[A] Investment Company Act of 1940

[1]

The SEC’s authority to investigate and bring enforcement proceedings alleging violations of the Investment Company Act of 1940 (the “Investment Company Act”) is set forth in Section 9. 15 U.S.C. § 80a-9.

[2]

In addition to permanent or temporary suspension or a cease and desist order discussed below, Section 9(d) of the Investment Company Act authorizes the SEC to impose civil monetary penalties. 15 U.S.C. § 80a-9(d). (The authority to impose civil monetary penalties in addition to a cease and desist order was added by the Dodd-Frank Act.) The penalties are capped according to a tier system, depending on the nature of the respondent, the nature of the allegation, and the nature of the harm. 15 U.S.C. §§ 80a-9(d)(2)(A-C).

[3]

Section 9(e) authorizes the SEC to seek and issue an order for disgorgement and accounting, including reasonable interest. 15 U.S.C. § 80a-9(e).

[4]

Section 9(f) authorizes the Commission to enter a cease and desist order to prevent future violations, and to require the respondent to take steps to affect future compliance with SEC rules. 15 U.S.C. § 80a-9(f).

[5]

The imposition of any and all authorized penalties and remedies is dependent on a preliminary finding by the Commission that the order is appropriate and in the public interest. 15 U.S.C. § 80a-9(b).

[6]

Section 9 authorizes the SEC to initiate proceedings against advisers for, inter alia, breach of fiduciary duty in connection with advisory compensation (Section 36(a)), material misrepresentations in offering documents (Section 34); participation in an illegal joint arrangement (as defined by Rule 17d-1), and books and records violations (Section 31).

[7]

See also Section 42, which authorizes the SEC to determine to proceed by civil action, rather than administrative proceeding before the Commission, as provided in Section 42(a), to seek injunctions as provided in Section 42(d), and to seek certain tiered monetary penalties in civil actions as provided in Section 42(e). 15 U.S.C. § 80a-41. The Dodd-Frank Act added Section 48(b), which gives the SEC authority to seek injunctions or monetary

penalties in civil actions with respect to aiders and abettors. 15 U.S.C. § 80a-47.

[B] Investment Advisers Act of 1940

[1]

The SEC’s authority to enforce violations of the Investment Advisers Act of 1940 (the “Investment Advisers Act” or the “Advisers Act”) is set forth in Section 203, which closely parallels Section 9 of the Investment Company Act. 15 U.S.C. § 80b-3.

[2]

Section 203(e) of the Investment Advisers Act authorizes the Commission to institute a proceeding, and after notice and opportunity for hearing, temporarily suspend the operations of an investment adviser (for a period not to exceed 12 months), permanently revoke an investment adviser’s registration, or censure an adviser or any person associated with an adviser who willfully makes or causes to be made “in any registration statement, application or report filed with the Commission under this title any statement which was at the time and in light of the circumstances under which it was made false or misleading with respect to any material fact, or has omitted to state in any such registration statement, application, or report any material fact which was required to be stated therein.” 15 U.S.C. § 80b-3(e)(1).

[3]

Sections 203(e)(5) and 203(e)(6) of the Investment Advisers Act authorize the SEC to impose the same remedies against any adviser or associated person who willfully violates any provision of the Securities Act, the Exchange Act, the Investment Company Act, or the Investment Advisers Act, or an adviser or associated person who aids and abets any such violation. 15 U.S.C. §§ 80b-3(e)(5-6).

[4]

In addition to permanent or temporary suspension or a cease and desist order discussed below, Section 203(i) of the Investment Advisers Act authorizes the SEC to impose civil monetary penalties. 15 U.S.C. § 80b-3(i). (The authority to impose civil monetary penalties in addition to a cease and desist order was added by the Dodd-Frank Act.) The penalties are capped according to a tier system, depending on the nature of the respondent, the nature of the allegation, and the nature of the harm. 15 U.S.C. §§ 80b-3(e)(2)(A-C).

[5]

Section 203(j) of the Investment Advisers Act authorizes the SEC to seek and issue an order for disgorgement and accounting, including reasonable interest. 15 U.S.C. § 80b-3(j).

[6]

Section 203(k) of the Investment Advisers Act authorizes the Commission to enter a cease and desist order to prevent future violations, and to require the respondent to take steps to effect future compliance with SEC rules. 15 U.S.C. § 80b-3(k).

[7]

The imposition of any and all authorized penalties and remedies is dependent on a preliminary finding by the Commission that the order is appropriate and in the public interest. 15 U.S.C. § 80b-3(e).

[8]

Section 203 of the Investment Advisers Act authorizes the SEC to initiate proceedings against advisers for, inter alia, failing to prevent misuse of nonpublic information (Section 204A), material misrepresentations in public disclosures (Section 207), books and records violations (Section 204), inappropriate advisory fees (Section 205), and for engaging in fraudulent activity towards a client or prospective client (Section 206). In relevant part, the Investment Advisers Act’s anti-fraud provision reads, “It shall be unlawful for any investment adviser, by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly (1) to employ any device, scheme, or artifice to defraud any client or prospective client; (2) to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” 15 U.S.C. § 80b-6.

[9]

The Investment Advisers Act does not expressly create a fiduciary duty on behalf of investment advisers. In 1963, however, the Supreme Court interpreted Section 206 of the Investment Advisers Act as “reflect[ing] Congressional recognition ‘of the delicate fiduciary nature of an investment advisory relationship’ as well as congressional intent to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser – consciously or unconsciously – to render advice which was not disinterested.” SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-192 (1963) (emphasis supplied). See also Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979) (“§206 establishes ‘federal fiduciary standards’”). Consistent with this interpretation, many of the SEC’s

enforcement actions against investment advisers rely, at least in part, on breach of fiduciary duty.

[10]

See also Section 209(c), which authorizes the SEC to seek injunctions with respect to persons violating the Investment Advisers Act and aiders and abettors of violations, and Section 209(d) which authorizes the SEC to seek certain tiered monetary penalties in civil actions against persons violating such Act. The Dodd-Frank Act added Section 209(f) that essentially gives the SEC authority to seek monetary penalties in civil actions with respect to aiders and abettors. 15 U.S.C. § 80b-9.

[C] The Securities Act of 1933

[1]

Section 8A of the Securities Act authorizes the Commission to enter a cease and desist order “[i]f the Commission finds, after notice and opportunity for hearing, that any person is violating, has violated, or is about to violate any provision of [the Securities Act], or any rule or regulation thereunder.” 15 U.S.C. § 77h-1(a).

[2]

In an enforcement proceeding initiated pursuant to Section 8A, the Commission may also enter an order for disgorgement or accounting. 15 U.S.C. § 77h-1(e).

[3]

The Commission has relied on Section 8A of the Securities Act in proceedings against mutual fund distributors for fraudulent conduct in the offer and sale of securities of registered investment companies, prohibited by Section 17(a) of the Securities Act. See In the Matter of Bank of America Capital Mgmt., LLC, BACAP Distributors, LLC, and Banc of America Securities, LLC, Investment Advisers Act Rel. No. 2355 (Feb. 9, 2005) (issuing a cease and desist order pursuant to Section 8A of the Securities Act against a mutual fund distributor for violating Section 17(a) of the Securities Act).

[D] The Securities Exchange Act of 1934

[1]

Section 21C of the Securities Exchange Act authorizes the Commission to enter a cease and desist order “[i]f the Commission finds, after notice and opportunity for hearing, that any person is violating, has violated, or is about to violate any provision of [the Exchange Act], or any rule or regulation thereunder.” 15 U.S.C. § 78u-3(a).

[a]

In an enforcement proceeding initiated pursuant to Section 21C, the Commission may also enter an order for disgorgement or accounting. 15 U.S.C. § 78u-3(e). Pursuant to Section 21C, the Commission may institute proceedings to remedy violations of Section 10(b) of the Exchange Act and Rule 10b-5, which prohibit fraudulent conduct in the purchase and sale of securities.

[b]

The Commission has relied on Section 21C of the Securities Exchange Act in proceedings against entities that assisted market timers in evading advisers’ anti-market timing policies. See In the Matter of Veras Capital Master Fund, VEY Partners Master Fund, Veras Investment Partners, LLC, Kevin D. Larson, and James R. McBride, Investment Advisers Act Rel. No. 2466 (Sept. 22, 2009) (issuing a cease and desist order pursuant to Section 21C of the Securities Act against an a hedge fund, its traders and its adviser for deliberately masking their timing activities, in violation of Section 10(b)(5) of the Exchange Act).

[2]

Section 15(b) of the Securities Exchange Act authorizes the SEC to pursue enforcement actions against registered broker-dealers. 15 U.S.C. § 78o(b)(4).

[A] Savings Clauses in Federal Securities Statutes

[B] New York

[1]

The Act conveys substantial investigatory powers, including broad subpoena authority. Id. at § 352-2.

[2]

The Act further authorizes the NYAG to seek injunctive relief and restitution upon satisfaction that any person, corporation or partnership has engaged in or is about to engage in a fraudulent practice (Id. at § 353), and authorizes criminal prosecution for fraud in connection with the purchase or sale of most securities. (Id. at § 352c-6).

[3]

The Act defines “fraudulent practices” broadly and is liberally construed. See, e.g., People v. F.H. Smith, Co., 243 N.Y.S. 446 (1930) (“The [Martin Act] is remedial in its nature, and was passed to protect the inexperienced, confiding and credulous investor, and . . . should, therefore, be liberally and sympathetically construed in order that its beneficial purpose may, so far as possible, be attained”).

[4]

The Martin Act remained dormant as an enforcement tool for nearly three-quarters of a century after the passage of the Securities Act and Exchange Act, with federal agencies generally charged with policing securities violations. NYAG Eliot Spitzer resuscitated the Act as an investigatory and prosecutorial mechanism in connection with his challenge to alleged conflicts of interests between research and investment banking divisions at leading Wall Street Firms. Statement By Attorney General Eliot Spitzer Regarding the “Global Resolution” of Wall Street

Investigations (Apr. 23, 2003), available at www.oag.state.ny.us/press/statements/global_resolution.html. Similarly, the Martin Act provided the basis for the NYAG’s investigation into the mutual fund industry’s trading practices, which resulted in more than 21 proceedings and $3.9 billion in restitution for investors between 2004 and 2006. Press Release of NYAG (Dec. 21, 2006), available at www.oag.state.ny.us/press/2006/dec/dec21b_06.html.

NYAG Andrew Cuomo also filed a number of lawsuits alleging violations of New York State’s Martin Act. For example, the NYAG included Martin Act claims in lawsuits against (1) Charles Schwab & Co. charging the firm with falsely representing auction rate securities as liquid, short-term investments without discussing the risks, (2) Ivy Asset Management LLC and former Ivy officers for deliberately misleading clients about investments tied to Bernard L. Madoff, and (3) Steven L. Rattner, alleging he paid kickbacks in order to obtain $150 million in investments in a private equity firm from the New York State Common Retirement Fund. See Press Releases of NYAG (August 17, 2009, May 11, 2010 and November 18, 2010), available at www.ag.ny.gov/media_center/2009/aug/aug17a_09.htm; www.ag.ny.gov/media_center/2010/may/may11a_10.html; and www.ag.ny.gov/media_center/2010/nov/nov18a_10.html, respectively.

Current NYAG Eric Schniederman also has relied on the Martin Act as the basis for a lawsuit against J.P. Morgan Securities and related entities as successors to Bear Stearns, alleging they misled investors regarding evaluation of the quality of mortgage loans backing residential mortgage-backed securities (RMBS) prior to Bear Stearns’ collapse. See Press Release of NYAG (Oct. 2, 2012), available at www.ag.ny.gov/press-release/ag-schneiderman-sues-jpmorgan-fraudulent-residential-mortgage-backed-securities-issued. This suit was the first case from the state and federal RMBS Working Group formed by President Obama in 2012. For later SEC actions in coordination with the RMBS Working Group, see the approximately $300 million and $120 million settlements with J.P. Morgan and Credit Suisse, respectively, announced by the SEC in November, 2012. See Press Release, SEC Charges J.P. Morgan and Credit Suisse With Misleading Investors in RMBS Offerings (Nov. 16, 2012), available at www.sec.gov/news/press/2012/2012-233.htm.

