Adviser Regulatory & Compliance News

A reminder that even under the current hard times, compliance and regulatory vigilance is vital came from the SEC on March 23. In a public statement from the SEC's Co-Directors of Enforcement, the staff emphasized "the importance of maintaining market integrity and following corporate controls and procedures." They illustrated their point with a discussion of insider trading, noting that, "...broker-dealers, investment advisers, and other registrants must comply with policies and procedures that are designed to prevent the misuse of material nonpublic information." Please use the link in the headline to this blurb to access the Public Statement.

The SEC responded to the outbreak of coronavirus disease 2019 (COVID-19) with respect to investment advisers by issuing an order (Order) that states for the time period specified below that: (1) a registered investment adviser is exempt from the requirements: (a) under Rule 204-1 of the Advisers Act to file an amendment to Form ADV; and (b) under Rule 204-3(b)(2) and (b)(4) related to the delivery of Form ADV Part 2 (or a summary of material changes) to existing clients, where the conditions below are satisfied; (2) an exempt reporting adviser is exempt from the requirements under Rule 204-4 under the Advisers Act to file reports on Form ADV, where the conditions below are satisfied; and (3) a registered investment adviser that is required by Section 204(b) of and Rule 204(b)-1 under the Advisers Act to file Form PF is exempt from those requirements, where the conditions set forth in the Order are satisfied.

In a somewhat unusual move, the Mass. Securities Division recently asserted its jurisdiction over an individual, who was not registered as a broker or investment adviser, and who's business sought to have investors sell their securities to buy insurance products. This move by the Mass. regulator is consistent with the state's increasingly assertive actions regarding a state fiduciary standard. The law firm Mintz Levin in Boston published an fine memo detailing the case, which can be accessed by clicking the heading to this blurb.

The SEC brought an enforcement action against William M. Malloy, III and two investment adviser firms under his control, MWM 1835, LLC and Fortress Investment Management, LLC for, among other things improperly registering with the SEC as investment advisers when such entities were not eligible to register as such.

The SEC brought an enforcement action against Sica Wealth Management, LLC (SWM), a registered investment adviser, and its principal Jeffrey C. Sica for not adequately disclosing certain conflicts of interest to advisory clients. The SEC found that from October 2013 to March 2015, on Sica’s recommendation, approximately 45 SWM advisory clients invested a total of more than $30 million in securities issued by Aequitas Commercial Finance, LLC (ACF), one of numerous entities affiliated with the Aequitas enterprise, the ultimate parent of which is Aequitas Management, LLC.

The SEC brought an enforcement action against Lone Star Value Management LLC (Lone Star) and its founder, Jeffrey Eberwein, for improperly effecting 19 interfund cross trades in 2014 between two funds Lone Star managed, and, in June 2015, while registered with the SEC as an investment adviser, and improperly effecting 2 trades between a fund Lone Star managed and a separately managed account (SMA) for which Lone Star served as an investment adviser. The SEC stated that these 21 trades were made on a principal basis because Eberwein’s ownership stake in the Lone Star fund involved in each of these trades was more than 35% during the relevant time period. The SEC found that Lone Star failed to disclose in writing that it engaged in these principal transactions and did not obtain client consent before the completion of each of the transactions as required under Section 206(3) of the Advisers Act.

The SEC updated its frequently asked questions guidance about Form CRS. On June 5, 2019, the SEC adopted a new rule, Regulation Best Interest or Regulation BI that will require all SEC-registered investment advisers (as well as broker-dealers) with retail clients to create a new Form ADV, Part 3, also known as a Client Relationship Summary (Form CRS). SEC-registered investment advisors who service retail investors will be required to develop and deliver to clients Form CRS beginning in 2020.

The SEC updated its frequently asked questions guidance about Form CRS. On June 5, 2019, the SEC adopted a new rule, Regulation Best Interest or Regulation BI that will require all SEC-registered investment advisers (as well as broker-dealers) with retail clients to create a new Form ADV, Part 3, also known as a Client Relationship Summary (Form CRS). SEC-registered investment advisors who service retail investors will be required to develop and deliver to clients Form CRS beginning in 2020.

The Washington, DC law firm, Katz, Marshall & Banks, recently published its 2020 edition of The SEC Whistleblower Practice Guide. The Guide which is a nice compilation of whistleblower standards and practices. While the Guide appears designed as recruitment tool for whistleblowers, advisers and other industry participants may find it useful as well as they design their whistleblower policies and procedures. Please click the heading to this blurb for a link to the Guide.

The SEC brought an enforcement action against Cannell Capital, LLC (CCL) finding that from 2014 through October 2019, for failing to establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of its business, to prevent the misuse of material nonpublic information. Specifically, the SEC found that CCL failed to follow its written policies and procedures by not maintaining a 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.

In late January 2020, OCIE published a 13 page booklet with its observations and commentary on cybersecurity. The observations cover a variety of areas, including 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 cover a broad variety of securities markets participants and SEC registrants, including investment advisers. Please refer to the link in the heading of this blurb to connect with the publication.

We're pleased to announce that Karl is co-author of the first new textbook about the '40 Acts in over 30 years! "Investment Management Regulation: An Introduction to Principles and Practices." Available now at cap-press.com. Just click on the headline to this blurb above to be taken to the publisher's site. As Members or ETF Conference attendees you are entitled to a 25% discount and free shipping at the Carolina Academic Press's site. Use code: FRANCO2020. Limited time only.

In late Nov. 2019, the SEC again addressed the complicated subject of the use of derivatives by registered fund and BDCs, including mutual funds,ETFs and closed-end funds. The newly proposed rules supersede those proposed in 2015. The focus of the proposal is proposed Rule 18f-4 under the '40 Act, which would set forth the conditions under which open-end funds (including ETFs but excluding money market funds), closed-end funds and BDCs could enter into derivatives transactions. In addition, the proposal includes new rules under the Exchange Act and Advisers Act that governing sales practices for leveraged/inverse funds. The sales and use of such funds by brokers and advisers has been the source of some controversy in recent years. Finally, the proposal also includes new reporting requirements related to the use of derivatives by registered funds and BDCs. The attached article includes links to the SEC's proposal and to articles and analyses prepared by law firms. Updated by Karl Hartmann 01-17-2020

You don't have to be rich or super smart to be an "accredited investor" under the proposal made by the SEC recently. Traditionally, certain types of private investments such as private funds have been available only to investors who meet the standards for being an accredited investor, meaning that they met certain standards regarding wealth and sophistication. Under new rules proposed Dec. 18, 2019, the definition would be expanded to include more qualitative standards such as education/certification (e.g., Series 7 brokers) and employment (e.g., by a hedge fund). In addition, the SEC is seeking comments on whether clients of a registered investment adviser or broker-dealer but do not otherwise meet the financial thresholds should be considered accredited. The attached article contains a variety of analyses and reference materials.

In late November, the Commodity Futures Trading Commission ( “CFTC”) finalized two new rule amendments which simplify and clarify the commodities registration/exemptions for investment advisers, investment companies and business development companies ("BDCs"). Historically, funds have filed notices under CFTC Rule 4.5 to claim exemption from registration as commodity pool operators ("CPOs"). In short, the new rules rationalize the approach by having fund advisers claim such exemptions and add a similar provision for BDC advisers. Additional provisions also codify a variety of no-action positions by adopting exemptions from CPO and CTA registration for qualifying “family offices.” Please refer to the attached article for links to the CFTC releases and additional reference materials. Updated Jan. 10, 2019 by Karl Hartmann

The annual exam priorities were announced by the SEC's Office of Compliance Inspections and Examinations (OCIE) on Jan. 7. In summary, regarding investment advisers and investment companies, OCIE will continue its risk-based examinations as it has in recent years. In particular, examinations of 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 ETFs, the activities of their RIAs, and the oversight practices of their boards of directors. Please click on the headline to this blurb to be linked to the SEC's Priorities document.

