RIA Compliance Blog

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.

SEC Charges Options Trading Instructor with Defrauding Investors in Private Funds

June 9, 2017 | Elizabeth Dalziel

On May 24, 2017, the Securities and Exchange Commission (“SEC”) filed a complaint against an options trading instructor and unregistered investment adviser, Gustavo A. Guzman (“Guzman”). The complaint alleges that Guzman obtained more than $2.1 million from investors, assuring them that their funds would be invested in equity options and real estate. However, evidence showed that Guzman misappropriated a third of the funds “and lost the remainder through his options trading while misleading existing or prospective investors.”

Guzman was not registered as an investment adviser with the SEC or any state authority. However, he was tasked with managing investments in two private funds specializing in options trading and one real estate hedge fund. He also received management fees for managing these funds. As a result, Guzman met the definition of an investment adviser in the Investment Advisers Act of 1940 (“Advisers Act”) and was subject to its anti-fraud provisions. Continue reading ›

SEC’s Office of Compliance Inspections and Examinations Publishes Cybersecurity Alert Following Ransomware Attack

June 7, 2017 | Bryan Gort

On May 17, 2017, the Securities and Exchange Commission’s (“SEC’s”) Office of Compliance Inspections and Examinations (“OCIE”) published a Risk Alert pertaining to cybersecurity. According to the Risk Alert, an extensive ransomware attack called WannaCry, WCry, or Wanna Decryptor “rapidly affected numerous organizations across over one hundred countries.” In light of the WannaCry attack, OCIE is urging registered investment advisers, broker-dealers, and investment companies, to address cybersecurity vulnerabilities.

According to the Risk Alert and an alert published by the Department of Homeland Security, U.S. Cert Alert TA17-132A, the hacker or hacking group who instigated the WannaCry attack obtained access to enterprise servers by way of exploiting a Windows Server Message Block vulnerability. WannaCry infects computers using software that encrypts data on a server using a .WCRY file-name extension, which prevents the rightful owner from accessing the data. Once infected, the ransomware software demands payment from the business in return for access to the business’ data. Microsoft released a patch to this vulnerability in March of 2017, but many users of Microsoft operating systems do not diligently update their software. Continue reading ›

Private Placement Brokers Await Attention by SEC

June 6, 2017 | Steve Parker

As previously noted in this firm’s sister blog (see “Private Placement Brokers Should be Legalized along with M&A Brokers” in the RIA Compliance Blog, Jan. 21, 2015), there has long been a large gray market of unregistered private placement brokers. Also see “Report and Recommendations of the Task Force on Private Placement Broker-Dealers” (American Bar Association Business Law Task Force, 2005). This cadre, often calling themselves “finders,” have continued to operate in plain sight, with little response from the SEC other than the issuance of a few inconsistent no-action letters and an occasional enforcement action against such brokers whose conduct was egregious in other ways.

The SEC’s Advisory Committee on Small and Emerging Companies (the “Committee”) has twice weighed-in on this subject urging SEC action.

The Committee first reported on this subject September 23, 2015, noting that:

SEC Adopts JOBS Act Inflation Adjustments for Title III Crowdfunding and Title I Emerging Growth Companies

May 25, 2017 | Steve Parker

The JOBS Act requires the SEC to make inflation adjustments to certain JOBS Act rules every five years. Recent SEC action marks the first of these adjustments, effective on the fifth anniversary of the JOBS Act’s April 5, 2012 adoption. The following adjustments have been announced for Title III Regulation Crowdfunding or “Regulation CF”:

1. The maximum aggregate amount an issuer can sell under Regulation CF in a 12 month period has been increased from $1,000,000 to $1,070,000;

2. The threshold for assessing an investor’s annual income or net worth to determine investment limits is increased from $100,000 to $107,000;

On One-Year Anniversary of Reg CF, JOBS Act Author Urges Significant Revisions

May 24, 2017 | Steve Parker

As Regulation Crowdfunding or “Reg CF,” the SEC’s extensive rules implementing the federal/interstate crowdfunding provisions (Title III) of the JOBS Act, recently marked its one-year anniversary, the congressional author of Title III, Congressman Patrick McHenry (R-NC), is now urging the SEC to essentially rewrite Reg CF.