[C] California

[D] Massachusetts

[E] Colorado

[A] Preferential Allocation of Investment Opportunities

[1]

In In the Matter of Thomas Richards, Investment Advisers Act Rel. No. 1495 (June 6, 1995), a mutual fund portfolio manager who also managed a portion of his company’s Employee Profit Sharing Plan (“PSP”), allegedly placed purchase and sale orders without simultaneous or prior designation of the account for which the orders were placed. By holding the investments in a suspense account, the adviser could determine whether orders would be profitable before allocating them to advisory accounts. The adviser’s disproportionate allocation of profitable trades to the PSP at the expense of mutual funds managed by the same portfolio manager violated the manager’s obligation of loyalty under Section 206 of the Investment Advisers Act. Without admitting or denying the violation, the respondent agreed to a cease and desist order prohibiting future violations of Section 206. See also In the Matter of Edward F. Gobora, Investment Advisers Act Rel. No. 2042 (July 10, 2002) (allegedly delaying execution of foreign trades and allocating profitable trades to preferred customers); In the Matter of Kemper Financial Services, Investment Advisers Act Rel. No. 1387 (Oct. 20, 1993) (failure to supervise portfolio manager that disproportionately allocated profitable trades to one advisory client over mutual funds managed by the adviser).

[2]

In In the Matter of Robert Burstein, Investment Advisers Act Rel. No. 1511 (July 28, 1995), a portfolio manager managed both a pension fund and a bank in its securities trading. The SEC alleged that the manager directed same-day purchases and sales of US Treasury Bonds without prior identification of the account for which the manager was trading. The portfolio manager allegedly allocated profitable transactions to the bank while identifying the pension fund as the original purchaser if the transaction resulted in a loss. Among other penalties, the SEC barred the respondent from association with any broker-dealer,

investment adviser, investment company or municipal securities dealer for breach of his fiduciary duty under Section 206.

[3]

In In the Matter of Melhado, Flynn & Assoc., Inc., Investment Advisers Act Rel. No. 2593 (Feb. 26, 2007), an adviser allegedly misallocated profitable trades to its proprietary trading account and purchases that declined in value to the accounts of its advisory clients. The SEC charged that the trade allocations violated Section 10(b) of the Securities Exchange Act, Rule 10b-5, and Section 206 of the Investment Advisers Act. The SEC further charged that altering trade tickets to conceal the trade misallocations violated Section 204 of the Investment Advisers Act and Section 17(a) of the Securities Exchange Act, requiring that advisers maintain accurate books and records in connection with the purchase and sale of securities.

[4]

In In the Matter of James C. Dawson, Admin. Proc. File No. 3-13579, Lit. Rel. No. 392 (Dec. 18, 2009, amended July 23, 2010), an ALJ barred an unregistered adviser to a hedge fund and three individual accounts from association with any investment adviser based on the following uncontested facts. From April 2003 through October 2005, the adviser secretly cherry-picked profitable trades for his personal account at the expense of his clients by purchasing securities throughout the day and delaying allocation to either his personal account or his clients’ accounts until the end of the day, when he knew whether they had appreciated in value. On July 24, 2009, the United States District Court for the Southern District of New York had enjoined the adviser from future violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Advisers Act; ordered the adviser to disgorge $303,472, plus interest; and ordered him to pay a $100,000 civil penalty. SEC v. Dawson, 08-CV-7841 (S.D.N.Y. Sept. 9, 2008).

[5]

The SEC also has brought actions against advisers that designated accounts for transactions immediately but which allegedly allocated the most favorable transactions to preferred clients.

[6]

The SEC filed fraud charges against now-bankrupt Sentinel Management Group, Inc. (“Sentinel”) and two of its former executives in SEC v. Sentinel Mgmt. Group, Inc., 1:07-CV-4684 (N.D. Ill.), Lit. Rel. No. 20624 (June 18, 2008). The SEC alleged that Sentinel, a registered investment adviser, promised clients that it would invest their assets in safe, highly-liquid, short-term products, hold their assets in segregated accounts, and that their investments would be redeemable on a same-day basis. Instead, Sentinel appropriated client assets to pursue risky and highly illiquid investments and to secure leveraged trading for the benefit of Sentinel’s house account, owned by Sentinel insiders. The SEC additionally alleged that the insiders fabricated daily updates to clients, misrepresenting the clients’ securities holdings and interest income and failing to disclose the encumbrances incurred on the clients’ assets through Sentinel’s leveraging and borrowing activities. As credit markets tightened, redemption volume increased; because client assets were allegedly tied up in Sentinel’s house account’s leveraging strategy, Sentinel was unable to meet client redemptions, forcing it to suspend redemptions and shortly thereafter file for Chapter 11 bankruptcy. The SEC alleged that Sentinel’s conduct, through its officers, constituted a violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Sections 206(1), 206(2) and Section 206(4) of the Investment Advisers Act and Rule 206(4)-2 thereunder. The complaint sought a permanent injunction against all defendants, and also sought disgorgement, interest, and civil penalties against its former executives. On December 17, 2008, Sentinel consented to an injunction

permanently enjoining it from violating the antifraud provisions of the federal securities laws. See also In the Matter of Altschuler, Melvoin and Glasser LLP and G. Victor Johnson, II, CPA, Investment Advisers Act Rel. No. 3096 (Oct. 4, 2010) for settled proceeding against Sentinel’s auditors and the engagement partner for their role in Sentinel’s custody violations.

[7]

In In the Matter of Ark Asset Mgmt. Co., Inc., the SEC addressed a “cherry-picking” scheme engaged in by a portfolio manager between August 2000 and December 2003. In the Matter of Ark Asset Mgmt., Investment Advisers Act Rel. Nos. 2962 and 3091 (Dec. 14, 2009); In the Matter of Stephen J. Mermelstein, Investment Advisers Act Rel. No. 2961 (Dec. 14, 2009 and Sept. 29, 2010). The portfolio manager allegedly allocated favorable trades to the fund’s proprietary accounts to the detriment of its client accounts. The SEC alleged that Ark profited by $19 million in performance fees by these actions. The portfolio manager and those working for him allegedly failed to record trade allocations between the proprietary and client accounts in violation of Section 204 of the Investment Advisers Act and the adviser misrepresented its trade allocation policy in its Form ADV. The SEC alleged that the adviser’s Chief Operating Officer failed to supervise the portfolio manager, failed to monitor trading patterns, and failed to respond to “red flags of possible wrongdoing.” On December 14, 2009, the SEC filed cease and desist proceedings against the adviser. At the same time, the Chief Operating Officer consented to a settlement with the SEC, agreeing to cooperate with the SEC in its investigation of the adviser. The SEC also suspended the Chief Operating Officer pursuant to Section 203(f) of the Investment Advisers Act for a six-month period and imposed a $50,000 fine. In September 2010, the adviser settled the matter and, among other things, and agreed to disgorgement of $19.8 million (of which the adviser was only required to pay $750,000 since the assets of the adviser’s estate were limited).

[8]

See also Custody of Funds or Securities of Clients by Investment Advisers, Investment Advisers Act Rel. No. 2968, at 3 n.1 (Dec. 30, 2009) (listing 2009 enforcement actions regarding misappropriation).

[9]

In In the Matter of Emil C. Busse, Jr., Investment Advisers Act Rel. No. 3133, (Nov. 22, 2010), the SEC instituted settled cease

and desist proceedings against Busse, the former head of securities lending for FAF Advisors, Inc., for the improper real-location of numerous loans of securities between a money market fund and bond fund he managed in an effort to artificially increase the net asset value per share (“NAV”) of the bond portfolio. Both funds were vehicles exclusively for the investment of securities lending proceeds for customers of an affiliate of FAF. Busse caused the reallocation of numerous loans of securities from customers invested in the money market portfolio to customers invested in the bond portfolio in an effort to increase the assets in the bond portfolio and its NAV. He did not disclose these reallocations to customers or to his supervisors. Without admitting or denying the allegations, he consented to the entry of an order barring him from association with any broker, dealer, investment adviser, or investment company with the right to reapply after three years, and imposing a civil penalty of $65,000.

[10]

In SEC v. ICP Asset Mgmt., LLC, ICP Securities, LLC, Institutional Credit Partners, LLC, and Thomas C. Priore, 10-CV-4791 (S.D.N.Y. June 21, 2010), Lit. Rel. No. 21563 (June 22, 2010), the SEC charged an investment advisory firm, Thomas Priore, its founder, owner and President, its affiliated broker-dealer, and its holding company with fraudulently managing CDOs, causing substantial losses to the CDOs and allowing Priore and his companies to improperly obtain increased advisory fees and undisclosed profits. The complaint alleged, inter alia, that Priore directed trades for the CDOs at inflated prices, caused certain CDOs to overpay for securities in order to make money for the firm and protect other ICP clients from realizing losses, caused CDOs to make prohibited investments without obtaining necessary approvals, misrepresented investments, and executed undisclosed cash transfers from a hedge fund they managed in order to allow another ICP client to meet the margin calls of one of its creditors.

The complaint alleged numerous securities law violations, including violations of Section 17(a) of the Securities Act, direct and aiding and abetting violations of Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, and direct and aiding and abetting violations of Sections 204, 206(1), (2), (3) and (4) of the Investment Advisers Act and Rules 204-2, 206(4)-7 and 206(4)-8 thereunder.

Defendants settled the action in September 2012 as follows: Priore and his companies consented, without admitting or denying the allegations, to permanent injunctions from violations of the securities laws they allegedly violated. Priore and his companies were ordered to pay more than $23 million (including payment by Priore and his companies of disgorgement of approximately $800,000 and $14 million, respectively, plus interest, and penalties of approximately $500,000 and $650,000). Priore also consented to a five-year industry bar. Lit. Rel. No. 22477 (Sept. 10, 2012).

[11]

In SEC v. State Street Bank and Trust Company, 1:10-CV-10172 (D. Mass.), Lit. Rel. No. 21408 (Feb. 4, 2010), the SEC charged State Street with securities law violations for misleading investors during the subprime mortgage crisis in 2007 about the extent of subprime mortgage-backed securities held in certain funds under its management, while selectively disclosing more complete information about subprime investments to certain investors. The SEC alleged that State Street marketed its Limited Duration Bond Fund as an “enhanced cash” investment strategy that was an alternative to a money market fund for certain types of investors. By 2007, however, the Fund was almost entirely invested in subprime RMBS and derivatives. The SEC alleged that State Street continued to describe the Fund to prospective and current investors as having better sector diversification than a typical money market fund, while failing to disclose the extent of the Fund’s concentration in subprime investments to investors generally. At the same time, it was providing certain investors with more complete information about the Fund’s subprime concentration and other issues. The SEC alleged that State Street sold the Fund’s most liquid holdings and used the cash it received from these sales to meet the redemption demands of better-informed investors, leaving the Fund and its remaining investors with largely illiquid holdings. Without admitting or denying the allegations of the complaint, State Street consented to the entry of a final judgment ordering it, among other things, to pay a civil penalty of $50 million and disgorgement of over $7 million. State Street also agreed to pay more than $250 million to compensate investors (State Street had already paid over $340 million through settlements of private actions). State Street also agreed to a cease and desist order with respect to Sections

17(a)(2) and 17(a)(3) of the Securities Act. Rel. No. 9107 (Feb. 4, 2010).

At the same time, State Street agreed to settle charges brought by Secretary of the Commonwealth of Massachusetts, William Galvin, involving the same facts. In the Matter of State Street Bank and Trust Company, Docket No. E-2007-0084 (Mass. Feb. 4, 2010).