Just in time for the holidays, NASAA revealed its top threats list. Based on its survey of members---being the state and provincial securities regulators throughout the United States, Canada and Mexico---the list was a short five threats long: 1. Promissory notes; 2. Ponzi schemes; 3. Real estate investments; 4. Cryptocurrency-related investments (e.g., tokens, ICOs, etc.); and 5. Social media/internet-based investment schemes (e.g., Crowdfunding among others). NASAA's President advises, “Remember, if it sounds too good to be true, it usually is.” Sound advice indeed as we head into the New Year and hopefully Roaring '20s! Please click the headline to be linked to the NASAA release.

In Sept. 2019, the SEC adopted a long-awaited rule to standardize and simply ETF formation and regulation. This rule will likely have an enormous impact on the shape and structure of the money management industry. Basically, Rule 6c-11 sets aside many of the exemptive orders that ETFs have had to obtain in order to offer their shares to the public. The Rule replaces such exemptive orders with a standardized set of regulations applicable to most ETFs. In the attached article (click on the headline to this blurb) we will collect a variety of materials for your review and use. Last updated: Dec. 21, 2019 by Karl Hartmann

The SEC charged Sacramento, California-based investment adviser firm Springer Investment Management, Inc. and owner Keith Springer with defrauding hundreds of retail clients, most of them in or close to retirement. The SEC' alleged that Springer and hfs firm received millions of dollars in undisclosed compensation and other benefits for recommending certain investment products while claiming that they did not have any conflicts of interest. According to the SEC, many clients learned of Springer through his radio show, "Smart Money with Keith Springer," and Springer misled prospective clients into believing he was selected to host the show because of his industry expertise. In reality, SFA paid to broadcast the show. The SEC alleged that Springer went to great lengths to hide prior charges by the SEC and his disciplinary history with the New York Stock Exchange, hiring internet search suppression consultants and instructing employees not to provide the information to prospective clients.

Being on the board of several Hong Kong based ETFs, Karl has a special interest in Hong Kong. We recently discovered an article which nicely spells out the regulatory environment for Hong Kong funds and advisers. It's a very thorough article covering the range of pooled funds from SMAs to retail funds. Please click the headline to be linked to the article.

The staff of the SEC’s Division of Investment Management and the Division of Trading and Markets have prepared a Frequently Asked Questions (FAQ) about Form CRS. The SEC stated that it expected to update from time to time its responses to additional questions.

The SEC brought an enforcement action against Channing Capital Management, LLC (“Channing”) because of its failure to adequately implement written policies and procedures governing the allocation of trading commission costs associated with aggregated (or block) securities trades on behalf of its institutional investor and pension fund clients. The SEC found that Channing’s written trade aggregation and allocation policies and procedures required it to allocate the transaction costs associated with block trades on a pro rata basis amongst all clients participating in the same block trade. It further noted that a separate written policy and procedure required Channing to follow the requirements and restrictions set forth in each client’s investment management agreement, including limitations placed on trading commissions. Certain of Channing’s institutional clients placed limitations on the amount they were willing to pay in commission rates for execution of their brokerage transactions. The SEC stated that Channing routinely conveyed those clients’ restrictions to executing brokers and requested that executing brokers apply lower commission rates for those clients while permitting them to participate in block trades with Channing’s other clients. This practice according to the SEC resulted in clients participating in the same block trade paying different commission rates. By failing to adequately implement its policies and procedures, the SEC concluded that Channing violated Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder.

In recent years the use of proxy voting advice firms has come under scrutiny. In early Nov. 2019, a divided SEC proposed rule amendments to enhance the transparency of the voting advice being given by these firms and enhance the quality of the disclosure about material conflicts of interest that proxy voting advice businesses may have. In addition, the proposal would provide an opportunity for a period of review and feedback through which companies and other soliciting parties would be able to identify errors in the proxy voting advice. The attached article (click the headline to this blurb) provides links to the SEC's materials as well as law firm memos and analyses.

In early November 2019, the SEC proposed to modernize two rules under the Advisers Act which regulate advertising and solicitations. The advertising rule, Rule 206(4)-1, has been in use since 1961. The proposed changes shift the Rule's focus from standards setting to "principles based" regulation, meaning there's potentially more flexibility in administering ad requirements. If adopted the new ad rule would significantly change and update the regulatory landscape. The solicitation rule, Rule 206(4)-3, has been in use since 1979. The proposal would expand the rule to cover solicitation arrangements involving all forms of compensation, rather than only cash compensation, eliminate requirements duplicative of other rules, and tailor the required disclosures solicitors would provide to investors. The proposed rule would also refine the existing provisions regarding disciplinary events that would disqualify a person or entity from acting as a solicitor. The attached article provides links to the rule proposal (505 pages in length!!) and law firm analyses and memos.

In early Nov. 2019, the SEC's OCIE branch published a Risk Alert highlighting the most often cited deficiencies and weaknesses that the SEC staff has observed in recent examinations. The Alert also includes SEC staff observations from national examination initiatives focusing on money market funds and target date funds. Key points highlight: 1. Compliance programs often aren't tailored to the fund or clients' investment mandates 2. Policies and procedures aren't followed 3. Inadequate service provider oversight 4. Annual reviews aren't performed or don't address the adequacy of the funds' policies and procedures 5. Material gaps in disclosures to investors 6. Weaknesses in fund 15(c) advisory and distribution contract approval processes 7. Inadequacies in Code of Ethics adoption and implementation The full Risk Alert is available by clicking the heading to this blurb.

The SEC proposed amendments under the Investment Advisers Act of 1940 to the rules that prohibit certain investment adviser advertisements and payments to solicitors, respectively. The proposed amendments to the solicitation rule update its coverage to reflect regulatory changes and the evolution of industry practices since the rule was adopted in 1979. The SEC is also proposing amendments to Form ADV that are designed to provide the SEC with additional information regarding advisers’ advertising practices. Finally, the SEC is proposing amendments under the Advisers Act to the books and records rule, to correspond to the proposed changes to the advertising and solicitation rules. We will publish more information on the proposal as it becomes available.

In mid-October the SEC's Div. of Investment Management posted a series of FAQs designed to address potential conflicts of interest arising from certain types of adviser compensation. Noting that "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. Many investment advisers appear to have recognized these conflicts and 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." Noting that Rule 12b-1 payments and revenue sharing arrangements are among the more obvious potential conflict situations, the SEC also noted potential conflicts can arise from "an investment adviser’s direct or indirect receipt of service fees from its clearing broker-dealer, marketing-support payments from a mutual fund’s investment adviser, transaction fees, or receipt of payments from a mutual fund’s investment adviser to help defray the costs of educating and training its personnel regarding certain investment products." The FAQs then proceed to expand on these points. Please click on the heading to this summary to access the full SEC version of the FAQs.

In early October 2019, the SEC published an Accounting and Disclosure Information notice, "ADI 2019-09 - Performance and Fee Issues." The notice summarizes recent findings by the DRAO, the Division of Investment Management’s Disclosure Review and Accounting Office, regarding general shortcomings in filings by advisers and funds with respect to performance and fee data. As noted by the SEC staff, "Key Takeaway: Verify the accuracy of your performance and fee disclosures prior to filing them with the Commission and providing them to investors." Please click the headline to this blurb to access the ADI.

In 2017, we reported on a Supreme Court decision in the case of Kokesh v. SEC, which effectively limited disgorgement penalties for cases brought outside the five-year statute of limitations for civil penalties. An law firm article from earlier this year reported that the impact of the case has been almost $1 billion in foregone penalties and attempts by Congress to address some of the issues raised in the case. Please click the headline to link to the article.

File this one under: "Warning to Securities Lawyers!" In mid-September 2019, the SEC brought an action against a South Florida attorney for aiding and abetting a client's fraudulent offering and sale of securities. As part of its complaint, the SEC alleged that the attorney "knowingly falsified or omitted important facts and offered the opinion that [client's] notes likely were not securities." In addition, "According to the complaint, Atlas received a percentage of the commissions generated on the sale of 1 Global's notes, which totaled more than $600,000." So, not only did the attorney lie, he also got kick-backs from the fraudulent sale of $322 million worth of the notes. Please be sure to click the headline to this summary to access the SEC Litigation Release and its related complaint.

