A Compilation of Enforcement and Non-Enforcement Actions

31 July 2012 Publication
Author(s): Terry D. Nelson Peter D. Fetzer

Legal News: Investment Management Update

Non-Enforcement Matters

  • Legislation Introduced That Would Impose User Fees on Registered Investment Advisers
  • CFTC Grants Conditional Delay in Registration for Commodity Pool Operators and Commodity Trading Advisers
  • New FINRA Rule 5123 Imposes New Requirements on Broker-Dealers

Enforcement Matters

  • SEC Takes Enforcement Action Against Violator of Regulation M
  • Adviser Defrauded Hedge Fund and Its Investors Through an Arrangement of Interest-Free Loans


Legislation Introduced That Would Impose User Fees on Registered Investment Advisers
As reported previously in our Legal News: Investment Management Update newsletters, there have been several proposals to enhance regulation of registered investment advisers. Such proposals are a result of the SEC’s admitted lack of sufficient resources to effectively regulate the thousands of investment advisers registered with the SEC under the Investment Advisers Act of 1940. According to SEC records, the SEC examined only 8 percent of the registered investment advisers in 2011. That number compares to 58 percent of broker-dealers examined during the same period.

The latest proposal comes from U.S. Rep. Maxine Waters (D-Calif.), who introduced legislation on July 25, 2012 designed to collect user fees from registered investment advisers, which would be used to fund additional capacity by the SEC to regulate investment advisers. The bill does not state the amount of the user fee that would be imposed.

According to a recent report by the Boston Consulting Group, 80 percent of registrants would prefer the imposition of a user fee rather than pay fees as a member of the Financial Industry Regulatory Authority (as you may recall, one of the proposals is to require each registered investment adviser to be registered by FINRA).

Already the Financial Planning Coalition, a group representing approximately 75,000 financial planners, applauded the user-fee-based legislation. The Coalition is on record as being against FINRA or any other self-regulatory organization having the authority to regulate investment advisers.

CFTC Grants Conditional Delay in Registration for Commodity Pool Operators and Commodity Trading Advisers
The Commodity Futures Trading Commission (CFTC) issued a no-action letter on July 13, 2012 permitting commodity pool operators and commodity trading advisors an additional period to obtain registration until December 31, 2012. Back in February of this year, the CFTC adopted rule changes that rescinded the registration exemption for those persons who came under the definition of commodity pool operator and commodity trading adviser, namely regulated investment companies that invest in commodities or investment advisers that provide advice to certain funds that engage in commodity trading. Prior to this time, such funds and advisers relied upon an exemption from CFTC registration.

The new time period to come into registration compliance provided by the CFTC comes after the industry argued for additional time to determine if registration was required and, if so, to complete the registration process.

CFTC’s no-action letter requires the person relying upon the delay in registration (i.e., until December 31, 2012) to first file a notice with the SEC. The notice is effective on the day of filing if it is deemed to be a complete filing.

New FINRA Rule 5123 Imposes New Requirements on Broker-Dealers
The SEC recently approved FINRA Rule 5123, which will impose new requirements for broker-dealers who sell private placement offerings.

Fueled by numerous enforcement actions in connection with private placement offerings in which member firms participate, FINRA proposed in January 2011 an amendment to existing Rule 5122 to cover private placements sold by broker-dealer member firms. That amendment came under strong resistance from member firms, and FINRA dropped its effort to amend Rule 5122. Instead, FINRA proposed a new rule, Rule 5123 (Rule). The new proposed Rule, however, met strong resistance; it also imposed, as initially proposed, that member firms, among other things, provide investors with existing disclosure documents or create new ones that included a description of the use of the offering proceeds, amount, and type of offering expenses, and amount and type of compensation to be paid to various parties, including to the FINRA member. There were only a limited number of exemptions included in the initial Rule proposal.

Since the initial proposal back in 2011, FINRA has retreated substantially in what will be required by member firms selling private placement offerings, and greatly expanded the number of exemptions available from the new Rule’s provisions.