[12]

In a related action against two former State Street Corp. executives, an administrative law judge ruled in an initial decision that the executives appropriately highlighted the risks involved in a $2.9 billion fund that was heavily invested in subprime mortgage-related securities, rejecting the SEC’s fraud claims. The ALJ found that letters and other communications drafted by John P. Flannery and James Hopkins in late 2006 and 2007 did not mislead investors about the makeup of the Limited Duration Bond Fund, and that the two acted in the best interest of their clients and the fund. According to the SEC, the fund was marketed as an enhanced cash investment strategy that was as safe as a money market account, but by 2007 was heavily invested in subprime RMBS and derivatives. State Street allegedly continued to describe the fund as less risky than a typical market fund, and selectively disclosed to investors the extent of the fund’s sub-prime investments.

However, the ALJ ruled that Flannery had taken the necessary steps to ensure that communications to investors were accurate, including having State Street’s legal department and other executives review several letters sent to clients. Furthermore, Hopkins made edits to various communications sent to clients but never had authority to make substantive changes that would affect their accuracy, the judge ruled. In March, 2012, the Commission granted the Division of Enforcement’s Petition for Review of the ALJ’s decision, noting that the “proceeding raises important legal and policy issues by presenting us with a case of first impression regarding the applicability of the Supreme Court’s holding in Janus to claims other than those brought pursuant to Exchange Act Rule 10b-5(b). The proceeding also raises the issue of whether investor sophistication is relevant to an analysis of liability under the antifraud provisions of the federal securities laws in a Commission enforcement proceeding.” In the Matter of John P. Flannery and James D. Hopkins, Investment

Advisers Act Rel. No. 3387 (Mar. 30, 2012); Initial Decision Rel. No. 438 (Oct. 28, 2011); Investment Advisers Act Rel. No. 3094, (Sept. 30, 2010).

The SEC’s Division of Enforcement petitioned for review by the full Commission, which, in a 3-2 decision, found both respondents liable. See In the Matter of John P. Flannery, Investment Advisers Act Rel. No. 3981 (Dec. 15, 2014). The Commission found Hopkins liable under Rule 10b-5(a), (b), and (c) and Section 17(a)(1) of the Securities Act on the ground that he “made” a false statement in a single slide of a Power-Point presentation that he delivered orally to one investor. The Commission found Flannery liable under Section 17(a)(3) of the Securities Act as a result of misstatements in two letters to investors that he was involved in drafting or approving.

In addition to reaching these factbound conclusions, the Commission took the opportunity in Flannery to offer a 15-page commentary on the proper interpretation of Section 10(b), Rule 10b-5, and Section 17(a) after Janus. Most of the Commission’s interpretations were never briefed by the parties, and instead serve as advisory opinions. Some commentators have written that the Commission appeared to be making a bid for Chevron deference from the courts for its interpretations of those provisions, first asserting that there is “ambiguity in Section 10(b), Rule 10b-5, and Section 17(a),”14 and then claiming that its interpretations are “informed by [the agency’s] experience and expertise in administering the securities laws.” See Matthew Martens, et al., “‘We Intend to Resolve the Ambiguities’: The SEC Issues Some Surprising Guidance on Fraud Liability in the Wake of Janus” 47 Securities Regulation & Law Report, 220 (Feb. 2, 2015).

In December 2015, the United States Court of Appeals for the First Circuit reversed a decision by the US Securities and Exchange Commission imposing sanctions against two former employees of State Street Bank and Trust Company. The Commission had found one of the employees liable under Section 17(a)(1) of the Securities Act of 1933, as well as Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The Commission found the other employee liable under Section 17(a)(3) of the Securities Act. The First Circuit disagreed with the Commission’s interpretation of the facts, held

that the Commission had abused its discretion, and vacated the findings of liability.

The Commission’s findings against the first employee were based on a presentation that the employee had made to a fund investor in May 2007. The First Circuit assumed that the slide was misleading (the slide depicted an allocation of 55% to asset backed securities when the fund, based on redemptions, had reached nearly 100% in asset backed securities) but noted that “context makes a difference.” The Court found the SEC’s materiality showing was “marginal” in part because State Street made accurate allocation information available to investors upon request. The court also relied upon expert testimony that a typical investor in an unregistered fund would not rely solely on a slide presentation, but would have conducted additional due diligence. Moreover, the investment consultant who claimed to have been misled never requested a sector breakdown or the fund’s financial statements. There was no testimony from actual investors to support a finding of materiality or evidence to suggest that the credit risks posed by asset backed securities were materially different from other mortgage backed securities. For these reasons, the court concluded that any misstatements in the slide had not “significantly altered the ‘total mix’ of information made available.”

The Commission’s decision against the other employee was based on the conclusion that the employee had edited or drafted misleading letters to fund investors. The Commission concluded that the letters were part of a larger effort to convince investors to stay in the fund by concealing the risks of the fund. The court rejected the Commission’s analysis, finding that the decision to sell certain bonds had reduced the risk of the fund and the Commission had “misread the letter.” In the absence of more than one misleading statement, there was no violation of Section 17(a)(3), which requires a course of dealing. Flannery v. SEC., 810 F.3d 1 (1st Cir. Dec. 8, 2015)

[13]

In April 2011, Wells Fargo Securities LLC settled charges stemming from Wachovia Capital Markets LLC’s violation of investor protection rules under the securities laws in connection with two CDOs tied to the performance of RMBS in late 2006 and early 2007. In the Matter of Wells Fargo Securities LLC, Securities Act Rel. No. 9200 (Apr. 5, 2011). Wachovia Capital Markets (since renamed Wells Fargo Securities) allegedly

charged undisclosed and excessive mark-ups in its sale of preferred shares of a CDO, as the investors unknowingly paid over 70% more than the price at which the equity had been marked for accounting purposes. In another CDO, Wachovia allegedly misrepresented to investors that it acquired assets from affiliates “on an arm’s-length basis” and “at fair market prices” when, in fact, 40 RMBS were transferred from an affiliate at above-market prices. It then transferred these assets at stale prices in order to avoid losses on its own books. The SEC did not find that Wachovia Capital Markets acted improperly otherwise in structuring the CDOs or in the way it described the roles played by those involved in the structuring process. It agreed to pay more than $11 million in disgorgement and penalties to settle the charges. Wells Fargo Securities consented to the entry of an administrative order directing that it cease and desist from committing or causing any violations and any future violations of Section 17(a)(2) and (3) of the Securities Act, and agreed to pay disgorgement of $6.75 million and a penalty of $4.45 million.

[14]

The SEC initiated two proceedings against an investment adviser in January 2014, which charged the adviser with: (1) performing improper cross trades; and (2) failing to promptly disclose to its ERISA clients an error that resulted in an improper allocation of a restricted security.

[15]

In In the Matter of Structured Portfolio Mgmt., LLC, Investment Advisers Act Rel. No. 3906 (Aug. 28, 2014), the SEC charged a hedge fund adviser and affiliated advisers with compliance

failures, including: failure to disclose a conflict of interest, failure to supervise a portfolio manager, and failure to adopt and implement written policies and procedures to prevent violations of the Advisers Act.

The conflict at issue arose from a situation in which the portfolio manager advised three different funds: one to make a profit and the other two to hedge interest rate risk. The situation allegedly created a potential conflict of interest concerning allocation of purchases amongst the three funds. The advisers’ compliance manual stated that it would allocate trades in a fair and equitable manner and that traders (here, the portfolio manager) were required to complete a trade blotter identifying the funds for which securities were traded. The adviser allegedly did not, however, institute any procedures to confirm that traders actually complied with the manual.

Between 2006 and 2009, concerns were raised several times about the trade allocation among these three funds. Internally, the adviser removed the portfolio manager from trading on behalf of two of the funds in 2006 for a six-month period. In 2008, an independent firm raised similar concerns about trade allocations during a compliance review. One of the funds was closed in 2009 after internal concerns arose again. During this period, the adviser addressed some of these concerns, but did not update any of its written policies or procedures regarding conflicts or inaccurate disclosures.

In the settlement, the adviser consented to a civil penalty of $300,000, a censure, a cease and desist order, and a series of undertakings to improve its compliance structure.

[16]

In June 2015, the SEC announced the first enforcement arising out of a new, data-driven approach to detecting cherry-picking. In In the Matter of Welhouse & Associates, Inc., Investment Advisers Act Rel. No. 4132 (June 29, 2014), the agency charged an investment advisory firm and its individual owner with improperly allocating better-performing options trades to his personal accounts. The owner managed client accounts as well as a small number of personal accounts. He purchased ETF options in an omnibus account, then allocated the purchases later in the day with knowledge of their subsequent performance. The adviser claimed to have allocated trades pro rata. However, the Division of Economic and Risk Analysis ran simulations of the

adviser’s allocations and found an “infinitesimal” chance that the significantly better performance of his personal accounts could have arisen by chance.

The SEC charged Welhouse with violations of Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5, Section 206(1) and 206(2) of the Investment Advisers Act. The respondent settled the charges, agreeing to pay a disgorgement of $418,141 with $50,918.60 in prejudgment interest. The adviser also consented to a $300,000 civil penalty and censure. The individual owner was barred from the industry. In the Matter of Welhouse Associates, Inc., Investment Advisers Act Rel. No. 4231 (Oct. 16, 2015).

[B] Usurping Investment Opportunity

[1]

In In the Matter of Ronald Speaker and Janus Capital Corp., Investment Advisers Act Rel. No. 1605 (Jan. 13, 1997), for example, a portfolio manager declined to purchase particular debentures on behalf of a fund. He subsequently received a bid for the same debentures at a higher price. The manager purchased the debentures for his personal account and then sold them to the second bidder for a same day profit of $16,000. The SEC contended that having been presented with offers in his capacity as an investment adviser, the fiduciary obligation of loyalty required that the manager take the opportunity to the fund’s shareholders, or a disinterested employee authorized to waive the opportunity on behalf of the fund. The settlement agreement required disgorgement of the manager’s profits and suspension from association with any broker-dealer, investment adviser, investment company or municipal securities dealer.

[2]

See also In the Matter of Joan Conan, Investment Advisers Act Rel. No. 1446 (Sept. 30, 1994) (usurpation of an opportunity by an investment adviser at expense of fund viewed as a violation of the duty of loyalty imposed by Section 206 of the Investment Advisers Act).

[3]

In a case that highlights the SEC’s increased scrutiny of private equity fund managers, In the Matter of Matthew Crisp, Investment

Advisers Act Rel. No. 3267, Investment Co. Act Rel. No. 29772, (Aug. 29, 2011), the SEC initiated cease-and-desist proceedings against Matthew Crisp, a partner with Adams Street Partners, LLC, a registered investment adviser providing advisory services to private equity funds. The SEC alleges that Crisp exploited undisclosed conflicts of interest for his personal gain, by redirecting an investment opportunity in a portfolio company from the private equity funds managed by his firm to an unregistered investment club, which Crisp jointly owned with a friend; concealing his personal investments and the conflicts of interest associated with his join venture from Adams Street’s compliance department; changing the allocation of interests in the portfolio company for his personal benefit; and demanding a $150,000 “transaction bonus” for his contributions as an outside director to the portfolio company; and ignoring Adams Street’s policies prohibiting employees from receiving personal payments in connection with portfolio company transactions and failed to disclose his receipt of such income. The SEC alleges that Crisp willfully violated, or in the alternative aided and abetted and caused violations of, Sections 206(1), 206(2) and 206(4) of the Advisers Act and Rule 206(4)-8 thereunder, and that he willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. This matter was settled in 2012 with Crisp’s agreement to a cease and desist order, an industry bar (with the right to reapply in one year) and payment of approximately $140,000 (approximately $90,000 in disgorgement and a $50,000 penalty). In the Matter of Matthew Crisp, Investment Advisers Act Rel. No. 3452, Investment Co. Act Rel. No. 30187, (Aug. 30, 2012).

[C] Disclosures Relating to Investment Performance, Strategy or Risk

[D] Performance-Based Advisory Fees

[1]

Rules 205-1 and Rule 205-2, as well as a series of no-action letters issued by the SEC Staff, relate to the computation of performance fees. 17 C.F.R. § § 275.205-1, 275.205-2. Rule 205-1 states that the investment performance of a mutual fund must be calculated according to the return of the fund based on the change in the fund’s net asset value per share. 17 C.F.R. § 275.205-1.

