Investment Adviser

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.

SEC Charges Fund Manager with Fraudulently Misleading Investors

March 11, 2016 | Patricia Klusmeyer

The Securities and Exchange Commission (“SEC”) recently brought an administrative proceeding against unregistered fund manager Steven Zoernack and his firm, EquityStar Capital Management, LLC (“EquityStar”), for engaging in allegedly fraudulent conduct in violation of federal securities and investment adviser laws. Mr. Zoernack and EquityStar allegedly concealed Mr. Zoernack’s criminal history, used false identities, and distributed false and misleading marketing materials, among other things, in their bid to lure investors.

As alleged, Mr. Zoernack created EquityStar in May of 2010 to serve as the investment adviser for two private investment funds, Global Partners and Momentum. Between 2011 and 2014 Mr. Zoernack actively sought investors for the two funds, managing to sell approximately $5.6 million of interests in Global Partners and Momentum. As EquityStar’s managing member and sole employee, he handled all activities of the firm and drafted all marketing and offering materials. In the furtherance of these activities, Mr. Zoernack allegedly made many material misrepresentations to investors and prospective investors regarding himself and EquityStar.

FINRA Files Revised Pay-to-Play Rule Proposal with SEC

February 15, 2016 | Patricia Klusmeyer

The Financial Industry Regulatory Authority (“FINRA”) recently filed its revised pay-to-play rules proposal with the Securities Exchange Commission (“SEC”). Investment advisers have been awaiting FINRA’s pay-to-play rules ever since the SEC announced last year that it would not recommend enforcement action against an investment adviser or its associated persons for the payment to a third party for the solicitation of a government entity for investment advisory services until either FINRA or the Municipal Securities Rulemaking Board (“MSRB”) had adopted its own pay-to-pay rules for broker-dealers.

Pay-to-play activities involve the practice of making cash or in kind contributions, or soliciting others to make those contributions, to state or local officials or other government entities as an incentive for the receipt of government contracts. Pursuant to Rule 206(4)-5, investment advisers are prohibited from providing a government entity with investment advisory services for compensation within two years of contributing monetarily to that government entity. In addition, and of particular interest here, under Rule 206(4)-5 investment advisers may not provide payment to any third party to solicit a government entity for investment advisory services on behalf of the investment adviser unless that third party is a registered investment adviser, a registered broker-dealer, or a registered municipal adviser.

SEC Releases Examination Priorities for 2016

February 9, 2016 | Patricia Klusmeyer

The Office of Compliance Inspections and Examinations (“OCIE”) of the Securities Exchange Commission (“SEC”) recently released its Examination Priorities for 2016. These examination priorities provide valuable insight into what OCIE perceives to be the greatest risk to investors and what it will be focusing its efforts on throughout the year. This year its overall goals stayed approximately the same as last year: 1) protecting investors saving for retirement; 2) assessing market-wide risks; and 3) using data analytics to identify and examine illegal activity.

In regards to its goal of protecting investors saving for retirement, OCIE intends to continue its Retirement-Targeted Industry Reviews and Examinations (“ReTIRE”) initiative which focuses on the suitability of investment recommendations made to investors, supervision and compliance procedures, conflicts of interest, and marketing practices. It will also continue to review the supervision procedures of branch offices of SEC-registered entities and fee selections which can lead to reverse churning. New areas of focus include exchange-traded funds (“ETFs”) which OCIE intends to examine for compliance with various regulatory requirements. It will focus on sales strategies, trading practices, disclosures, excessive portfolio concentration, and suitability, and will pay particularly close attention to niche or leveraged/inverse ETFs. In addition, variable annuities have become a large part of many investors’ retirement plans and OCIE intends to assess the suitability of these sales as well as the adequacy of disclosures. Lastly, OCIE will examine public pension advisers to ensure these advisers are not engaging in any pay-to-play activities or giving undisclosed gifts in return for appointments or other favors.

