A Compilation of Enforcement and Non-Enforcement Actions

27 February 2015 Publication
Authors: Terry D. Nelson Peter D. Fetzer

Legal News: Investment Management Update


  • 2015 Legislative Agenda Includes Dodd-Frank Revisit and Cybersecurity


  • SEC Enforcement Action Underscores Importance of Custody Rule Compliance
  • Joint SEC/State Enforcement Action Against New York Hedge Fund Manager for Stealing Funds From Investors


2015 Legislative Agenda Includes Dodd-Frank Revisit and Cybersecurity

According to the new chairman of the U.S. House of Representatives Subcommittee on Financial Institutions and Consumer Protection, Representative Randy Neugebauer, the three main priorities of the House Subcommittee in 2015 will be revisiting the Dodd-Frank regulations that have been put into effect since that Act’s passage in 2010, improving upon cybersecurity protection systems in place by financial institutions, and possibly introducing “creative” solutions for enhanced consumer protection.

The Subcommittee’s jurisdiction includes financial regulations and the Consumer Financial Protection Bureau. The Subcommittee also covers consumer and institutional issues such as cybersecurity. Almost all of these issues come under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Based upon the Subcommittee Chairman’s recent remarks, he believes that although most of the Dodd-Frank’s provisions were targeted towards Wall Street institutions, it appears that a lot of the regulations imposed under that Act have had more effect on “main street” investors. Those regulations, according to the Chairman must be reviewed to determine if they need to be refocused.

As to cybersecurity, the Chairman is interested in reviewing the overall structure put in place by the financial services industry to determine if everyone in the cybersecurity process is “doing everything they are supposed to be doing” in order to keep that data secure.

Apparently, the new Chairman sees the role of his Subcommittee is to bring the important players to the table such as banks, merchants, and credit card companies to determine what steps are being taken by the private sector and what still needs to be accomplished to maintain data security. The new Chair does not believe that it is necessary for Congress to create new laws or regulations if the private sector can achieve the Dodd-Frank goals through their compliance with existing regulations.


SEC Enforcement Action Underscores Importance of Custody Rule Compliance

A SEC registered investment adviser to several registered mutual funds was the subject of a recent SEC enforcement action for violations of custody requirements under the Investment Company Act of 1940 (See also, In the Matter of Water Island Capital LLC, Release No. 31455). Investment companies that publicly offer their shares are registered as investment companies under the Investment Company Act of 1940.

In this enforcement action, the investment adviser to the registered funds, maintained fund assets (about $247 million) at the funds’ broker-dealer counterparties instead of maintaining those assets as required with the funds’ qualified bank. The Investment Company Act generally requires that registered fund assets be maintained with a qualified custodian such as a bank, including the cash proceeds from the sale of those assets. Indeed, the adviser’s compliance policies and procedures in place at the time required that fund assets and sale proceeds be maintained in the custody of a qualified bank. However, according to the SEC, for at least the period during January to September 2012, the adviser allowed fund broker-dealer counterparties instead of the bank to hold fund assets of approximately $247 million in cash collateral.

This failure by the adviser caused violations of the custody and supervision rules under the Investment Company Act.

In order to settle the SEC’s enforcement matter, the adviser agreed to the issuance by the SEC of a cease and desist order and to payment of a civil penalty in the amount of $50,000.

Joint SEC/State Enforcement Action Against New York Hedge Fund Manager for Stealing Funds From Investors

In a joint enforcement action, the office of the New York State Attorney General and the SEC’s New York Regional Office recently took enforcement action (see also SEC v. Malik, S.D.N.Y. , No. 1:15-cv-01025, 2/13/2015) against a New York-based hedge fund manager for allegations of securities fraud, grand larceny, and forgery. The lawsuit was filed by the SEC in the U.S. District Court for the Southern District of New York and on the same day, the hedge fund manager was indicted in New York. The manager has entered a plea of not guilty to the criminal charges.

According to the SEC’s complaint, the hedge fund manager raised about $840,000 from investors into a hedge fund that never made any investments and never had more than $90,000 in assets. The manager allegedly enticed persons to invest by stating that the fund had $100 million in assets and delivered “consistently high returns.” The SEC’s complaint alleges that in spite of the manager’s statements to investors, almost all of the investors’ investments were used to maintain the manager’s personal lifestyle. As investors sought to redeem their investments, the manager delayed such requests and even created a message to some investors that the manager had died as an excuse for delaying or refusing to redeem investors interests in the fund.

The violations alleged to have occurred by the SEC are under the “anti-fraud” provisions under the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940. The SEC, in its civil action, is seeking an asset freeze, disgorgement, and prejudgment interest and penalties.

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