[2]

Rule 205-2 defines the “fulcrum fee” as the fee charged when the fund’s performance equals that of the benchmark index over the period of time chosen. Rule 205-2(b) also mandates that the period over which the net asset value of the fund is averaged to calculate the fee must be the same period for which the benchmark index and the investment performance are determined. Thus, under Rule 205-2(b), “the fulcrum fee (i.e., the fixed portion of the fund’s advisory fee) and the performance adjustment (i.e., the performance-based portion of the fund’s advisory fee) must be calculated on the fund’s net asset value averaged over the performance period.” See Jack W. Murphy and Julien Bourgeois, Mutual Fund Performance Fees: Discussion and Observation, 39 The Investment Lawyer, 1, 10 (Nov. 2006) for a general discussion of the SEC’s treatment of fulcrum fees.

[3]

Rule 205-2(c) may permit the period over which the net asset value of the fund is averaged to differ from the period used to calculate the performance adjustment if certain conditions are met. See id.

[4]

In In the Matter of The Dreyfus Corp., Investment Advisers Rel. No. 2549 (Sept. 7, 2006), The Dreyfus Corp. settled an action over its performance-based fees, and reimbursed its mutual funds over $3 million. The SEC alleged that Dreyfus incorrectly calculated its fee by measuring it against its funds’ daily net asset value instead of the averaged asset value of the funds over the 36-month performance period. Thus, when a fund’s assets generally increased and outperformed the benchmark index, the daily net asset value was consistently higher than the fund’s asset value over a 36-month period. Applying the highest performance rate against that inflated value allegedly assured that the adviser received performance-based compensation significantly higher than it would have received had it calculated the fund’s fee in accordance with Section 205 and Rule 205-2(b) of the Investment Advisers Act. Likewise, when a fund’s assets generally decreased and lagged against the benchmark index, its daily net asset value was allegedly lower than the fund’s asset value over a 36-month period. Applying the lowest performance rate against that deflated value resulted in a lower deduction in performance adjustment from its fulcrum fee and provided total performance-based compensation higher than the adviser would have received

had it calculated the fund’s fee in accordance with Section 205 and Rule 205-2(b) of the Investment Advisers Act.

[5]

The Dreyfus action was part of an industry sweep of performance-based fees. For additional performance fee actions, see In the Matter of Gartmore Mutual Fund Capital Trust, Investment Advisers Act Rel. No. 2548; (Sept. 7, 2006); In the Matter of Kensington Investment Group Inc., Investment Advisers Act Rel. No. 2545 (Sept. 7, 2006); In the Matter of Numeric Investors LLC, Investment Advisers Act Rel. No. 2546 (Sept. 7, 2006); In the Matter of Putnam Investment Mgmt. LLC, Investment Advisers Act Rel. No. 2547 (Sept. 7, 2006).

[E] Wrap Fees

[1]

In In the Matter of Royal Alliance Associates, Inc., SagePoint Financial, Inc. and FSC Securities Corporation, Securities Exchange Act Rel. No. 77362, Investment Advisers Act Rel. No. 4351 (Mar. 14, 2016), the Commission charged three AIG affiliates with investing their advisory clients in mutual fund classes with 12b-1 fees, rather than the same funds without fees, which are frequently available to fee-based advisory accounts. Respondents received approximately $2 million in fees paid by the funds and breached their fiduciary duty by failing to disclose the conflict of interest related to the investments in higher fee funds. Additionally, Respondents failed to monitor client accounts each quarter for inactivity, or “reverse churning,” as was required by their compliance policies and despite citations from the SEC for similar violations several years earlier. Without monitoring for inactivity the Respondents were unable to determine whether a fee-based advisory account is appropriate compared to a commission-based product. Respondents were ordered to pay nearly $2 million in disgorgement, as well as nearly $100,000 in interest.

[2]

In In the Matter of Raymond James & Associates, Inc., Investment Advisers Act Rel. No. 4525 (Sept. 8, 2016), the Commission found that an investment adviser failed to properly disclose charges that wrap fee clients could incur in addition to the base fee for the wrap program. While the wrap fee paid to the investment adviser included investment advisory services, trade execution, custody, and other brokerage services, it did not include commissions paid when clients traded with broker-dealers that were not affiliated with the investment adviser. The investment adviser failed to acquire information about the extent of the commissions paid to “trade away,” and did not separate the commissions from the net price of each trade on clients’ account statements. The investment adviser agreed to pay a civil penalty of $600,000.

[3]

In In the Matter of Robert W. Baird & Co. Incorporated, Investment Advisers Act Rel. No. 4526 (Sept. 8, 2016), an investment adviser offered a wrap fee program that allowed clients to gain access to select sub-advisers and trading strategies, financial advice, and trade execution through the adviser. If a sub-adviser did not direct trades through the adviser, a client could incur a charge for “trading away.” The adviser did not monitor whether its sub-advisers traded away, and did not track how the costs to clients associated with trading away. Even when the adviser began monitoring “trade away” costs, it did not adopt or implement policies or procedures related to monitoring the costs. As a result, the adviser was unable to consider whether the costs of trading away for their client’s portfolios harmed the clients.

[4]

In In the Matter of Riverfront Investment Group, LLC, Investment Advisers Act Rel. No. 4453 (July 14, 2016), an investment adviser progressively increased its amount of trading away. However, the adviser failed to update its brochure to indicate that it frequently traded away and instead the disclosure continued to note that the adviser would generally trade through the sponsor.

[F] Pricing and Valuation of Portfolio Securities

[1]

In December 2003, the SEC filed a civil injunctive action against Heartland Advisors (“Heartland”) and its independent directors in connection with the pricing of bonds in the portfolio of certain Heartland bond funds. SEC v. Heartland Advisors, United States District Court for the Eastern District of Wisconsin, CA No. 03 C-1427 (Complaint, dated Dec. 11, 2003). The SEC alleged that Heartland refused to reduce the prices of portfolio securities of two high yield municipal bond funds, notwithstanding indications that the bonds suffered liquidity and credit problems and could only be sold at substantial discounts to their marked values. Heartland’s alleged failure to lower the mark for portfolio bonds resulted in overstated NAV that, in turn, caused investors purchasing the Funds to pay inflated share prices. The deterioration in the value of the portfolio created cash flow and liquidity problems for the Funds, leaving Heartland unable to meet investor redemptions at Heartland’s represented valuations. When Heartland later sold the bonds at a significant discount to generate cash to satisfy its investor redemptions, the Fund’s NAV dropped significantly.

The SEC asserted that Heartland’s valuation procedures violated Section 17(a) of the Securities Act and Section 10(b) and Rule 10b-5 of the Exchange Act (fraud in connection with the sale of securities), and Section 206 of the Investment Advisers Act (fraud and breach of fiduciary duty to Fund clients and potential investors). The SEC also alleged that Heartland violated its disclosure obligations under Section 34(b) of the Investment Company Act through representations that it had meaningful risk controls and that it had sufficient liquidity to meet investor redemptions. The SEC additionally contended that the conduct violated Rule 22c-1(a) of the Investment Company Act (prohibiting the sale or

redemption of Fund shares except at a price based on the current NAV of the security) because Heartland calculated the funds’ NAV using inflated bond prices.

In 2008, the SEC and Heartland Advisors resolved the action. SEC v. Heartland Advisors, Investment Advisers Act Rel. No. 2698 (Jan. 25, 2008). In the order, the SEC alleged that the investment adviser failed to price portfolio securities of two high yield municipal bond funds notwithstanding indications that the portfolios’ securities suffered liquidity and credit problems and could be sold only at a substantial discount to the value at which the funds had priced the securities. The SEC alleged that information was provided to the funds’ Directors that should have alerted them to the bonds’ illiquidity and that the bonds had been mispriced. Heartland’s alleged failure to re-price the portfolio securities caused the funds’ NAV to be overstated, and investors who purchased fund shares paid prices in excess of the value of the funds’ assets. The SEC charged the adviser with violating Section 17(a) of the Securities Act, Section 206 of the Investment Advisers Act, Section 34(b) of the Investment Company Act and Rule 22c-1(a). The adviser consented to the entry of a cease and desist order, censure, disgorgement and a civil penalty of $3.5 million.

[2]

In In the Matter of Garrett Van Wagoner and Van Wagoner Capital Mgmt., Inc., Investment Advisers Act Rel. No. 2281 (Aug. 26, 2004), an investment adviser purchased on behalf of its mutual funds unregistered securities, with an emphasis on companies that would soon complete IPOs. The funds’ prospectuses, however, limited the purchase of illiquid securities to 15% of the portfolio. The adviser’s purchase of unregistered securities allegedly exceeded the 15% limitation. The adviser allegedly concealed this violation by categorizing securities in lock-up agreements as liquid. When the characterization of locked-up securities still did not satisfy the 15% illiquidity bucket, however, the adviser purportedly made an across-the-board devaluation of the funds’ unregistered securities.

The SEC averred that the adviser violated the Investment Company Act’s fair valuation rules because writing down securities in an effort to shrink the entire portfolio was bad faith and in violation of Rule 22c-1. The SEC further maintained that the adviser’s purchase of illiquid securities for funds that already held in

excess of 15% of their assets in illiquid investments rendered the prospectus disclosures materially false. Last, the SEC charged that the adviser with violations of Section 206 of the Investment Advisers Act because “[t]he knowing or reckless failure to fair value private securities that materially affects a fund’s NAV constitutes fraud.” The adviser consented to a cease and desist order and agreed to pay civil penalties.

[3]

In SEC v. Lauer, No. 03-80612-CIV, 2008 U.S. Dist. LEXIS 73026 (S.D. Fla. Sept. 24, 2008), the District Court for the Southern District of Florida granted summary judgment on behalf of the SEC and against a hedge fund adviser and its principal. The court found that the adviser lacked a legitimate basis for, and materially overstated, the valuation of the funds’ portfolios, manipulated the prices of seven of the funds’ portfolio securities, falsely misrepresented the nature and composition of the funds’ holdings, and provided investors with fake portfolio statements. The adviser’s conduct violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Advisers Act. Additionally, the adviser’s principal was found to be liable as a control person of the adviser under Section 20(a) of the Exchange Act. The Court entered a permanent injunction against both defendants, and reserved decision on the SEC’s claim for disgorgement and civil penalty against the adviser’s principal. The SEC is seeking a financial penalty and disgorgement of more than $50 million. On January 29, 2009, an ALJ issued an order barring Lauer from association with any investment adviser, pursuant to Section 203(f) of the Investment Advisers Act.

[4]

In SEC v. Brantley Capital Mgmt., LLC, the SEC filed suit against an investment adviser, its Chief Executive Officer, and its former Chief Financial Officer for overstating assets. SEC v. Brantley Capital Mgmt., LLC, Robert Pinkas and Tab Keplinger, 09-CV-01906 (JSG) (N.D. Ohio Aug. 13, 2009). The SEC alleged that the Chief Executive Officer, who made all investment and valuation decisions, advised investors in an unregistered fund that its equity investment in a private airline was worth $32.5 million, when the airline was in financial distress. The SEC also alleged that the adviser intentionally and knowingly overstated the value of the fund’s debt investments in another issuer while reassuring the board that the issuer would repay its

loans. The Chief Financial Officer settled the claims, without admitting or denying the charges. The settlement included a $50,000 penalty and a 5-year suspension. The Chief Executive Officer subsequently also settled the charges and the settlement included an injunction, disgorgement of over $600,000 plus interest and a penalty of $325,000. According to a later unsettled administrative proceeding, the Chief Executive Officer misappropriated fund assets to pay for the costs of his defense and disgorgement in the initial proceeding, misrepresented to fund investors that these payments were permitted indemnification and violated the bar. In the Matter of Robert Pinkas, Investment Advisers Act Rel. No. 2271 (Feb. 15, 2012).

