Articles Tagged with SEC

SEC Issues Risk Alert to Private Fund Advisers, Part 2

This supplements our previous post relating to a Risk Alert issued by the SEC’s Office of Compliance Inspections and Examinations on June 23. The Risk Alert was directed at investment advisers to private investment funds. While the prior post discussed the portion of the Risk Alert dealing with fees and expenses, this post discusses the SEC’s findings relating to failure to disclose conflicts of interest.

By way of background, the Risk Alert reminds private fund advisers that they owe duties of care and loyalty to the investors in private funds. In order to fulfill the duty of loyalty, the adviser may not prefer his own interests to those of the investors and must disclose to its clients, in a full and fair manner, all material facts relating to the advisory relationship. The scope of the investment adviser’s duties is discussed at length in IA-5248, issued in June 2019, which we have discussed in a previous post.

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Earlier this week, the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a risk alert in which it discussed ongoing deficiencies identified during compliance examinations of investment advisers that advise private funds. This risk alert follows on the heels of other SEC activity relating to private fund advisers, including enforcement referrals, deficiency letters, and informal guidance.

The deficiencies discussed in the risk alert fall into three broad categories: disclosures relating to fees; disclosures relating to conflicts of interests; and sufficiency of a firm’s policies relating to nonpublic material information and its internal enforcement of such policies. The purpose of this risk alert was to provide guidance to private fund advisers regarding steps they should take to improve their compliance policies and program, while simultaneously advising investors in private funds of the types of issues to be aware of when dealing with private fund advisers. Many investors in private funds are pensions or other qualified retirement plans, charities and endowments, and families who have family offices.

This blog post focuses on the portion of the risk alert relating to fees and expenses. Continue reading ›

Last month Wells Fargo Advisors Financial Network LLC agreed to settle administrative charges brought by the SEC, and will pay a $35 million civil penalty in order to resolve the matter. According to the allegations, Wells Fargo failed to supervise investment adviser representatives who recommended inverse exchange-traded funds to their customers, leading to investor losses.

Inverse ETFs allow investors to short the entire market or a sub-market, depending on the ETF involved. However, because they usually “re-set” every day, inverse ETFs are not designed to be held for longer than a single trading day. Instead, they are designed to be used by traders to implement risk hedges on an intra-day basis. If they are held on a long-term basis, they will not necessarily perform consistently with the long-term direction of the market being shorted. This is especially true in volatile markets.

These risks are often described in detail in the product prospectuses but are not often explained sufficiently by financial advisers. In fact, advisers who are not specifically trained on the products often do not understand their unique characteristics. For example, a single-inverse ETF based on a particular index will usually lose money even if the index performance remains flat. In fact, even if the index falls the ETF can lose money.

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Following SEC guidance regarding investment advisers’ proxy voting obligations issued in August of this year, and rule changes proposed by the SEC consistent with that guidance a few weeks later, investor organizations, including the Council of Institutional Investors (CII), and Institutional Shareholder Services (ISS), have taken actions to challenge the guidance and he rule proposals.

In August, the SEC voted 3 to 2 to issue the new guidance and to include potential rule amendments in its regulatory agenda. In general terms, the SEC’s interpretations are designed to make all proxy voting recommendations by a proxy adviser a “solicitation” under the federal proxy rules and subject to the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 14a-9.

In a letter to the SEC in October, CII questioned the wisdom of the guidance and urged the SEC not to adopt proposed rule changes over concerns that both the guidance and the rules would weaken corporate oversight by investors and make it more difficult to replace or oppose existing management.  CII claimed that both the guidance and the proposed rulemaking would increase costs, add regulatory burdens, increase litigation, and otherwise make it more expensive and difficult for investors to retain the benefits offered by proxy advisory firms.  CII said in its letter that the guidance and proposed rule changes not driven by investor protection because there is no “call from the investment community” or regulatory intervention on the issue of proxy voting.  Rather, CII contends that SEC made the announcement and proposals because of pressure from issuers who believe that proxy advisors are too often influential in successful corporate voting campaigns.  The letter indicated that CII’s position was supported by the Comptroller for New York City and the CEO of the California Public Employee’s Retirement System, among other major institutional investors.

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Recent developments within two of the three branches of the federal government portend significant potential changes in the SEC’s ability to obtain disgorgement of ill-gotten gains in civil actions brought by its enforcement arm. Early in November, the U.S. Supreme Court decided to hear an appeal of a Ninth Circuit case, SEC v. Liu, involving the issue of whether the SEC has statutory authority to obtain disgorgement at all. Then, not three weeks later, the U.S. House of Representatives responded by passing H.R. 4344, a bill explicitly codifying the SEC’s authority to obtain disgorgement. While the ultimate decision of the high court remains months away, and the House’s action has no legal significance until a companion bill in the Senate is acted upon and the two bills are passed by both chambers, these developments are of great significance to securities litigators and SEC-watchers alike.

Disgorgement has long been a powerful arrow in the SEC’s enforcement quiver, allowing it to obtain, on behalf of aggrieved investors, reimbursement of ill-gotten gains. However, despite it having obtained billions of dollars in disgorgement in civil actions over the last few decades, no statute explicitly confers the SEC with authority to seek this remedy. Rather, lacking any express authority, federal judges have implied it in scores of decisions dating back to the 1970s. Now, that entire foundation has come into question, prompted first by the Supreme Court’s 2017 decision in Kokesh v. SEC, and now by the high court’s acceptance of the Liu appeal.

