A Compilation of Enforcement and Non-Enforcement Actions

07 August 2008 Publication
Authors: Terry D. Nelson

Legal News: Investment Management Update

Non-Enforcement Matters

SEC and Self-Regulators to Take Action Against Manipulation of Securities Prices Through Intentionally Spreading False Information
The U.S. Securities and Exchange Commission (SEC) announced that the Office of Compliance Inspections and Examinations, the Financial Industry Regulatory Authority, and NYSE Regulation, Inc. will immediately conduct investigations aimed at preventing the intentional spread of false information intended to manipulate securities prices. See SEC Release 2008-140, July 13, 2008.

In addition to this measure, the SEC is currently investigating alleged intentional manipulations of securities prices through rumor-mongering and abusive short selling. Specifically, the examiners will focus on the supervisory and compliance controls that investment advisers have in place to prevent violations of securities laws, and whether they are reasonably designed to prevent the intentional creation of or the spread of false information.

SEC Chairman Christopher Cox stated the goal of these examinations is to ensure “that investors continue to get reliable, accurate information about public companies in the market place.” According to Mr. Cox, the examinations also will “provide an opportunity to double-check that broker-dealers and investment advisers have appropriate training for their employees and sturdy controls in place to prevent intentionally false information from harming investors.”

SEC to Provide Guidance to Fund Directors Regarding Investment Adviser Trading of Portfolio Securities and Use of Soft Dollars
The SEC voted unanimously to provide guidance to investment company directors regarding their responsibilities to oversee investment advisers who trade fund portfolio securities and use soft dollars. See SEC Release 2008-160, July 30, 2008.

The proposed SEC guidance is intended to assist the boards of directors of investment companies with their fiduciary duties under the Investment Company Act to oversee the safety of their funds’ assets and protect the funds’ investors. Specifically, the proposed guidance would assist boards of directors in their oversight of conflicts of interest that arise with investment adviser use of soft dollars.

The proposed guidance does not impose new requirements on directors or investment advisers; rather, it proposes parameters within which directors should work when conducting oversight of investment adviser trading. The text of the proposed guidance has not yet been released, but the SEC press release provides that “the guidance suggests information for a fund board to request from an investment adviser in order to determine whether the adviser is managing any conflicts and using fund assets in the best interests of the fund.” This guidance follows the SEC’s 2006 interpretive guidance clarifying for advisers what can and cannot be purchased with soft dollars under the safe harbor of Securities Exchange Act Section 28(e).

Senator Introduces Bill Imposing Additional Penalties for Fraud Against Investors Over 62
Senator Robert P. Casey, Jr. (D-PA), supported by Senator Herb Kohl (D-WI), introduced the Senior Investor Protections Enhancement Act of 2008, which would assess an additional fine of $50,000 to any investment fraud targeting investors over the age of 62. See Senior Investor Protections Enhancement Act of 2008, S. 3219, June 27, 2008.

The stated purpose of the proposed bill is “to enhance penalties for violations of securities protections that involve targeting seniors.” Specifically, the proposed bill would amend the Securities Act of 1933, Securities Exchange Act of 1934, Investment Company Act of 1940, and the Investment Advisers Act of 1940 by adding a “special rule for seniors” provision to the relevant clause in each act. These provisions would allow the existing penalties to be increased by up to $50,000 if the violation is primarily directed towards, targets, or is committed against an individual who, at the time of the violation, is 62 years of age or older.

SEC ComplianceAlert Letter Summarizes Deficiencies and Weaknesses Found by Examiners
The SEC released a ComplianceAlert letter summarizing common deficiencies and other issues SEC examiners have found in their reviews of investment advisers. See ComplianceAlert 0708.

The SEC ComplianceAlert letter alerts investment advisers of certain recurring deficiencies and issues in order to encourage firms to review compliance in targeted areas and encourage improvements in compliance and related programs. The letter addresses specific practices, including personal trading by advisory staff, proxy voting and funds’ use of proxy voting services, and investment adviser soft-dollar practices.

The letter first addresses personal trading by access persons as a focus area of investment adviser examinations. Recurring deficiencies found by examiners in this area include incomplete adviser code of ethics, code of ethics not being followed, reporting requirements not followed and/or monitoring not being performed, and inadequate disclosure. The letter recommends various internal compliance controls that examiners found in advisory firms with effective compliance programs.

The letter also addresses proxy voting and funds’ use of proxy voting services. Examiners found that most advisory firms had adopted policies and procedures required by the proxy voting rule. However, examiners found that some proxy voting policies and procedures contained inaccurate information or were not followed. The letter recommends that firms have a process to identify adviser conflicts of interest with respect to proxy voting.

Finally, the letter addresses investment adviser soft-dollar practices. Examiners focused on soft-dollar practices to understand the extent to which advisers to institutional clients use soft-dollar arrangements to obtain third-party or proprietary services or products, the disclosures advisers provide to their clients regarding soft-dollar practices, and the policies and procedures that advisers who receive soft-dollar benefits use to meet their fiduciary duty to seek the best execution.

Enforcement Matters

Hedge Fund Adviser Settles Charges of Unauthorized Transfers to Meet Margin Call
Thomas C. Palmer, director of operations for a hedge fund adviser, settled SEC charges of making unauthorized cash transfers from two hedge funds to satisfy a third fund’s margin call. See In the Matter of Thomas C. Palmer and Aeneas Capital Management, L.P., SEC Admin. Proc. File No. 3-13092, July 23, 2008.