[5]

In SEC v. Paul T. Mannion, Jr., Andrew S. Reckles, PEF Advisors LLC, and PEF Advisors Ltd., 10-CV-3374 (N.D. Ga.), Lit. Rel. No. 21699 (Oct. 19, 2010), the SEC charged two portfolio managers and their investment advisory businesses with defrauding investors in a hedge fund by overvaluing illiquid assets that were held in a side pocket of the fund. In particular, the SEC alleged that the managers placed the fund’s investment in certain illiquid securities in a side pocket and valued them in a manner that was inconsistent with the fund’s valuation policies and contrary to an undisclosed internal assessment. The SEC asserted that this resulted in an overvaluation of the assets by as much as 60% over the managers’ internal valuations. In addition, the SEC also alleged that the managers stole investor money to pay for their personal investments and made material misstatements about their trading positions to an issuer in connection with their participation in a PIPE offering.

[6]

On June 22, 2011, Morgan Asset Management, Inc. and Morgan Keegan & Company, Inc. reached an agreement to pay $200 million to settle allegations by the SEC and FINRA, consisting of $25 million in disgorgement plus interest, a $75 million penalty to the SEC to be placed into a Fair Fund for investors and $100 million into a state fund for investors. The firms are additionally required to abstain from involvement in valuing fair valued securities on behalf of investment companies for three years. The SEC alleged that during certain periods in 2007, the NAV of several funds managed by the adviser were materially inflated. Each of the funds held securities backed by subprime mortgages, and the SEC alleged that when the market for the

securities deteriorated, the portfolio manager fraudulently manipulated the funds’ NAVs. The SEC further alleged that the broker-dealer fraudulently published NAVs for the funds without following procedures reasonably designed to determine that the NAVs were accurate.

Among other allegations, the SEC claimed that respondents willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. FINRA also filed a complaint against the broker-dealer on April 7, 2010, alleging that it marketed and sold shares of its funds to investors using false and misleading sales materials and that the firm had deficient internal guidance and failed to train its brokers about the risks of the funds’ investments which led the brokers to make material misrepresentations to investors. The firm’s former portfolio manager and comptroller also reached settlements with the SEC. In re Morgan Asset Mgmt., Inc. and Morgan Keegan & Co., Inc., Securities Exchange Act Rel. No. 64720, Investment Advisers Act Rel. No. 3218, Investment Co. Act Rel. No. 29704 (June 22, 2011). A number of states have brought related proceedings against the firms.

[7]

On June 8, 2009, the SEC charged Evergreen Investment Management Company and its distributor with violations of Section 206(2) of the Advisers Act for misstating the value of holdings in mortgage-backed securities, and subsequent selective disclosure to investors regarding the negative impact of re-valuation of those securities. In the Matter of Evergreen Investment Mgmt. Company, LLC, Investment Advisers Act Rel. No. 2888 (June 8, 2009). The SEC alleged that Evergreen overstated the Fund’s NAV for at least 17 months by failing to factor in readily available market information in its calculations. The SEC found that the overstated NAV resulted in certain investors redeeming at a higher share price to the detriment of other investors. The SEC also found that this practice resulted in inflated advisory fees.

The SEC charged Evergreen with violations of Section 204A of the Investment Advisers Act for failing to maintain policies to prevent the misuse of material nonpublic information, as well as aiding and abetting violations of Sections 17(a)(2) and 34(b) of the Investment Company Act and Rule 22c-1 thereunder. The affiliated distributor was also charged with violations of Rule 22c-1 and the Investment Company Act and violations of Sections 15(f)

and 17 of the Exchange Act. Without admitting or denying the allegations, Evergreen settled with the SEC, agreeing to a cease and desist order and monetary penalties of approximately $40 million in settlement and disgorgement fees. See alsoSEC v. Charles J. Marquardt. Evergreen also entered into a consent order with the Massachusetts Securities Division Secretary based on a state investigation arising out of the same facts. In the Matter of Evergreen Inv. Mgmt. Co, LLC, Docket No. E-2008-0062 (Mass. June 8, 2009).

[8]

In January 2014, the SEC settled proceedings against a former portfolio manager. In the Matter of Brian Williamson, Investment Advisers Act Rel. No. 3760 (Jan. 22, 2014). The SEC charged the portfolio manager with making material false and misleading statements and omissions from September 2009 through June 2010 to investors and prospective investors about the valuation of a fund he managed in violation of Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act, and Section 206(4) of the Investment Advisers Act and Rule 206(4)-8.

The alleged misstatements included: (1) those made in marketing materials that misled investors as to the fund’s internal rate of return by not taking into account certain expenses and fees; (2) those made to investors and prospective investors in pitch books, and other materials and communications, that the valuation of the fund was “based on the underlying managers’ estimated values”—the value was instead based on the portfolio manager’s own valuation; and (3) those made to disguise the foregoing statements. A number of investors made investments based on the marketing materials containing the portfolio manager’s false statements.

Without admitting or denying the findings, the portfolio manager agreed to a bar from the securities industry with a right to apply for reentry after two years, a cease and desist order, and a civil penalty of $100,000.

[9]

The SEC has also brought charges against a hedge fund adviser for failure to adopt and implement written compliance policies and procedures to periodically review investor disclosures regarding the valuation of non-widely quoted securities. In In the Matter of Agamas Capital Management, LP, Investment Advisers Act Rel. No. 3719 (Nov. 19, 2013), the SEC found that the hedge fund failed: (1) to document the basis for discretionary pricing of non-widely quoted securities, (2) to adopt policies that would ensure

proper description of the valuation process, and (3) to implement policies to avoid conflicts of interest in cross trades among the broker dealer’s funds. The Hedge Fund’s Chief Financial Officer, who also served as the Chief Compliance Officer, had final authority over pricing. The fund described to investors that it had an objective criteria for valuing securities based on independent quotes that could be overridden by good faith discretion. However, the hedge fund eliminated low quotes over 85% of the time, overrode prices using its discretion, and did not fully document the basis for the invalidation of those quotes. The hedge fund also did not have any policies in place for determining cross trade pricing and managing potential conflicts in the transaction. To resolve the proceeding with the SEC, the hedge fund agreed to a censure, requirements that it notify its investors of the order, and a civil penalty of $250,000.

[10]

In In the Matter of AlphaBridge Capital Mgmt., LLC, Investment Advisers Act Rel. No. 4135 (July 1, 2015), the SEC charged a hedge fund and its individual owners with fraud in connection with to investors and auditors that they priced certain unlisted, lightly-traded residential mortgage-backed securities using independent price quotes from broker-dealers. The adviser allegedly provided broker-dealer representatives with its own internal valuations, which the broker-dealers then presented as their own. The SEC alleged that the inflated price of these assets caused the funds to pay higher management and performance fees to the adviser. The SEC charged the adviser with violations of Sections 206(1) and 206(2) of the Investment Advisers Act. Both AlphaBridge and the CEO were censured. The Chief Compliance Officer, who was found to have priced the securities on the basis of his own data rather than that of the broker-dealer, was barred from the industry for three years. The adviser consented to a $4.025 million disgorgement and $725,000 penalty. The broker-dealer representative who allegedly assisted in the scheme agreed to a $15,000 penalty and a one-year industry bar.

[11]

In SEC v. Summit Asset Strategies Investment Mgmt., LLC Civil Action No. 2:15-cv-01429 (W.D. Wa. Sept. 4, 2015), the SEC charged a Seattle-area hedge fund adviser with collecting unearned fees by inflating the valuation of assets. The SEC brought an action against the fund’s external auditors. Summit Asset Strategies Investment Management was entitled to withdraw net profit

as fees. The adviser allegedly withdrew fees that were based on inflated asset values. In one example, the principal claimed that the fund owned a bank asset worth approximately $2 million, when allegedly the fund owned a different asset that was worth less than $200,000. The SEC charged the accountants with failure to comply with generally accepted auditing standards in the deficient audit, which materially overstated the fund’s valuation. The auditors failed to obtain sufficient evidence to support the principal’s valuation of assets.

[12]

In a high-profile case, the SEC alleged that Lynn Tilton, her Patriarch Partners LLC and related entities, defrauded certain funds by providing false and misleading information relating to the values reported for fund assets. The SEC has alleged that the respondents did not prepare quarterly financial statements in accordance with GAAP, but rather by a discretionary approach employed by Tilton. The SEC asserts that, by not employing GAAP, the funds’ assets have been overstated and in turn the adviser and Ms. Tilton have overcharged management fees on the inflated assets. The Second Circuit rejected Tilton’s challenge to the constitutionality of the SEC’s administrative courts. The case went to trial on October 24, 2016. In the Matter of Lynn Tilton; Patriarch Partners, LLC; Patriarch Partners VIII, LLC; Patriarch Partners XIV, LLC; and Patriarch Partners XV, LLC, Investment Advisers Act Rel. No. 4053, Investment Co. Act Rel. No. 31539 (Mar. 30, 2015).

[13]

In In the Matter of Calvert Investment Management, Inc., Investment Advisers Act Rel. No. 4554, Investment Co. Act Rel No. 32321 (Oct. 18, 2016), the SEC charged a mutual fund adviser with improper fair valuation of certain securities held by funds advised by the mutual fund adviser. The improper valuation led to pricing and trading the funds at an incorrect NAV, which resulted in incorrect performance figures for the funds. When the mutual fund adviser tried to remedy the loss to the funds and the funds’ shareholders, the adviser improperly calculated the remediation and failed to disclose the calculation process.

[G] Failure to Supervise

[1]

Supervision of Employees

[2]

Supervision of Employee E-mail Communications

Correspondence between broker-dealers and the external community is heavily regulated to prevent the dissemination of materially misleading information to investors. Accordingly, regulators have long maintained that broker-dealers are required to monitor their employees’ external communications. The SEC initiated an action against Bear Stearns & Co, Inc. (“Bear Stearns”) for its failure to adequately supervise its employees’ outgoing electronic correspondence. In the Matter of Bear Stearns & Co., Exchange Act Rel. No. 54806 (Nov. 21, 2006). Although Bear Stearns’ internal procedures prohibited salespersons from mailing hard-copy correspondence without management pre-approval, the procedures did not require that Bear Stearns managers screen all e-mail before transmission. The SEC alleged that salespersons at Bear Stearns had offered securities for sale in e-mail communications prior to the effectiveness of the registration statements for the securities, in violation of Section 5(b) of the Securities Act. Because e-mails went unchecked under Bear Stearns’ policies governing customer communications, the SEC asserted that Bear Stearns violated its duty under Exchange Act Section 15(b) (4)(E) to reasonably supervise persons subject to its supervision. Without admitting or denying the allegations, Bear Stearns undertook to develop, review and establish procedures to supervise employee e-mail, and consented to a censure.

[H] Notice of Source of Dividend Payments

[1]

In In the Matter of Delaware Service Co., Inc., Investment Co. Act Rel. No. 27473 (Aug. 31, 2006), the adviser performed accounting and administrative functions for funds in the Delaware Investment Complex. Three closed-end funds within the complex offered regular dividend payments to shareholders. Between January 2000 and May 2004, ninety-eight dividends were paid to shareholders of the funds, each of which included a

return of a portion of the shareholder’s capital. The adviser determined the amount and composition of all dividend payments and prepared the shareholder notice. The adviser, however, allegedly failed to include the required 19(a) notices, and the SEC maintained that the failure was in violation of Section 19(a) and Rule 19a-1 of the Investment Company Act.

The adviser additionally had requested and procured an exemption from Section 19(b) of the Investment Company Act (which limits the number of payments from long-term capital a Fund may make to its shareholders) on behalf of certain funds in the Delaware complex. In its application for the exemption, the adviser represented that the distributions complied with Rule 19a-1 under the Investment Company Act and were accompanied by 19(a) notices. Its alleged failure to distribute the notices rendered its application false, in violation of Section 34(b) of the Investment Company Act, which prohibits materially false disclosures in documents required to be filed with the Commission.

