain aspects of how the advisers selected investments in their retail investment advisory program, known as the Managed Asset Allocation Program (MAAP), which included the selection of more expensive investments from which BMO advisers profited.

According to the SEC’s order, when selecting investments for clients, BMO Harris Financial Advisors Inc. (BMO Harris) and BMO Asset Management Corp. (BMO Asset Mgmt) preferred mutual funds managed by BMO Asset Mgmt (proprietary funds) and invested approximately 50% of MAAP client assets in proprietary funds. This practice resulted in payment of additional management fees to BMO Asset Mgmt, however, the SEC’s order found that neither BMO adviser disclosed this practice or the associated conflict of interest to clients. Moreover, the SEC’s order found that, when considering mutual funds for MAAP, BMO Asset Mgmt evaluated the lower-cost institutional share class for both proprietary and non-proprietary funds, but the higher-cost, non-institutional share class for proprietary mutual funds always was selected for MAAP.

In addition, the SEC found that BMO Harris failed to disclose its conflicts of interest arising from investing MAAP client assets in higher-cost share classes of certain mutual funds, including funds managed by BMO Asset Mgmt, when lower-cost share classes were available. By selecting the higher-cost share classes, BMO Harris received revenue sharing payments and avoided paying certain transaction costs, while clients received lower returns on these investments.

“These BMO advisers repeatedly put their own financial interests ahead of clients by giving preference to their own mutual funds or selecting higher-cost share classes,” said C. Dabney O’Riordan, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “This is important information for an adviser to tell clients as it goes to the heart of the adviser-client relationship and will impact the clients’ returns.”

The SEC’s order finds that BMO Harris and BMO Asset Mgmt willfully violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder. Without admitting or denying the SEC’s findings, BMO Harris and BMO Asset Mgmt agreed to cease and desist from committing or causing any future violations of these provisions, to pay disgorgement and prejudgment interest of $29.73 million, and to pay a civil penalty of $8.25 million, amounts which will be distributed to harmed investors, and to be censured. [Release No. IA-5377 In the Matter of BMO Harris Financial Advisors, Inc. and BMO Asset Management Corp.]  Top 

IA Ordered to Pay $2.5 Million to Clients Related to Mutual Fund Share Class Selection Violations

Registered investment adviser Sigma Planning Corp. has agreed to settle charges that it selected mutual fund investments for clients that provided the firm with financial benefits without disclosing its conflicts to clients. The settlement includes a distribution to harmed investors.

The SEC's order finds that Sigma had two undisclosed financial conflicts with respect to the selection of 12b-1 fee-paying mutual fund share classes. First, Sigma failed to fully disclose its conflicts relating to select mutual fund share classes for which Sigma was paid a portion of the 12b-1 fees when lower cost share classes for the same mutual fund were available to Sigma's clients. Second, Sigma failed to disclose to clients that by selecting these 12b-1 fee share classes, the firm also avoided paying its clearing broker an asset-based fee that it would have otherwise had to pay. In addition, Sigma failed to disclose the conflicts associated with its broker-dealer affiliates receiving revenue-sharing payments in connection with certain alternative investment products that Sigma purchased for its advisory clients. The order also finds that Sigma itself acted as an unregistered broker-dealer.

The SEC's order finds that Sigma violated the antifraud provisions of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder, as well as the broker registration provisions of Section 15(a) of the Securities Exchange Act of 1934.

Without admitting or denying the SEC's findings, Sigma will pay disgorgement of $1,920,809, prejudgment interest of $225,909, and a civil penalty of $400,000. Sigma has agreed to distribute these funds to harmed investors. Sigma also consented to a censure and the entry of a cease-and-desist order from committing or causing further violations of these provisions of the federal securities laws.
[Please login to IA Act UnwrappedTM to view Release No. IA-5356 In the Matter of Sigma Planning Corp.] Top

SEC Charges Morgan Stanley for Recommending Unsuitable Municipal Bond Transactions

On September 17, 2019, the SEC announced administrative and cease-and-desist proceedings against Morgan Stanley Smith Barney LLC (Morgan Stanley), a registered broker dealer and investment adviser that is also registered with the Municipal Securities Rulemaking Board (MSRB), for allegedly recommending unsuitable municipal bond transactions to its customers.

According to the SEC's order, from June 2013 through December 2017, Morgan Stanley recommended 135 "swap" transactions to its retail customers in which the customers sold one municipal bond while purchasing another municipal bond that was nearly identical to the bond sold or that otherwise provided no apparent economic benefit to the customer. Further, the order finds Morgan Stanley did not document information about the customers that indicated that any of the swaps were suitable for the customers. Morgan Stanley received over $340,000 in commissions and fees upon execution of these swap transactions, which Morgan Stanley returned, with interest, to affected customers during the course of the SEC's investigation.

