The F-Squared Investments matter continues to have far-reaching consequences for those investment advisers who used F-Squared’s falsely inflated and improperly labeled backtested performance results in advertisements. As discussed previously, in November of 2015 Virtus Investment Advisers was fined $16.5 million for including the false and misleading performance results in its own advertisements and filings with the Securities Exchange Commission (“SEC”). More recently, the SEC charged Cantella & Co. (“Cantella”), a Boston-based investment adviser that licensed F-Squared’s Alpha Sector strategy, with securities violations for employing F-Squared’s false track record in its marketing materials.

F-Squared is an investment adviser that creates and markets index products using exchange-traded funds (“ETFs”). It sub-licenses these indexes to various unaffiliated investment advisers who manage assets pursuant to those indexes. In 2014 F-Squared admitted in a settled SEC administrative proceeding that it had materially misrepresented the performance results of its largest ETF strategy, AlphaSector, by labeling these results as actual results from a seven-year period when they were in fact hypothetical results derived through backtesting. In addition, F-Squared claimed that the strategy had outperformed the S&P 500 Index from 2001 to 2008 when in fact the hypothetical data contained a calculation error that falsely inflated results by 350 percent. F-Squared agreed to pay disgorgement of $30 million and a penalty of $5 million to settle the claim.

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The U.S. Circuit Court of Appeals for the District of Coumbia recently denied a petition to review an order of the Securities Exchange Commission (“SEC”) imposing sanctions against Raymond J. Lucia and investment adviser Raymond J. Lucia Companies, Inc. (“Lucia Companies”) for violations of the Investment Advisers Act of 1940 and the advertising rule thereunder, Rule 206(4)-1. In denying the motion, the DC Circuit affirmed the SEC’s broadened views on the use of back-tested performance in marketing and advertising materials.

As discussed previously, this case involves the improper use by an investment adviser of back-tested performance data in retirement-planning seminars. Raymond J. Lucia, and Lucia Companies allegedly used a hypothetical inflation rate that was lower than actual historical rates to make their performance results more favorable. In addition, the performance data allegedly failed to reflect the deduction of advisory fees and was not calculated in a manner fully consistent with the advertised investment strategy. As a result, the SEC barred Raymond J. Lucia from the securities industry and imposed civil penalties of $300,000.

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Earlier this month, FINRA issued a regulatory notice advising that it has proposed various changes to the rules relating to gifts, gratuities and non-cash compensation.  If adopted, the proposal would amend FINRA Rule 3220 (the “Gifts Rule”) and would create two new rules, Rule 3221 (“Non-Cash Compensation”) and Rule 3222 (“Business Entertainment”).

The current Gifts Rule prohibits any FINRA member or associated person from giving anything of value in excess of $100.00 per year to any person, if such payment is connected with the business of the recipient’s employer.  Under the proposed revised Gifts Rule, the $100.00 limit would be increased to $175.00 per recipient per year.  The proposed increase is designed to account for the rate of inflation since the adoption of the original Gifts Rule.  The current requirements that all associated persons’ gifts must be consolidated with those of the member firm and that records be maintained with respect to all such gifts, will be continued in the new rule.  Continue reading

Pursuant to an order entered by the Securities and Exchange Commission (“SEC”) on June 14, 2016, the exemption contained under Rule 205-3 of the Investment Advisers Act (“Advisers Act”), which allows registered investment advisers to charge performance-based compensation to clients notwithstanding the general prohibition against same contained in Section 205(a)(1) of the Advisers Act, will be slightly modified.  This modification is the result of a provision in the Dodd-Frank Act (“Dodd Frank”) implementing a provision of that act under Rule 205-3, which requires the SEC to adjust the dollar amounts contained in the exemption for inflation and to round the adjustment to the nearest $100,000.00.  This adjustment must occur every five years.

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Last month the Securities and Exchange Commission (“SEC”) sanctioned a registered investment adviser and its managing member for violating the Investment Adviser’s Act of 1940 (“Adviser’s Act”) and for acting as an unregistered broker-dealer in connection with the services the adviser provided to a private fund that it managed and the fees charged for those services.