[2]

In In the Matter of Gabelli Funds, Investment Advisers Act Rel. No. 2938 (Oct. 19, 2009), the SEC alleged violations of Section 19(a) and Rule 19a-1 of the Investment Company Act by two closed-end funds—Gabelli Convertible and Income Securities Fund and Gabelli Utility Trust—managed by Gabelli LLC. The two funds allegedly paid shareholders from shareholder capital and capital gains in violation of Section 19(a), requiring that payments come from net income unless accompanied by contemporaneous written statements explaining the deviation. Gabelli was responsible for the administration of the funds and allegedly failed to include the required written statements. Without admitting or denying the allegations, Gabelli entered into an Offer of Settlement agreeing to a cease and desist order from further violations of Section 19(a) and Rule 19a-1 of the Investment Company Act. The SEC also fined Gabelli $450,000 for its violations.

[3]

See also In the Matter of AllianceBernstein, Investment Advisers Act Rel. No. 2663 (Sept. 28, 2007) (consented to a cease and desist order and civil penalty of $450,000); In the Matter of Putnam Investment Mgmt., LLC, Investment Advisers Act Rel. No. 2666 (Sept. 28, 2007), In the Matter of Smith Barney Fund Mgmt., LLC, Investment Advisers Act Rel. No. 2665 (Sept. 28, 2007).

[4]

On August 5, 2008, the SEC issued an exemption from Section 19(b) and Rule 19b-1 under the Investment Company Act. The exemptive order permitted two closed end funds to make distributions of capital gains as frequently as twelve times per year and as frequently as the terms of any outstanding preferred stock would allow, subject to conditions and representations designed to ensure that there is sufficient Board oversight and that each fund’s shareholders are provided sufficient information to understand that the periodic distributions are not tied to the fund’s net investment income. See, e.g., ING Clarion Real Estate Income Fund, Investment Co. Act Rel. No. 28352 (Aug. 5, 2008).

[I] Insider Trading

[J] RFPs and the Marketing of Investment Management Services

[1]

In In the Matter of CapitalWorks, Investment Advisers Act Rel. No. 2520 (June 6, 2006), the SEC charged an investment adviser and its Chief Compliance Officer for fraudulent representations in its responses to investor Requests for Proposal, which are solicitations to advisers from prospective investors seeking information about the adviser’s investment management services, generally in the form of a questionnaire. The alleged misstatements related to representations about SEC deficiency letters that had been issued to the adviser. In 2002, the SEC issued a deficiency letter to CapitalWorks, identifying several deficiencies relating to marketing, advertising, custody of client assets, assignment of advisory contracts and internal controls. The Chief Compliance Officer (who was also the firm’s Director of Marketing) allegedly worked on the adviser’s response to the deficiency letter, which indicated the measures CapitalWorks intended to address the deficiencies.

Subsequent to the adviser’s receipt of the deficiency letters, the Chief Compliance Officer/Director of Marketing responded to additional RFPs. In some of the responses, CapitalWorks allegedly represented that the SEC did not find any deficiencies during its examination of the adviser. The adviser failed to adopt written procedures to prevent violations of the Investment Advisers Act and, in particular, for responding to RFPs. The SEC charged further that the Chief Compliance Officer had aided and abetted a violation of Rule 206(4)-7 for failing to ensure that the adviser adopted such procedures. The settlement provided for the payment of civil penalties, a censure, a cease and desist order, and various undertakings related to corporate governance reforms.

[2]

In In the Matter of Aletheia Research and Mgmt., Inc., Investment Advisers Act Rel. No. 3197 (Mar. 3, 2011), the SEC instituted settled administrative proceedings against Aletheia Research and Management, Inc. (“Aletheia”) and two of its principals, alleging that Aletheia, in its responses to requests for proposals and other inquiries from prospective investors, did not disclose accurate information about whether it had been

subject to “findings,” “deficiencies” or “corrective actions” in connection with past SEC examinations. Aletheia agreed to pay $200,000 in penalties, and each principal agreed to pay $100,000 as part of the settlement.

[K] Gifts and Gratuities

[1]

In In the Matter of Jefferies & Co., Inc. and Scott Jones, Exchange Act Rel. No. 54861 (Dec. 1, 2006), the SEC alleged that certain Jefferies & Co., Inc. (“Jefferies”) employees entertained fund advisers with over $2 million in travel, gifts and gratuities. Although Jefferies’ policies prohibited employees from giving goods or services to a customer in excess of that permitted by NASD Rule 3060, and placed restrictions on reimbursement, the policies allegedly were neither followed nor enforced. The SEC averred that the payment of gifts and gratuities to investment advisers aided and abetted the violation of Section 17(e)(1) of the Investment Company Act (prohibiting affiliated persons of Investment Companies from accepting compensation from other sources for the purchase and sale of property to or for the investment company). The SEC also maintained that Jefferies violated the Exchange Act’s record-keeping requirements (Section 17(a)(1) and of the Exchange Act and Rule 17a-3), failed to supervise by approving prohibited uses of travel and entertainment as business expenses, and failed to enforce firm policies designed to ensure compliance with NASD Rule 3060, respectively. Without admitting or denying the allegations, Jefferies agreed to disgorgement, censure and a cease and desist order.

[2]

The same month as the Jefferies settlement, Fidelity Investments announced that its independent trustees had accepted the recommendation of an internal investigation report, and that Fidelity intended to refund $42 million to certain of its funds.

The internal investigation arose as a response to an SEC inquiry into whether Fidelity traders had directed brokerage to firms that gave those gifts and gratuities. Although Fidelity reported that its investigation did not demonstrate that the funds had received unfavorable brokerage execution, it resolved uncertainty in favor of its funds. See Jennifer Levitz and William M. Bulkeley, Fidelity Imposes Penalty On Itself After Gifts Probe, Wall St. Journal, Dec. 22, 2006, at C3.

[3]

In In the Matter of Fidelity Mgmt. & Research Co. and FMR Co., Inc., Investment Advisers Act Rel. No. 2713 (Mar. 5, 2008), the SEC alleged that two senior executives and ten equity traders associated with the adviser to the Fidelity group of mutual funds allegedly accepted more than $1.6 million in travel, entertainment and gifts (including expensive trips, lodging at fine hotels, tickets to premium sporting events and concerts, and illegal drugs) from brokerage firms seeking business from the adviser. The SEC alleged that the employees’ receipt of travel, entertainment and gifts influenced the selection of execution brokers, resulting in the likelihood of higher execution costs to advisory clients. The SEC asserted that the alleged failure to assure that factors other than best execution were considered in the traders’ brokerage selection, and the alleged failure to disclose that receipt of travel, entertainment, and gifts from brokers were factors in the selection process, violated Section 206(2) of the Advisers Act. The SEC also asserted violations of Sections 204, 206(2) and 207 of the Advisers Act and Rule 204-1 thereunder and Section 34(b) of the Investment Company Act for the adviser’s alleged failure to include the broker’s gifts in the itemized list of factors used to select brokers that it reported on its Forms ADV and fund statements of additional information. The SEC additionally alleged violations of Section 17(e)(1) of the Investment Company Act, prohibiting affiliated persons of a registered investment company from accepting “from any source any compensation (other than regular salary or wages from such registered company) for the purchase or sale of any property” of the investment company by accepting gifts from brokers who sought and obtained transactions for advisory clients. Further, the SEC alleged that the adviser failed to adopt and implement controls sufficient to detect, deter and prevent its executives’ receipt of travel, entertainment and gifts paid for by brokers, violating its obligation to reasonably supervise its executives

and traders with a view toward preventing their violations of Section 17(e)(1) of the Investment Company Act, as required by Advisers Act Section 203(e)(6). Finally, the SEC alleged that by allowing the traders’ use of an unrecorded electronic messaging network to communicate to brokers, Fidelity violated its obligations under Section 204 of the Advisers Act and Rule 204-2 thereunder to keep true, accurate and current books and records relating to its investment advisory business, including originals or copies of documents reflecting its communications with brokerage firms related to the placing or execution of orders to purchase or sell securities. Without admitting or denying the allegations, the adviser agreed to a cease and desist order, censure, various undertakings related to corporate governance and an $8 million civil penalty.

In related matters, the SEC settled enforcement actions against the individual traders for aiding and abetting and causing the adviser’s primary violations, additionally charging the senior executives with supervisory violations. Without admitting or denying the SEC’s evaluations, the individuals consented to cease and desist orders, industry bars, disgorgement and civil penalties. See, e.g., In the Matter of Scott E. DeSano, Investment Advisers Act Rel. No. 2815 (Dec. 11, 2008).

[L] Conflicts of Interest and Affiliated Transactions

[1]

Rule 12b-1 of the Investment Company Act permits a registered investment company to pay distribution costs for fund shares pursuant to a written plan approved by the funds’ board of directors. It further requires the adviser to provide fund boards such information as is reasonably necessary for the board to determine the appropriateness of the 12b-1 Plan.

[2]

In In the Matter of Smith Barney Fund Mgmt., LLC and Citigroup Global Markets, Investment Advisers Act Rel. No. 2390 (May 31, 2005), Citigroup Asset Management (“CAM”), a registered investment adviser, allegedly negotiated a substantial discount for the services of the transfer agent for the funds. Thereafter, CAM replaced its existing transfer agent with a CAM affiliate. The SEC claimed that under a side agreement, the affiliate subcontracted the transfer agent work to the original transfer agent, which performed substantially the same services it had performed previously, but at discounted rates, while the affiliate transfer agent performed limited oversight and quality control functions.

The SEC alleged that CAM breached its fiduciary obligations by failing to disclose the contents of the side-arrangements to the funds’ boards when recommending the new transfer agent. Specifically, the adviser had a duty to inform the board that its existing transfer agent was offering nearly identical services as it had previously performed at a significant discount and that its affiliated transfer agent stood to gain significant profit for performing limited oversight functions over those services. The SEC charged that “[t]his self-interested proposal permitted the Adviser and its affiliates to profit from the transfer agent function at the expense of the funds” in violation of its fiduciary obligations under Section 206 of the Investment Advisers Act. Without admitting or denying the allegations, CAM agreed to pay disgorgement and civil penalties, and consented to a cease and desist order.

[3]

In In the Matter of New York Life Investment Mgmt., LLC, Investment Advisers Act Rel. No. 2883 (May 27, 2009), the SEC settled an administrative enforcement action against New York Life Investment Management LLC (“NYLIM”) regarding the adviser’s disclosures to a mutual fund board during the annual investment advisory contract renewal process, including certain disclosures about the cost to shareholders of a guarantee feature applicable to their investment in the fund. The mutual fund involved was an index fund with a guarantee feature pursuant to which an affiliate of the adviser agreed to make up certain shortfalls in the value of a shareholder’s investment in the fund. The SEC charged that the adviser had urged the fund’s board to consider the guarantee feature in evaluating the management fees it proposed, but failed to provide the board with factual information to evaluate the cost of the guarantee. The SEC also alleged that at the same time the adviser was claiming that the guarantee should be considered to justify the fund’s management fees, the adviser filed prospectuses, annual reports, and registration statements in which it represented that there was no charge to the fund or its shareholders for the guarantee. Without admitting or denying the allegations, NYLIM agreed to a cease and desist order, censure, and disgorgement in the amount of $3,950,075, interest and a civil penalty.

[4]

In In the Matter of Renberg Capital Mgmt., Inc., Investment Advisers Act Rel. No. 2064. (Oct. 1, 2002), the SEC alleged that Renberg failed to seek best execution in securities transactions because cross trades between certain client accounts had the effect of subjecting some accounts to higher execution costs than others. Renberg agreed to a number of undertakings and was censured, ordered to cease and desist from violation of Section 206(2) of the Advisers Act and required to pay a $40,000 penalty.

[5]

The SEC alleged in an administrative proceeding that a fund manager for multiple hedge funds improperly transferred $2 million from one fund to a second fund to fulfill a redemption request in the second fund and that the fund manager made material misstatements regarding his educational background in the funds’ offering materials. The fund manager agreed to a cease and desist order, a bar from association with an investment adviser with the right to reapply in three years, and a

penalty of $35,000. In the Matter of Steven Andrew Roberts, Investment Advisers Act Rel. No. 2662, Investment Co. Act Rel. No. 27997, (Sept. 27, 2007).