SEC Publishes Guidance on Avoiding Mischaracterization of 12b-1 Fees

February 3, 2016 | Patricia Klusmeyer

The Securities and Exchange Commission (“SEC”) recently published guidance on the characterization of mutual fund fees, specifically 12b-1 distribution fees and sub-accounting fees, as part of their ongoing Distribution-in-Guise Initiative. Pursuant to Rule 12b-1 under the Investment Company Act of 1940, payments made by mutual funds (“funds”), to financial intermediaries from fund assets for the distribution of fund shares must be paid pursuant to a Rule 12b-1 plan that has been approved and adopted by the fund’s shareholders and Board of Directors (“Board”). In recent years the SEC has noticed that there are various fees being paid to intermediaries, in addition to distribution fees, that are being characterized as non-distribution-related fees and are not being paid pursuant to a Rule 12b-1 plan. Those fees include sub-transfer agent fees, administrative sub-accounting fees, and other shareholder servicing fees (collectively “sub-accounting fees”).

While these sub-accounting fees may in some cases be valid non-distribution-related fees, if they directly or indirectly compensate at all for any distribution-related activities, they are improperly labeled. Because of the importance of this issue given that fund fees directly impact investor returns and inherently involve conflicts of interest, the SEC has published guidance to assist funds in ensuring that distribution-related fees are being properly labeled and disclosed in a Rule 12b-1 plan as required. This potential problem was brought to the SEC’s attention after a recent sweep examination of various market participants including mutual funds, investment advisers, transfer agents, and broker-dealers.

Hedge Fund Manager Settles Charges with SEC for Overcharging on Fees and Overvaluing Assets

January 26, 2016 | Patricia Klusmeyer

A Denver-based alternative fund manager was recently charged by the Securities Exchange Commission (“SEC”) with engaging in fraudulent behavior regarding the handling of its futures fund, The Frontier Fund (“TFF”). The alternative fund manager, Equinox Fund Management LLC (“Equinox”), allegedly overcharged management fees to its investors and overvalued certain assets.

Equinox is registered as an investment adviser with the SEC and thus owes its investors certain fiduciary duties, one of which is to act in the best interests of its investors by being accurate and complete with its registration statements and SEC filings. Equinox, however, allegedly failed to meet those duties by misrepresenting in their TFF registration statements that management fees were based on the net asset value of the assets, when in reality they were based on the notional trading value of the assets. The notional trading value takes into account both the amount invested and the amount of leverage used in the underlying investments, and is significantly higher than net asset value.

Common Mistakes to Avoid in Form ADV Annual Updates

January 22, 2016 | Patricia Klusmeyer

Filing annual updating amendments to Form ADV is an important requirement for all registered investment advisers. All information contained in Parts 1 and 2 of Form ADV must be both accurate and complete. Unfortunately, this is not always the case, and the Securities Exchange Commission (“SEC”) and state regulators have not hesitated in bringing enforcement actions against investment advisers who misrepresent or fail to disclose certain information in their annual filings and amendments.

Based on 1170 routine state-coordinated investment adviser examinations in 2015, as reported by the North American Securities Administrators Association (“NASAA”), the most common errors that are routinely found on Form ADVs include inconsistencies between Form ADV Part 1 and Part 2, inconsistencies between fees charged and fees listed on the ADV, inconsistencies between services provided and services described in ADV, misrepresentations in business description, overstatements or understatements of assets under management, and failure to disclose conflicts of interest.

SEC Clarifies RIA Performance Advertising Obligations: The Virtus & Alpha Fiduciary Matters

January 19, 2016 | Patricia Klusmeyer

Last week we discussed the Lucia matter and the parameters it added for investment advisers to consider prior to utilizing performance advertisements. Today we will discuss two more administrative proceedings involving performance advertisements and the practical implications which can be taken from these cases.

The matter of Virtus Investment Advisers revolved around one of Virtus’ sub-advisers, F-Squared Investments. F-Squared was an investment adviser that had previously been fined by the SEC for allegedly advertising false inflated performance numbers of its most successful investment strategy, AlphaSector. AlphaSector consisted of an algorithm-based sector rotation strategy which traded nine industry exchange-traded funds from the S&P 500 Index. Virtus’ assets under management which utilized this strategy grew from $191 million at the end of 2009 to 11.5 billion by 2013. Unfortunately, F-Squared allegedly falsely stated that the AlphaSector strategy had a history dating back to 2001 and that it had historically outperformed the S&P 500 Index from 2001 to 2008. The SEC found that no assets had tracked the strategy from 2001 to 2008 and its back-tested performance data was miscalculated and substantially overstated results.