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As discussed in our most recent posting on this blog, the SEC has proposed a wholesale rewrite of its existing advertising and cash solicitation rules. While that last post delved into the specifics of the SEC’s proposed amendment of its advertising rule, in this installment, we take up the Commission’s plans for revamping its cash solicitation rule.

The SEC’s Release No. IA-5407, published on November 4th, aims to modernize both rules to reflect the dramatic changes seen in technology and the advisory industry since the initial adoption of these rules decades ago. While just a proposal for now, it offers the best view into what any ultimate final rules will probably look like. At this stage, RIAs and other industry participants are closely reviewing both proposed rules, and many will be submitting public comments to the SEC as permitted pursuant to the Commission’s public comment process. While the public comment process runs a fixed 60 days, the ultimate publication of final rules is at the SEC’s discretion.

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On November 4th, the SEC released for public comment proposed replacements to its decades-old advertising and cash solicitation rules. The proposed rules, which are accompanied by almost 500 pages of explanatory text, are now subject to the SEC’s “notice and comment” process, whereby interested persons will have 60 days to file comments to the SEC, after which time the SEC will likely issue final versions of the new rules. While the content of the final rules ultimately adopted by the SEC may differ substantially from the versions now being circulated, the current proposals are the most likely outcome at this point in time and offer valuable insight into the SEC’s thinking in this area.

According to the SEC, both the advertising and cash solicitation rules are ripe for updates and modernization as a result of “changes in technology, the expectations of investors seeking advisory services, and the evolution of industry practices.” Notably, the advertising rule (Advisers Act Rule 206(4)-1) has been largely untouched since its adoption in 1961. Likewise, the cash solicitation rule (Advisers Act Rule 206(4)-3) has not been amended since its adoption in 1979. In this installment of our blog, we will outline some of the more salient points of the SEC’s proposal to replace the advertising rule. Look for our discussion of the proposed cash solicitation rule amendment in an upcoming post.

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In a recently-announced administrative proceeding, the SEC has entered a permanent securities industry bar against Joseph B. Bronson, effectively preventing Bronson from ever again associating with any investment adviser, broker, dealer, or municipal securities dealer/advisor. The SEC Order barring Bronson—consented to by Bronson—comes on the heels of an August final judgment against Bronson and his former RIA, Strong Investment Management, obtained by the SEC in a civil case filed in a California federal district court. This final judgment against Bronson and his RIA was especially harsh as it found him and the firm jointly and severally liable for nearly $1 million in disgorgement plus $100,000 in prejudgment interest. Bronson was also individually ordered by the court to pay a $184,000 civil penalty.

The Bronson case is instructive as it highlights an especially egregious case of fraudulent conduct and fiduciary disregard in the form of a “cherry-picking” scheme that—while invisible to Bronson’s clients—did not go unnoticed by the regulators. In a nutshell, over a four-year period, Bronson utilized his firm’s omnibus trading account at two different broker/dealers to effect a bald-faced cherry-picking scheme, whereby he entered block trades via the omnibus account, waited to see the trades’ intra-day performance, and then disproportionately allocated the winning trades to his own personal accounts and the losers to client accounts.

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The SEC has just concluded settlement negotiations with two large RIA subsidiaries of the Bank of Montreal, resulting in a total settlement of almost $38 million—with $25 million of that in disgorgement. The SEC’s announcement and administrative order resolves enforcement proceedings against BMO Harris Financial Advisors, Inc. (“BMO Harris”) and BMO Asset Management Corp. (“BMO Asset”)(together, the “BMO Advisers”) involving conflicts of interest violations under the Advisers Act antifraud provisions.

The SEC’s administrative settlement with the BMO Advisers marks yet another significant action by the Commission against RIAs for failing to disclose material conflicts of interest. As fiduciaries, RIAs must seek to avoid conflicts of interest with clients, and, at a minimum, must fully disclosure all material conflicts. The SEC enforces violations of this requirement pursuant to Advisers Act Section 206(2), which prohibits RIAs from engaging in “any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.”

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The SEC has filed fraud charges against a large ($85 billion AUM) registered investment adviser for its failure to disclose material conflicts of interest in connection with a “revenue sharing” arrangement with its clearing broker. The SEC’s Complaint against the adviser, Boston-based Commonwealth Equity Services, LLC, d/b/a Commonwealth Financial Network (“Commonwealth”), was filed in Massachusetts federal district court, and alleges that Commonwealth received over $100 million in revenue sharing from the clearing broker while failing to properly apprise its advisory clients of the full nature of the revenue sharing arrangement and the inherent conflicts of interest implicated by it. The Commonwealth case is just the latest in a string of actions by the SEC involving mutual fund share class selection by advisers and comes on the heels of the recent DC Circuit decision in the Robare case, which has likely emboldened the SEC somewhat.

The Commonwealth case involves a revenue sharing arrangement between Commonwealth and National Financial Services, LLC (“NFS”), an affiliate of mutual fund giant Fidelity Investments. Pursuant to that arrangement, NFS paid Commonwealth a percentage of the money paid to NFS by mutual fund companies in return for the right to sell their mutual funds through NFS. The money paid to Commonwealth by NFS under this arrangement, in turn, was directly related to the amount of Commonwealth client assets invested in certain share classes of specific funds offered on NFS’ platform. In other words, the more client assets placed by Commonwealth into particular funds and classes of those funds, the more revenue shared with Commonwealth. Continue reading ›

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