The order instituting the proceeding found that Morgan Stanley willfully violated Section 15B(c)(1) of the Securities Exchange Act of 1934, which prohibits broker dealers from effecting transactions in municipal securities in contravention of MSRB Rules, and also found that Morgan Stanley violated MSRB Rules G-8, G-17, G-19, and G-27. Morgan Stanley consented, without admitting or denying the findings in the SEC's order, to the entry of a cease-and-desist order, to be censured, and to pay a $225,000 civil penalty. [Please
login to IA Act UnwrappedTM to view Release No. IA-5354 In the Matter of Morgan Stanley Smith Barney, LLC]  Top

Investment Adviser Principal and Agency Cross Trading Compliance Issues

On September 4, 2019 OCIE issued a Risk Alert to provide an overview of the most compliance issues identified by OCIE related to principal trading and agency cross transactions under Section 206(3) of the Advisers Act, which were identified in examinations of investment advisers. Examples of the four most common compliance issues are:

1. Section 206(3) requirements not followed.  OCIE staff observed advisers that did not appear to follow the specific requirements of Section 206(3).  For example, OCIE staff observed: 

• Advisers that, acting as principal for their own accounts, had purchased securities from, and sold securities to, individual clients without recognizing that such principal trades were subject to Section 206(3).  Thus, these advisers did not make the required written disclosures to the clients or obtain the required client consents. 
 
• Advisers that had recognized that they engaged in principal trades with a client, but did not meet all of the requirements of Section 206(3), such as:

 o Failing to obtain appropriate prior client consent for each principal trade.

 o Failing to provide sufficient disclosure regarding the potential conflicts of interest and terms of the transaction.

• Advisers that had obtained client consent to a principal trade after the completion of the transaction.

2. Principal trade issues related to pooled investment vehicles.  OCIE staff observed advisers that engaged in certain transactions involving pooled investment vehicle clients where such advisers did not appear to follow the requirements of Section 206(3).  For example, OCIE staff observed:


• Advisers that effected trades between advisory clients and an affiliated pooled investment vehicle, but failed to recognize that the advisers’ significant ownership interests in the pooled investment vehicle would cause the transaction to be subject to Section 206(3).
 
• Advisers that effected principal trades between themselves and pooled investment vehicle clients, but did not obtain effective consent from the pooled investment vehicle prior to completing the transactions.

3. Agency cross transactions.  OCIE staff observed advisers’ practices that gave rise to compliance issues in connection with agency cross transactions.  For example, OCIE staff observed:

• Advisers that disclosed to clients that they would not engage in agency cross transactions, but in fact engaged in numerous agency cross transactions in reliance on Rule 206(3)-2.  
 
• Advisers that effected numerous agency cross transactions and purported to rely on Rule 206(3)-2, but could not produce any documentation that they had complied with the written consent, confirmation, or disclosure requirements of the rule. 

4. Policies and procedures related to Section 206(3).  OCIE staff observed advisers that did not have policies and procedures relating to Section 206(3) even though the advisers engaged in principal trades and agency cross transactions.  OCIE staff also observed advisers that established—but failed to follow—policies and procedures regarding principal trades and agency cross transactions.

OCIE encourages advisers to review their written policies and procedures and the implementation of those policies and procedures to ensure that they are compliant with principal trading and agency cross transaction provisions of the Advisers Act and the rules therender. [Please
login to IA Act UnwrappedTM to view the full text of the Investment Adviser Principal and Agency Cross Trading Compliance Issues Risk Alert in the Examination Tools Database, or under Regulatory Database Rule 206(3)-2 Risks Tab.]  Top 


SEC Monitoring Impact of Hurricane Dorian on Capital Markets


The SEC is closely monitoring the impact of Hurricane Dorian on investors and capital markets.  The SEC divisions and offices that oversee companies, accountants, investment advisers, mutual funds, brokerage firms, transfer agents, and other regulated entities and investment professionals will continue to closely track developments. They will evaluate the possibility of granting relief from filing deadlines and other regulatory requirements for those affected by the storm. Entities and investment professionals affected by Hurricane Dorian are encouraged to contact Commission staff with questions and concerns:

Individuals experiencing problems accessing their securities accounts or with similar questions or concerns relating to the hurricane are encouraged to contact the SEC's Office of Investor Education and Advocacy by phone at 1-800-SEC-0330 or email at help@sec.gov.

Investors should be vigilant for Hurricane Dorian-related securities scams and check the background of anyone offering them an investment by using the free and simple search tool on Investor.gov. The Division of Enforcement will vigorously prosecute those who attempt to defraud victims of the storm. The SEC is asking investors to report any suspicious solicitations at www.sec.gov/complaint/tipscomplaint.shtml. Top 

RSM US LLP Charged With Violating Auditor Independence Rules

On August 27, 2019, the SEC charged public accounting firm RSM US LLP with violations of the agency’s auditor independence rules in connection with more than 100 audit reports involving at least 15 audit clients.

According to the SEC’s order, RSM US repeatedly represented that it was “independent” in audit reports issued on the clients’ financial statements, which were included or incorporated by reference in public filings with the Commission or provided to investors.  Instead, the SEC found that RSM US or its associated entities, including other member firms of the RSM International network, provided non-audit services to, and had an employment relationship with, affiliates of RSM US audit clients, which violated the SEC’s auditor independence rules.  The prohibited non-audit services included corporate secretarial services, payment facilitation, payroll outsourcing, loaned staff, financial information system design or implementation, bookkeeping, internal audit outsourcing, and investment adviser services.  The prohibited employment relationship concerned a partner at an RSMI member firm in Australia serving on a voluntary basis as a non-discretionary member of the board of an affiliate of a RSM US issuer audit client.  As detailed in the SEC’s order, certain of RSM US’s independence controls were also inadequate, resulting in the firm’s failure to identify and avoid these prohibited non-audit services and the prohibited employment relationship.  These violations occurred between 2014 and 2015, with certain violations remaining undetected until at least 2016.