It’s a matter of caveat emptor: buyer beware. After many months of consideration, investor testing/surveying, and circa 6,000 comment letters, the SEC acted in early June 2019 to enhance the protection of retail investors while not materially disrupting the existing investment industry business models and the ability of investors to choose among different types of providers such as advisers and brokers. The key measures adopted are as follows: • New Regulation BI (as in "Best Interest")…generally referred to as “Reg. BI;” • New Form CRS (i.e., "Customer Relationship Summary"); • Interpretive advice re: an investment adviser's fiduciary duties; and • An interpretation of the "solely incidental" aspect of the broker-dealer exclusion from the definition of an "investment adviser" under the Advisers Act. The new Reg. BI will go into effect in about a year (following formal publication of the new regulation). Many think that this will bring an end to the long journey and discussion regarding fiduciary duties of advisers and brokers. In reality, it really is a matter of caveat emptor both for the industry and retail investors. Much will be written in the coming months about the likely impact of the new measures. As a practical matter, advisers and brokers must review their policies and procedures (such as disclosure and customer on-boarding processes) to assure compliance in the future. PLEASE BE SURE TO CLICK THE HEADLINE TO THIS BLURB TO ACCESS AN EXTENSIVE RESOURCE COLLECTION ON THE NEW INITIATIVES. WE ARE ADDING TO THE REFERENCE LIST AS WE FIND MATERIALS.

We generally don't post news about markets and conditions. However, this is significant: the shift from active to passive management has been underway for many years, and it's accelerated this decade. According to the Bloomberg article, Morningstar data is showing that fund flows this past August tilted on balance to passive funds compared to actively managed funds. Of course, there's no knowing whether this will become a permanent trend, but it's noteworthy. Please click the headline to this blurb to be connected to the Bloomberg story.

In early Sept. 2019, the SEC published a new web page designed as "A Small Entity Compliance Guide" relating to Form CRS and Form ADV compliance. The Guide provides a nicely curated set of materials and a Q&A format describing how to comply with the new requirements of Form CRS, the Client Relationship Summary adopted in June 2019 as well as related Form ADV changes. Please click the link in the headline of this article to access the original SEC document.

In early Sept. 2019, the SEC issued a Risk Alert by its OCIE division, providing an overview of the most common compliance issues identified by OCIE related to principal trading and agency cross transactions under Section 206(3) of the Advisers Act. These issues were identified in examinations of investment advisers over the past few years. Consistent with a series of enforcement actions for the most extreme violations, the key issues identified involve principal transactions and agency cross transactions when the adviser acts as a broker. The Risk Alert provides color and detail regarding the observed weaknesses and violations and "encourages advisers to review their written policies and procedures and the implementation of those policies and procedures to ensure that they are compliant with the principal trading and agency cross transaction provisions of the Advisers Act and the rules thereunder." Please click the headline to this article to access the complete, original Risk Alert.

In late August, the SEC published two forms of guidance regarding the proxy voting responsibilities of investment advisers. The guidance documents were not without controversy as they were adopted by a 3 to 2 vote of the Commissioners. As published, the guidance documents provide guidance and interpretations regarding the proxy voting responsibilities of investment advisers under Rule 206(4)-6 under the Investment Advisers Act of 1940 (the “Advisers Act”), and Form N-1A, Form N-2, Form N-3, and Form N-CSR under the Investment Company Act of 1940 (the “Investment Company Act”), generally with respect to: (1) ensuring advisers are voting proxies in accordance with each client’s best interests; (2) advisers properly evaluate and oversee proxy advisory firms; and (3) structuring the client relationship to make clear the investment adviser’s proxy voting responsibilities. THE ACCOMPANYING ARTICLE PROVIDES ADDITIONAL INSIGHTS AND LINKS TO THE SEC DOCUMENTS AND A VARIETY OF HELPFUL LAW FIRM MEMOS. We'll be updating these as they become available.

The SEC brought an enforcement action against Lefavi Wealth Management, Inc. (LWM) for violating its fiduciary duty to clients in connection with its recommendation and investment of client assets in non-traded real estate investment trusts, business development companies, and private placements (Alternative Investments). From June 2014 through December 2016, the SEC found that LWM recommended and invested certain advisory client assets in Alternative Investments at a share price that reflected a 7% commission. The SEC stated that LWM failed to disclose that it could have invested advisory client assets in the same Alternative Investment at a lower share price and that LWM did, in almost all instances, recommend and invest advisory client assets in Alternative Investments with higher share prices that included seven percent commissions. LWM also failed to disclose the conflict of interest associated with its and its investment adviser representatives’ (IARs) receipt of additional compensation for investing advisory client assets in Alternative Investments at a higher share price that included a commission. According to the SEC, LWM’s practice of recommending and investing advisory client assets in Alternative Investments with embedded commissions, rather than seeking for clients lower share prices for the exact same investments, was inconsistent with LWM’s duty to seek best execution for those transactions. LWM did not adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder in connection with Alternative Investments.

The SEC brought an enforcement action against Laurel Wealth Advisors, Inc. (LWA) for failing to supervise an investment adviser representative (IAR) associated with LWA engaging in undisclosed “cherry-picking,” a practice of fraudulently allocating profitable trades in an omnibus account to favored accounts. The SEC stated that LWA failed reasonably to supervise the IAR who engaged in cherry-picking and failed to implement policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules. More specifically, LWA had a compliance procedure to prevent conflicts of interest that required IARs to pre-clear and obtain written approval before trading in their personal accounts, but LWA did not implement that procedure until January 2015. During the relevant time period, the SEC found that LWA’s Code of Ethics as disclosed in its Forms ADV stated that it had a pre-clearance procedure for IARs’ personal trading and that the firm required all transactions be carried out in a way that put its clients’ interests before its employees’ interests. These disclosures, according to the SEC, were false and misleading because LWA did not implement the pre- clearance procedure until January 2015, and an IAR’s misconduct put his personal interests before his clients’ interests.

The SEC brought an enforcement action against MVP Manager LLC (MVP), the personnel of which received brokerage commissions from counterparties to certain transactions with MVP’s advisory-client funds without adequate disclosure to those MVP clients or to investors in the client funds. MVP’s clients are private funds that it formed to invest in venture-backed companies that have not yet conducted an initial public offering (pre-IPO companies) that MVP projects have a potential for liquidity within two to five years by sale or public listing. In three instances, MVP personnel arranged to receive a brokerage commission from the counterparty that was selling pre-IPO company securities to MVP’s advisory client. The arrangement created a potential or actual conflict of interest for MVP in advising its client funds, which MVP failed to adequately disclose.

Well, that's not really the SEC's conclusion. However, caution and compliance monitoring is appropriate. In late July, the SEC's OCIE arm published a Risk Alert highlighting the observations of its staff from examining and inspecting a broad spectrum of investment advisers that had hired supervised persons with disclipinary histories. The Risk Alert details the findings and makes suggestions. Notably, the highlighted summary suggestion is, "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 click on the headline to this Blurb to connect to the Risk Alert.