According to the SEC, Mr. Palmer made five unauthorized transfers totaling $13.4 million in cash from two separate hedge funds operated by Aeneas Capital Management, L.P. (Aeneas), to a third hedge fund in order to satisfy margin calls. The SEC order alleges that the transfers were improper because they were not disclosed, nor were they consistent with Mr. Palmer’s fiduciary duties as director of operations of the hedge funds.

Mr. Palmer was charged with willfully aiding and abetting and causing violations of Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. In addition, Aeneas was charged with failing to reasonably supervise Mr. Palmer, and failing to have in place adequate policies and procedures to protect and prevent such unauthorized transfers of cash among funds. As a result of these charges, Mr. Palmer agreed to pay a civil penalty of $65,000, to cease and desist from future violations, and to suspend associating with any investment adviser for 12 months. Aeneas agreed to pay a civil penalty of $150,000 and cease and desist from future violations. 

SEC No-Action Letter States Cash Solicitation Rule Does Not Generally Apply to Investment Pool Solicitations
In response to an inquiry letter, the SEC Division of Investment Management issued a no-action letter stating that the Cash Solicitation Rule does not apply to payments to persons who refer investors solely for the purpose of investing in private investment pools managed by the adviser. See Mayer Brown, LLP, SEC No-Action Letter, File No. 132-3, July 15, 2008.

The Cash Solicitation Rule (Rule 206(4)-3 of the Investment Advisers Act of 1940) prohibits a registered investment adviser from paying a cash fee, directly or indirectly, to a solicitor with respect to solicitation activities unless, among other requirements, the arrangement is pursuant to a written agreement and certain disclosures regarding the payment and the solicitor’s relationship with the investment adviser are made and acknowledged in writing by the prospective investor.

In response to the inquiry letter, the SEC Division of Investment Management staff explained their belief that the Cash Solicitation Rule “generally does not apply to a registered investment adviser’s cash payment to a person solely to compensate that person for soliciting investors or prospective investors for, or referring investors or prospective investors to, an investment pool managed by the adviser.

The letter explained three reasons the rule does not apply to this type of payment. First, neither the proposing release nor adopting release suggest that the rule would apply to investment advisers’ cash payments to others solely to compensate them for soliciting investors for investment pools managed by the advisers. Second, the rule is designed to apply clearly to solicitations in which the solicited person may ultimately enter into an investment advisory contract, whereas investors in investment pools do not typically enter into such contracts. Finally, the use of “client” and “prospective client” instead of “investor” and “prospective investor” strongly suggests that the rule was intended to apply to solicitations in which the solicited person might enter into an investment advisory contract.

SEC Sanctions Investment Adviser for Acting Contrary to Representations Made to Investors
The SEC sanctioned Pax World Management Corp. for acting contrary to representations it made to investors and the boards of the mutual funds it advised. See In the Matter of Pax World Management Corp., Admin. Proc. File No. 3-13107, July 30, 2008.

According to the SEC, Pax World Management Corp. (Pax World) is a registered investment adviser to several socially responsible mutual funds. Investors in these funds were told the funds had socially responsible investment (SRI) restrictions, meaning they would not include securities issued by companies involved in government defense contracts, alcohol, tobacco, or gambling products. The SEC order alleges that from 2001-2005, Pax World purchased at least 10 securities which were prohibited by the SRI restrictions.

The SEC order specifically found that Pax World acted contrary to representations made to investors and violated the funds’ SRI restrictions through several purchases, including securities of a company that derived revenue from the manufacture of gambling and liquor products, and a company who derived more than five percent of its income from government defense contracts, among others.

As a result of these alleged violations, the SEC order requires Pax World to pay a $500,000 civil penalty and to cease and desist from committing or causing violations of section 206(2) of the Investment Advisers Act and Sections 13(a)(3) and 34(b) of the Investment Company Act.

Administrative Law Judge (ALJ) Issues Initial Decision Against Investment Adviser for Failure to Maintain Advisory Business Records
An ALJ issued an initial decision sanctioning investment adviser Amaroq Asset Management, LLC and its sole principal, Dwight Andree Sean O’Neal Jones for failure to maintain advisory business records and make them available for review by SEC staff as required by law. See In the Matter of Amaroq Asset Management, LLC and Dwight Andree Sean O’Neal Jones, July 14, 2008, Initial Decision Release No. 351, Admin. Proc. File No. 3-12822.

According to the SEC order instituting proceedings, in addition to failing to maintain advisory business records, Amaroq Asset Management, LLC (Amaroq) and Mr. Jones failed to file three amendments to its form ADV, and failed to promptly notify the SEC when it changed the location of its principle business office. Mr. Jones also claimed that Amaroq discontinued its advisory business in 2004, but never notified the SEC of its discontinuation as required by law and continued to promote its program on the Internet for nearly three more years.

The initial decision orders Amaroq and Mr. Jones to cease and desist from committing or causing violations of Section 204 of the Investment Advisers Act and Investment Advisers Act Rule 204-1. Additionally, the initial decision revokes Amaroq’s registration as an investment adviser and bars Mr. Jones from associating with any investment adviser. Finally, Mr. Jones must pay a $15,000 civil penalty.

Legal News: Investment Management Update is part of our ongoing commitment to providing up-to-the minute information about pressing concerns or industry issues affecting our clients and our colleagues.

If you have any questions about this issue or would like to discuss these topics further, please contact your Foley attorney or any of the following individuals:


Terry D. Nelson
Madison, Wisconsin

Gregory F. Monday
Madison, Wisconsin