[6]

In SEC v. WealthWise, LLC and Jeffrey A. Forrest, 2:08-CV-06278-GAF-SS (C.D. Cal.), Lit. Rel. No. 20737 (Sept. 24, 2008), an investment adviser allegedly recommended that its clients invest in a hedge fund without disclosing a side agreement it had with the hedge fund manager whereby the adviser received a portion of the manager’s performance fee. The hedge fund collapsed in 2007, and the investment adviser’s clients lost nearly all of the money they invested in the fund. The SEC’s complaint named the adviser and its principal, and contended that their alleged failure to disclose a material conflict of interest when making investment recommendation to its clients violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Investment Advisers Act. Without admitting or denying the allegations, the adviser settled with the SEC, agreeing to a permanent injunction against future violations, disgorgement, interest, and a civil penalty.

[7]

In In the Matter of Thomas C. Palmer and Aeneas Capital Mgmt., L.P., Investment Advisers Act Rel. No. 2757 (July 23, 2008), the director of operations for hedge fund adviser allegedly transferred $13.4 million in cash from two separate hedge funds managed by the adviser to a third hedge fund in order to satisfy margin calls. The SEC asserted that because the transfers among funds were not disclosed, they were inconsistent with the adviser’s fiduciary obligations, and that the director therefore willfully or recklessly aided and abetted the adviser’s violation of Investment Advisers Act Sections 206(1) and 206(2). The SEC additionally alleged that the adviser failed to establish or implement policies and procedures for the approval and/or detection of intra-fund cash transfers, and thereby failed to reasonably supervise the director of operations in violation of Section 203(e)(6) of the Investment Advisers Act. Without admitting or denying the allegations, the director consented to a cease and desist order, a 12-month suspension from associating with any investment adviser, and a civil monetary penalty in the amount of $65,000. The adviser also without admitting or

denying the allegations, consented to censure and a monetary penalty of $150,000.

[8]

In In the Matter of Banc of America Investment Services, Inc. and Columbia Mgmt. Advisors, LLC, Investment Advisers Act Rel. No. 2733 (May 1, 2008), the SEC settled an action against an investment adviser for alleged misrepresentations made to clients for whom it maintained discretionary mutual fund wrap fee accounts between July 2002 and December 2004. During that period, the adviser allegedly deviated from its stated methodology for selecting funds for its wrap accounts, instead emphasizing subjective factors that favored its proprietary funds, from which it earned asset-based fees. The adviser allegedly did not disclose the purported conflict it had as adviser to clients with wrap fee accounts and as adviser to the affiliated fund from which it derived asset-based fees. The SEC asserted that the alleged direction of client assets to the adviser’s affiliated funds breached its fiduciary obligations to select the most appropriate mutual funds on their wrap fee clients’ behalf regardless of whether the funds were affiliated or not. The SEC additionally alleged that the adviser’s alleged failure to adhere to its stated selection methodology rendered the public disclosures of that methodology misleading, and that the adviser’s alleged failure to disclose the scope of its conflict of interests and bias in the fund selection process constituted a material omission. On the basis of the alleged conduct, the SEC asserted that the adviser violated Sections 17(a)(2) of the Securities Act, and Section 206(2), 206(4) and 207 of the Advisers Act, and Rule 206 (4)-1(a)(5) thereunder. Without admitting or denying the allegations, the respondent consented to censure, a cease and desist order, approximately $10 million in disgorgement, interest and civil penalties, and various undertakings.

[9]

In In the Matter of Michael R. Donnell, Investment Advisers Act Rel. No. 2718 (Mar. 11, 2008), the SEC alleged that Michael Donnell, an officer of an investment adviser, failed to disclose that a sub-adviser he recommended to carry out investment strategies for a fund managed by the adviser had agreed to pay a substantial portion of its sub-advisory fee to his mother. The SEC asserted that the alleged arrangement between the sub-adviser and Donnell’s mother constituted a material conflict of interest, and Donnell’s failure to disclose the conflict to the

fund’s Board of Directors aided and abetted the adviser’s violation of Sections 206(1) and 206(2) of the Advisers Act. Without admitting or denying the SEC’s allegations, Donnell consented to a cease and desist order, a bar from association with any investment adviser, and a $50,000 civil monetary penalty.

[10]

In In the Matter of INTECH Investment Mgmt., LLC and David E. Hurley, Investment Advisers Act Rel. No. 2872 (May 8, 2009), a registered investment adviser and the adviser’s Chief Operating Officer allegedly failed to put in place written policies addressing conflicts of interest related to the adviser’s voting authority over client securities in violation of Section 206(4) and Rule 206(4)-6(a) and 206(4)-6(c) of the Investment Advisers Act. The adviser voted proxies for union-affiliated and other clients who delegated authority to the adviser in accordance with Institutional Shareholder Services (“ISS”) guidelines that corresponded to AFL-CIO proxy voting recommendations (“ISS-PVS”), without adequately describing its proxy voting policies or disclosing potential conflicts arising from use of ISS-PVS Guidelines, instead of more general ISS guidelines. The adviser’s policy did not address the potential conflicts caused by the use of the ISS-PVS Guidelines for all clients while the adviser maintained an interest in the retention of union-affiliated clients. Without admitting or denying the allegations, the adviser and the Chief Operating Officer agreed to a cease and desist order, censure, and penalties.

[11]

See also In the Matter of M.A.G. Capital, LLC and David F. Firestone, Investment Advisers Act Rel. No. 2849 (Mar. 2, 2009) (settling with investment adviser and principal for taking warrants from hedge funds without compensating the funds or disclosure to investors).

[12]

In In re Valentine Capital Asset Mgmt., Investment Advisers Act Rel. No. 3090 (Sept. 29, 2010), the SEC found that the adviser “fail[ed] to fully and adequately disclose a material conflict of interest” by not informing its clients that the adviser would receive an additional commission if its clients accepted its recommendation to switch from one series of a managed fund to another series in that same fund. The SEC reached this conclusion although the adviser had fully disclosed all commission costs to its clients. Respondents were censured, ordered to cease and desist from violations of Section 206(2) of the

Advisers Act. The firm was ordered to pay disgorgement of $394,710 and interest of $37,296, and the adviser was ordered to pay a civil money penalty in the amount of $70,000.

[13]

In In the Matter of Wunderlich Securities,Inc., Rel. No. 64558, Investment Advisers Act Rel. No. 3211 (May 27, 2011), the SEC charged Wunderlich Securities, Inc. (WSI) with overcharging advisory clients for commissions and other transactional fees, failing to satisfy the disclosure and consent requirements of Section 206(3) of the Advisers Act when WSI engaged in principal trades with advisory clients, failing to adopt, implement and review written policies and procedures, and failing to establish, maintain, and enforce a written code of ethics.

[14]

The SEC alleges that Montford Associates, a registered investment adviser, and Ernest Montford, the firm’s sole owner/CEO, defrauded their clients by failing to disclose material conflicts of interest. Specifically, Montford and the firm told clients and disclosed to the Commission that they were independent and did not accept any fees from investment managers. However, they recommended that certain clients invest in two hedge funds managed by SJK Investment Management, LLC (SJK) without disclosing that Montford Associates had a compensation arrangement with, and ultimately received $210,000 from, SJK for recommending that clients invest in the hedge funds and providing certain administrative services to SJK. In the Matter of Montford and Company, Inc. d/b/a Montford Associates, and Ernest V. Montford, Sr., Investment Advisers Act Rel. No. 3273 (Sept. 7, 2011).

[15]

The SEC filed a civil action against Warren D. Nadel, his broker-dealer, Warren D. Nadel & Co. (WDNC), and his investment advisory firm, Registered Investment Advisers, LLC (RIA), alleging that between 2007 and 2009, defendants fraudulently induced clients to invest tens of millions of dollars in a purported investment program in order to receive over $8 million in commissions and fees. They allegedly overstated the value and liquidity of client holdings by misrepresenting and concealing critical information about the way they were executing it. For example, Defendants repeatedly informed clients that they were executing open-market transactions on the clients’ behalf, when in fact most of these transactions simply consisted of trades between advisory accounts controlled by defendants at

inflated prices made up by Nadel. This created the false impression of liquidity for these securities, bolstering the perception of the inflated values that defendants reported to their clients. SEC v. Nadel, 11-CV-0215 (E.D.N.Y. Jan. 13, 2011), Lit. Rel. No. 21812.

[16]

The SEC instituted settled administrative proceedings against two individuals, former co-portfolio managers of the Tax Free Fund for Utah, who, while working for Aquila Investment Management LLC, allegedly charged municipal bond issuers a onetime “credit monitoring fee” on certain non-rated and private placement bonds in TFFU’s portfolio. See In the Matter of Kimball L. Young, Rel. No. 63675, Investment Advisers Act Rel. No. 3133, Investment Co. Act Rel. No. 29549 (Jan. 7, 2011); In the Matter of Thomas S. Albright, Rel. No. 63676, Investment Advisers Act Rel. No. 3134, Investment Co. Act Rel. No. 29550 (Jan. 7, 2011). The order alleges that any credit monitoring work the respondents performed would have been part of their regular job responsibilities; yet they allegedly did not disclose the fees to Aquila or TFFU. In settling the charges, the respondents agreed to disgorgement of the fees, penalties and industry bars.

[17]

In In the Matter of Sam P. Douglass and Anthony R. Moore, Investment Advisers Act Rel. Nos. 3166 and 3169, Investment Co. Act Rel. Nos. 29588 and 29594 (Feb. 24 and Mar. 3, 2011), the SEC had charged Douglass, the chairman of a fund who also controlled the fund’s outgoing investment adviser, with making misleading disclosures regarding a payment of approximately $400,000 by the fund to a senior fund officer in connection with the replacement of the fund’s investment adviser in June 2005. Moore, who controlled the fund’s new investment adviser, knew about the deal before the new investment adviser took over, and sought reimbursement of $535,000 from the fund for “unforeseen expenses” without informing the fund’s board or its CFO that this was tied to the senior fund officer’s compensation arrangement. The SEC alleged numerous violations of the Exchange Act and of Section 206(2) of the Advisers Act. Douglass and Moore each agreed to cease and desist orders, censure and a $25,000 civil penalty,

[18]

The SEC instituted settled administrative proceedings against Pegasus Investment Management, LLC and several of its

principals for violation of duties to fund investors, stemming from PIM’s alleged receipt of undisclosed cash payments in connection with its trading activities. See In the Matter of Pegasus Investment Mgmt., Investment Advisers Act Rel. No. 3215 (June 15, 2011). The SEC alleges that these payments were received from a proprietary trading firm in return for combining that firm’s trades with PIM’s trades, thus enabling the trading firm to obtain reduced commissions. In addition, the SEC alleged that PIM improperly treated the cash payments as its own assets rather than those of its fund investors. In settling the charges, PIM agreed to disgorgement of the allegedly improper fees totaling $90,000 plus interest, and each PIM principal agreed to additional financial penalties.

[19]

JSK Associates, Inc., a registered investment adviser, together with its President and Chief Compliance Officer and its Vice President, settled an administrative proceeding relating to failure to disclose benefits an affiliated broker-dealer derived from trading in advisory client accounts and failure to obtain required consent to riskless principal transactions between advisory clients and the affiliated broker-dealer. The adviser was censured and ordered to pay a $60,000 penalty. The officers were censured and ordered to pay penalties of $10,000. Respondents were ordered to pay disgorgement of $60,000 plus interest. In the Matter of JSK Associates, Inc., Jerome S. Keenan, and Paul Dos Santos, Investment Advisers Act Rel. No. 3175 (Mar. 14, 2011).

