RIA Compliance Blog
On November 22, 2017, the Securities and Exchange Commission issued an Order Making Findings and Imposing Remedial Sanctions and Cease and Desist Order against an investment adviser, Gray Financial Group, Inc., its founder, Laurence O. Gray, and its co-CEO, Robert C. Hubbard, IV. The SEC alleged that Gray Financial, Gray, and Hubbard “offered and sold investments in a Gray Financial proprietary fund of funds… to four Georgia public pension clients, despite the fact that they knew, were reckless in not knowing, or should have known that these investments did not comply with the restrictions on alternative investments imposed by Georgia law.” This case brings attention to an investment adviser’s obligation to “know its clients,” including the obligation to be familiar with laws and contractual provisions that place limitations on the types and amounts of investments in which certain clients, such as pension plans, can invest.
The Public Retirement Systems Investment Authority Law (“the Act”), codified as O.C.G.A. §§ 47-20-80 through 47-20-87, allows certain large retirement systems to invest in alternative investments, such as venture capital funds and merchant banking funds, subject to certain restrictions. For example, the Act provides that such investments cannot in the aggregate exceed five percent of the retirement system’s assets at any time. The Act also provides that before a large retirement system can invest in an alternative investment, the alternative investment needs to have had or concurrently have four or more other investors not affiliated with the investment’s issuer.
According to the SEC, in about July 2012, Gray Financial and Gray, with Hubbard’s help, breached their fiduciary duty to the public pension clients because the investments they sold to the funds did not comply with the Act. For example, the Act provides that alternative investments can only be carried out in private pools and issuers with $100 million or more in assets. Gray Financial’s fund had only $78 million initially, and it never reached the $100 million threshold. Moreover, the SEC alleged that two of the public pension clients each contributed more than 20 percent of the fund’s corpus. Under the Act, a single investor cannot contribute more than 20 percent to an alternative fund’s corpus. The SEC also alleged that all of the public pension clients’ investments violated the Act’s rule that “four non-issuer affiliated investors exist prior to the investment by a Georgia public pension.”
The SEC’s Order does not state with certainty whether Gray Financial, Gray, and Hubbard knew that the investments they made on behalf of the public pension clients were not in compliance with the Act. However, the Order does provide that if Gray Financial, Gray, and Hubbard did not know that the investments were not in compliance with the law, they were “reckless in not knowing” or “should have known that those investments did not comply with the restrictions on alternative investments imposed by Georgia law.” This shows that, as part of their duty to make suitable recommendations to clients, Gray Financial, Gray, and Hubbard had an obligation to be aware of the limitations that the Act placed on the types and amounts of alternative investments that the public pension clients could invest in.
Gray Financial, Gray, and Hubbard all agreed to be enjoined from further violations of the Investment Advisers Act of 1940. Gray Financial and Gray also agreed to pay, jointly and severally, disgorgement of $224,071 and prejudgment interest of $27,227.72. Gray agreed to pay a civil money penalty of $150,000. Hubbard agreed to pay a civil money penalty of $75,000. Gray consented to be barred from the securities industry for a period of two years, and Hubbard consented to be barred from the securities industry for a period of one year.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.