Blackstreet Capital Management, LLC (“Blackstreet”) serves as the manager of two private equity funds (the “Funds”).  In the Funds’ governing documents, Blackstreet disclosed to the Funds’ investors that it would charge fees for brokerage services rendered in connection with acquiring portfolio companies.  Blackstreet did, in fact, perform brokerage services including soliciting transactions, identifying buyers and sellers, negotiating and structuring transactions, arranging for financing, and executing transactions. In exchange for those services it received over $1.8 million.

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Increased focus on cybersecurity by the Security Exchange Commission’s (“SEC”) continues as it recently issued charges against Morgan Stanley Smith Barney (“Morgan Stanley”) for failing to adopt written policies and procedures reasonably designed to protect confidential client information. These charges stemmed from a cybersecurity breach which began in 2011 and continued until 2014, resulting in the misappropriation of confidential client information in over 730,000 client accounts.

Broker-dealers and investment advisers are required pursuant to Regulation S-P and comparable regulation of the Federal Trade Commission to adopt written policies and procedures reasonably designed to protect client records and information. These policies and procedures must address the administrative, technical, and physical safeguards in place, and must be reasonably designed to insure the security and confidentiality of client records and information, protect against unanticipated threats, and prevent unauthorized access.

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The Securities and Exchange Commission (SEC) has frequently said that an investment adviser’s fiduciary duty requires an adviser to plan for unexpected disruptions in business. Consequently, advisers have developed business continuity plans as a “best practice” without necessarily being required to do so by rule.  Recently, however, the SEC proposed a rule that would require all SEC-Registered investment advisers to adopt and implement written business continuity and transition plans and to review them no less often than once per year.  The SEC also issued guidance for the baseline requirements that such plans should contain.

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The Securities Exchange Commission (“SEC”) recently settled charges against a New Jersey private fund administrator, Apex Fund Services (“Apex”), for failing to notice or correct what it contended were clear indications of fraud by two of its clients, ClearPath Wealth Management (“ClearPath”) and EquityStar Capital Management (“EquityStar”). The SEC’s Division of Enforcement noted that Apex failed to “live up to its gatekeeper responsibility” and thereby enabled the fraudulent activities of these two investment advisers.

Apex provided accounting and administrative services to various private funds, including several managed by ClearPath and EquityStar. Its duties as fund administrator included keeping records, preparing financial statements, and preparing investor account statements. The SEC charged both ClearPath and EquityStar with securities fraud in enforcement actions, finding that ClearPath had allegedly misappropriated fund assets and used fund assets for unauthorized investments, and that EquityStar had allegedly made materially false and misleading statements to investors and prospective investors of its funds regarding undisclosed withdrawals of fund assets.

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The Massachusetts Securities Division (the “Division”) recently issued a policy statement in which it stated, “It is the position of the Division that fully automated robo-advisers, as currently structured, may be inherently unable to carry out the fiduciary obligations of a state-registered investment adviser.”  According to the Division, robo-advisers are generally incapable of fulfilling their fiduciary obligations, principally because they do not meet with clients, gather sufficient information on which investment advice can be rendered, nor provide highly personalized advice tailored to the information gathered.  Continue reading

The Securities Exchange Commission (“SEC”) recently filed suit against a North Carolina investment adviser for allegedly defrauding investors in the sale of certain real estate-related investments in unregistered pooled investment vehicles. The adviser, Richard W. Davis Jr., solicited investors primarily from the Charlotte, North Carolina region and was able to raise approximately $11.5 million from 85 investors, the majority of which were individuals with retirement accounts. However, he allegedly failed to disclose to clients that the money in the funds was being steered towards several other entities beneficially owned by himself.

Davis allegedly told investors in one of his funds that the fund’s capital would be invested in short term fully secured loans to real estate developers. He allegedly failed to mention, however, that many of the real estate developers receiving these loans were companies owned and operated by himself, creating an inherent conflict of interest. Furthermore, the companies never repaid the loans in full and Davis allegedly failed to inform his investors of this or reappraise the value of the fund’s investment. Instead, Davis allegedly misrepresented the value of the pooled fund by repeatedly stating that it had not lost any value.

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