A Compilation of Enforcement and Non-Enforcement Actions

05 October 2009 Publication
Authors: Peter D. Fetzer Terry D. Nelson

Legal News: Investment Management Update

Non-Enforcement Actions

SEC Promulgates Its Affiliate Marketing Rule
The SEC recently adopted Regulation S-AM (Regulation), in order to implement Section 624 of the Fair Credit Reporting Act (amended by Section 214 of the Fair and Accurate Credit Transactions Act of 2003). The intendment of the Regulation is to limit use of personal information for solicitation and marketing purposes. It is promulgated with similar rules for certain banking agencies, including the FDIC, the Board of Governors of the Federal Reserve, and the FTC, among others.

The Regulation prohibits the using of information by affiliates for solicitation purposes. Notice, however, that it does not prohibit the sharing of such information. The Regulation also permits using the information for solicitation purposes if (1) the consumer is given conspicuous notice of the potential marketing purposes; (2) the consumer is given a simple way to opt out of such marketing efforts; and (3) the consumer has not opted out.

The Regulation provides some exceptions to the notice and opt-out requirements such as when an affiliate has a pre-existing relationship with a consumer or provides marketing material in response to an unsolicited request by a consumer. The Regulation provides that the notice and opt-out may be combined with the disclosures required by law such as for Regulation S-P.

The Regulation applies to broker-dealers, investment companies, registered investment advisers, and transfer agents. Other entities may be regulated by similar rules promulgated by other agencies. Compliance with the Regulation becomes mandatory on January 1, 2010. The Regulation includes an appendix of model forms to use to provide the notice and opt-out provisions.

Massachusetts Tightens Information Security Rules
The Commonwealth of Massachusetts released 201 CMR 17.00 in June 2009, which requires new safeguarding standards of entities that own, license, maintain, or store Massachusetts residents’ personal information. Under the regulations, every entity that owns, licenses, maintains, or stores personal information about a Massachusetts resident would be required to develop comprehensive, written policies and procedures for safeguarding the information. Of course, this set of rules would apply to third-party service providers such as investment advisers.

Since its announcement, the effective date has been pushed back to March 1, 2010. The regulation, as revised, generally tracks the proposed rule amendments by the SEC to Regulation S-P. In its revisions, the Massachusetts Office of Consumer Affairs and Business Regulation made clear that the policy developed should depend, in part, on the size and nature of the entity developing the policy. Investment advisers would benefit from understanding the new Massachusetts regulations and should consider using them as the basis for reviewing their information security policies and procedures in advance of the changes to Regulation S-P.

Enforcement Actions

West Virginia Investment Adviser Allegedly Breached Fiduciary Duty to Clients
The SEC issued an Order Instituting Administrative Proceedings on September 15, 2009 against KHF Advisors, LLC (KHF Advisors) and against Appalachia Asset Management, Inc (Appalachia Asset), pursuant to Section 203(e) of the Investment Advisers Act of 1940. Both KHF Advisors and Appalachia Asset are registered investment advisers based in West Virginia and were created and controlled by Knox H. Fuqua. The SEC claims KHF Advisors and Appalachia Asset misappropriated client funds and failed to invest the client funds in the manner directed by the client, specifically with regard to risk. The order further contends that Mr. Fuqua and the investment advisers used the clients’ money to pay for Mr. Fuqua’s business expenses and to pay off other defrauded investors.

Mr. Fuqua and KHF Advisors failed to appear in federal court to answer these charges. As a result, the SEC was awarded a default judgment. KHF Advisors has been permanently enjoined from violating Sections 206(1) and (2) of the Investment Advisers Act of 1940; Section 17(a) of the Securities Act of 1933; and Section 10(b) of the Securities and Exchange Act. The hearing is still pending on the Appalachia Asset case.

Investment Adviser Misappropriated Funds
The SEC issued an Order Instituting Administrative Proceedings on September 23, 2009, pursuant to Section 203(f) of the Investment Advisers Act of 1940, Making Findings and Imposing Remedial Sanctions against Scott M. Ross, who was serving as the investment adviser for three funds. According to the SEC’s order, Mr. Ross raised $10 million from 300 investors. Mr. Ross, however, also misappropriated money from two of the funds, took undisclosed commissions from another fund, and used one fund’s investors’ money to pay off another fund’s investors. Mr. Ross admitted wrongdoing, and has been subject to a permanent injunction from violations of Sections 17(a)(1-3) of the Securities Act of 1933 and Section 10(b) of the Securities and Exchange Act of 1934. Although Mr. Ross did not admit or deny the allegations, he accepted that he is not permitted to have any association with an investment adviser.

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


Terry D. Nelson
Madison, Wisconsin

Joseph D. Shumow
Madison, Wisconsin

Peter D. Fetzer
Milwaukee, Wisconsin