A Compilation of Enforcement and Non-Enforcement Actions

01 June 2012 Publication
Author(s): Peter D. Fetzer

Legal News: Investment Management Update

Non-Enforcement Matters

  • New SEC Investment Adviser Registrants to Experience First SEC Exam by End of Year
  • NASAA Labels the JOBS Act as a “Disaster Waiting to Happen”
  • Follow-Up to Proposed SRO for SEC-Registered Investment Advisers

Enforcement Matters

  • SEC Charges Boston-Based Hedge Fund Managers With Fraud
  • SEC Charges Miami-Based Hedge Fund Manager With Fraud

Non-Enforcement Matters

New SEC Investment Adviser Registrants to Experience First SEC Exam by End of Year
According to an SEC spokesperson, newly registered hedge fund and private equity advisers should expect to experience their first SEC examination some time before the end of 2012. Of course, that timetable could slip into 2013 if more important issues arise to take away the SEC’s staff time. Approximately 1,300 new fund advisers registered with the SEC during the period between January 1, 2012 and April 30, 2012.

SEC examinations will be scheduled based upon the perceived level of risk that the registrant’s business provides. To assist the SEC in the selection process, early last year, the SEC sent out “informal inquiry” letters requesting information from private fund managers about such items as valuation practices. In reviewing the risk level of a particular registrant, the SEC will include: post-regulatory or legal violations; aberrational behavior; the size of fund(s) managed by the adviser (i.e., the larger the assets size of the fund(s), the greater the impact); the adviser’s management complexity; internal inconsistencies; timing of the last exam (if any); and material changes in the adviser’s assets and business.

In addition, the following “red flags” will be taken into consideration in determining who the SEC will place at the top of the list to examine: consistently claiming high rates of return; apparent smoothing of returns; apparent overstatement of assets; and significant turnover among fund managers and other managerial positions.

During its risk-level evaluation, the SEC will rely almost exclusively on information provided by the adviser on its Form ADV as filed with the SEC.

It is expected that the SEC will continue to fine-tune its level of risk evaluations as it completes its first cycle of exams for newly registered hedge fund and private equity advisers.

NASAA Labels the JOBS Act as a “Disaster Waiting to Happen”
The Jumpstart Our Business Startups Act (JOBS Act), which became law on April 5, 2012, has been characterized by Jack E. Herstein, President of the North American Securities Administrators Association, Inc. (NASAA), as legislation that will act to roll back important investor protections and expose investors to a greater risk of fraud.

It appears that the chief concern of state securities regulators, as voiced by NASAA President Herstein is that Congress preempted state securities registration requirements when creating the new crowdfunding securities registration exemption. The crowdfunding exemption is a newly created public offering exemption for issuer offerings of up to $1 million in a period of 12 consecutive months with no limitations on the use of public advertising or general solicitation. State securities review of such offerings is limited to a notice filing with the home state of the issuer and for any state where 50 percent or more of the issuer’s shareholders reside. Each state, of course, maintains authority to investigate any offering conducted in the state if fraud is suspected.

Prior to passage of the JOBS Act, Congress apparently took into account the advice of state securities regulators and other investor advocates by imposing some significant limitations on the conduct of a crowdfunding offering to potential investors. Those safeguards include: the offering must be conducted through a registered broker-dealer or portal, which provides an additional layer of investor protection; prescribed certain written disclosures that must be provided to prospective investors; a “put right” for investors prior to the closing of the offering; an escrow of offering proceeds requirement; a “bad-actor” provision that eliminates the use of the exemption for certain issuers; and due diligence requirements for the registered broker-dealer or portal prior to commencement of a crowdfunding offering.

The several investor protections placed in the exemption just prior to its passage at the urging of state securities regulators, among others, may have rendered this exemption as the least likely to be used among the many regulatory reduction measures provided under the JOBS Act.

Follow-Up to Proposed SRO for SEC-Registered Investment Advisers
Last month, we reported on the introduction of legislation for the creation of a self-regulatory organization (SRO) to register and regulate SEC-registered investment advisers. Many believe that if this route is taken, it is likely that the Financial Regulatory Authority (FINRA) would be the designated SRO for such registrants. Reportedly, the SEC examined only eight percent of registered investment advisers in 2011.

In a recent speech, Representative Maxine Waters (D-Calif.), ranking member of the House Financial Services Capital Markets Subcommittee, stated that the best approach, instead of creating another layer of registration with an SRO, is to impose “user fees” on registrants in order to fund the increased staff needed by the SEC to effectively regulate SEC-registered investment advisers. Representative Waters expressed concern about the considerable industry costs that would result from the creation of an SRO. She stated that the user fee concept instead should be the “best option,” as that fee would be substantially less than one assessed by an SRO. FINRA disputes that the creation of an SRO would be as costly as envisioned (annual cost expected to be $460 million to $510 million). FINRA instead puts the costs estimate much lower to $150 million to $155 million. In the meantime, the House Financial Services Committee has scheduled a hearing for June 6, 2012 on the bill introduced last month to bring investment advisers under the oversight of one or more SROs.

Enforcement Matters

SEC Charges Boston-Based Hedge Fund Managers With Fraud
The SEC recently charged Boston-based father and son managers of hedge funds and their firm with securities fraud for misleading fund investors about past performance and investment strategy.

After an investigation by the SEC’s Boston office, the SEC alleges that Gabriel and Marco Bitran, through their firms, GMB Capital Management LLC and GMB Capital Partners LLC, raised millions of dollars by falsely telling investors that they had a successful fund track record but failed to inform investors that the track record was not based on actual trades but on back-tested hypothetical simulations. In addition, the Bitrans told investors that they used quantitative optional pricing models they devised to invest in exchange-traded funds and other liquid securities but instead of making such investments, they used investor funds merely to invest in other hedge funds. Finally, GMB Capital Management provided the SEC with documents alleged by the SEC to be false while it examined the firm’s claims about its track record.

In response to the SEC’s charges, the Bitrans decided not to contest the changes and agreed to be barred from the securities industry and pay a total of $4.8 million to settle the charges. Of that total, $4.3 million is the amount of disgorgement and a $250,000 payment by each of the father and son in penalties. The SEC uncovered the alleged fraudulent activities during the conduct of a books and records examination of the SEC-registered investment adviser.

SEC Charges Miami-Based Hedge Fund Manager With Fraud
The SEC recently charged a Miami-based hedge fund adviser Quantek Asset Management LLC with making various misrepresentations to investors in the $1 billion Quantek Opportunity Fund. The misrepresentations alleged to have been made by the adviser included that the executive officers of the adviser had invested in the fund, when they had not. In addition, according to the SEC’s complaint, certain statements made by representatives of the adviser with respect to the investment process utilized and certain related-party transactions were false.

The adviser’s lead executive, Javier Guerra, operations director Ralph Patino, and its former parent company, Bulltick Capital Markets Holdings LP, agreed to settle the matter by paying more than $3.1 million in total disgorgement and penalties. In addition, Messrs. Guerra and Patino agreed to industry bars.

The SEC noted that investors in private funds are interested in whether the executives of the fund’s manager have “skin in the game” by investing their own assets in the fund. In this instance, Mr. Quantek, and particularly Mr. Patino, during a period of at least a couple of years, made misrepresentations to investors about their personal investment in the fund.

Legal News is part of our ongoing commitment to providing legal insight to our clients and colleagues. If you have any questions about or would like to discuss these topics further, please contact your Foley attorney or any of the following individuals:

Terry D. Nelson
Madison, Wisconsin

Peter D. Fetzer
Milwaukee, Wisconsin


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