The SEC brought an enforcement action against N. Gary Price a principal of registered investment adviser firm Genesis Capital LLC (Genesis), to disclose his conflicts of interest to advisory clients. From 2013 through 2015, the SEC found that Genesis’s three mutual fund advisory clients made investments in promissory notes issued by Aequitas Commercial Finance, LLC (ACF), one of numerous entities affiliated with the Aequitas enterprise, the ultimate parent of which is Aequitas Management, LLC (Aequitas). Price served on the Genesis investment committee that approved these investments. As Genesis made the ACF investments, the SEC stated that Price benefited from financial ties to Aequitas. Price held ownership stakes with Aequitas in two other businesses in the Aequitas enterprise that together received a $10 million line of credit and $3.6 million in loans from ACF—the entity from which the mutual fund clients purchased the promissory notes. Additionally, during the same time period when Genesis’s mutual fund clients were investing their money in ACF, ACF was paying management fees to another Aequitas entity, which in turn paid $8 million in fees to another firm part-owned by Price in exchange for referring investors (separate from the Genesis clients) to ACF and other Aequitas issuers. These ties created a conflict between Price’s interests and those of the mutual funds. Genesis’s written policies and procedures required it to disclose such conflicts of interest to its clients in the firm’s Form ADV Brochure. During 2014 and 2015, Price received several drafts of the Genesis ADV Brochure to review. The drafts did not adequately disclose Price’s Aequitas- related conflicts of interest, and Price did not correct this deficiency. By the end of 2015, two of the Genesis-advised mutual funds each had more than 15 percent of its net assets invested in the ACF promissory notes. In March 2016, the Commission charged ACF and several other Aequitas companies and officers with concealing the true financial condition of Aequitas while defrauding the purchasers of more than $300 million in ACF promissory notes and other Aequitas securities. In May 2016, the two mutual funds were liquidated following ACF’s default on promissory notes held by the two funds.

OCIE issued a risk alert that notes that that nearly half of the disclosure-related deficiencies of its exams of investment were due to the firms providing inadequate information regarding disciplinary events. For example, OCIE found that advisers: • Omitted material disclosures regarding disciplinary histories of certain supervised persons or the adviser itself. Often the disciplinary omissions related to supervised persons occurred because the advisers solely relied on these supervised persons to self-report to the firms information about their required disclosures. • Included incomplete, confusing, or misleading information regarding disciplinary events. For example, they did not, as applicable: include the total number of events, the date for each event, the allegations, or whether the supervised persons were found to be at fault (i.e., whether fines, judgments or awards, or other disciplinary sanctions were imposed). • Did not timely update and deliver disclosure documents to clients, such as updating Form ADV for new disciplinary events of supervised persons reported on CRD (e.g., Form U5s). OCIE in the Risk Alert encouraged investment 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.

The SEC published in the Federal Register in its interpretation of the standard of conduct for investment advisers under the Investment Advisers Act of 1940. In its Interpretation, the SEC states that an investment adviser's fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. This fiduciary duty requires an adviser “to adopt the principal's goals, objectives, or ends.” This means the adviser must, at all times, serve the best interest of its client and not subordinate its client's interest to its own. In other words, the investment adviser cannot place its own interests ahead of the interests of its client. This combination of care and loyalty obligations has been characterized as requiring the investment adviser to act in the “best interest” of its client at all times.

Supposed investment adviser to many NFL and other sports stars got sacked by the SEC recently. Daryl M. Davis and his firm Parrish Group, LLC were fined and Davis barred from the industry for multiple violations. While we expect that no one reading this news blurb would engage in the activities leading to the bar and fine, the findings and facts are nonetheless illustrative of the kind of competition and puffery endemic to our industry. In this case, Davis was: (1) an unregistered IA; (2) misrepresented his client list; (3) misrepresented his firm's staffing; and (4) lied about the firm's AUM. The SEC's settlement, which can be accessed by clicking the headline to this blurb, was premised on two findings of fraud under Sections 206(1) and 206(2) of the Advisers Act.

In a speech in Boston, Massachusetts, SEC Chairman Clayton reminded the audience that the SEC recently adopted a package of rules and interpretations designed to enhance the quality and transparency of retail investors’ relationships with broker-dealers and investment advisers. Importantly, he stated that they bring the legal requirements and mandated disclosures for broker-dealers and investment advisers in line with reasonable investor expectations. These actions, in his view, do not attempt to favor one type of service or relationship. Rather, he stated that they are designed to increase investor protection while preserving access for Main Street investors—both in terms of choice and cost—to a variety of investment services and products.

We're pleased top announce that Karl is co-author of the first new textbook about the '40 Acts in over 30 years! Investment Management Regulation: An Introduction to Principles and Practices. Available now at cap-press.com Just click on the headline to this blurb above to be taken to the publisher's site. As Members you are entitled to a 30% discount at the Carolina Academic Press's site. Please use the discount code, IMR2019. Valid until Sept. 30th, 2019. If you are a professor teaching this material, you may order a free review copy at the site.

An often overlooked area of agreements of all sorts, including advisory agreements, is the clause regarding out of pocket expenses. Vendors often use them to pass off large costs to clients.....so, as a client, look at the clause carefully. See if you can limit it with a maximum amount or limit what is considered an out of pocket expense. A recent SEC enforcement action against State Street Bank is a clear reminder of this issue. State Street for almost two decades charged clients for bank related messaging services---and added a nice markup for doing so without disclosing it to clients. The expense and markup were billed under the OOPS clause. So next time you review a contract, check the expenses clause, lest you cause an OOPS for your firm! Click the headline to this blurb for the full SEC release.

Advisers who offer private funds or invest in private placements encounter the challenges of the crazy quilt of private/public securities offering regulations. Aware of this growing issue, in June 2019, the SEC released a "Concept Release." The Concept Release seeks public comment on ways to simplify, harmonize, and improve the exempt offering framework to expand investment opportunities while maintaining appropriate investor protections and to promote capital formation. THE ARTICLE ACCOMPANYING THIS BLURB CONTAINS LINKS TO THE SEC DOCUMENTS.

Dechert has published an aggregation page on its website for all key actions, legislation, rulemaking, and judicial decisions regarding the Department of Labor's now dead fiduciary rule under ERISA. In addition, the page highlights and tracks the efforts of various states to implement fiduciary standards. However, the page does not integrate the SEC's efforts in this area, notably Reg. BI and related initiatives. Please click the headline to this blurb to access the Dechert site. Thanks to Dechert for making this material available.

While not covered in the Dechert paper on ESG investing (see our May 31 blog posting), a recent Presidential Executive Order is an example of how ESG investing may be impacted by the vagaries of politics. In early April 2019, an Executive Order was issued directing the Department of Labor ("DOL") to assess, among other things, how the energy industry is being impacted by the proxy voting of retirement plans. Specifically, the Order directs DOL to do the following, within 180 days of the date the Order was issued: 1. Complete a review of available data filed with DOL by retirement plans subject to the ERISA in order to identify whether there are discernible trends with respect to such plans’ investments in the energy sector; 2. Provide an update to the Assistant to the President for Economic Policy on any discernible trends in energy investments by such plans; and 3. Complete a review of existing DOL guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets. A copy of the order can be accessed by clicking the headline to this blurb.

ESG investing---investing with with environmental, social or governmental socially conscious screens---has been a hot topic in the industry on and off for the past 30+ years. Dechert recently published an excellent short paper on the "Unintended Consequences of Investing According to Environmental, Social and Governance Principles." The paper notes that lack of coherence and standards regarding such investments. Notably advisers are cautioned to keep in mind the sometimes disparate regulatory requirements of different governments, and how they might clash, when developing their firm's ESG screens. Please click the headline to this blurb to access the article.

The SEC charged with Stephen Brandon Anderson with defrauding clients by overcharging advisory fees of at least $367,000. According to the SEC, Anderson owned and operated River Source Wealth Management, LLC, a now-defunct registered investment adviser in North Carolina. River Source’s primary revenue stream was customer advisory fees. Customer agreements provided that those fees would be based on each customer’s assets under management. The SEC found, however, that in 2015 and 2016, Anderson overcharged a majority of his clients. The amount and percentages of the overcharges varied according to the SEC but, in the aggregate, amounted to approximately 40% more than the agreed-upon maximum customer advisory fees. The SEC further noted that Anderson misled his clients about the reason he transferred their assets from River Source’s long-time asset custodian, falsely stating that it was his decision and that the separation was “amicable.” In fact, as the SEC stated that the asset custodian ended the relationship with River Source after it noticed irregular billing practices and failed to receive sufficient supporting documentation from Anderson. Furthermore, the SEC found that Anderson made material misstatements in reports filed with the SEC, including overstating River Source’s assets under management by at least $34 million (18%) in 2015 and $61 million (35%) in 2016, and failed to implement required compliance policies and procedures.

