Investment Advisers

Recent DOL Action: Proposed Delay of Fiduciary Rule and New Transition Period Guidance

August 18, 2017 | Patricia Klusmeyer

The Department of Labor (DOL) recently indicated in a court filing that it has submitted a proposed rule to the Office of Management and Budget (OMB) to extend the transition period of the Fiduciary Rule and delay the second phase of implementation from January 1, 2018 to July 1, 2019. This proposal is currently under review by the OMB.

The DOL also recently released a new set of FAQ guidance regarding compliance with the Fiduciary Rule during the transition period when providing advice to IRAs, plans covered by the Employee Retirement Income Security Act of 1974 (ERISA), and other plans covered by section 4975 of the Internal Revenue Code (Code). Most of the questions dealt specifically with the prohibited transaction exemption under ERISA section 408(b)(2) for service providers to ERISA plans. Continue reading ›

SEC Proposes Amendments to Investment Advisers Act Regarding Small Business Investment Companies

June 29, 2017 | Elizabeth Dalziel

The Securities and Exchange Commission (“SEC”) recently announced a proposal to amend Rules 203(l)-1 and 203(m)-1 of the Investment Advisers Act of 1940 (“Advisers Act”). The purpose of these proposed amendments is to “reflect changes made by… the Fixing America’s Surface Transportation Act of 2015 (the “FAST Act”).” The FAST Act amended sections 203(l) and 203(m) of the Advisers Act to provide advisers to small business investment companies (“SBICs”), venture capital funds, and certain private funds with additional avenues to registration exemption.

SBICs are commonly defined as privately-owned investment companies that are licensed and regulated by the Small Business Administration (“SBA”). They typically provide a vehicle for funding small businesses through both equity and debt. Section 203(b)(7) of the Advisers Act provides that investment advisers who only advise SBICs are exempt from registration. Moreover, investment advisers who use the SBIC exemption are not obligated to comply with the Advisers Act’s reporting and recordkeeping provisions, and they are not subject to SEC examination. 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 ›

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 ›

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.

DOL Action on Fiduciary Rule Makes Important Changes

April 28, 2017 | Patricia Klusmeyer

The Department of Labor (DOL) recently released a final rule delaying by 60 days the implementation date of the DOL Fiduciary Rule from April 10th to June 9th. This is in response to President Trump’s February memorandum asking the DOL to review the impact of the DOL Fiduciary Rule and assess whether it negatively effects the ability of retirement investors to gain access to retirement information and financial advice. The DOL Fiduciary Rule seeks to assign fiduciary duties to all advisers to retirement investors by expanding the definition of fiduciary investment advice under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (Code) to cover a wider array of advice relationships.

Under the DOL’s final delay rule, the revised definition of fiduciary investment advice and certain provisions of the Best Interest Contract (BIC) exemption will be implemented on June 9th. At that time, advisers acting as fiduciaries and engaging in transactions covered by the exemption must comply with the impartial conduct standards of the BIC exemption. The impartial conduct standards include providing investment advice in the best interest of the retirement investor, receiving only reasonable compensation, and not making any materially misleading statements. Continue reading ›

SEC Settles Charges with Investment Adviser for Failure to Disclose Conflicts of Interest Stemming From Revenue Sharing Arrangement

March 27, 2017 | Elizabeth Dalziel

On March 8, 2017, the Securities and Exchange Commission (“SEC”) issued an Order Instituting Administrative and Cease-and-Desist Proceedings (“Order”) against Voya Financial Advisors, Inc. (“Voya”), an SEC-registered investment adviser. The Order, to which Voya consented, obligates Voya to pay disgorgement of $2,621,324, prejudgment interest of $174,629.78, and a civil money penalty of $300,000.