“The SEC’s auditor independence rules specifically prohibit audit firms from providing certain non-audit services,” said Carolyn M. Welshhans, Associate Director of the SEC’s Division of Enforcement.  “Audit firms must put in place procedures, training, and systems that provide a reasonable assurance of independence, and they must monitor for independence on an ongoing basis.”

The SEC’s order finds that RSM US violated the auditor independence provisions of the federal securities laws and caused the audit clients to violate their obligations to have their financial statements audited by independent public accountants.  The order also finds that RSM US engaged in improper professional conduct within the meaning of Rule 102(e) of the SEC’s Rules of Practice by virtue of its violations of the auditor independence requirements.

RSM US consented to the SEC’s order without admitting or denying the findings and was ordered to cease and desist from future violations.  RSM US agreed to pay a $950,000 penalty and be censured.  RSM US additionally agreed to engage an independent consultant to evaluate its current quality controls for complying with auditor independence requirements for non-audit services.  In determining to accept RSM US’s offer of settlement, the SEC considered remedial acts undertaken by RSM US. [Please
login to IA Act UnwrappedTM to view Release No. IA-5331 In the Matter of RSM US LLP (f/k/a McGladrey LLP)]  Top 

SEC Brings Settled Actions Charging Cherry Picking and Compliance Failures

Laurel Wealth Advisors, Inc., a registered investment adviser based in La Jolla, California, and its former investment adviser representative, Joseph C. Buchanan, agreed to settle charges relating to Buchanan's multi-year cherry-picking scheme. Cherry-picking is the fraudulent practice of preferentially allocating profitable trades or failing to allocate unprofitable trades to an adviser's personal accounts at the expense of the adviser's client accounts.

The SEC's orders found that from at least March 2013 to June 2015, Buchanan disproportionately allocated profitable trades to his personal accounts, and disproportionately allocated unprofitable trades to his clients' accounts. The orders found that Buchanan's allocation scheme resulted in $56,075 in net same-day profits to Buchanan and $60,821 in net same-day losses to his clients. According to the SEC's order against Buchanan, the likelihood of these profitable trades being randomly allocated to his personal accounts are less than one in one billion.

According to a separate order against Laurel Wealth, Laurel Wealth failed reasonably to supervise Buchanan, despite receiving written and telephonic warnings from its brokerage provider regarding Buchanan's late allocations, and despite the brokerage provider imposing a one-month suspension on Buchanan's omnibus account. The order also found that during the relevant period, Laurel Wealth failed to implement its own internal procedures that required Buchanan and others to pre-clear and obtain written pre-approval before transacting securities for their personal accounts. The order found that Laurel Wealth's Form ADV contained misleading statements that it employed a pre-clearance procedure to prevent conflicts of interest and to ensure that its employees' personal transactions were carried out in a way that did not endanger client interests.

The SEC's order against Buchanan found that Buchanan violated the antifraud provisions of Sections 206(1) and 206(2) of the Investment Advisers Act of 1940 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(a) and 10b-5(c) thereunder. Without admitting or denying these findings, Buchanan consented to the entry of a cease-and-desist order, and an order to pay disgorgement of $56,227 and prejudgment interest of $15,284. Payment of the disgorgement and interest amounts, except for $40,000, was waived and no penalty was imposed based on Buchanan's financial condition. Buchanan also consented to a permanent associational bar and investment company bar.

The SEC's order against Laurel Wealth found that Laurel Wealth made misleading statements in violation of Section 206(2) of the Investment Advisers Act of 1940, failed to implement written policies and procedures reasonably designed to prevent violations of the Advisers Act in violation of Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, and failed reasonably to supervise Buchanan within the meaning of Section 203(e)(6) of the Advisers Act. Without admitting or denying these findings, Laurel Wealth consented to the entry of a cease-and-desist order, which includes a censure, payment of a $100,000 penalty, and a voluntary undertaking to provide a copy of the order to each of Buchanan's former Laurel Wealth clients. [Please
login to IA Act UnwrappedTM to view Release No. IA-5330 In the Matter of Laurel Wealth Advisors, Inc.]  Top 


SEC Clarifies Investment Advisers' Proxy Voting Responsibilities and Application of Proxy Rules to Voting Advice


On August 21, 2019, the SEC issued guidance to assist investment advisers in fulfilling their proxy voting responsibilities. The guidance discusses, among other matters, the ability of investment advisers to establish a variety of different voting arrangements with their clients and matters they should consider when they use the services of a proxy advisory firm.  In addition, the Commission issued an interpretation that proxy voting advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules and provided related guidance about the application of the proxy antifraud rule to proxy voting advice.  Both of these actions explain the Commission’s view of various non-exclusive methods entities can use to comply with existing laws or regulations or how such laws and regulations apply.

“Voting is a key component of shareholder engagement and investing more generally,” said SEC Chairman Jay Clayton.  “I’d like to thank Commissioner Elad Roisman for his leadership on our efforts to consider improvements to the proxy process, and for helping to develop this important guidance that, among other things, will provide clarity to investment advisers regarding proxy voting responsibilities, and ultimately benefit their clients.”      