The final Rule only requires that broker-dealers file a copy of the offering documents used in the offering and material amendments to such documents within 15 days of the date of first use. If no offering documents are used (a rarity), the broker-dealer must make a notice filing with FINRA indicating that no such offering documents were used. If more than one broker-dealer participates in the selling of the offering, one member of the group may be designated on behalf of the group to make the required filing with FINRA.

The final Rule includes numerous exemptions, including offerings to certain categories of investors (such as institutional investors, qualified institutional buyers or QIB’s, and accredited investors, as defined under Regulation D under the Securities Act of 1933).

The final Rule, although greatly watered down from what FINRA intended initially in early 2011, will require broker-dealers to determine if their participation in the selling efforts of a private placement requires a filing with FINRA. What FINRA does with the filings remains to be seen. The Rule does require FINRA to provide confidential treatment to all documents and information filed under the Rule.


SEC Takes Enforcement Action Against Violator of Regulation M
Investment advisers are reminded again of their obligations under Regulation M under the Securities Exchange Act of 1934. The following summarizes a recent SEC enforcement action against a registered investment adviser who allegedly violated Rule 105 of Regulation M. (In the Matter of Wesley Capital Management, LLC, IA Release No. 3439/July 26, 2012).

As readers of our Legal News: Investment Management Update newsletter will recall, Rule 105 of Regulation M was adopted according to the SEC’s enforcement release “to protect the independent pricing mechanism of the securities market before follow-on or secondary offerings.” The Rule makes it unlawful for any person to sell short a security that is subject to a public offering and purchase the offered securities from an underwriter or broker-dealer participating in the offering if the short sale was effected during the shorter of the period (i) beginning five business days before the pricing of the securities being offered, or (ii) beginning with the initial filing of the registration statement with the SEC and ending with the pricing in connection with that registration statement.

Wesley Capital Management, LLC, an SEC-registered investment adviser located in New York City, managed several hedge funds and a managed account, with about $253 million of combined assets under management. On two occasions in 2009, according to the SEC, Wesley violated the Rule 105 by purchasing securities in a public offering after having sold short the securities of the issuer during the five business days prior to the pricing of the offering of the securities. By such actions, Wesley apparently illegally profited by about $142,000.

As a result of the conduct and without admitting or denying the SEC’s findings, Wesley entered into an agreement with the SEC to resolve the SEC’s enforcement matter. As part of the agreement, Wesley agreed to an administrative cease-and-desist order issued under Section 21C of the Securities Exchange Act of 193 4 and Section 203(e) of the Investment Advisers Act of 1940, which ordered that Wesley be censured and pay disgorgement of its profits with interest ($142,124) resulted from the illegal transactions, and a civil penalty of $75,000. Investment advisers should ensure that their compliance policies and procedures address compliance with Rule 105 of Regulation M.

Adviser Defrauded Hedge Fund and Its Investors Through an Arrangement of Interest-Free Loans
The SEC recently imposed administrative sanctions against a registered investment adviser who during a three-year period took interest-free loans from a hedge fund it managed in order to meet the adviser’s own expenses (In the Matter of Centaur Management Co. LLC, IA Release No. 3432 dated July 17, 2012).

Centaur Management, a registered investment adviser at the time, directed its client Argent Classic Convertible Arbitrage Fund L.P. to provide it with approximately $15 million in interest-free loans during a three-year period. The proceeds from the loans were used by Centaur to meet its payroll and other expenses. The SEC alleged that the interest-free loans served to derive the hedge fund from the use of its capital and were not adequately disclosed to the investors in the fund. In the fund’s audited financial statements, Centaur caused the loans to be described as payroll receivables, instead of loans.

The SEC, within its order in this matter, stated that Centaur violated the anti-fraud provisions and breached its fiduciary duty to the fund, which are violations of Sec. 206 of the Investment Advisers Act of 1940. As a result, and with Centaur’s decision not to contest the SEC’s charges, Centaur agreed, without admitting or denying any of the charges, to the SEC’s issuance of a cease-and-desist order, a censure and agreement to pay disgorgement of $172,438 plus interest of $41,884, and a civil penalty in the amount of $150,000.

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 one of the following individuals:

Terry D. Nelson
Madison, Wisconsin

Peter D. Fetzer
Milwaukee, Wisconsin


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