Enforcement

SEC Announces Enforcement Activity Under New Marketing Rule

September 19, 2024 | Charlie Jarrett

Last week, the SEC announced a series of enforcement actions tied to its ongoing sweep of investment adviser compliance with the new Marketing Rule. In total, nine firms settled claims that they violated Advisers Act Rule 206(4)-1, the “new Marketing Rule,” resulting in $1,240,000 in civil penalties.

We have previously written about the implementation of the new Marketing Rule, the announcement of the corresponding examination sweep program, and the subsequent enforcement actions that have resulted. While the previous enforcement actions have largely centered around investment advisers who have failed to adopt policies and procedures designed to prevent violations of the new Marketing Rule, the recent enforcement actions give greater insight into the real-world application of the new Marketing Rule. Namely, the actions detail marketing violations due to the use of third-party ratings by the investment advisers.

Investment Adviser Fined and Ordered to Deregister for Fraud and Failure to Produce Records to SEC

September 3, 2024 | Katherine Oberlies

In September 2023, the U.S. Securities and Exchange Commission (“SEC”) filed a complaint against Lufkin Advisors, LLC, a now de-registered Registered Investment Adviser, and its President, Chauncey Forbush Lufkin, III (collectively, “Defendants”) in the U.S. District Court for the Southern District of Florida.

The SEC first alleged an ongoing fraudulent course of conduct for multiple years. To support this claim, they alleged that the Defendants

Failed to manage assets entrusted to them,
Lost control–due to a lost or forgotten password–of cryptocurrency assets valuing an estimated $10 million for at least a year without notification to the client(s),
Made investments with Mr. Lufkin’s spouse’s company without the appropriate conflict of interest disclosures,
Failed to account for withdrawals from private funds, and
Failed to monitor the value of investments in private funds.

First Circuit Ruling Gives SEC Victory in Long Fought Case

August 8, 2024 | Charlie Jarrett

Earlier this month, the United States Court of Appeals for the First Circuit issued a unanimous decision upholding a circuit court’s ruling in SEC v. Navellier & Associates, Inc.[i] This ruling granted the SEC summary judgment finding that Navellier & Associates, a Nevada based investment adviser, violated Section 206 of the Adviser’s Act.

For the past ten years, we have written about a series of SEC enforcement actions centered around the advertisement of performance returns tied to F-Squared, previously the U.S. largest marketer of ETF-based index products. The F-Squared and related cases not only established the SEC’s position regarding the publication of performance advertising but also recognized an investment adviser’s fiduciary duty when adopting statements made by third parties in advertisements. The SEC’s positions were codified under the new Marketing Rule adopted in 2021.

SEC Announces Enforcement Results for 2023

December 7, 2023 | Charlie Jarrett

With the end of the federal government’s fiscal year, the Securities and Exchange Commission (SEC) once again recently released results from the enforcement program, covering November 2022 through October 2023. The release included cumulative totals and highlighted individual cases and enforcement areas of concentration. The annual release serves as a roadmap for where the SEC is spending its resources, and what conduct will likely lead to enforcement actions.

During fiscal year 2023, the SEC’s Enforcement Division filed 3% more total enforcement actions than during 2022. This included an 8% increase in “stand-alone,” or original actions, along with increases in the number of “follow-on” administrative proceedings. These “follow-on” actions are typically filed after an associated criminal, civil, or other regulatory action, and look to impact an individual’s ability to conduct business in the securities industry.

SEC Fines Adviser Under New Marketing Rule

September 5, 2023 | Katherine Oberlies

On August 21, 2023, the U.S. Securities and Exchange Commission (“SEC”) issued an order imposing civil monetary penalties against Titan Global Capital Management USA LLC (“Titan”) for violations of the new investment adviser Marketing Rule, Rule 206(4)-1. The new rule had a mandatory compliance date of November 4, 2022, but advisers could voluntarily adopt the rule sooner.

Titan elected to comply with the new rule in June 2021; however, the firm did not adopt new policies and procedures or adapt its practices as required by the new rule. Between August 2021 and October 2022, Titan violated the new Marketing Rule by advertising hypothetical performance without adopting policies and procedures reasonably designed to ensure the hypothetical performance was relevant to client’s or prospective client’s financial situation and investment objectives and also by failing to provide information underlying the hypothetical performance as required by the new rule. Continue reading ›

SEC Settles Charges Against RIA for Failure to Review Wrap Fee Programs

February 16, 2023 | Katherine Oberlies

On August 26, 2022, the U.S. Securities and Exchange Commission (“SEC”) issued an order settling charges against Kovak Advisors, Inc. (“Kovak”), for compliance failures related to its wrap fee program. The case highlights how important it is for an investment adviser to adopt and follow policies and procedures relating to any wrap fee program, to ensure that the adviser’s services are in the client’s best interest.