“Today’s releases have benefited from the substantial engagement from the public over the past decade, including last November’s Staff Roundtable on the Proxy Process and the extensive public comments the Commission has received,” said Commissioner Roisman.  “The releases reiterate the Commission’s views on the importance of investment advisers’ voting responsibly on behalf of their clients and the applicability of our proxy rules to proxy voting advice.  Advisers who vote proxies must do so in a manner consistent with their fiduciary obligations and, to the extent they rely on voting advice from proxy advisory firms they must take reasonable steps to ensure the use of that advice is consistent with their fiduciary duties. In addition, proxy advisory firms, to the extent they engage in solicitations, must comply with applicable law.”

FACT SHEET
SEC Open Meeting
August 21, 2019


The Commission has issued guidance to assist investment advisers in fulfilling their proxy voting responsibilities, particularly where they use the services of a proxy advisory firm, and provides guidance on proxy voting disclosures under Form N-1A, Form N-2, Form N-3, and Form N-CSR under the Investment Company Act of 1940.  The Commission has also issued an interpretation of Exchange Act Rule 14a-1(l) that proxy voting advice generally constitutes a solicitation under the federal proxy rules and related guidance regarding the application of the antifraud provisions in Exchange Act Rule 14a-9 to proxy voting advice.

Proxy Voting Responsibilities of Investment Advisers


Investment advisers owe each of their clients a duty of care and loyalty with respect to services undertaken on the clients’ behalf, including proxy voting.  Rule 206(4)-6 under the Advisers Act requires an investment adviser who exercises voting authority with respect to client securities to adopt and implement written policies and procedures that are reasonably designed to ensure that the investment adviser votes proxies in the best interest of its clients.

The guidance clarifies how an investment adviser’s fiduciary duty and Rule 206(4)-6 under the Advisers Act relate to an adviser’s proxy voting on behalf of clients, particularly if the investment adviser retains a proxy advisory firm.  The guidance follows a question and answer format and provides examples to help facilitate compliance.

In particular, the guidance discusses, among other things:

Applicability of the Federal Proxy Rules to Proxy Voting Advice

The federal proxy rules apply to any solicitation for a proxy with respect to any security registered under Exchange Act Section 12.  Under Exchange Act Rule 14a-1(l), a solicitation includes, among other things, a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy,” and includes communications by a person seeking to influence the voting of proxies by shareholders, regardless of whether the person itself is seeking authorization to act as a proxy.

Under the Commission interpretation, proxy voting advice provided by proxy advisory firms generally constitutes a solicitation subject to the federal proxy rules.  The Commission’s interpretation does not affect the ability of proxy advisory firms to continue to rely on the exemptions from the federal proxy rules’ filing requirements.  These exemptions, found in Rule 14a-2(b), among other things, provide relief from the obligation to file a proxy statement, as long as the advisory firm complies with the exemption’s conditions.

Solicitations that are exempt from the federal proxy rules’ filing requirements remain subject to Exchange Act Rule 14a-9, which prohibits any solicitation from containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact.  The Commission guidance explains what a person providing proxy voting advice should consider when considering the information it may need to disclose in order to avoid a potential violation of Rule 14a-9 where the failure to disclose such information would render the advice materially false or misleading.

What’s Next?


The guidance and interpretation will be effective upon publication in the Federal Register.

We encourage investment advisers to review their policies and procedures in light of the guidance in advance of next year’s proxy season.  To the extent that firms identify operational or other questions in the course of that review, we encourage them to contact the staff of the Division of Investment Management. 
[Please login to IA Act UnwrappedTM to view Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, Release No. IA-5325, “Fiduciary Release”; also see Release No. 34-86721 Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice ]. Top

SEC Releases Videos on Choosing and Working with a Financial Professional

On August 15, 2019, the SEC released a series of short educational videos designed to provide ordinary investors with basic information about choosing and working with a financial professional. The videos are now available at SEC.gov and Investor.gov/CRS.

“Through my discussions with Main Street investors across the country, it became apparent to me that there are several key concepts involving working with a financial professional that have not been well explained,” said Chairman Jay Clayton. “These videos are designed to describe, generally and in plain language, the differences between brokers-dealers and investment advisers, arming investors with the information they need to ask better questions and help them make sound decisions for themselves and their families with their hard-earned money. We encourage investors to ask direct questions of their financial professional, so that they can better understand the services they will receive and what they are paying.  I encourage investors to ask my favorite question:  If I work with you, how much of my money is going to fees and costs, and how much is going to work for me?”

The videos released are a part of the Commission’s larger Main Street investor engagement and education campaign, following recently adopted rulemakings and interpretations designed to enhance the quality and transparency of retail investors’ relationships with investment advisers and broker-dealers and bring the legal requirements and mandated disclosure in line with reasonable investor expectations, while preserving access (in terms of choice and cost) to a variety of investment services and products. Specifically, these actions include new Regulation Best Interest, the new Form CRS Relationship Summary, and two separate interpretations under the Investment Advisers Act of 1940.

Chairman Clayton previously announced that these videos, along with investor events, would be part of a new campaign designed to help retail investors understand key differences between broker-dealers and investment advisers, and to help them decide whether working with one of those types of financial professionals is right for them. [Please
login to IA Act UnwrappedTM Regulatory Database Rule 204-5 for more information under the Description Tab.]   Top 

SEC Charges IA with Failing to Disclose Financial Conflict of Interest

The Commission announced settled charges against MVP Manager LLC ("MVP"), a New York-based investment adviser to private funds, for failing to adequately disclose conflicts of interest.