The SEC’s Order claims that Voya did not inform its clients that it was receiving compensation from a third-party broker-dealer and that these receipts created a conflict of interest. Section 206(2) of the Investment Advisers Act of 1940 (“Advisers Act”) states that investment advisers are forbidden from participating in “any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” Section 207 provides that investment advisers are not allowed to “make any untrue statement of a material fact in any registration application or report filed with the Commission, or to omit to state in any such application or report any material fact which is required to be stated therein.” Finally, Rule 206(4)-7 under the Adviser’s Act compels investment advisers to “[a]dopt and implement written policies and procedures, reasonably designed to prevent violation” of the Adviser’s Act and the rules thereunder. Continue reading ›

Investment Adviser Charged With Misappropriating Client Funds

March 22, 2017 | Elizabeth Dalziel

On February 2, 2017, the Securities and Exchange Commission (“SEC”) filed a complaint in the United States District Court for the District of Connecticut against Sentinel Growth Fund Management, LLC (“Sentinel”), an investment adviser, and its founder, Mark J. Varrachi (“Varrachi”). The complaint alleges that from about December 2015 to November 2016, Varacchi and Sentinel stole $3.95 million or more from investment advisory clients. The complaint asks that the District Court impose a permanent injunction against Varacchi and Sentinel, order them to disgorge any ill-gotten gains, and order them to pay civil penalties.

Neither Sentinel nor Varrachi was registered as an investment adviser with the SEC or with any state regulatory authority. However, the SEC charged both of them with violations of the Investment Advisers Act of 1940 (“Advisers Act”). The SEC found that Sentinel was “in the business of providing investment advice concerning securities for compensation,” which fits the definition of an investment adviser in Section 202(a)(11) of the Advisers Act. As for Varrachi, the SEC determined that because he owned and managed Sentinel, he too was an investment adviser. As a result of meeting the definition of an investment adviser, Sentinel and Varrachi were subject to the Advisers Act’s antifraud provisions. Continue reading ›

FINRA Requests Comments on Rule Amendment Permitting Use of Investment-Strategy Projections

March 15, 2017 | Elizabeth Dalziel

In February 2017, the Financial Industry Regulatory Authority Inc. (“FINRA”) published a Regulatory Notice asking for comment on proposed changes to FINRA Rule 2210, which governs communications with the public. Under current Rule 2210, broker-dealers are not allowed to make communications that “predict or project performance, imply that past performance will recur or make any exaggerated or unwarranted claim, opinion or forecast.” According to FINRA, the purpose of this rule is to prevent retail investors from relying on performance projections relating to individual investments, which tend to be deceptive.

However, FINRA has acknowledged that performance projections that are not based on how well an individual investment performed can be helpful to investors who are contemplating an investment strategy. Furthermore, investment advisers are permitted to use performance projections in choosing an investment strategy for their clients, provided that the projections do not violate the Investment Advisers Act of 1940’s antifraud rules. Therefore, FINRA proposed the amendments to Rule 2210 in order to allow broker-dealers to use projections in a way that benefits clients and to make the rules governing performance projections by broker-dealers and investment advisers more uniform. Continue reading ›

Arizona Adviser’s Outside Business Activity Constituted Unlicensed Sale of Securities

February 9, 2017 | Elizabeth Dalziel

On December 13, 2016, the Arizona Court of Appeals (“Court of Appeals”) affirmed an Arizona Superior Court’s decision finding that Patrick Shudak, an investment adviser, violated the Arizona Securities Act by acting as an unregistered securities salesperson or dealer in connection with the sale of interests in a real estate venture.

From January 2008 through July 2009, Shudak sold membership units in a company known as Parker Skylar & Associates, LLC (PSA). Neither Shudak nor PSA was registered as a securities salesperson or dealer under the Arizona Securities Act. Shudak stated in PSA’s promotional materials that the money invested in PSA would “be used to purchase and develop real property.” In reality, however, Shudak placed the money that investors put into PSA into his personal account, the personal accounts of others such as his girlfriend, and business accounts of other business that Shudak owned or had some affiliation with.

In December 2009, investors started to grow worried when Shudak stopped returning phone calls and replying to the investors’ demands for information. As a result, Shudak was obligated to stop serving as PSA manager and to give up his PSA membership. He subsequently filed for bankruptcy in April 2010.