In late May 2019, OCIE issued an Alert for advisers and broker-dealers entitled, "Safeguarding Customer Records and Information in Network Storage – Use of Third Party Security Features." The Alert is derived from the exam experience of OCIE, wherein it detected a variety of weaknesses at advisers and brokerage firms using cloud storage. The Risk Alert "highlights risks associated with the storage of electronic customer records and information by broker-dealers and investment advisers in the cloud and on other types of network storage solutions." OCIE noted that in its exam experience, some advisers and brokers have compliance problems with respect to the privacy and potential identity theft of their client data. Please click the headline to this blurb to access the Risk Alert.

In conjunction with its issuance of Guidance on crypto currencies ("CVCs"), FinCEN in early May 2019, issued an "Advisory on Illicit Activity Involving Convertible Virtual Currency." The Advisory was issued "to assist financial institutions in identifying and reporting suspicious activity concerning how criminals and other bad actors exploit convertible virtual currencies (CVCs) for money laundering, sanctions evasion, and other illicit financing purposes, particularly involving darknet marketplaces, peer-topeer (P2P) exchangers, foreign-located Money Service Businesses (MSBs), and CVC kiosks. Virtual currencies, particularly CVCs, are increasingly used as alternatives to traditional payment and money transmission systems. As with other payment and money transmission methods, financial institutions should carefully assess and mitigate any potential money laundering, terrorist financing, and other illicit financing risks associated with CVCs. This advisory highlights prominent typologies and red flags associated with such activity and identifies information that would be most valuable to law enforcement, regulators, and other national security agencies in the filing of suspicious activity reports (SARs)." As a practical matter, advisers should be reviewing and updating their policies and procedures to deal with CVCs, most notably the anti-money laundering and SAR policies and procedures. Please click the headline to this blurb to access the Advisory.

Bitcoin, ICOs, and various other types of crypto currency offerings have been the talk of the markets over the past few years. The regulatory agencies have struggled with classifying and regulating these offerings and enterprises. In early May 2019, FinCEN issued a Guidance document entitled, "Application of FinCEN’s Regulations to Certain Business Models Involving Convertible Virtual Currencies." FinCEN derives its powers in part from the Bank Secrecy Act ("BSA") and issued the Guidance with reference to the BSA. As noted in the document, "This guidance does not establish any new regulatory expectations or requirements. Rather, it consolidates current FinCEN regulations, and related administrative rulings and guidance issued since 2011, and then applies these rules and interpretations to other common business models involving CVC engaging in the same underlying patterns of activity." Given the interest of many advisers in crypto currencies and ICOs, we thought it would be helpful to alert you to the Guidance, which can be accessed by clicking the headline to this blurb.

Enacted in late March, a series of amendments to Regulation S-K and related rules and forms are now effective. Such amendments are designed to modernize and simplify certain disclosure requirements applicable to public companies, investment advisers and investment companies. These amendments implemented several of the recommendations in the SEC Staff’s November 2016 Report on Modernization and Simplification of Regulation S-K mandated by the FAST Act. For most advisers the changes will have little impact. For some, the most noteworthy changes included a simplification of MD&A disclosure and a significant reduction of the need for registrants to submit confidential treatment requests when omitting information from their exhibit filings. These amendments were originally proposed in October 2017 and received relatively little attention. Please click the headline to this blurb to access the SEC release.

In mid-April the SEC announced the hiring (from other SEC departments) of two new deputy chief counsels. This helps restaff the legal area after last fall's departure of some key folks including former Chief Counsel Doug Scheit. Please click the headline to this summary to access the SEC's press release.

Privacy policies and relevant regulatory compliance have been on-going challenges for advisers. The SEC's exam staff have noted that they often observe issues in these areas at advisers. Growing out of the exam program is a recent Risk Alert which focuses on key issues observed by the OCIE staff during their exams. Key areas of issues are: 1. timely disclosure of privacy policies to clients and opt-out provisions 2. need for written documentation of privacy policies and procedures 3. policies which have not been properly implemented or not reasonably designed to safeguard customer records and information Please click on the headline to this summary to access the SEC announcement and Risk Alert.

In early April, the SEC announced a new investor education program including several TV and other media public service announcements. As noted on the investor.gov site, "The SEC’s Office of Investor Education and Advocacy launched a public service campaign to empower Main Street investors to take control of their financial future. The campaign encourages investors to use the free tools and unbiased information available on Investor.gov to get answers to their questions about investing. Videos from the Good Questions campaign are available...." Please click the headline to this summary to access the SEC's site and materials.

From time to time we discover some good reads. A few months ago, the CFA Institute Research Foundation published a wonderful short monograph on the future of the industry. The arc and scope of the research paper by Ronald N. Kahn, managing director and global head of systematic equity research at BlackRock, is comprehensive, starting with the roots of the investment advisory industry to the current trends and projecting what things will look like in 5-10 years. It's a short, good read and paints a pretty optimistic picture despite several seemingly negative trends (e.g., passive investing, fee compression, etc.). Please click the headline to link to the document and enjoy the read!

Cross-trading remains a fertile ground for fraudulent behavior. A recent SEC enforcement action is illustrative: a private fund manager and COO was barred from the industry for a cross-trading fraud he facilitated. Basically, the manager sold securities from one client to a private fund managed by the firm at an artificially low price because the adviser and manager failed to obtain required third-party bids. Rather, the manager obtained manipulated prices for the securities which the fund purchased at a discount, which benefited the manger due to his holdings of the fund. An industry bar and $400,000 fine resulted. Please click the headline to be linked to the enforcement action.

Law firm Stradley Ronon issued a fine summary of SEC adviser and fund enforcement activities this week.Noting the government shutdown and SEC staff turnover, the authors explain that only 13 settled administrative actions involved Advisers Act violations during fiscal year 2018. For 2019, they predict vigorous enforcement in support of protecting retail investors. Click the headline to access the report.

As we reported earlier this year,in February the SEC announced its Share Class Selective Disclosure Initiative offering a certain form of clemency for self-reporting advisers. In recent years, the SEC has investigated via sweep and targeted exams numerous advisers for their mutual fund share sales practices, finding a variety of fraudulent and inappropriate practices. In mid-March, the SEC staff announced that 79 advisers had self-reported and paid $125 million is restitution to investors. Click the headline for the full SEC press release and report.

In early March, the SEC published a letter to Karen Barr, President of the Investment Adviser Assoc. seeking public comments on how the Custody Rule works for/with digital assets (e.g. bitcoin). The Division of Investment Mgmt’s request for comments includes several aspects (some of which are not Custody Rule-specific), including: (1) the treatment of digital assets for purposes of the Custody Rule; (2) how such assets are custodied (specifically whether advisers are relying on state-chartered trust companies or foreign financial institutions such custody; (3) how such custodians have performed in their duties; (4) the most appropriate ways to address concerns about adviser misappropriation of client digital assets and how to effectively leverage address the hazards of misappropriation; (5) if losses arise, how to remedy them effectively; and (6) whether advisers regard digital assets as “securities” for the purpose of determining whether they meet the definition of an investment adviser and their registration and reporting obligations. Please click on the headline to this blurb to access the letter.

The SEC brought an enforcement action against a registered investment adviser, Talimco, LLC (Talimco), in connection with the sale of a mortgage loan participation by one of its clients, a collateralized debt obligation, to another one of its clients, a commercial real estate investment fund (Fund). The SEC stated that Talimco, which owed a fiduciary duty to both the seller and buyer, breached its duty to the seller in violation of Section 206(2) of the Advisers Act by failing to seek out willing bidders for the asset. As part of the sale process, Rogers, Talimco’s chief operating officer, convinced two unwilling parties to agree to bid on the asset by assuring each of them that it would not win the auction. As a result of these actions, the SEC found that the collateralized debt obligation was deprived of the opportunity to obtain multiple bona fide bids for the asset. The Fund, which won the auction, later sold the asset at a profit, resulting in Talimco receiving management and performance fees.

