Investment Adviser

Recent SEC Enforcement Actions Signal Shift Towards Closer Scrutiny on Chief Compliance Officers

June 3, 2016 | Patricia Klusmeyer

Chief Compliance Officers (“CCOs”) play an important role in registered investment adviser firms, as they are responsible for ensuring the firm is developing adequate compliance programs and following its compliance policies and procedures. In the past, the Securities Exchange Commission (“SEC”) has generally avoided second-guessing the professional judgment of CCOs. However, recent SEC enforcement actions show a clear trend towards growing scrutiny over the conduct of CCOs and towards enforcement actions being taken against them.

Two high-profile cases from 2015 illustrate the shift in the SEC’s tone towards CCOs. First, in an April enforcement action against BlackRock Advisors the SEC charged the firm with failing to disclose the outside business interests of one of the firm’s portfolio managers to its board of directors or advisory clients, as well as failing to adopt any policies and procedures addressing outside business activities. In addition, the SEC also charged the then-CCO for causing BlackRock’s compliance-related violations by failing to ensure the firm adopted the required policies and procedures. BlackRock settled the charges with a $12 million penalty, while the then-CCO paid $60,000.

SEC Issues No-Action Letter Lessening Custody Rule Requirements for Sub-Advisers

May 31, 2016 | Patricia Klusmeyer

The Securities Exchange Commission (“SEC”) recently released a no-action letter allowing sub-advisers in certain situations to avoid the annual surprise examination requirement of Rule 206(4)-2 for investment advisers with custody of client funds or securities. Going forward, sub-advisers who do not have actual custody of client assets but are deemed to have custody because they are related to the qualified custodian and primary adviser will no longer have to comply with this burdensome requirement, so long as certain conditions are met.

As a review, custody is defined by Rule 206(4)-2 under the Investment Advisers Act of 1940 as the holding, directly or indirectly, of client funds or securities, or having any authority to obtain possession of them. This includes situations where a “related person,” or a person controlled by you or under common control with you, has custody of client funds. Pursuant to SEC Rule 206(4)-2, investment advisers with custody of client funds must take certain steps to safeguard such client assets. Those steps include: 1) maintaining assets with a qualified custodian; 2) notifying clients about the qualified custodian; 3) ensuring that the qualified custodian sends quarterly account statements to client; and 4) obtaining an annual surprise examination by an independent public accountant.

Investment Adviser Accused of Raising Operating Capital From Clients by False and Misleading Statements

May 26, 2016 | Steve Parker

Earlier this month, the Securities and Exchange Commission (“SEC”) instituted an administrative proceeding against Blue Ocean Portfolios, LLC (“Blue Ocean”), an SEC-registered investment advisor with approximately $106 million in regulatory assets under management, and its Principal, CEO and Chief Compliance Officer, James A. Winkelmann, Sr. According to the allegations, Blue Ocean and Winkelmann began raising capital from clients of Blue Ocean in order to generate business proceeds for Blue Ocean in April, 2011. The adviser raised the funds by issuing a number of what it called “Royalty Units,” which were in fact interests that paid a minimum return to the investors with the prospect of a higher return if Blue Ocean’s advertising investment yielded successful new customers with annually recurring revenue.

SEC Issues Investor Bulletin on Performance Claims in Advertising

May 24, 2016 | Patricia Klusmeyer

The Securities Exchange Commission (“SEC”) Office of Investor Education and Advocacy recently released an investor bulletin educating investors on investment performance claims in investment adviser advertising and pointing out specific things they should consider prior to investing. This bulletin and newsletter highlight the increasing emphasis regulators have been placing on performance claims in recent years.

Performance advertising is regulated under the Investment Advisers Act of 1940 (“Advisers Act”) and Rule 206(4)-1. Pursuant to Section 206 of the Advisers Act and Rule 206(4)-1, it is considered fraudulent for a registered investment adviser to publish, circulate, or distribute any advertisement which contains any untrue statement of material fact or which is false or misleading. The SEC has issued specific guidance regarding performance claims in advertising that all investment adviser firms must follow in order for their performance advertising to be considered non-fraudulent.

SEC Fines, Suspends Accounting Firm Over Deficient Audits

May 20, 2016 | Steve Parker

Last month, the Securities and Exchange Commission (“SEC”) brought and simultaneously settled administrative proceedings against accounting firm Santos, Postal & Co. P.C. (“SPC”) and one of its accountants, finding that SPC and the accountant conducted deficient surprise audits of investment adviser SFX Financial Advisory Management Enterprises (“SFX”). The surprise examinations were conducted pursuant to the SEC custody rule and are designed to confirm the adviser’s appropriate handling of assets under their custody and to uncover, to the extent possible, fraudulent activity of the advisers.

As background to this enforcement action, under Advisers Act Rule 206(4)-2, investment advisers with custody of client funds or securities must maintain certain controls, commonly known as “safekeeping procedures,” to protect those assets. State-registered advisers must comply with rules that vary from state to state, but the model rule of the North American Securities Administrators Association is substantially similar to the SEC rule. Since approximately March 2010, the Rule has required advisers that have custody other than because of an ability to deduct client fees to obtain an annual surprise exam by an independent public accountant to verify all client assets. Another basic requirement of the rule applicable to all advisers with custody is having a reasonable basis for believing that a qualified custodian or the adviser sends quarterly account statements to each client for which custody was maintained. Advisers that advise hedge funds or pooled investment vehicles may satisfy the audit requirement and other safekeeping provision by having an audit completed by a PCOAB auditing firm and timely delivering audit results to the fund’s shareholders.

