Enforcement

New SEC Co-Directors of Enforcement Identify Cyber Threats as the Greatest Threats to Financial Markets

October 24, 2017 | Elizabeth Dalziel

Earlier this year, Securities and Exchange Commission Chairman Jay Clayton appointed Stephanie Avakian and Steven Peikin as co-directors of the SEC’s Enforcement Division. In an interview with Reuters, Avakian and Peikin expressed particular concern about cyber threats and how the SEC should make cybersecurity an enforcement priority. According to Peikin, “The greatest threat to our markets right now is the cyber threat… That crosses not just this building, but all over the country.”

The SEC has expanded of investigations relating to cybercrimes. There also appears to be an increase in incidents of hackers attempting to gain access to brokerage accounts. In response, the SEC has begun obtaining statistics about cybercrimes to assess market-wide issues. Continue reading ›

Supreme Court Rules that SEC’s Ability to Seek Disgorgement is Subject to a Five-Year Statute of Limitations

June 13, 2017 | Elizabeth Dalziel

On June 5, 2017, the United States Supreme Court, in a unanimous decision, ruled that disgorgement, a remedy that the SEC frequently utilizes to recover so-called “ill-gotten gains” from respondents in enforcement proceedings, is subject to 28 U.S.C. § 2642’s five-year statute of limitations for “an action, suit, or proceeding for the enforcement of any civil fine, penalty, or forfeiture.” As discussed previously, the Supreme Court agreed to hear the underlying case, SEC v. Kokesh (“Kokesh”), after a split in the appellate judicial circuits over whether SEC disgorgement was a “penalty” subject to the five-year statute of limitations.

The Supreme Court’s decision in Kokesh is not the first time that the Supreme Court has placed limitations on the SEC’s enforcement powers. In Gabelli v. SEC, a case from 2013, the Supreme Court ruled that civil monetary penalties were subject to the five-year statute of limitations.

Supreme Court Expected to Rule on Case Involving Potential Restrictions on SEC Disgorgement Remedy

May 11, 2017 | Elizabeth Dalziel

On January 13, 2017, the United States Supreme Court agreed to examine a case involving the Securities and Exchange Commission’s (“SEC’s”) ability to seek disgorgement of ill-gotten gains in fraud cases, including fraud cases involving investment advisers. The case, Kokesh v. SEC, raises the issue of whether claims for disgorgement are subject to a five-year statute of limitations on civil penalties. Oral arguments were heard by the Supreme Court in April.

The underlying case involves a New Mexico investment adviser named Charles R. Kokesh (“Kokesh”), who acted as an investment adviser to various funds organized as limited partnerships. The SEC filed suit against Kokesh, alleging that from 1995 through 2006, Kokesh ordered the funds’ treasurer to take money from the funds to pay various expenses, including $23.8 million for salaries and bonuses to the funds’ officers, including Kokesh, $5 million for office rent, and $6.1 million characterized as “tax distributions.” According to the Tenth Circuit, the payments violated the funds’ contracts because the contracts did not permit payments for salaries of the funds’ controlling persons, including Kokesh, until 2000. The contracts also did not address bonus payments, and they only permitted payment of tax obligations if certain prerequisites were present. A jury found that Kokesh violated the Investment Advisers Act of 1940, among other statutes, and the District Court ordered Kokesh to pay a $2.4 million civil penalty, plus disgorgement of $35 million based on amounts going back to 1995.

In response, Kokesh appealed to the Tenth Circuit Court of Appeals, arguing that the disgorgement was a penalty subject to a five-year statute of limitations under 28 U.S.C. § 2462. The SEC argued that the disgorgement was remedial and not punitive, and therefore not a penalty subject to the statute of limitations. The Tenth Circuit agreed with the SEC and held that disgorgement was not a penalty.

FINRA Updates Sanction Guidelines

April 24, 2017 | Elizabeth Dalziel

On April 10, 2017, the Financial Industry Regulatory Authority’s (“FINRA”) National Adjudicatory Council (“NAC”) updated FINRA’s Sanction Guidelines. The purpose of these updates is to “ensure that the guidelines reflect recent developments in the disciplinary process, comport with changes in FINRA’s rules, and accurately reflect the levels of sanctions imposed in FINRA disciplinary proceedings.”

FINRA’s Sanction Guidelines are designed to acquaint FINRA-member firms with common securities-industry rule violations that take place and the variety of disciplinary sanctions that may be imposed because of those rule violations. The Sanction Guidelines also serve as a tool to help FINRA’s adjudicators find suitable sanctions in disciplinary proceedings. From time to time, FINRA conducts reviews of the Sanction Guidelines to account for “changes in FINRA’s rules” and to reflect accurately “the levels of sanctions imposed in FINRA disciplinary proceedings.” Continue reading ›

Arizona Adviser’s Outside Business Activity Constituted Unlicensed Sale of Securities

February 9, 2017 | Elizabeth Dalziel

On December 13, 2016, the Arizona Court of Appeals (“Court of Appeals”) affirmed an Arizona Superior Court’s decision finding that Patrick Shudak, an investment adviser, violated the Arizona Securities Act by acting as an unregistered securities salesperson or dealer in connection with the sale of interests in a real estate venture.

From January 2008 through July 2009, Shudak sold membership units in a company known as Parker Skylar & Associates, LLC (PSA). Neither Shudak nor PSA was registered as a securities salesperson or dealer under the Arizona Securities Act. Shudak stated in PSA’s promotional materials that the money invested in PSA would “be used to purchase and develop real property.” In reality, however, Shudak placed the money that investors put into PSA into his personal account, the personal accounts of others such as his girlfriend, and business accounts of other business that Shudak owned or had some affiliation with.

In December 2009, investors started to grow worried when Shudak stopped returning phone calls and replying to the investors’ demands for information. As a result, Shudak was obligated to stop serving as PSA manager and to give up his PSA membership. He subsequently filed for bankruptcy in April 2010.

SEC Sanctions Investment Adviser for Breaking Promises to Correct Deficiencies

January 17, 2017 | Steve Parker

Most deficiencies identified in the course of investment adviser examinations can be remedied by the adviser simply taking corrective measures. This can be true even with regard to deficiencies that are somewhat serious violations, but only if corrective action is taken and sustained.

In 2016, the Securities and Exchange Commission (“SEC”) starkly demonstrated the importance of following through with promises advisers make to the SEC Examinations Staff. Because they did not make promised corrections, Moloney Securities Co., Inc. and Joseph R. Medley, Jr. were forced to consent to the entry of an Order Instituting Proceedings that required them, among other things, to pay civil penalties and to hire an independent compliance consultant to monitor and report certain aspects of the firm’s compliance program. Continue reading ›

SEC Continues Increased Focus on RIA Performance Advertising

September 19, 2016 | Patricia Klusmeyer

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.

Court Affirms SEC’s Sanction of Investment Adviser Over Fraudulent Performance Advertising

September 7, 2016 | Patricia Klusmeyer

The U.S. Circuit Court of Appeals for the District of Columbia 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.

Private Equity Fund Adviser Sanctioned for Acting as Unregistered Broker-Dealer

July 28, 2016 | Steve Parker

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.

SEC Fines Broker-Dealer for Failing to Protect Confidential Client Information

July 19, 2016 | Patricia Klusmeyer

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.