A Compilation of Enforcement and Non-Enforcement Actions

28 June 2013 Publication
Author(s): Terry D. Nelson Peter D. Fetzer

Legal News: Investment Management Update

Non-Enforcement Matters 

  • Re: Possible SRO for Investment Advisers and Fiduciary Standard for Broker-Dealers — What Others Are Saying 
  • Investment Advisers and Investment Companies Admonished to Adhere to Terms of Exemptive Orders

Enforcement Matters 

  • Adviser Who Charged Clients Excessive Management Fees Sanctioned by the SEC 
  • JOBS Act Fraud Case Results in Injunction

Non-Enforcement Matters

Re: Possible SRO for Investment Advisers and Fiduciary Standard for Broker-Dealers — What Others Are Saying

In the ongoing debate over whether a supervisory regulatory agency, other than the SEC, should be delegated the task of examining and otherwise regulating registered investment advisers, the Investment Adviser Association (IAA) has recently made its position on the subject known to the SEC’s new chair, Mary Jo White. The IAA is a nonprofit association that exclusively represents the interests of its members, who represent 500 registered investment advisers with about $9 trillion in assets under management.

In a recent meeting on June 17, 2013 with Chairman White and certain staff members of the SEC, representatives of the IAA expressed their support for the “user fee” method (i.e., charging each registrant an annual fee) of raising sufficient funds for the SEC to employ additional staff and resources to be able to examine registered investment advisers at a pace mandated by U.S. Congress in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. It is widely thought that it may take an additional 2,500 examiners to adequately police SEC-registered investment advisers. Currently, there are reportedly only 400 SEC examiners who examine annually about eight percent of the approximate 11,000 SEC registrants.

In Chairman White’s testimony on June 25, 2013 to the U.S. Senate’s Subcommittee on Financial Services and General Government Committee of Appropriations in support of President Obama’s 2014 fiscal year budget request, she stated that the budget request, if fully funded, would add approximately 672 new staff positions. In her testimony, Chairman White stated that more than 40 percent of registered investment advisers have never been examined and that the number of registered investment advisers has increased by more than 40 percent during the past decade and assets under management by such advisers have increased more than two-fold, to more than $50 trillion. However, only 250 additional examiners could be added to the SEC’s investment adviser examination program even if the budget request was totally funded. That number of new examiners is roughly 10 percent of the number of examiners believed to be necessary in order for the SEC to examine roughly the same percentage of registrants as currently examined by FINRA of registered broker-dealers.

Those who support the user fee model (as the IAA does) do so in large degree because they believe that FINRA would be the likely “SRO” entity to step up to that role if that model would be employed to examine and regulate investment advisers. The user fee model would leave the SEC in place as the examining body and would avoid duplicate regulation that may be one of the results of using a separate entity as an SRO, such as FINRA.

In a separate letter to Chairman White dated June 4, 2013, the IAA made known its position on the recent Request for Information (RFI) release by the SEC regarding the possible extension of a fiduciary duty to broker-dealers. The SEC has recommended in a study on the subject mandated under Dodd-Frank to adopt parallel rules under both the Advisers Act and the Securities Exchange Act of 1934 laying out the fiduciary duty that is the same for both investment advisers and broker-dealers, respectively. While the IAA supports the SEC’s recommendation, the organization made it known to Chairman White that it believes the fiduciary standard adopted by the SEC for broker-dealers should be “no less stringent than the existing standard under the Advisers Act.” The IAA also noted that the RFI fails to emphasize the fiduciary standards necessary to make it a level playing ground for broker-dealers and investment advisers. The IAA voiced its concerns that if the RFI is closely followed by responders, the fiduciary standard eventually adopted will be nothing more than a standard comparable to the existing suitability “know your customer” test for registered broker-dealers. The chief concern among some members of the IAA is that a weakened version of the fiduciary standard for broker-dealers would, over time, serve to water down the fiduciary standard for investment advisers, and their clients would be the victims as a result.

Investment Advisers and Investment Companies Admonished to Adhere to Terms of Exemptive Orders

The Division of Investment Management of the Securities and Exchange Commission (SEC) has issued guidance reminding firms that have obtained exemptive orders that they have to adhere to the representations and conditions found in those exemptive orders, or face potential severe consequences under the federal securities law.

