A Compilation of Enforcement and Non-Enforcement Actions

18 December 2009 Publication
Author(s): Peter D. Fetzer Andrew L. Nelson

Legal News: Investment Management Update

Non-Enforcement Matters

House Regulatory Reform Bill Does Not Include FINRA Provision
On December 11, 2009, the United States House of Representatives approved legislation that would result in a major overhaul of the financial services regulatory regime. The much-anticipated vote broke mostly along party lines, with no Republicans supporting the bill and 27 Democrats opposing the bill, which passed 223-202.

The investment adviser industry has watched the legislative deliberations with suspense, in part to learn whether the Financial Industry Regulatory Agency (FINRA) would gain a larger regulatory role over investment advisers. FINRA is a self-regulating organization that has regulatory authority over securities broker-dealers. An amendment to the House bill was proposed that would extend FINRA regulatory authority to investment advisers that are associated with broker-dealers. The amendment’s sponsor, Rep. Spencer Baucus (R-Ala.), proposed the amendment in the wake of the Bernie Madoff Ponzi scheme, among others. Rep. Baucus voiced a lack of confidence in investment advisers’ existing regulator, the SEC.

One day before the legislation finally passed, House Financial Services Committee Chairman Barney Frank (D-Mass.) and Rep. Baucus agreed that the amendment should be deleted from the bill. Passing on a voice vote with bipartisan support, the FINRA provision was deleted from the bill. Both Rep. Baucus and Chairman Frank indicated that the FINRA provision was not necessarily dead, though. It is likely to remain the subject of hearings on Capitol Hill for at least the rest of this session of Congress.

Nonetheless, the removal of the FINRA provision was greeted with the support of Investment Adviser Association Executive Director David Tittsworth. He acknowledged that the measure could regain traction in the Senate’s version of the regulatory reform bill, but he applauded the removal of the FINRA provision from the House bill. The Senate’s version of the regulatory reform bill is being shepherded through the upper chamber by Senator Christopher Dodd (D-Conn.). The bill is still being developed in committee, and is likely to be debated into 2010 before it could make its way to the Senate floor for a vote.

Investment Advisers and Broker-Dealers Generally Support a Single Fiduciary Duty Standard
Although the House’s regulatory reform bill does not call for the harmonizing of which entity regulates broker-dealers and investment advisers, industry professionals support efforts to bring both service providers under the same fiduciary duty standard. The fiduciary duty standard currently applies only to investment advisers. Broker-dealers that provide investment advice are not currently required to abide by the same high standard.

According to a survey by SEI Advisor Network, of the 890 investment advisers and broker-dealers surveyed, 53 percent of broker-dealers and 86 percent of investment advisers support being governed by the same fiduciary duty currently in place for investment advisers. Some industry analysts note that this is a shift in opinion among broker-dealers, who have tended to oppose being governed by those standards in the past.

Even as legislation moves forward in Congress that does not bring broker-dealers and investment advisers under identical regulatory regimes, there appears to be a growing consensus among industry professionals that some regulatory uniformity would be appropriate.

Enforcement Matters

SEC Thwarts Ponzi Scheme in Beginning Stages
Part of the reason Ponzi schemes are so difficult to prevent is that they can go undetected, particularly in the early stages. Those posing as investment managers collect “investments” and the would-be investors do not expect an immediate return. Typically a Ponzi scheme is detected several years down the road when requested returns to investors are not made. In one recent case, though, the SEC broke up an alleged Ponzi scheme within a year of the investments.

The SEC filed a complaint against Rockford Funding Group LLC (Rockford) and its manager, Genadi Yagodayev. The SEC alleged that Rockford purported to have been founded in 1999 (when it was founded in late 2008) and that Rockford’s portfolio increased 251 percent during the past decade (when it had not been in existence). The SEC further averred that Rockford has accumulated $11 million from 200 investors since March 2009, all of whom have given money that has been transferred to banks in Hong Kong and Latvia.

The District Court for the Southern District of New York froze Rockford’s and Mr. Yagodeyev’s assets, together with the assets of a dozen holding companies with unknown affiliations with Rockford, but all of which retained some of the would-be investors’ assets. With this quick action by the SEC, investors hold some hope of getting a substantial amount of their money back, which would make for an unusual ending to the typical Ponzi scheme.

SEC Issues Cease-and-Desist for Mutual Fund Manager Engaging in Late Trading
The SEC issued an Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order against Simpson Capital Management, Inc. (Simpson Capital), a hedge fund manager, Robert Simpson, its president, and John Dowling, its head trader.

According to the SEC, Simpson Capital, at the direction of Mr. Simpson and Mr. Dowling, engaged in late trading. Late trading is the practice of buying or selling mutual fund shares after the close of trading but based on that day’s mutual fund share price or net asset value (NAV). Under Rule 22c-1 of the Investment Company Act of 1940, all such trades are to be processed the following day at the next day’s NAV.

The Order requires Simpson Capital and Mr. Simpson, jointly and severally, to disgorge ill-gotten gains of $6.1 million and to pay a civil penalty of $500,000. Mr. Dowling must pay a civil penalty of $150,000.

Although the SEC alleges that several broker-dealers executed the late trades for Simpson Capital, the SEC did not bring charges against the broker-dealers as part of its Order.

Legal News: Investment Management Update is part of our ongoing commitment to providing legal insight to our investment management clients and our 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