According to the SEC's order, MVP advised and managed private fund clients that invested in the securities of venture-backed companies that had not conducted initial public offerings. The order finds that on three occasions between December 2014 and December 2015, MVP personnel arranged to receive a brokerage commission from the counterparty that was selling such securities to MVP's client funds. Each of these arrangements created a potential or actual conflict of interest because MVP and its personnel had an economic incentive to cause the private funds to purchase the securities at the prices MVP negotiated with the counterparties, which would trigger the payment of the commissions. None of the disclosure documents that MVP provided to fund investors, however, revealed the existence of the arrangements or MVP's attendant conflicts of interest.

The SEC order finds that MVP willfully violated the antifraud provisions of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. Without admitting or denying the SEC's findings, MVP agreed to settle by consenting to a cease-and-desist order and censure, disgorgement and prejudgment interest of approximately $170,000, and a civil monetary penalty of $80,000. [Please
login to IA Act UnwrappedTM to view Release No. IA-5319 In the Matter of MVP Manager LLC.]  Top 

SEC to Consider Proxy Voting Guidance
Open Meeting Agenda for Wednesday, August 21, 2019


Item 1: Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers

Office: Division of Investment Management

Staff: Dalia Blass, Paul Cellupica, Holly Hunter-Ceci, David Bartels, and Thankam Varghese

The Commission will consider whether to publish guidance regarding the proxy voting responsibilities of investment advisers under Rule 206(4)-6 under the Investment Advisers Act of 1940, and Form N-1A, Form N-2, Form N-3, and Form N-CSR under the Investment Company Act of 1940.

For further information, please contact Thankam Varghese or Holly Hunter-Ceci in the Division of Investment Management at (202) 551-6825.

Item 2: Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice

Office: Division of Corporation Finance

Staff: William Hinman, Michele Anderson, Ted Yu, Tamara Brightwell, and Adam Turk

The Commission will consider whether to publish an interpretation and related guidance regarding the applicability of certain rules, which the Commission has promulgated under Section 14 of the Securities Exchange Act of 1934, to proxy voting advice.

For further information, please contact Adam Turk in the Division of Corporation Finance at (202) 551-3500. Top

SEC Charges Recidivist IA for Failing to Disclose Conflicts of Interest

On July 24, 2019, the Commission announced that recidivist N. Gary Price, a principal of formerly registered investment adviser Genesis Capital LLC, agreed to settle charges that he failed to disclose to clients significant conflicts of interest relating to recommendations to invest in securities issued by Aequitas Commercial Finance, LLC. The SEC previously charged Aequitas Management LLC and four of its affiliates, including ACF, with fraudulently raising more than $350 million from investors.

According to the SEC's order, from 2013 through 2015, Genesis made several investments for its mutual fund clients in promissory notes issued by ACF. Price, of Gig Harbor, Washington, approved these investments through Genesis's investment committee. At the time Genesis made these investments, Price benefited from significant financial ties to Aequitas entities. In particular, the SEC's order found that Price held ownership stakes in two Aequitas-affiliated businesses that together received $3.6 million in loans from ACF as well as a $10 million line of credit. At the same time, a broker-dealer part-owned by Price allegedly received fees from another Aequitas affiliated-business for referring other investors to ACF.   Despite several opportunities to disclose his ties to Aequitas, the SEC's order found that Price repeatedly failed to do so.

The SEC's order found that Price violated Section 206(2) of the Investment Advisers Act of 1940. Without admitting or denying the SEC's findings, Price consented to a cease-and-desist order, and agreed to pay disgorgement and prejudgment interest of $67,033 and a civil penalty of $75,000. The order also bars Price from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, with the right to apply for reentry after one year. 
[Please login to IA Act UnwrappedTM to view Release No. IA-5307]   Top 

Adviser & Principals Charged with Failing to Disclose Conflicts of Interest

On July 24, 2019, the Commission announced that Foundations Asset Management, LLC (“FAM”), an Anchorage, Alaska-based investment adviser, along with its principals Michael Shamburger and Rob Wedel, agreed to settle charges that they failed to disclose conflicts of interest related to compensation FAM received.

The SEC’s order finds that from May 2013 to June 2016, FAM breached its fiduciary duty to its retail clients by failing to disclose conflicts of interest FAM had in recommending investments in the private real estate fund Alaska Financial Company III LLC (“AFC III”).

As detailed in the order, during this period, AFC III and its manager paid FAM approximately $254,000, in both up-front payments and annual trailing fees, in exchange for FAM recommending investments in the fund. FAM ultimately recommended its clients put approximately $12 million in AFC III. The order finds that FAM, Shamburger, and Wedel failed on multiple occasions to adequately disclose to clients the conflicts of interest presented by FAM’s AFC III compensation, including that FAM earned significantly more money by recommending AFC III investments as compared to other investments. The SEC’s order further finds that FAM failed to register as a broker and made materially false statements regarding its compensation in SEC filings.

The SEC’s order finds that FAM willfully violated the broker-dealer registration provision of Section 15(a) of the Securities Exchange Act of 1934 and the antifraud provisions of Sections 206(2) and 207 of the Investment Advisers Act of 1940, that Shamburger caused FAM’s violations of Section 15(a) of the Exchange Act and Sections 206(2) and 207 of the Advisers Act, and that Wedel caused FAM’s violations of Section 15(a) of the Exchange Act and Section 206(2) of the Advisers Act.

