A Compilation of Enforcement and Non-Enforcement Actions

30 October 2015 Publication
Author(s): Peter D. Fetzer Stuart E. Fross Terry D. Nelson

Legal News: Investment Management Update


  • SEC Decides Against Mounting an Appeal in Koch Ruling 
  • Hang in There CCOs
  • Enhancing Compliance and Boardroom Action to Address an Increasingly Active SEC


  • Adviser’s Mismanagement of Private Funds Results in SEC Enforcement Action



SEC Decides Against Mounting an Appeal in Koch Ruling

The July 2015 ruling by the D.C. Circuit Court in Koch v. SEC will apparently not be challenged by the SEC. The Court ruled in that decision that the Dodd-Frank Act did not provide authority for the SEC to apply retroactively provisions barring a person from associating with municipal advisors or statistical rating organizations for bars that were issued by the SEC prior to the enactment date of the Dodd-Frank legislation. The court made its ruling in response to the SEC imposing a bar on an adviser for conduct that occurred prior to July 22, 2010, the effective date of the Dodd-Frank legislation.

Based upon the Court’s ruling and the SEC’s decision not to appeal the ruling means that any person that is the subject of a bar by the SEC for conduct that occurred prior to the effective date of Dodd-Frank, may request the SEC vacate the bar order. This process only applies to bars associated with a municipal adviser or national recognized statistical rating organization (NRSRO). All other bars imposed by the SEC were not the subject of the Court’s ruling and remain in effect.

Hang in There CCOs

Andrew Donohue, SEC’s Chief of Staff, in a recent speech to investment management professionals, appeared to provide encouragement to those persons who serve as chief compliance officers of registered investment advisory firms, to continue with their important work in creating and maintaining strong compliance programs and providing investor protections.

While recent enforcement actions by the SEC against CCOs might serve to discourage persons from serving in that role, Mr. Donohue’s recent comments should help to support and encourage persons to serve as CCOs. Donohue stated that the SEC’s staff will continue to work with CCOs in support of their efforts and strive to better understand the problems and concerns that CCOs have in installing and maintaining effective compliance programs.

According to Mr. Donohue, the SEC seeks to provide compliance professionals such as CCOs with important resources to help them do their jobs, through published regulatory updates, risk alerts, and examination priorities.

Donohue emphasized that compliance professionals need to keep up with regulatory changes and adjust their firm’s business practices and risk controls accordingly.

Enhancing Compliance and Boardroom Action to Address an Increasingly Active SEC

The SEC is increasingly active in reviewing investment adviser and investment company compliance and commenting on the types of policies and procedures that should exist and how they should operate. This guidance is largely informal and dynamic as the SEC’s views evolve in response to market events, regulatory and political pressure, and the development of new financial products. In response to these developments, investment advisers and investment companies need to ensure that their compliance programs and boardroom practices stay abreast of changes in the regulatory climate.

Compliance teams for investment companies and investment advisers should review compliance policies and board practices with fresh eyes by re-reading relevant statutes, rules, and other recent guidance to confirm that the language in the policies and procedures is accurate, comprehensive, and current. Here is a summary of some of the recent SEC developments to consider when reviewing compliance policies and board practices:

Division of Investment Management Guidance Updates

The Division of Investment Management issues “Guidance Updates” to set forth the Division's views on issues of interest. These updates are a window into the Staff's current thinking, both in terms of areas of focus as well as how they view particular issues.

  • Compliance With Exemptive Orders. An investment company that relies on any exemptive order that contains conditions and representations should adopt policies and procedures specifically designed to facilitate compliance with the representations and conditions in the order.
  • Risk Management in Changing Fixed Income Market Conditions. Fixed income managers should consider subjecting their portfolios to a “stress test” and monitor liquidity in market conditions where there are fewer market makers, and appropriately disclose liquidity risks to investors. Investment advisers and investment companies should review existing policies and procedures to more fully address liquidity risk.
  • Guidance on the Testimonial Rule and Social Media. The interactive nature of social media raises concerns as to whether comments about an investment adviser on its website or through social media sites would constitute an impermissible “testimonial” in violation of the Investment Advisers Act. Investment advisers should review and update their policies and procedures to take into account the most recent SEC guidance.
  • Cybersecurity Guidance. Investment advisers and investment companies may mitigate exposure to risks associated with cyber threats through compliance policies and procedures that are reasonably designed to prevent violations of the federal securities laws.
  • Acceptance of Gifts and Entertainment by Fund Advisory Personnel. While many firms are satisfied that their current gifts and entertainment policies remain reasonably designed to protect against violations of federal securities laws, including Section 17(e) of the Investment Company Act, investment advisers and investment companies should understand how this guidance could impact their current practices regarding gifts and entertainment and make an informed decision on how to address the SEC’s concerns.