The SEC charged Ascension Asset Management, LLC (Ascension) for not having a compliance manual and conducting annual compliance reviews. The SEC found from in or about October 2004 until November 2015, Ascension did not adopt and implement any written compliance policies and procedures required by Advisers Act Rule 206(4)-7(a). During this same time period, the SEC stated that Ascension did not conduct the reviews required by Advisers Act Rule 206(4)-7(b). Gooder, the founder of Ascension, despite being Ascension’s sole control person, failed to take any steps to prepare the required written compliance policies and procedures or conduct the required reviews for Ascension.

The SEC brought an enforcement action against Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, finding breaches of fiduciary duty and inadequate disclosures in connection with mutual fund share class selection practices and the fees the Wells Fargo companies received pursuant to Rule 12b-1 under the Investment Company Act of 1940 (Rule 12b-1 fees). During the period January 1, 2014 to July 31, 2015, the Wells Fargo companies purchased, recommended, or held for advisory clients mutual fund share classes that charged 12b-1 fees instead of lower-cost share classes of the same funds for which the clients were eligible. The Wells Fargo companies received 12b-1 fees in connection with these investments. According to the SEC, the Wells Fargo companies failed to disclose in their Forms ADV or otherwise the conflicts of interest related to (a) their receipt of 12b-1 fees, and/or (b) their selection of mutual fund share classes that pay such fees. The Wells Fargo companies received 12b-1 fees for advising clients to invest in or hold such mutual fund share classes. Please click the heading to this blurb to link to the litigation release.

The SEC created a new position called the “Chief Risk Officer.” Gabriel Benincasa was named the SEC’s first Chief Risk Officer. This position will primarily focus on the agency’s risk management and cybersecurity efforts. The Chief Risk Officer will coordinate the SEC’s efforts to identify, monitor and mitigate key risks facing the SEC. The Chief Risk Officer is housed within the SEC’s Office of the Chief Operating Officer. The Chief Risk Officer will also serve as a key adviser on other matters related to enterprise risks and controls.

Maryland is joining the effort of states to regulate securities brokers and insurance agents as fiduciaries. Legislation was introduced this week in the Maryland state house containing a brief provision that would require brokers and insurance agents to act as fiduciaries in the best interests of their customers, i.e., "without regard to" their own financial interests. Maryland's actions are part of a larger trend of states seeking to regulate fiduciary standards. The bill entitled the "Financial Consumer Protection Act of 2019" can be accessed by clicking the heading to this article.

Our friends at the Wagner Law Group have published a nice summary of state actions regarding establishment of fiduciary standards for advisers. Nevada is the latest state to propose a fiduciary standard. The article is reprinted below--please click the headline to access the reprint.

The on-going government shutdown has had some severe impacts on the SEC and its Div. of Investment Management. According to our discussions with various compliance folks and '40 Act counsel, the impacts are increasingly troublesome for their clients. Impacts include: inability to complete registration of new advisers; inability to get effectiveness of fund registration statements (other than those going automatically effective); and administrative actions and cases have ground to a halt as have inspections and examinations. In other branches of the SEC activities impacted by the shutdown include review of financial filings like 10Ks under the '34 Act and the review of IPO offerings/registrations under the '33 Act.

OCIE released a Risk Alert on Dec. 14, 2018 concerning the use of electronic messaging systems by registered investment advisers and their personnel. The Alert cites the staff’s observations from an initiative in 2018 that surveyed advisers regarding their use of electronic messaging. The Alert “reminds” advisers of their obligations regarding business communications under the Advisers Act that may apply to electronic messages. Electronic messages are defined very broadly and include “written business communications” via text message, instant message, personal/private message, personal email, personal websites and social media posts that are “conducted on the adviser’s systems or third-party applications...or platforms” or sent on adviser computers, adviser-issued mobile devices or personally owned devices that are used for business purposes, but not emails via an adviser’s email system. A key point made in the Alert is the need of Advisers to improve their relevant systems, policies and procedures regarding such electronic messages and systems. The headline to this story has a link connecting you to the Risk Alert.

The SEC brought enforcement actions against against two robo-advisers for making false statements about investment products and publishing misleading advertising. The proceedings are the SEC’s first enforcement actions against robo-advisers. The SEC found that Redwood City, California-based Wealthfront Advisers LLC , a robo-adviser with over $11 billion in client assets under management, made false statements about a tax-loss harvesting strategy it offered to clients. Wealthfront disclosed to clients employing its tax-loss harvesting strategy that it would monitor all client accounts for any transactions that might trigger a wash sale – which can diminish the benefits of the harvesting strategy – but failed to do so. Over a period of more than three years during which it made this disclosure, wash sales occurred in at least 31 percent of accounts enrolled in Wealthfront’s tax loss harvesting strategy. The SEC’ also found that Wealthfront improperly re-tweeted prohibited client testimonials, paid bloggers for client referrals without the required disclosure and documentation, and failed to maintain a compliance program reasonably designed to prevent violations of the securities laws. The SEC in a separate enforcement action found that New York City-based Hedgeable Inc., a robo adviser which had approximately $81 million in client assets under management, made a series of misleading statements about its investment performance. According to the order, from 2016 until April 2017, Hedgeable posted on its website and social media purported comparisons of the investment performance of Hedgable’s clients with those of two robo-adviser competitors. The performance comparisons were misleading because Hedgeable included less than 4 percent of its client accounts, which had higher-than-average returns. Hedgable compared this with rates of return that were not based on competitors’ actual trading models. The SEC also found that Hedgeable failed to maintain required documentation and failed to maintain a compliance program reasonably designed to prevent violations of the securities laws.

The SEC's Office of Compliance Inspections and Examinations (OCIE) released its 2019 examination priorities. OCIE publishes its exam priorities annually to promote transparency of its examination program and provide insights into the areas it believes present potentially heightened risk to investors or the integrity of the U.S. capital markets. In this release, OCIE focused on digital assets, cybersecurity, and matters of importance to retail investors, including fees, expenses, and conflicts of interest. OCIE's examination priorities are broken down into six categories: (1) compliance and risk at registrants responsible for critical market infrastructure; (2) matters of importance to retail investors, including seniors and those saving for retirement; (3) FINRA and MSRB; (4) digital assets; (5) cybersecurity; and (6) anti-money laundering programs.

The SEC adopted rules and amendments designed to promote research on mutual funds, exchange traded funds, registered closed-end funds, business development companies, and similar covered investment funds. These changes reduce obstacles to providing research on investment funds by harmonizing the treatment of such research with research on other public companies. The Commission took this action in furtherance of the mandate in the Fair Access to Investment Research Act of 2017 (FAIR Act). The rules and amendments generally establish a safe harbor for a broker or dealer to publish or distribute research reports on investment funds under certain conditions. This new safe harbor is similar to a regulatory safe harbor that currently exists for research reports about public companies.

The SEC brought an enforcement action against Retirement Capital Strategies, Inc. (RCS) for failing to apply advisory fee discounts to certain client accounts contrary to its disclosures, representations to clients, and its advisory agreements. From January 2010 through February 2018, RCS offered clients an advisory fee between 0.4% and 1.5% of their assets under management based on fee breakpoints described in a fee schedule that reduced the advisory fee as client assets under management increased. RCS’s fee schedule was incorporated by reference in client advisory agreements, distributed to clients upon request, and, starting in 2011, disclosed in RCS’s Form ADV Part 2A filed with the SEC. RCS’s written policies and procedures manual stated that RCS was to conform its client fees and fee billing practices to those described in the Form ADV and in the advisory agreements provided to clients. In certain instances, however, RCS failed to apply the breakpoint discounts. As a result, RCS improperly calculated advisory fees and thereby overcharged certain clients.

Continuing efforts to enhance investor understanding of adviser and broker services, the SEC’s Office of the Investor Advocate recently made available a report on investor testing conducted by the RAND Corporation. The investor testing gathered feedback on a sample Relationship Summary issued in April 2018 as part of a package of proposed rulemakings and interpretations designed to enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers. Results were clear: investors still don't really understand their relationship (fiduciary or otherwise) with advisers and brokers.....“Based on my discussions with many retail investors over the last several months, it is clear to me that too many retail investors are not aware of the material aspects of their relationships with their investment professionals,” said SEC Chairman Jay Clayton.The report is available for review and comment on the SEC’s website: simply click on the heading to this blog posting.

