A Compilation of Enforcement and Non-Enforcement Actions

30 April 2013 Publication
Author(s): Peter D. Fetzer

Legal News: Investment Management Update

Non-Enforcement Matters

  • Legislation Reintroduced to Charge Investment Advisor User Fees 
  • SEC Examination Program for Newly Registered Investment Advisers Reveals Common Areas of Concern 
  • Recent Developments Spell Relief From FATCA Reporting Requirements for Managers of Certain Offshore Funds

Enforcement Matters 

  • SEC Initiates Enforcement Action Against Adviser for Fraudulent Advertisement 
  • Misrepresenting AUM Leads to SEC Charges

Non-Enforcement Matters

Legislation Reintroduced to Charge Investment Advisor User Fees

The ongoing debate about shoring up the oversight of federally registered investment advisers found another voice (or at least the reintroduction of a previous voice in the discussion) from U.S. Rep. Maxine Waters (D-Calif.), who reintroduced legislation in Congress on April 19, 2013 that would impose industry user fees. The proceeds from the fees collected would be used to further fund the SEC’s investment adviser examination program.

No one appears to seriously question that the SEC’s current examination program is ill-equipped to examine the number of registered investment advisers. In a 2011 study required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC’s staff recommended that either a self-regulatory organization (SRO) be used to regulate investment advisers or that user fees be implemented to help fund and enhance the SEC’s investment adviser examination program.

Rep. Water’s bill was first introduced in the previous congressional session but died before a vote was taken. In opposition to the proposed legislation are proponents of the creation of an SRO for the industry. The chief proponent of creating an SRO is FINRA which hopes to operate the SRO.

Supporters of the concept of imposing industry fees include the Investment Adviser Association (IAA) and the North American Securities Administrators Association (NASAA). Both groups believe that the implementation of user fees rather than creating another layer of regulation (i.e., a SRO) would be the most efficient and quickest way to address the problem.

The bill would require the SEC only to collect as many fees as it needed to carry out the necessary examinations. Based on 2011 statistics, the SEC examined only eight percent of the nearly 11,000 SEC-registered investment advisers, due to a lack of staff and funds. The user fees would be used to both add examination staff and funds to conduct the additional exams. According to a recent study of the views of the industry, more than 80 percent of advisers preferred to pay user fees rather than have an SRO regulate their activities.

SEC Examination Program for Newly Registered Investment Advisers Reveals Common Areas of Concern

The SEC commenced the initial examinations of newly registered investment advisers during the last part of 2012. Those examinations are continuing this year with about 130 exams having been completed or are in the process of being completed. The SEC expects to conduct examinations of at least 25 percent of the new registrants by 2014.

During the examinations, which the SEC describes as “presence exams,” the staff recently announced that the following are areas of common non-compliance found during the examinations:

  • Fees and expenses. Some advisers were found to have incorrectly computed the fees charged to individual clients or are charging fees for fund clients that were not disclosed within the fund’s private placement memorandum or were inadequately disclosed. 
  • Marketing materials. The staff found advertising materials in use that were either misleading or included false statements. 
  • Custody. The final common area of concern involved lack of compliance with the Custody Rule under the Investment Advisers Act of 1940.

Recent Developments Spell Relief From FATCA Reporting Requirements for Managers of Certain Offshore Funds

As the U.S. Treasury prepares to open its portal for registering Foreign Financial Institutions under the Foreign Account Tax Compliance Act of 2010 (FATCA), recent developments in the Cayman Islands and the British Virgin Islands are welcome news for managers of offshore private investment funds. In 2010, Congress enacted FATCA as part of the U.S. government’s initiative to curtail tax evasion by U.S. taxpayers through the use of foreign financial accounts. As part of this effort, FATCA requires withholding on payments to certain foreign financial institutions (FFIs) that do not provide information reporting about their U.S. account holders. The definition of an FFI is rather broad in scope and generally applies to all types of foreign financial groups, including offshore private equity, hedge and other private investment funds. Thus, unless offshore funds provide information about their U.S. account holders, such funds will be subject to a significant withholding tax.

Under FATCA, FFIs must provide certain identifying information to the U.S. Treasury, including the name, address, and the taxpayer identification number (TIN), as well as account-related information, for any “specified U.S. person” named on the account or any “substantial U.S. owner.” A “specified U.S. person” is defined as any U.S. resident, with a few exceptions, including publicly traded corporations and certain banks, to name a couple. A “substantial U.S. owner” is defined as any person who owns more than a ten-percent interest in any entity or, in cases where the payees are primarily in the business of trading, anyone who owns any interest in the entity (including a profits-only interest).

