FINRA Announces Regulatory and Examination Priorities for 2013
At the beginning of each year, the Financial Industry Regulatory Authority (FINRA) announces its regulatory and examination priorities for the year. The priorities are based on FINRA’s current assessment of both investor protection needs and market issues. The following represents the 2013 regulatory and examination priorities for business conduct and sale practices, as recently published by FINRA:
SEC Previews Hedge Fund Enforcement Trends for 2013
Not to be outdone by FINRA (see article above), the SEC often uses the first of the year to announce its priorities for examinations to be conducted within the investment management sector for the upcoming year. In a recent presentation by Bruce Karpati, Chief of the SEC’s Enforcement Division’s Asset Management Unit (AMU), the following represent the priority areas for AMU’s enforcement and inspection agenda for 2013.
The AMU’s primary focus is on hedge funds and investment advisers to such funds and other alternative investments and private funds. In order to more effectively conduct examinations of such funds and their advisers, the AMU has recently hired professionals from the hedge fund and alternative investment industry to help conduct the exams. According to Mr. Karpati, “They know where the bodies are buried.”
During the past three years, the SEC has initiated more than 100 enforcement actions against hedge fund managers. With the AMU’s newly acquired expertise in the operations of such funds and their management, the number of enforcement actions is likely to increase in 2013. The main type of violations cited within these actions involved conflicts of interest, valuation, performance, and compliance and controls.
According to Mr. Karpati, the AMU will focus more closely on private equity fund advisers that are at higher risk for fraudulent behavior (based on performance data of hedge fund advisers that raises unusual or extraordinary results). In addition, it appears that the AMU will focus on those private fund advisers who have less than $150 million in assets under management and are not otherwise required to be registered as investment advisers under the Investment Advisers Act of 1940.
Mr. Karpati recommended certain steps that hedge fund and other private fund managers could take to ensure that they fulfill their fiduciary duties and avoid SEC enforcement actions. He reminds managers that they need to have a culture of compliance throughout their operations and employees, coupled by effective and written policies and procedures. He also stresses the need to provide compliance personnel adequate authority, management support, and time to do an effective job. Finally, such managers need to prepare for the inevitable AMU examination.
Another “Cherry-Picking” Enforcement Action Brought by the SEC
In the December 2012 edition of our Investment Management Update, we reported on an SEC enforcement matter involving a hedge fund manager who “cherry picked” investments over the interests of its clients. This past month, the SEC settled an enforcement matter (In the Matter of Middlecove Capital, LLC and Noah L. Myers, Investment Advisers Act of 1940 Release No. 3534 January 16, 2013), which included similar allegations against a Connecticut-based investment advisory firm and its principal owner and chief investment officer.
At its peak, the firm, which is no longer registered as an investment adviser under the Advisers Act, had about $129 million of assets under management for more than 350 clients. During the adviser’s existence, it was not uncommon for the firm to trade for its own account alongside its client accounts. However, for a period of about two and a half years, the adviser engaged in a cherry-picking scheme in which its own and those of the firm’s principals’ accounts were allocated profitable trades and client accounts were allocated unprofitable trades. During that period of time, one of the principal’s trading accounts had a track record where 95 percent of the trades were profitable, a result that could only suggest fraudulent conduct. According to the SEC’s calculations, time and time again, clients lost money in the same positions when the adviser’s and its principals’ accounts profited or did not lose money from trades in such positions.
This matter was recently settled when the respondents agreed to a cease and desist order from engaging in fraudulent behavior under the Securities Exchange Act of 1934 and the Advisers Act, a bar imposed on the firm’s principal from association with, among others, any investment adviser, and from acting or serving as an employee, officer, director, or member of an investment adviser or investment company. The firm and its principal also were ordered to pay disgorgement of $462,022 plus interest of $26,096 and a civil penalty of $300,000.
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 any of the following individuals:
Terry D. Nelson
Peter D. Fetzer
Michael G. Dana