The guidance follows the release of the findings of the SEC' Office of Inspector General regarding its review of the SEC's oversight of compliance with the representations and conditions of exemptive orders. This review found examples of firms that failed to comply with the representations and conditions of exemptive orders. In light of this finding, the Division of Investment Management of the SEC has issued guidance to firms to remind them that they must adhere to these representations and conditions and that adherence to these representations and conditions is covered by such firms' compliance programs, as failure to comply may result in severe consequences under the federal securities law.

Rule 206(4)-7 under the Investment Advisers Act requires investment advisers to adopt and implement written policies and procedures reasonably designed to prevent violation of the Investment Advisers Act and the rules thereunder and to annually review the adequacy of those policies and procedures and the effectiveness of their implementation. Rule 38a-1 under the Investment Company Act requires funds to adopt and implement written policies and procedures reasonably designed to prevent the fund from violating the federal securities laws, to obtain board approval of such policies and procedures, and to annually review the adequacy of the policies and procedures of the fund. So firms should consider adopting and implementing policies and procedures in accordance with Rule 206(4)-7 or Rule 38a-1 that are reasonably designed to ensure ongoing compliance with each representation and condition of their exemptive orders.

Adherence to the representations and conditions of applicable exemptive orders will likely take on new importance as the SEC has signaled this issue as an exam priority, and is working to ensure that there is increased coordination among the SEC's divisions and the SEC's Office of Compliance Inspections and Examination (OCIE) when OCIE conducts its onsite compliance examinations of firms.

Enforcement Matters

Adviser Who Charged Clients Excessive Management Fees Sanctioned by the SEC

Noonan Capital, LLC, a Georgia-based investment advisory firm, recently settled an administrative proceeding with the SEC by agreeing to the issuance of a cease and desist order, a censure, a revocation of the firm’s SEC registration, the owner being barred from association with and from serving as an officer or director of an investment adviser, and agreement to the payment of more than $100,000 in disgorgement and interest.

The SEC announced its charges against the adviser in 2012 for violations of the anti-fraud provisions under the Advisers Act based upon the adviser misappropriating client assets by charging excessive fees and misstating material facts within its Form ADV about the amount of assets under the adviser’s management. In addition, the SEC charged that the adviser failed to maintain proper books and records and provide Part 2 of its Form ADV to clients, all as required under the Advisers Act.

According to the SEC, the adviser’s fee schedule as contained within its Form ADV stated that its fees would range from 1 percent to 1.5 percent based on assets under management per client when, in fact, fees charged clients by the adviser were up to seven percent. In addition, the adviser reported within its Form ADV of having almost $40 million of assets under management at a time when it had only approximately $9 million under management.

Based on the adviser’s published fee schedule, its 22 clients should have been charged a total of $92,212 in fees during one billing period, but instead were charged about double that amount, which amounted to some of these clients paying fees of up to seven percent, well in excess of the 1 percent to 1.5 percent stated within the adviser’s Form ADV. The SEC views the statements made by the adviser within information provided to clients and prospective clients about the adviser’s fee schedule and assets under management as “material” misstatements subject to the anti-fraud provisions under the Adviser’s Act.

JOBS Act Fraud Case Results in Injunction

Sometimes you just have to wonder why some investors are so gullible about investing in apparent “too good to be true” investment schemes especially with promoters who are personally unknown to such investors.

In another example where investors fixated on a “get rich” scheme and invested with a person promising “huge profits,” the SEC announced on June 21, 2013 that it had reached an agreement with Daniel F. Peterson to the issuance of a permanent injunction by a federal court enjoining Mr. Peterson from issuing or soliciting any securities of an entity he controls.

According to the SEC complaint, during the period of November 2010 to early 2012, Mr. Peterson cited to prospective investors the Jumpstart Our Business Startups Act (JOBS Act) as a way to raise billions of dollars through a secondary securities offering as the JOBS Act would allow general solicitation and advertising of such an offering resulting in enormous profits for investors. In total, Mr. Peterson managed to convince at least 21 investors to part with $400,000 to get in on the “ground floor” of such an apparent great investment opportunity. As is the case in many of these “too good to be true” propositions, Mr. Peterson not only had no investment vehicle to offer, but used the investor monies to pay his personal expenses, including lease payments for an expensive car and vacations for his wife and himself.

Initially Mr. Peterson denied the SEC’s allegations, which consisted of alleged violations of the anti-fraud provisions under the federal securities laws. Mr. Peterson had been serving as an officer and director of a Washington State-based fund, USA Real Estate Fund I.

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