Almost as soon as the Treasury began reviewing the FATCA legislation for the purpose of issuing regulations, it saw cooperation with other countries as integral to carrying out the FATCA mandate. Accordingly, the Treasury has issued model intergovernmental agreements. Under a “Model 1” agreement, the FFI is required to report the required information to its home country, which then will report the relevant information to the Treasury. Under a “Model 2” agreement, a procedure similar to the statutory procedure is employed — that is, the FFI reports information directly to the Treasury, but is supplemented by exchange of information requests to the foreign government.

Recently, the Cayman Islands and BVI have both announced that they intend to enter into a Model 1 agreement with the U.S. Treasury. Thus, under this arrangement, FFIs, including foreign private equity, hedge, and other private investment funds will not have to register with the U.S. Treasury and report information thereto; rather, it will simply report FATCA-related information to its home country, which will then transmit the information to the Treasury. This should come as welcome news for foreign private investment funds incorporated in the Cayman Islands and BVI, who will not have to register as FFIs with the Treasury.

Fund managers should consult with their legal and tax advisors regarding FATCA and what next steps should be taken to ensure compliance. Without proper counseling, fund managers could risk having the funds they managed subject to significant withholding tax and thus negatively affecting the funds’ IRRs.

Enforcement Matters

SEC Initiates Enforcement Action Against Adviser for Fraudulent Advertisement

Recently, the SEC initiated an enforcement action against ZPR Investment Management, Inc. and its principal, Max E. Zavonelli, for distributing advertisements that included statements that were materially misleading or false. The investment advisory firm was registered with the SEC and is based in Orange City, Florida. The firm and its principal were the subject of similar allegations by the SEC back in 1987, which resulted in an administrative order of censure and agreement with the SEC not to solicit any new advisory clients for a period of 180 days.

In the recent action, the SEC is seeing an administrative cease-and-desist order against the respondents and likely other civil and administrative penalties. The SEC alleges that Mr. Zavonelli distributed advertisements to prospective clients that omitted material information which would have revealed that the firm’s historical reports were underperforming rather than outperforming its benchmark index. In addition, the SEC alleges that the advertisements falsely stated that the firm was in compliance with the Global Investment Performance Standards (GIPS), and that its performance results were verified by a GIPS verification firm.

Mr. Zavonelli’s firm has approximately $125 million of assets under management, approximately 105 client accounts, and caters mostly to “retail” investors. The SEC alleges that the firm periodically advertised its performance results in such national publications as SmartMoney and Barron’s and on its own Web site. In many of these advertisements, the firm stated that it complied with GIPS, although it did not include the firm’s corporate performance results as required. In addition, by this omission, the firm failed to disclose that its results were actually underperforming the relevant index rather than outperforming the index as stated. Finally, in a public advertisement in March 2011, the firm falsely stated that it was not under a “pending SEC investigation” at the time.

The SEC alleges that the firm and its principal violated the “anti-fraud” provisions under Sec. 206(1) and 206(2) of the Advisers Act which make it unlawful for an investment adviser to “employ any device, scheme, or artifice to defraud any client or prospective client” and “to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” According to the SEC’s complaint, such activities were also in violation of Sec. 206(4) of the Advisers Act which makes it unlawful for an investment adviser to engage in fraudulent behavior, which includes the publishing, circulating, or distributing any advertisement containing any untrue statement of a material fact, or that is otherwise false or misleading.

Misrepresenting AUM Leads to SEC Charges

On April 18, 2013, the SEC charged the CEO of Seiman Capital Management, a Chicago-based investment advisory firm, with making false statements to clients and potential clients about the amount of assets it had under management (AUM). The SEC also alleges that Umesh Tandon, the firm’s CEO, caused the AUM to be falsely reported to the SEC on its Form ADV.

According to the SEC, Mr. Tandon used an inflated AUM to garner business from institutional and other clients who use criteria such as the adviser’s AUM to select an investment advisory firm to provide services. In addition, Mr. Tandon used the fact that Seiman Capital Management had been selected by one or more institutional clients to attract other prospective clients. Mr. Tandon allegedly used the inflated AUM numbers during the period of 2008 to 2011 and he urged other employees of the firm to employ the same tactics. Allegedly, Mr. Tandon caused false filings with the SEC on at least four occasions through the inflated AUM on its Form ADV. According to the SEC’s complaint, the activities by Mr. Tandon resulted in violations of the “anti-fraud” provisions under Sec. 206(1) and (2) and Sec. 207 of the Investment Advisers Act of 1940.

Mr. Tandon, without admitting or denying the SEC allegations, agreed to be barred from the industry and pay disgorgement of $20,018, prejudgment interest of $1,680, and a penalty of $100,000.

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
Madison, Wisconsin

Peter D. Fetzer
Milwaukee, Wisconsin

Michael G. Dana
Miami, Florida


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