Enforcement Actions and Speeches

Another area of guidance is found in SEC enforcement actions and speeches, as they demonstrate current regulatory focus, and particular areas of interest or concern on the part of the SEC.

  • Auditor Independence. Investment companies should ensure that their trustee and officer questionnaires expressly cover business relationships with the auditor’s affiliates, and provide sufficient training to assist the board members in the discharge of their responsibilities as to auditor independence.
  • Broken Windows. The SEC is looking to hold deficient “gatekeepers” including boards of investment companies and auditors accountable for even small violations.
  • Conflicts, Conflicts Everywhere. For investment companies, the SEC is taking a close look at the 15(c) process and compliance with issues regarding fund distribution, including compliance with Rule 12b-1. The SEC is also focused on the issue of conflicts by investment advisers and breaches of fiduciary duty. Investment companies and investment advisers must be sure to identify potential conflicts, disclose them to clients, including fund boards, and take steps to either eliminate or mitigate the conflicts.

Rule Releases

Another area of guidance is found in SEC rule releases.

  • Valuation Guidance. The SEC's adopting release to the new money market fund rules also contained guidance relating to valuation that went beyond money market funds with respect to the use of amortized cost for instruments that mature in less than 60 days and with respect to SEC expectations relating to the use of pricing services that provide evaluated prices for fixed income funds.
  • Liquidity Risk Guidance. The SEC recently released a rule proposal on liquidity risk management for mutual funds and exchange-traded funds (ETFs). The rule proposal also contains guidance that the SEC has provided to help mutual funds and ETFs manage their liquidity risk.


Adviser’s Mismanagement of Private Funds Results in SEC Enforcement Action

In a recent enforcement case (In the Matter of Retirement Investment Advisors, Inc., Research Holdings, LLC, and Joseph Wayne Bowie, IA Release No. 4237, October 21, 2015), the SEC issued a cease and desist order and imposed remedial sanctions upon a registered investment adviser, an affiliated unregistered investment adviser, and its president for various violations of the Investment Advisers Act of 1940.

In the SEC’s complaint, the respondents were alleged to have violated, among other provisions under the Advisers Act, the” anti-fraud” provisions. Specifically, the unregistered adviser and its principal sold interests in various private funds organized and managed by the unregistered adviser to clients of the registered adviser. Two of the funds were sold with the promise to investors that they would receive audited financial statements of the fund on an annual basis. However, due to the costs of obtaining audited financial statements, the funds did not have the audits conducted. In addition, the offering documents of each of the private funds informed investors that the funds’ financial statements would be prepared in accordance with GAAP. Instead, the funds’ assets were valued at cost rather than fair market value as required under GAAP. The SEC pointed out that the unregistered adviser knew at the time that some of the assets held in some of the funds were at no value or significantly lower value than their cost. In addition, the valuation of the funds’ assets were contrary to the registered adviser’s policy of valuation of securities that required securities to be valued at current market rates.

The inflated values of the assets in several of the funds resulted in clients who invested in the funds paying a greater advisory fee than if such assets were valued at market rates.

Finally, the president of the adviser apparently deleted certain emails that reflected the disbursement of fees and advice about client accounts although all such emails are required to be maintained by the adviser under the books and records requirements under the Advisers Act.

In determining the sanctions to be imposed in this matter, the SEC apparently took into account the remedial and prompt actions taken by the respondents in connection with the SEC’s investigation. Such actions included reimbursement of fees to clients who invested in the various private funds.

In addition to the cease and desist order issued by the SEC against each of the respondents, the respondents were censured and ordered to pay disgorgement of $144,243, prejudgment interest of $14,742, and combined civil penalties of $100,000. The disgorgement and interest payments are to be used for a disgorgement fund established to reimburse clients for overpayment of fund management fees.

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

Stuart E. Fross
Boston, Massachusetts