A Compilation of Enforcement and Non-Enforcement Actions

31 July 2015 Publication
Authors: Terry D. Nelson Peter D. Fetzer

Legal News: Investment Management Update

Non-Enforcement

  • States are Accommodating Crowdfunding Offerings While the SEC Continues to Ponder Crowdfunding Rules
  • Public Pension Officials Request Increased Transparency of Fees Paid in Private Equity Funds
  • DOL’s Fiduciary Proposal Declared Unworkable by SEC Commissioner
  • Auditor’s Independence Not Properly Monitored

Enforcement

  • Hedge Fund Manager’s Fraudulent Valuation of Assets Results in Industry Bar

Non-Enforcement

States are Accommodating Crowdfunding Offerings While the SEC Continues to Ponder Crowdfunding Rules

The SEC first proposed rules in October 2013 for the crowdfunding exemption which was included in the Jumpstart Our Business Startups Act (JOBs Act) passed by Congress in 2013. The SEC has not finalized those rules as of yet although it is possible that those rules will be in place before the end of 2015.

In the meantime, state legislatures of several states, tired of waiting for the SEC to finalize rules for the national crowdfunding exemption that may be used in all 50 states, have taken it upon themselves to enact a crowdfunding exemption to be used by entities located in their home state. Virginia is the most recent state to enact legislation and now there are 20 states and the District of Columbia that include a crowdfunding exemption within their state securities law.

Generally, the state crowdfunding exemption is for offerings to an unlimited number of persons in the state provided that all offers and sales are conducted exclusively within the state, not more than $1 million (in some cases, up to $2 million) of securities are sold within a 12 month period, and a filing is made with the state administrator either before or after the commencement of the offering.

Reportedly, seven additional states are looking to enact similar legislation in 2015 in order to provide its state issuers with a crowdfunding exemption.


Public Pension Officials Request Increased Transparency of Fees Paid in Private Equity Funds

In a recent letter to the SEC, a group of state treasuries and other officers representing 13 states, voiced concern about the lack of sufficient disclosure of fees paid by public pensions invested in private equity funds. As more and more pension plans make investments in private equity funds, the concern by such public officials is the inability to know, at least on a frequent enough basis, the fees being paid.

The problem of insufficient disclosure arises from the private equity manager’s desire to keep such information away from the public domain (at least until the annual audit has been completed) and the public requirement under state laws, to have such information readily available. Pension plans, in search for higher returns than what is typically found from investments in publically traded stocks and bonds, are increasingly looking to invest a greater amount of public money in private equity investments. The government officials are urging the SEC to require the managers of such finds to provide the pension plans and other investors with enhanced and more frequent fee disclosures.


DOL’s Fiduciary Proposal Declared Unworkable by SEC Commissioner

In a recent comment letter to the Department of Labor (DOL), SEC Commissioner Daniel Gallagher, stated that the recent proposal by DOL, in creating a fiduciary rule for broker-dealers, is at best, unworkable and should be withdrawn. Instead, according to the Commissioner, DOL should work with the SEC to find a reasonable way to address the fiduciary responsibilities of a broker-dealer.

Reportedly, the relationship between the two agencies is not always conducive to finding common ground in policy making. Also, the SEC is apparently working on its own fiduciary proposal for broker-dealers. Commissioner Gallagher believes that the DOL needs to lean on the SEC’s expertise in this area and not create a DOL rule that would not be workable for broker-dealers and their clients.


Auditor’s Independence Not Properly Monitored

The Securities and Exchange Commission brought and settled an administrative proceeding against the independent auditor to three closed-end funds, an independent trustee of those funds, and the fund’s administrator for violations of the funds’ auditor independence requirements. Specifically, the independent trustee, who served on the funds’ audit committees, had an undisclosed consulting relationship with an associated entity of the fund auditor that negatively impacted the auditors’ independence.

The proceeding stresses the need to carefully monitor the independence of auditors, and makes it clear that the procedures used to monitor independence must be thorough. The administrator to the funds had agreed to assist the funds in discharging their responsibilities under Rule 38a-1 of the Investment Company Act, and assisted the funds in preparing and circulating trustee and officer questionnaires. However, its trustee and officer questionnaires did not expressly cover business relationships with the auditor’s affiliates, and it did not provide sufficient training to assist the funds’ board members in the discharge of their responsibilities as to auditor independence.

The SEC believed that as a result of the deficient questionnaires and insufficient training, one of the independent trustees, who served on the funds’ audit committees, had an undisclosed consulting relationship with an associated entity of the funds’ auditor. The relationship eventually was detected by the funds’ auditor, which reported it to the funds and, subsequently, to the SEC. The SEC found that the auditor violated the independence requirement; that the auditor and the trustee caused the funds to file reports that were not audited by independent public accountants; and that the fund administrator caused the funds to violate Rule 38a-1 of the Investment Company Act, which requires funds to adopt and implement written policies and procedures reasonably designed to prevent violation of the federal securities laws. The auditor was required to disgorge approximately $614,000 and to pay a civil money penalty of $500,000, while the trustee was required to disgorge approximately $35,000 and to pay a civil money penalty of $25,000, and the fund administrator was subjected to a civil money penalty of $45,000.

Funds should ensure that their trustee and officer questionnaires addresses business relationships with the auditor’s affiliates, and that their boards have sufficient training with regard to auditor independence. They should reassess the effectiveness of their questionnaires and training with regard to other independence determinations.


Enforcement

Hedge Fund Manager’s Fraudulent Valuation of Assets Results in Industry Bar

One of the primary target areas for examination by the SEC’s Enforcement Division Asset Management Unit is the valuation of hedge fund assets by its managers. In a recent enforcement case, the SEC took action, including an industry bar, against one of two owners of an investment advisory firm, the hedge fund manager, for fraudulently inflating the prices of securities in the portfolio of the hedge funds they manage.

Alpha Bridge Capital Management, a registered investment adviser based in Connecticut, and its two individual owners agreed in a settled matter with the SEC to a censure and one of the owners agreed to be barred from the securities industry for at least three years. In addition, the advisory firm agreed to the disgorgement of more than $4 million, the payment of about $1 million in penalties, and to close down the funds.

The fraud, according to the SEC allegations, occurred when the hedge fund manager told the fund’s investors and auditor that it had obtained independent price quotes for certain thinly traded securities when instead they used prices derived internally. The higher prices used resulted in the manager receiving greater fees based on a percentage of fund assets and performance.

The SEC found that the advisory firm and its two owners violated the anti-fraud provisions of the Investment Advisers Act of 1940.


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
608.258.4215
tnelson@foley.com

Peter D. Fetzer
Milwaukee, Wisconsin
414.297.5596
pfetzer@foley.com

Insights

PATH Summit 2019
18-20 December 2019
Arlington, VA
MedTech Impact Expo & Conference
13-15 December 2019
Las Vegas, NV
Review of 2020 Medicare Changes for Telehealth
11 December 2019
Member Call
BRG Healthcare Leadership Conference
06 December 2019
Washington, D.C.