The SEC brought an enforcement action against Pennant Management Inc. (Pennant) for negligently failing to perform adequate due diligence and monitoring of certain investments contrary to representations in its Form ADV Part 2A and in certain communications with its clients, ultimately contributing to substantial losses. From May 2013 to September 2014, the SEC stated that Pennant advised clients to purchase interests in facilities and other investments containing repurchase agreements (repos) originated by a repo counterparty, First Farmers Financial (FFF). The investments underlying the FFF repos consisted of 26 loans that Pennant believed were guaranteed by the U.S. Department of Agriculture (USDA). During the initial due diligence of FFF, the SEC found that certain concerning information was not escalated to Pennant’s Investment Committee or senior management, and although Pennant represented that it would advise clients of ongoing due diligence and monitoring of repo counterparties, it failed to adequately do so. In particular, despite concerns regarding the legitimacy of the investments starting in April 2014, Pennant continued to offer the FFF repos to clients. By the end of September 2014, Pennant determined that FFF had forged paperwork and that all of the FFF repos were fraudulent. In addition to the due diligence and monitoring failures, from January 2012 to June 2014, the SEC noted that Pennant’s compliance program lacked sufficient resources and Pennant failed to reasonably design and implement certain policies and procedures. Further, between at least April 2013 and April 2014, Pennant did not consistently follow its repo allocation policy disclosed in its Form ADV Part 2A and failed to maintain records related to repo client indications of interest and trade allocations.

Attorneys with the Groom Law Group have posted an excellent analysis of the demise of the DoL Fiduciary Rule. It can be accessed by clicking the heading to this blog post.

Just in time for Halloween the SEC revealed the spooky realities of widespread non-compliance by advisers wit the cash solicitations rule, Rule 206(4)-3 under the Advisers Act. Based on a survey of the past 3 years of examination experience and resulting deficiency letters, the SEC issued a Risk Alert. the Alert identifies the most common weaknesses and issues, including failures to: (i) ensure that third party solicitors provide adequate disclosure documents to clients; (ii) receive a timely signed and dated client acknowledgement of receipt of the adviser brochure and the solicitor disclosure document; (iii) execute required agreements with third party solicitors; and (iv) conduct adequate due diligence to determine whether solicitors complied with agreements. The complete Risk Alert can be accessed by clicking the heading to this blog posting.

The law firm Mayer Brown recently published an excellent and comprehensive Social Media Compliance Guide for Issuers, Brokers and Advisers. This is a really helpful publication and can be accessed by clicking the heading to this blog post.

On October 12, 2018, the staff of the SEC issued a no-action letter easing mutual fund board burdens regarding affiliated transactions, such as cross-trades between funds managed by the same investment adviser. In the no-action letter, the SEC stated that it would not recommend enforcement action for violations of Sections 10(f), 17(a), or 17(e) of the Investment Company Act of 1940, (the “1940 Act”) if a fund board receives from the fund’s CCO, no less frequently than quarterly, a written representation that any transactions effected in reliance on Rules 10f-3, 17a-7, or 17e-1 under the Act (“Affiliated Transactions Exemptive Rules”) complied with procedures adopted by the board pursuant to the relevant Affiliated Transactions Exemptive Rules, rather than the board itself reviewing affiliated transaction details on a quarterly basis and making such compliance determinations. The no-action letter appears to be an product of a recent SEC initiative to review and reevaluate fund directors’ responsibilities. The full text of the no-action letter can be found by clicking the heading to this posting.

On October 10, 2018, NASAA, the North American Securities Administrators Association, released its summary report on prosecutions by state securities administrators for the 2017 year. The Report reveals that there was significant increase in state prosecutions of both investment advisers and securities brokers, with NASAA reporting that state securities regulators conducted 4,790 investigations in 2017 and took 2,105 enforcement actions overall. These actions led to more than $486 million in restitution ordered returned to investors, fines of $79 million and criminal relief of 1,985 years, including incarceration and probation. The complete report can be accessed by clicking the heading to this blog post.

Private fund firms continue to struggle with SEC oversight and compliance requirements, as evidenced by a recent administrative order, This case illustrates two typical issues: the custody rule requirements and the fundamental requirement that firms adopt and/or properly implement written compliance policies and procedures. "An SEC investigation revealed that [the firm], which was not subjected to an annual surprise examination at any time, failed to timely distribute annual audited financial statements to investors in numerous private investment funds that it advised in each year since it registered with the Commission in 2012. The SEC investigation further revealed that [the firm] failed to adopt and implement reasonably designed written policies and procedures and failed to review at least annually its policies and procedures, as required by the compliance rule." The case is illustrative of the care which private fund advisers should be approaching their duties. The full case can be accessed by clicking the heading to this blog post.

In late September, the SEC settled an administrative action regarding Voya Financial Advisors, Inc. (VFA). The action cites VFA's failure to adequately protect customer information following a six-day cyber attack in 2016. The SEC’s order cites two key components: (1) violations of the Safeguards Rule under Regulation S-P (which is routinely used by the SEC in cyber security enforcement actions against broker-dealers and investment advisers) and (2) the first enforcement action for a violation of the Identity Theft Red Flags Rule under Regulation S-ID, which requires certain SEC registrants to create and implement programs to detect, prevent and mitigate identity theft. With the constant barrage of cyber security attacks on advisers, this action clearly signals the SEC's intent to enforce the protections it has adopted. Please click the heading for this posting to access the administrative order.

The SEC brought an enforcement action against Massachusetts Financial Services Company (MFS) for making material misstatements and omissions to certain of its advisory clients and others concerning hypothetical stock returns associated with MFS’s blended research stock ratings. The SEC stated that MFS offered investors blended research strategies that combined research ratings from MFS’s fundamental analysts and quantitative models to manage portfolios of stocks for client investment. The SEC found that from 2006 to 2015, MFS advertised that the basis of its blended research philosophy was that fundamental and quantitative management styles excel in differing market conditions, and that blending fundamental and quantitative stock ratings could over time yield better returns than either type of ratings alone. To illustrate the validity of its claim that blending two sources of ratings was better than one source alone, MFS advertised the results of a hypothetical portfolio of stocks rated “buy” by both MFS’s fundamental analysts and quantitative models. In its advertisements, MFS showed how this hypothetical portfolio had annualized returns from 1995 forward that exceeded the annualized returns of either a hypothetical portfolio of fundamental “buy” rated stocks or a hypothetical portfolio of quantitative “buy” rated stocks.

The SEC found that between July 2011 and June 2015, AEGON USA Investment Management, LLC (AUIM), a registered investment adviser, violated certain provisions of the federal securities laws in connection with the offer, sale, and management of 15 quantitative-model-based mutual funds, variable life insurance investment portfolios, and variable annuity investment portfolios (Products) and separately managed account (SMA) strategies (Strategies). AEGON marketed all of the Products and Strategies as managed using a proprietary quant model, and highlighted, when marketing certain of the Products and Strategies, their “emotionless,” “model-driven,” or “model- supported” investment management process and described how the models were supposed to operate. The SEC stated that these claims necessarily implied that the models worked as intended. The SEC found, however, that AEGON launched the Products and Strategies without first confirming that the models worked as intended and/or without disclosing any recognized risks associated with using the models. During the summer of 2013, AUIM (acting as the subadviser of the Products and Strategies) discovered that certain of the models contained errors and concluded that that these errors rendered at least one of the models “to not be fit for purpose.” AUIM stopped using, running, or relying on at least one of the models in September 2013. AUIM and TAM (the adviser of the Products) failed to disclose the models’ errors and AUIM’s decision to stop using the model to the board of trustees of Transamerica Funds.