Without admitting or denying the findings, FAM agreed to pay disgorgement and prejudgment interest of $278,947 and an $85,000 penalty, while Shamburger and Wedel agreed to pay $50,000 and $25,000 penalties, respectively. The SEC’s order also includes cease-and-desist orders against FAM, Shamburger, and Wedel; a censure against FAM; and a voluntary undertaking by FAM to relinquish its right to receive further trailing fees related to AFC III investments. AFC III and its manager were the subject of a 2018 SEC enforcement action alleging fraud. [Please
login to IA Act UnwrappedTM to view Release No. IA-5306 In the Matter of Foundations Asset Management, LLC, Michael W. Shamburger, and Rob E. Wedel] Top

OCIE Publishes Observations from Supervision Initiative

As part of OCIE’s Supervision Initiative and focus on protecting retail investors, OCIE staff conducted a series of examinations to assess the oversight practices of SEC-registered investment advisers that previously employed, or currently employ, any individual with a history of disciplinary events.

On July 23, 2019, OCIE issued a Risk Alert to raise awareness of certain compliance issues that OCIE observed by sharing the staff’s observations from these examinations.

The staff conducted over 50 exams of advisers in 2017 as part of the Supervision Initiative.  The advisers examined collectively managed approximately $50 billion in assets for nearly 220,000 clients, the vast majority of whom were retail investors.  Advisers were identified for examination through a review of information about disciplinary events and other legal actions involving supervised persons of the adviser, including legal actions that are not required to be reported on Form ADV (e.g., private civil actions).  

The Supervision Initiative focused on advisers’ practices in certain areas, including: compliance programs and supervisory oversight practices, disclosures, and conflicts of interest.

The Initiative identified a variety of observed deficiencies across a range of topics.  Nearly all of the examined advisers received deficiency letters.  The vast majority of these deficiencies relate to compliance issues, but many relate to disclosure issues, including undisclosed conflicts of interest. The OCIE Risk Alert also discusses staff observations on ways to improve compliance and considerations for advisers that hire or employ supervised persons with disciplinary histories.

OCIE encourages advisers, when designing and implementing their compliance and supervision frameworks, to consider the risks presented by hiring and employing supervised persons with disciplinary histories and adopt policies and procedures to address those risks. [Please
login to the IA Act UnwrappedTM Examination Tools Database/2019 Information to access the Risk Alert.]  Top

Portfolio Manager Charged with Mispricing Fund Investments

On July 18, 2019, the Commission announced settled administrative proceedings against Swapnil Rege, a North Brunswick, New Jersey portfolio manager and trader, for mispricing private fund investments, resulting in a large personal bonus.

According to the SEC's order, from June 2016 to April 2017, while employed by the fund's adviser, Rege manipulated the inputs he used to value interest rate swaps and swap options to create the false impression that his investments for the fund were profitable. Rege's conduct, the SEC's order finds, artificially inflated the fund's reported returns and caused the fund to pay too much in fees. Rege took steps to conceal his mispricing from the fund's adviser. Because of Rege's inflated valuations, he received a $600,000 bonus. The order states that the adviser ultimately fired Rege, closed the fund, and returned the excessive management fees to the fund.

"Rege overvalued fund assets to benefit only himself and then tried to cover it up," said C. Dabney O’Riordan, Co-Chief of the SEC Enforcement Division's Asset Management Unit. "Today the SEC, along with our colleagues at the Commodity Futures Trading Commission, are holding him accountable for his misconduct, which harmed both the fund and its investors."

The SEC's order finds that, based on the above conduct, Rege aided and abetted and caused the adviser's violations of the antifraud provisions of Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. Without admitting or denying the findings in the SEC's order, Rege agreed to a cease-and-desist order, an associational bar and investment company prohibition with a right to apply for reentry after three years, disgorgement of ill-gotten gains of $600,000 plus prejudgment interest, and a civil penalty of $100,000.

The Commodity Futures Trading Commission (CFTC) also entered a consent order against Rege, involving substantially the same conduct as described in the SEC’s order. The CFTC's order finds that Rege violated the Commodity Exchange Act and imposes a trading ban for a period of at least three years, disgorgement that will be deemed satisfied by the payment of disgorgement under the SEC's order, and an additional penalty of $100,000. [Please
login to IA Act UnwrappedTM to view Release No. IA-5303 In the Matter of Swapnil Rege]   Top 

SEC Charges Fund Adviser and Principal for Fraudulently Overvaluing Assets

The Commission has charged Paul Alar of Atlanta, Georgia, and his investment adviser firm, West Mountain, LLC, for fraudulently over valuing assets in two funds they managed, allowing them to collect significantly inflated fees.

The SEC's complaint alleges that, beginning in late 2016, West Mountain and Alar directed two funds that they managed to invest in subsidiaries of two privately held companies. According to the complaint, at the time of the investments, both companies had minimal revenues, very limited operations, and minimal numbers of employees. Nevertheless, Alar and West Mountain recorded in the financial records for their two funds a collective unrealized gain of $18.6 million based on those investments, thereby allowing them to collect approximately $900,000 of additional fees.