SEC Fines Investment Adviser Over Lack of Heightened Supervision

May 13, 2016 | Steve Parker

Last month the Securities and Exchange Commission (SEC) instituted and simultaneously settled an administrative enforcement case in which a civil penalty of $225,000.00 was assessed against Cambridge Investment Research Advisors, Inc. (Cambridge). The action illustrates the importance of designing and implementing effective heightened supervision programs for investment adviser representatives who have a history of allegations of rules violations or other misconduct or disclosure items on the Form U-4.

The case stemmed from an incident that was the subject of a separate SEC proceeding filed in 2013 against Richard P. Sandru, who was an investment adviser representative operating from Cambridge’s Perrysburg, Ohio branch office. In that proceeding, Sandru was found to have forged clients’ signatures on financial planning agreements or, in some cases, adding client charges to the agreements without the clients’ knowledge and without obtaining additional signatures from the clients authorizing the additional charges. Sandru’s conduct, which the SEC characterized as a fraudulent scheme to misappropriate client funds, took place between 2009 and 2011 and potentially affected 47 advisory clients, from whom Sandru allegedly misappropriated “at least $308,850.00.” Sandru was, at this time, an OSJ of Cambridge and supervised two other Cambridge representatives and other administrative assistants.

FINRA Provides Effective Practices for Digital Investment Advice

May 10, 2016 | Patricia Klusmeyer

The Financial Industry Regulatory Authority (“FINRA”) recently released guidance on effective practices for financial services firms that provide digital investment advice services. While the report analyzed rules of the securities industry that relate to such services, it discusses effective practices that “may be valuable to financial professionals generally,” including registered investment advisers. With the increasing use of digital investment advice tools in the financial services industry, FINRA undertook to review a broad range of these tools to ensure broker dealers as well as investment advisers are complying with their legal obligations.

The digital investment advice tools FINRA is referring to include both financial professional-facing tools and client-facing tools. These tools typically perform the necessary functions involved in managing an investor’s portfolio, including customer profile development, asset allocation, portfolio selection, trade execution, portfolio rebalancing, and tax-loss harvesting. Client-facing tools which perform these functions are commonly known as “robo advisors.” Financial professional-facing tools usually include portfolio analysis capabilities in addition to those listed functions.

DOL Releases Final Fiduciary Rule

April 20, 2016 | Patricia Klusmeyer

The Department of Labor (“DOL”) released the final version of its new fiduciary rule on Wednesday April 6, ending months of widespread speculation and apprehension in the financial services industry. The DOL appears to have heard the thousands of public comments asking for more clarification and simplification, particularly as related to the Best Interests Contract (“BIC”) exemption. The final rule contains some notable deviations from the proposed rule.

As we discussed in an earlier blog post, the former definition of fiduciary for providing investment advice to a covered employee benefit plan under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code of 1986 (“Code”) stated that financial advisers were generally only fiduciaries if such investment advice was given on a regular basis and pursuant to a mutual understanding that the advice would serve as the primary basis for investment decisions and would be individualized to the particular needs of the plan. This definition typically encompassed only financial advisers in established and ongoing relationships with their clients, such as investment advisers who provided investment advice to covered plans. Meanwhile, broker-dealers and insurance agents were generally excluded, and broker-dealers were only held to the same suitability standard for retirement plans that applies to their recommendations made to non-retirement plans.

SEC Enforcement Case Arises From “Free Dinner” Seminar Fraud

April 18, 2016 | Steve Parker

Earlier this month, the Securities and Exchange Commission (SEC) filed a civil lawsuit against four individuals who are alleged to have defrauded seniors through so-called “Free Dinner” investment seminars conducted by their investment adviser firm. The SEC alleged that Joseph Andrew Paul and John D. Ellis, Jr., who managed and jointly owned Paul-Ellis Investment Associates, LLC (PEIA), created materially false and fraudulent marketing material in order to induce Florida residents to attend the “Free Dinner” seminar. More specifically, the SEC alleged that the marketing materials included performance return statistics that were not consistent with the actual track record of the firm, but rather had been copied and pasted from another advisory firm’s website.

The individuals were also alleged to have recruited James S. Quay of Atlanta, Georgia and Donald H. Ellison of Palm Beach, Florida, who allegedly used the false material to mislead seniors who responded to the “Free Dinner” invitation. The SEC further alleges that Mr. Quay used an alias, Stephen Jameson in order to conceal his true identity. Mr. Quay was previously involved and was held liable in an enforcement action brought by the SEC in 2012. Before that, Quay was an active sales agent in a multi-million dollar Ponzi scheme operated by an attorney in Atlanta, Georgia. According to the SEC, Quay was also convicted of tax fraud in 2005.

SEC Charges Georgia Based Fund Investment Adviser With Front-Running and Other Fraud

April 4, 2016 | Steve Parker

Last month the Securities and Exchange Commission (“SEC”) commenced an administrative proceeding against an Augusta Georgia investment adviser to a hedge fund called Geier International Strategies Fund, LLC (“GISF”). According to the SEC’s Order Instituting Administrative Proceedings, Christopher M. Gibson, the fund’s adviser, caused the fund to invest the majority of the fund’s assets in a single security, then personally profited and helped both his friends and a preferred investor in the fund to personally profit at the expense of the fund and its other members by engaging in frontrunning and other fraudulent conduct.

More specifically the Order alleges that in 2011 GISF had 21 investors and a total asset value of approximately $60 million. In early, Gibson, who had previously advised the fund through a Georgia registered investment adviser called Geier Group, LLC, caused the fund to purchase large quantities of Tanzanian Royalty Exploration Corporation (“TRX”), and Alberta, Canada based gold mining resource company that has never been profitable. The fund held 10.3% of all of TRX’s outstanding common stock by April 29, 2011, a holding that was valued at over $70 million at the time. However, as TRX’s value plunged from late April to late September, the fund’s value also declined precipitously.