The SEC brought an enforcement action against Aria Partners GP, LLC for failing to implement a compliance program consistent with its obligations as a registered investment adviser. Among other things, this led to a failure to disclose to all investors in one of those private funds all their options to redeem their investment in the fund. The fund’s Limited Partnership Agreement (LPA) required 90 days’ written notice for redemptions. However, Aria Partners had an informal policy, which was not disclosed to all investors in the fund, of accommodating investors’ requests to provide partial redemptions on significantly less notice than 90 days. In addition, Aria Partners granted full redemptions to a limited number of investors on 60 days’ notice, while similarly situated investors were held to the 90 day notice period. These practices resulted in materially different full redemption amounts for two investors in 2015, when the fund lost value in a short period.

The SEC brought an enforcement action against Biltmore Wealth Management LLC, an investment adviser located in California. From at least June 2014 through August 2015, the SEC stated that Biltmore raised about $2.2 million from ten investors, eight of whom were pre-existing clients of Biltmore, to invest in Biltmore Capital, L.P. (Fund), a private fund. The SEC found that Biltmore misled the Fund and investors by claiming the Fund would invest primarily in leading growth stocks, but instead caused the Fund to make substantial trades in risky stock options and options on the SPDR S&P 500 ETF, which attempts to replicate the return of the S&P 500 (“SPY options”). Biltmore also misrepresented to investors that the Fund’s risk would be mitigated by “stops” that would limit its losses to just 7-8%, but the Fund’s losses often exceeded those limits. In monthly letters to Fund investors, Biltmore mischaracterized the source of the Fund’s returns and losses by failing to disclose that the Fund’s options trading, particularly its trading in SPY options, was the main driver of its few profits and many losses. Ultimately, the undisclosed SPY options trading caused the Fund to lose nearly all of its value in August 2015, and it was dissolved in November 2015.

A recent SEC settlement with Ameriprise reveals the limitations of automated compliance monitoring systems. Basically, their systems failed to catch fraud by several reps who stole over $1 million from clients.

The SEC charged BKS Advisors LLC, an investment adviser and Roger T. Denha, an investment adviser representative of BKS, with engaging in fraudulent trade allocation, or “cherry-picking.” BKS is a Michigan limited liability company with its principal place of business in Southfield, Michigan. Denha executed his cherry-picking scheme according to the SEC by unfairly allocating purchases of securities between his favored accounts (including his personal and family accounts) and his other BKS clients’ accounts. Denha disproportionately allocated profitable trades to the favored accounts, and disproportionately allocated unprofitable trades to the accounts of certain advisory clients. He executed his scheme by buying the securities in an omnibus account and then waiting to allocate until after he had an opportunity to see whether the securities had increased in price.

The SEC brought an enforcement action against Lockwood Advisors, Inc. (Lockwood) for failing to adopt and implement policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder in connection with its assessment, oversight, and disclosure of the trading away practices of the third-party portfolio management firms in its wrap programs. From at least 2008, and continuing on an ongoing basis to the present, the SEC stated that Lockwood’s policies and procedures failed to require that material information about trading away: • would be obtained and considered by Lockwood prior to making the third-party portfolio management firms available to clients in its wrap programs; and/or • would be disclosed to clients directly or through their third-party registered investment advisers.

Issues related to the defunct DoL Rule continue to arise. Meanwhile comments are rolling in to the SEC on its proposals. For back-reference see our June 2018 update.

The SEC brought an enforcement action against Hamlin Capital Management, LLC because of its deficient arrangement of cross trades of certain non- rated, thinly-traded, fixed income securities, the pricing of which resulted in undisclosed favorable treatment of certain of its advisory clients over others. From at least November 2011 through March 2016, the SEC found that Hamlin, a registered investment adviser, routinely engaged in cross trade transactions between two or more Hamlin client accounts. Hamlin’s pricing method for the cross trades resulted in it favoring certain of its clients over others in two ways: • when arranging cross trades, Hamlin generally arranged for the buy-side of the transaction to be executed at the security’s bid-side indicative quotation (Bid Price) obtained for month-end valuation purposes from various pricing brokers, who were typically the underwriters of the same bond, and arranged for the sell-side of the transaction at a small discount from that Bid Price. Hamlin failed to disclose that, by cross trading securities at the Bid Price, rather than obtaining and using an average or midpoint between the Bid Price and an ask-side evaluation quotation, Hamlin’s use of the Bid Price had the effect of favoring the purchasing clients in the transactions over the selling clients, even though Hamlin owed both the same fiduciary obligations; and • with respect to certain fixed income securities, Hamlin challenged the pricing broker’s bid-side evaluation quotations and requested prices higher than recent trades in the secondary market, without adequate documentation of the basis provided to the pricing broker for the challenge. Hamlin then arranged for the execution of cross trades at these higher levels, without undertaking any assessment as to whether the securities were available on similar or better terms for its buying clients in the secondary market. As a result, Hamlin’s buy-side advisory clients paid more than they would have paid had securities been available for purchase in the secondary market at terms similar to prior trades.

The SEC found that Knowledge Leaders Capital, LLC used client commissions under Section 28(e) of the Securities Exchange Act, commonly called “soft dollars,” to purchase approximately $1 million in research over a three-year period from a firm affiliated with an individual that was, at the time, the Managing Director of Knowledge Leaders and also functioned as its chief investment officer (CIO). While Knowledge Leaders approved the CIO’s company as a soft dollar recipient and approved the payments made to the CIO’s company for use of its research software, Knowledge Leaders failed to identify (and as a result, failed to disclose to clients) the financial conflicts of interest created by Knowledge Leaders using soft dollars to pay a company owned and controlled by Knowledge Leaders’ CIO. As a result, the SEC found that Knowledge Leaders violated Section 206(4) and Rule 206(4)-7 thereunder by failing to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act in connection with the identification and disclosure of conflicts of interest relating to the use of soft dollars.

The law firm Pepper Hamilton recently published a fine article on the various private fund models. It's interesting in that it highlights new and emerging models as well as the tried and true. Here's the link: https://www.pepperlaw.com/resource/32924/25E0 or just click the headline to this blurb.

SEC Commissioner Hester Peirce spoke about the meaning of “fiduciary” and the fiduciary rule at the NAPA DC Fly-in Forum in Washington, D.C.

The SEC found that Beverly Hills Wealth Management, LLC (BHWM) and Margaret Black, its primary owner, violated the Advisers Act by withholding prepaid, unearned advisory fees totaling $131,000 from 63 departing clients who requested terminating their advisory relationship with BHWM despite representations made in its Form ADV brochures and advisory agreements. Specifically, the firm and Black initially refused to recognize clients’ e-mails and mailed requests as proper termination notices, instead demanding that the clients send written requests with a “wet signature,” which request was contrary to the disclosures made to clients in both the Forms ADV, Part 2A (the “Firm Brochures”) and its advisory contracts. Additionally, between March 2013 and April 2018, BHWM and Black continually omitted material facts and made false and misleading statements regarding BHWM’s financial condition in its Firm Brochures. Specifically, the SEC fount that the firm failed to disclose that it was insolvent and financially unable to repay its loans during this entire time despite representing in thirteen Firm Brochures issued between March 2013 and April 2018 that “[w]e do not have a financial condition or commitment that impairs [our] ability to meet contractual and fiduciary obligations to clients.” In fact, BHWM had borrowed $700,000 just to keep the business afloat. The SEC stated that since 2014, BHWM has been in default on the loans and currently owes an additional $75,000 in unpaid interest.

On July 11, 2018 the Office of Compliance Inspections and Examinations issued a summary of it findings regarding investment adviser best execution practices.

In early July, the SEC restructured its website with some notable changes for advisers and funds.

Given its importance, we're republishing our May update. A federal court has essentially struck down the DoL Fiduciary Standard. No appeal was made. Meanwhile, the SEC has proposed two things: (1) a "Best Interest" Standard for Broker-Dealers (and certain advisers); and (2) Form CRS which would require brokers and advisers to provide to investors a document describing their services and nature of their client relationships, i.e., a Relationship Summary. The attached page has a list of the best law firm summaries we've seen to date. Please click the heading above to access the detailed discussion and links.