The complaint further alleges that, in valuing the unrealized gains, West Mountain and Alar falsely represented to investors that independent valuations by a third party supported their valuations, even though they knew that the third-party expressly stated it "should not be regarded as an independent valuation." In addition, West Mountain's auditors had advised that the valuation methodology used to calculate the unrealized gains was unreasonable and inappropriate. The SEC also alleges that, in 2017, West Mountain and Alar misrepresented that one of the companies was actively negotiating an anticipated agreement that would result in massive gains for investors. According to the complaint, however, these "active negotiations" never existed.

The SEC's complaint, filed in federal district court in Atlanta, Georgia, charges defendants with violating the antifraud provisions of Sections 206(1), (2) and (4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. The SEC seeks permanent injunctions and monetary relief. [Please
login to the IA Act UnwrappedTM Enforcement Case Database to view Litigation Release No. LR-24939 SEC v. Paul Alar and West Mountain, LLC] Top 

SEC and NASAA Explain Application of Securities Laws to Opportunity Zone Investments

The Securities and Exchange Commission and the North American Securities Administrators Association (NASAA) have issued a summary that explains the application of the federal and state securities laws to opportunity zone investments. The "opportunity zone" program was established by the Tax Cuts and Jobs Act in December 2017 to provide tax incentives for long-term investing in designated economically distressed communities.

The summary is intended to help participants in the opportunity zone program understand the compliance implications for qualified opportunity funds under federal and state securities laws.

"The opportunity zone program has the potential to encourage investment and economic development in many areas across the country that are in need of capital. The staff statement released today will help market participants understand securities laws implications when seeking to raise capital for opportunity zones," said SEC Chairman Jay Clayton. "In addition, today the SEC is issuing staff guidance regarding the ability of Main Street investors to participate in these offerings."

"This new program provides an opportunity to strengthen investments in low-income communities and rural areas that traditionally struggled to attract the capital necessary to spur economic growth and job creation," said Michael Pieciak, NASAA President and Vermont's Commissioner of Financial Regulation. "This joint summary is a good example of state and federal regulators working collaboratively to address new compliance issues raised by an innovative program and thereby promoting our dual mission of protecting investors and helping facilitate capital formation."

Specifically, this summary discusses:

  1. What are qualified opportunity zones (QOZs);
  2. When interests in qualified opportunity funds (QOFs) would be “securities” under federal and state securities laws;
  3. Registration of securities offerings with the SEC and/or state securities regulators and potential exemptions from securities registration for investments in a QOF (particularly through Rule 506 of federal Regulation D);
  4. Broker-dealer registration requirements for persons selling interests in QOFs; and
  5. Registration and exemptions from registration for QOFs that are “investment companies” and considerations for advisers to a QOF.

Please login to the IA Act UnwrappedTM Examination Tools Database/2019 Information to view the Opportunity Zones summary, “Staff Statement on Opportunity Zones: Federal and State Securities Laws Considerations.”  Top 

Agencies Adopt Final Rule to Exclude Community Banks from the Volcker Rule

Five federal financial regulatory agencies announced on July 9th that they adopted a final rule to exclude community banks from the Volcker Rule, consistent with the Economic Growth, Regulatory Relief, and Consumer Protection Act.

The Volcker Rule generally restricts banking entities from engaging in proprietary trading and from owning, sponsoring, or having certain relationships with hedge funds or private equity funds. Under the final rule, which is unchanged from the proposal, community banks with $10 billion or less in total consolidated assets and total trading assets and liabilities of 5% or less of total consolidated assets are excluded from the Volcker Rule.

The final rule also permits a hedge fund or private equity fund, under certain circumstances, to share the same name or a variation of the same name with an investment adviser as long as the adviser is not an insured depository institution, a company that controls an insured depository institution, or a bank holding company.

The final rule is being issued by the Federal Reserve Board, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission.  Top 

Lee Sworn in as SEC Commissioner

Allison Herren Lee was sworn into office on July 8 as an SEC Commissioner.  Ms. Lee was nominated to the SEC by President Donald J. Trump and unanimously confirmed by the U.S. Senate and fills a term that expires on June 5, 2022.

Commissioner Lee has over two decades of experience as a securities law practitioner. Most recently, she has written, lectured, and taught courses internationally on financial regulation and corporate law. She served for over a decade in various roles at the SEC, including as counsel to Commissioner Kara Stein, and as Senior Counsel in the Division of Enforcement’s Complex Financial Instruments Unit. In addition, Commissioner Lee has served as a Special Assistant U.S. Attorney, was a member of the American Bar Association’s former Committee on Public Company Disclosure, and participated on a USAID project in Armenia, assisting in the drafting of periodic reporting and disclosure provisions for a comprehensive law of the Republic of Armenia on Securities Market Regulation.

Prior to government service, Commissioner Lee was a partner at Sherman & Howard LLC, focusing on securities, antitrust, and commercial litigation. A member of the Colorado bar, she holds a bachelor’s degree in Business from the University of Colorado and a J.D. from the University of Denver College of Law, where she was salutatorian, a Chancellor’s Scholar, and served on the Law Review.  Top  

SEC Charges Investment Adviser with Fraud

On July 1, 2019, the Commission charged Fieldstone Financial Management Group LLC and its principal Kristofor R. Behn, both of Foxboro, Mass., with defrauding retail investment advisory clients by failing to disclose conflicts of interest related to their recommendations to invest in securities issued by affiliates of Oregon-based Aequitas Management LLC.  Behn also fraudulently misused approximately $500,000 of one investor’s funds to pay personal expenses.