From 2015 through August 2018, Kovak offered advisory services to clients through a wrap fee program. Clients that participated in the wrap fee program paid a fee that included asset management, trade execution, and other costs. The SEC made three findings during the time Kovak offered the wrap fee program.
Continue reading ›

SEC Enforcement Case Highlights Importance of Conflict of Interest Disclosure

January 30, 2023 | Steve Parker

In this first quarter of the year, most investment advisers are working diligently to complete and file their annual updating amendment to Form ADV, including Part 2A, commonly called the “Brochure.” One of the most important requirements in drafting a Brochure is to make sure that all conflicts of interests, together with a description of how the conflict is mitigated or addressed, are fully and fairly disclosed. An administrative action brought by the SEC and settled last week illustrates, and should serve to underscore, the importance of identifying and disclosing such conflicts.

The SEC charged registered investment adviser Moors & Cabot (“M&C”) with breaching its fiduciary duty to investment advisory clients by failing to disclose conflicts of interest relating to revenue sharing payments and other financial incentives that the adviser received from two clearing brokers. The financial benefits included discounts, incentive credits and shared revenue that were contingent upon M&C meeting certain thresholds in total assets maintained in FDIC-insure bank deposit cash sweeps. M&C also received a share of margin interest the clearing firms charged to M&C’s clients who maintained margin loans. M&C also received a portion of postage and handling fees that one of the clearing brokers charged to its clients.

SEC Announces Enforcement Action for Compliance Policies and Procedures Failures

December 15, 2022 | Charlie Jarrett

The Securities and Exchange Commission recently announced the filing of an administrative proceeding against a registered investment adviser and the investment advisers owner/CCO for failing to adopt compliance policies and procedures, a Code of Ethics, and for failing to conduct annual reviews of the same. The advisory firm is Two Point Investment Management, Inc., based in Pittsford, New York. The SEC found that the violations occurred over a 10-year period starting when the adviser first registered with the SEC in 2012.

SEC Fines Investment Adviser Over the Use of Hedge Clause in Advisory Agreement

February 22, 2022 | Steve Parker

Last month, the SEC commenced an administrative enforcement action that highlights the significance of its change in guidance over the use of “hedge clauses” in investment advisory agreements. Recall that in IA-5248, the SEC’s 2019 interpretive release that addressed the standard of conduct for investment advisers, the Commission withdrew the 2007 No-Action Letter previously issued in Heitman Capital Management, LLC (Feb. 12, 2007) (“Heitman Letter”). Prior to IA-5248, the Heitman Letter had frequently been relied upon by investment advisers to permit the use of hedge clauses, or clauses purporting to limit an adviser’s liability, as long as the clause contained an affirmative statement that it should not be construed to waive unwaivable claims under federal and state securities laws. Because the SEC concluded that the Heitman Letter had been often misconstrued, IA-5248 expressly withdrew it.

Prior to the issuance of the Heitman Letter in 2007, the SEC had rather consistently prohibited the use of hedge clauses. The Heitman Letter, however, constituted a departure from that previous near-blanket prohibition. In Heitman, the SEC staff stated that the use of a hedge clause that limits the adviser’s liability except for gross negligence or willfulness may under some circumstances be permitted, depending on “all the surrounding facts and circumstances.” Among the circumstances to be considered were whether it was written in plain English, whether it had been highlighted and explained to the client personally, whether there was a heightened explanation of the types of claims that were not waived, and whether impacted clients had access to other professional “intermediaries” upon whom they relied. After the Heitman Letter, the use of hedge clauses by investment advisers proliferated, not always consistently with the Heitman guidance.

Exchange-Traded Product Probe Results in Fines for Investment Advisory Firms

January 21, 2021 | Steve Parker

Late last year, the SEC announced the settlement of five enforcement cases against RIA firms relating to their recommendations and purchases of complex exchange-traded products (ETPs) in clients’ accounts. The settlements – against Benjamin F. Edwards & Co., Royal Alliance Associates, Inc., Securities America Advisors, Inc, Summit Financial Group, Inc., and American Portfolios Financial Services. The actions were announced in connection with the SEC’s ETP initiative.

These cases may be the first of many, and they followed a joint statement from SEC Chairman and division heads in October of last year indicating that firms would be examined relating to their use of complex ETPs. However, the SEC has not formally announced a new initiative on the subject. Earlier in 2020, the SEC had resolved a similar charge against Wells Fargo resulting in a $35 million fine.

Generally, the products in question were those that track market volatility and are designed as short-term investments. Typically, these products are tied to the CBOE volatility index or VIX. Examples of such products are the VelocityShares Daily Inverse VIX Short Term Exchange-Traded Notes and the ProShares VIX Short-Term Futures ETF, both of which are tied to the performance of the S&P 500 VIX Short-Term Futures Index. The product offering materials describe the objectives of these products as to manage trading risks on a daily basis, and warn that their use over periods longer than a single day is not suitable, as the risk control objective will not be met by using them over such longer period. The issuers’ materials clearly describe that the products could lead to substantial losses when held in portfolios over periods longer than a single day.