McHenry, a leading crowdfunding industry proponent, outlines his proposal in a seven page May 15th letter to newly sworn-in SEC Chairman Jay Clayton. In his letter to Clayton, McHenry calls for a “comprehensive reform” of Reg CF, outlining in great detail 13 specific revisions to Reg CF that he believes necessary for start-ups and small businesses to fully take advantage of the opportunities that crowdfunding offers. McHenry is hardly alone in his criticism of Reg CF, as the crowdfunding community has roundly panned Reg CF as excessively regulatory in nature and far too costly for start-ups to comply with. While it is unclear if or when the SEC will respond to McHenry’s letter, the proposal should be considered as the opening salvo in what will likely be a full court press by the crowdfunding community to have the rules implementing interstate crowdfunding rewritten in a way much more favorable to the start-up and growth company sectors. Indeed, Clayton’s multi-decade background as an M&A lawyer suggests that the SEC may at least adopt a heightened focus on capital formation issues.

Importantly, McHenry’s recommendations, in his opinion, are all fully within the SEC’s rulemaking ambit, and do not require any legislative action by Congress. Specifically, the main thrusts of McHenry’s proposal are as follows:

Firm and CEO Settle Charges with SEC for Ponzi-like Plot Relating to Life Settlements

May 23, 2017 | Elizabeth Dalziel

On May 4, 2017, the Securities and Exchange Commission (“SEC”) reached a settlement with Verto Capital Management, LLC (“Verto”), a New Jersey-based life settlement firm, and its CEO, William Schantz III (“Schantz”). Verto and Schantz consented to pay the SEC about $4 million, which includes both disgorgement and a penalty, to settle claims that they used funds from new investors to pay older investors in a Ponzi-type manner. The SEC also alleged that Verto and Schantz diverted investor funds for Schantz’s personal use.

The settlement resulted from a complaint filed by the SEC in the United States District Court for the District of New Jersey alleging that between November 2013 and November 2015 Verto and Schantz issued about $12.5 million worth of nine-month 7% promissory notes to investors. Verto and Schantz claimed that the funds from these promissory notes would be used to purchase “life settlements,” which are life insurance policies that have been sold by their original owners to third-party buyers. The SEC’s complaint alleges that Verto and Schantz made a variety of misrepresentations in the sale of these promissory notes. Continue reading ›

SEC Charges Investment Adviser and his Advisory Firm with Making Fraudulent Misrepresentations to Prospective Investors and Clients

May 19, 2017 | Elizabeth Dalziel

On April 17, 2017, the Securities and Exchange Commission (“SEC”) filed a complaint in the United States District Court for the Southern District of New York against Justin D. Meadlin (“Meadlin”), an investment adviser, and Hyaline Capital Management, LLC (“Hyaline”), his advisory firm. The complaint alleges that Meadlin and Hyaline made fraudulent misrepresentations and omitted material facts in order to “induce clients, and prospective investors… to invest funds with them.” These actions caused them to be in violation of Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 (“Advisers Act”) and Rule 206(4)-8 under the Advisers Act.

The SEC’s complaint alleges that from September 2012 to April 2013, Meadlin sent emails that exaggerated the amount of Hyaline’s assets under management (“AUM”) to clients and prospective investors. These emails provided that Hyaline had AUM that ranged from $17.5 million to $25 million. In reality, however, Hyaline had only $5.5 million in AUM during the relevant time period. Meadlin also sent emails that contained false statements pertaining to expected AUM. Continue reading ›

SEC Settles Charges with Barclays Capital for Overcharging Clients

May 18, 2017 | Elizabeth Dalziel

On May 10, 2017, the Securities and Exchange Commission (“SEC”) issued an Order Instituting Administrative and Cease-and-Desist Proceedings (“Order”) against Barclays Capital Inc. (“Barclays Capital”). The Order alleges that Barclays Capital, in its capacity as a dually-registered investment adviser and broker-dealer, overcharged advisory clients in the course of its wealth and investment management business. In conjunction with the Order, Barclays Capital submitted an Offer of Settlement where it agreed to pay about $97 million, which includes disgorgement and a penalty.

According to the SEC’s Order, Barclays Capital was the adviser and fiduciary to its advisory clients for two wrap fee programs: the Select Advisors Program and the Accommodation Manager Program, both of which were launched in September 2010. Starting in September 2010 and ending around the close of 2014, Barclays Capital assured Select Advisors Program clients in both client agreements and in its brochure that “Barclays Capital performed initial due diligence and ongoing monitoring of third-party managers it recommended to manage its clients’ assets using specific investment strategies.” Likewise, beginning in May 2011 and ending in March 2013, Barclays Capital assured Accommodation Manager Program clients that it conducted limited due diligence and monitoring of Accommodation Manager Program strategies. Continue reading ›

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.