According to the SEC’s order, from 2014 to early 2016, approximately 40 retail clients of Behn and Fieldstone invested more than $7 million in Aequitas securities, which were the subject of a previous Commission enforcement action.  The order finds that Behn and Fieldstone failed to disclose to their clients that Aequitas had provided Fieldstone with a $1.5 million loan and access to a $2 million line of credit, both of which had terms that created a significant financial incentive for Behn and Fieldstone to recommend Aequitas securities to their clients.  The order further finds that Behn and Fieldstone made material misstatements and omissions in reports filed with the Commission, including false representations that the repayment terms of the loan from Aequitas were not contingent on Fieldstone clients investing in Aequitas.

In addition, the order finds that Behn and Fieldstone fraudulently induced a client to invest $1 million in Fieldstone.  Within days of Fieldstone receiving the $1 million, Behn used approximately $500,000 to pay his personal taxes and make other payments to himself or for his personal benefit.

“Behn flagrantly disregarded his most basic duties as an investment adviser by concealing the significant financial incentives he and his firm would receive by recommending investments in Aequitas,” said Erin E. Schneider, Director of the SEC’s San Francisco Regional Office.  “The Commission is committed to rooting out breaches of fiduciary duty to retail investors.”

Without admitting or denying the Commission’s findings, Fieldstone and Behn consented to the issuance of the order, which finds that they violated the antifraud provisions of the federal securities laws, censures Fieldstone, orders them to cease and desist from future violations, and orders them to pay, on a joint-and-several basis, disgorgement and prejudgment interest of $1,047,971 and a penalty of $275,000, all of which will be distributed to harmed investors.  Behn will also be permanently barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization.

The SEC’s investigation was conducted by Tracy S. Combs and Thomas J. Eme of the San Francisco office and supervised by Steven D. Buchholz.  An examination of Fieldstone contributed to the investigation and was conducted by Mark S. Audet, Michael Garrity, Michael McGrath, and Mayeti Gametchu of the SEC’s Boston Regional Office.  [Please
login to IA Act UnwrappedTM to view Release No. IA-5263 In the Matter of Fieldstone Financial Management Group, LLC and Kristofor R. Behn]   Top 

 

Headline News

IA Charged with Inadequate Controls to Prevent Insider Trading

Did not address business-specific risks & lacked guidance regarding when trading in securities should be restricted
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Agencies Propose Changes to Modify “Covered Funds” Restrictions of Volcker Rule

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SEC Charges Portfolio Manager and Advisory Firm with Misrepresenting Risk in Mutual Fund
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OCIE Publishes Observations on Cybersecurity and Resiliency Practices

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OCIE Announces 2020 Examination Priorities

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Updates

Brightline Solutions updates IA Act UnwrappedTM on a daily basis. Recent updates are listed below. Click HERE for a more detailed summary of the information.

LR-24738 SEC v. Criterion Wealth Management Insurance Services, Inc., et al

LR-24736 SEC v. The Nutmeg Group LLC, et al

IA-5443 In the Matter of Joseph A. Meyer, Jr.

IA-5442 In the Matter of Jay Costa Kelter

IA-5441 In the Matter of Cannell Capital, LLC

Myths and Realities: Modernizing the Proxy Rules
Speech by SEC Commissioner Elad L. Roisman
Added to the IA Act UnwrappedTM Examination Tools Database/2020 Information and to the Plain English Description Tab under Regulatory Database Rule 206(4)-6

IA-5440 In the Matter of Edward E. Matthes

IA-5439 In the Matter of Barton W. Stuck

IA-5438 In the Matter of Patrick L. O'Connor

IA-5437 In the Matter of Jaswant Gill

IA-5436 In the Matter of Catalyst Capital Advisors, LLC and Jerry Szilagyi

Cybersecurity and Resiliency Observations
OCIE examination observations r
elated to cybersecurity and operational resiliency practices taken by market participants
Added to the IA Act UnwrappedTM Examination Tools Database/2020 Information

IA-5366A In the Matter of Leonardo Cornide and Jorge Falcon

IA-5435 In the Matter of John Thomas Capital Management Group LLC and George R. Jarkesy Jr.

IA-5434 In the Matter of Inter-American Development Bank

IA-5433 In the Matter of Mark J. Moskowitz

IA-5432 In the Matter of Lester W. Burroughs

LR-24714 SEC v. Michael B. Rothenberg

Frequently Asked Questions on Regulation Best Interest
Added to the IA Act UnwrappedTM Examination Tools Database/2020 Information, and linked to the term "Regulation Best Interest" in the Glossary & Definitions Database

IA-5431 In the Matter of Michael Mindlin

IA-5430 In the Matter of Patrick L. O'Connor

IA-5429 In the Matter of J.P. Morgan Securities LLC

IA-5428 Adjustments to Civil Monetary Penalty Amounts

IA-5427 In the Matter of Bradley C. Mascho

LR-24710 SEC v. ARO Equity, LCC et al

OCIE 2020 National Examination Priorities
Publication has been added to the IA Act UnwrappedTM Examination Tools Database/2020 Information