[20]

In In the Matter of Focus Point Solutions, Inc., Investment Advisers Act Rel. No 3458, Investment Co. Act Rel. No. 30196 (Sept. 6, 2012), the SEC alleged that an investment adviser, Focus Point, its principal and a related entity allegedly failed to disclose material conflicts of interest. They did not disclose compensation Focus Point received through a revenue-sharing agreement with a broker-dealer. In connection with becoming a sub-adviser to a mutual fund, Focus Point told the fund’s board that it would receive only its sub-advisory fee; however, it received supplemental compensated from the primary adviser. In addition, an entity related to Focus Point voted client proxies in favor of Focus Point’s becoming the mutual fund’s sub-adviser even though Focus Point would benefit financially by the vote.

The SEC alleged direct and aiding and abetting violations of Sections 206(2) and (4) and 207 of the Advisers Act,

Rule 206(4) under the Advisers Act and Section 15(c) of the Investment Company Act. The respondents settled the matter and were ordered to cease and desist from future violations and were censured. Focus Point was ordered to pay disgorgement of $900,000 plus interest and a penalty of $100,000 and its related entity was ordered to pay a penalty of $50,000. Focus Point agreed to an undertaking to retain an independent compliance consultant and, subject to certain conditions, implement its recommendations and to provide a copy of the order to existing clients and to new clients for one year. In a press release, the SEC focused particularly on Focus Point’s undisclosed revenue-sharing arrangements and announced an initiative relating to revenue-sharing arrangements between advisers and brokers. See Order Instituting Proceedings In the Matter of Focus Point Solutions, Inc., Investment Advisers Act Rel. No. 3458, Investment Co. Act Rel. No. 30196 (Sept. 6, 2012), available at http://www.sec.gov/litigation/admin/2012/ia-3458.pdf.

[21]

In In the Matter of Martin Currie Inc. and Martin Currie Investment Mgmt. Ltd., Investment Advisers Act Rel. No. 3404, Investment Co. Act Rel. No. 30062 (May 10, 2012), the SEC alleged that the investment adviser to both a registered investment company and a hedge fund caused the funds to engage in a joint transaction that benefited the hedge fund at the expense of the registered investment company. In this joint transaction, the hedge fund held illiquid securities of an issuer. The registered investment company purchased securities of the issuer and the issuer used the proceeds to redeem the illiquid securities held by the hedge fund. The SEC alleged that this conflict of interest was not adequately disclosed to the board of the registered investment company. Respondents agreed to a cease and desist order, censure and payment of an $8.3 million penalty.

[22]

The SEC brought an action against Frank Mazzola, a manager of private investment funds, alleging that he engaged in improper self-dealing and made false statements to investors in funds created to invest in Facebook and other companies prior to their IPOs. The fund managers received fees in excess of the 5% commissions on the funds’ acquisition of Facebook stock and resale of fund interests to new investors as disclosed in offering materials. The complaint alleges violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, Section 206(4)

of the Advisers Act and related rules and seeks an injunction, disgorgement and monetary penalties. SEC v. Frank Mazzola, CV-12-1258. (N.D. Cal. Mar. 14, 2012), Lit. Rel. No. 22292.

[23]

In a settled action involving pre-IPO investment in Facebook shares, the SEC charged Laurence Albukerk, a manager of private investment funds, with concealing compensation earned in connection with two funds he managed, in violation of Section 17(a)(2) of the Securities Act and Section 206(4) of the Advisers Act and Rule 206-4(8) thereunder. The offering materials for the Funds disclosed a 5% fee for an initial investment in the fund and a 5% fee when the shares were distributed to investors after a Facebook IPO. Albukerk allegedly arranged for additional compensation through other fees and mark-ups with the result that investors in the funds paid significantly more than the disclosed fees. After receipt of an SEC subpoena, Albukerk made limited disclosure of the additional compensation and offered investors rescission. In settling the action, Albukerk and his firm agreed to a cease and desist order, payment of over $200,000 in disgorgement and interest, and $100,000 in penalties. In the Matter of Laurence Albukerk, Investment Advisers Act Rel. No. 3383 (Mar. 14, 2012).

[24]

In In the Matter of Oxford Investment Partners, LLC and Walter J. Clarke, Investment Advisers Act Rel. No. 3412, Investment Co. Act Rel. No. 30086 (May 30, 2012), the SEC alleged that Clarke, the owner of a registered investment adviser, violated Sections 206(1), (2) and (4) of the Advisers Act. The SEC alleged that Clarke sold an interest in the adviser to a client at an inflated price and recommended and placed clients in investments in which Clarke and the adviser had an interest, but did not disclose this conflict to the clients.

[25]

The SEC also brought administrative proceedings alleging that Western Pacific Capital Management, LLC, a registered investment adviser, and O’Rourke, its sole owner, violated provisions of the Securities Act and the Exchange Act and Sections 206(1), (2), (3) and (4) of the Advisers Act and Rule 206(4)-8 thereunder. The SEC alleged that the adviser and O’Rourke failed to disclose that the adviser had a conflict due to its receipt of a 10% fee if a securities offering was successful; used a fund’s assets to resolve a dispute with another client; and made material misstatements to investors regarding a fund’s liquidity.

In the Matter of Western Pacific Capital Mgmt., LLC, and Kevin James O’Rourke, Investment Advisers Act Rel. No. 3313, Investment Co. Act Rel. No. 29859 (Nov. 10, 2011). In August 2013, Philip A. Falcone and Harbinger Capital Partners became the first investment adviser to agree to a statement of wrongdoing in a settlement agreement with the SEC. The consent agreement states that Falcone improperly borrowed $113.2 million from the Harbinger Capital Partners Special Situations Fund (SSF) at an interest rate less than SSF was paying to borrow money, to pay his personal tax obligation, at a time when Falcone had barred other SSF investors from making redemptions, and did not disclose the loan to investors for approximately five months.

Falcone and Harbinger further granted favorable redemption and liquidity terms to certain large investors in HCP Fund I, and did not disclose certain of these arrangements to the fund’s board of directors and the other fund investors. During the summer of 2006, Falcone heard rumors that a Financial Services Firm was shorting the bonds of the Canadian manufacturer, and encouraging its customers to do the same. In September and October 2006, Falcone retaliated against the Financial Services Firm for shorting the bonds by causing the Harbinger funds to purchase all of the remaining outstanding bonds in the open market. Falcone and the other Defendants then demanded that the Financial Services Firm settle its outstanding transactions in the bonds and deliver the bonds that it owed. Defendants did not disclose at the time that it would be virtually impossible for the Financial Services Firm to acquire any bonds to deliver, as nearly the entire supply was locked up in the Harbinger funds’ custodial account and the Harbinger funds were not offering them for sale. Due to Falcone’s and the other Defendants’ interference with the normal interplay of supply and demand in the bonds, the bonds more than doubled in price during this period.

The settlement submitted to the district court for approval requires Falcone to pay $6,507,574 in disgorgement, $1,013,140 in prejudgment interest and a $4 million penalty. The Harbinger entities are required to pay a $6.5 million penalty. Falcone consented to a bar from association with any broker, dealer, investment adviser, municipal advisor, transfer agent or nationally recognized statistical rating organization, with a right to reapply after five years. The bar permits Falcone to assist with the

liquidation of his hedge funds under the supervision of an independent monitor. See consent agreement in SEC v. Philip A. Falcone, No. 12 Civ. 5027 (PAC) (S.D.N.Y. Aug. 19, 2013), available at http://www.sec.gov/litigation/litreleases/2013/consent-pr2013-159.pdf.

[26]

In In the Matter of Total Wealth Mgmt., Inc., Investment Advisers Act. Rel. No.3818 (Apr. 15, 2014), the SEC initiated proceedings against an investment adviser and its principals for breaching fiduciary duties, failing to disclose their receipt of revenue sharing fees, making material misrepresentations to clients concerning the extent of due diligence performed on recommended investments, and violating the custody rule. The principals allegedly aided and abetted the foregoing violations.

The adviser had revenue sharing agreements in place as early as 2008, creating “clear” conflicts of interest for the adviser and its principals. Under the agreements, other funds paid the adviser a fee when the adviser placed clients’ investments in those funds. The adviser then paid its principals, through their separately established “side entities,” a percentage of all of the fees that it received. The side entities allegedly issued invoices to the adviser to conceal the receipt of those fees. According to the SEC’s Order, the Chief Compliance Officer signed off on the adviser’s 2010 Form ADV, which stated that the adviser “may” receive revenue sharing fees but failed to disclose that the adviser and its principals had already received such fees—thereby breaching their fiduciary duties to their clients.

The SEC further alleged the adviser misled investors as to the extent of due diligence performed, and that the adviser and its principals either violated or aided and abetted antifraud provisions of federal securities laws, the Custody rule, and Form ADV disclosure rules.

In the Order, the SEC sought disgorgement and civil penalties, a cease and desist order, and remedial undertakings. As of November 21, 2014, an Offer of Settlement pending between the SEC and the adviser was withdrawn due to concerns of potential misuse of investor funds to pay for the settlement. The SEC began a review of documents to determine the source of the proposed settlement payments and the action remains pending. In the Matter of Total Wealth Mgmt., Inc., Admin.

Proc. File No. 3-15842, Initial Decision Rel. No. 860 (Nov. 21, 2014).

The SEC later sued adviser and its principal for wrongfully using client money to pay the settlement of the administrative proceedings. SEC v. Total Wealth Management, Inc., Civil Action No. 15-CV-0226-BAS-DHB. The SEC also terminated the initial settlement and subsequently settled with additional charges and a larger settlement. In the Matter of Total Wealth Mgmt., Inc., Jacob Keith Cooper, Nathan McNamee, and Douglas David Shoemaker, Securities Act Rel. No. 9990, Securities Exchange Act Rel. No. 76643, Investment Advisers Act Rel. No. 4292, Investment Co. Act Rel. No. 31936 (Dec. 14, 2015).

[27]

In September 2014, the SEC charged an investment adviser with failing to maintain an adequate internal compliance system to prevent violations of federal securities regulations after acquiring Lehman Brothers Inc.’s advisory business in 2008. The SEC alleged that these compliance “deficiencies” contributed to other violations, which ultimately resulted in overcharges and client losses of approximately $472,000, and an additional $3.1 million in revenue to the adviser.

Two coordinated and concurrent examinations conducted by SEC staff from July 2011 through March 2012 identified the following alleged violations. First, the adviser engaged in more than 1,500 principal transactions without making required written disclosures or obtaining client consent. Second, the adviser charged commissions and fees that were inconsistent with what was disclosed to its clients in violation of Section 206(2) of the Advisers Act. These commissions and fees arose from errors in processing new clients, in placing trade orders, and in failing to maintain adequate billing procedures. Third, the adviser allegedly violated the Custody rule, which provides that an adviser is subject to an annual surprise examination of client funds and securities over which it has custody. The adviser failed to identify more than 800 advisory accounts over which it had custody to the independent public accountant performing its 2010 surprise examination. The SEC also alleged failures related to recordkeeping and material inaccuracies on the adviser’s 2011 Form ADV.

In assessing the offer of settlement, the SEC considered certain remedial actions taken by the adviser, such as cooperation

with the SEC and reimbursement of client funds approximating $3.8 million, including interest. To settle the case, the adviser consented to a $15 million civil penalty, a cease and desist order, a censure, and various remedial actions intended to improve its compliance systems and recordkeeping. In the Matter of Barclays Capital, Inc., Investment Advisers Act Rel. No. 3929 (Sept. 23, 2014).

[28]

In September 2014, the SEC instituted a proceeding against an investment adviser and its principals for failing to disclose conflicts arising from a compensation agreement that they had with a registered broker-dealer. The agreement created incentives for the adviser to favor particular investments and to favor the broker’s platform when recommending investments to and advising clients.

The adviser and broker entered the commission agreement in 2004, under which the adviser received from the broker a percentage of every dollar that its clients invested in certain mutual funds. The agreement remained in effect until 2012. At that time, the adviser and the broker entered a new agreement that also provided for servicing fee payments from the broker to the adviser. The adviser represented in both agreements that it would consider whether additional disclosure was necessary in its Form ADV and that it had made appropriate disclosures to its clients about the arrangement. From 2005 to 2011, the adviser failed to disclose the agreements or the incentives arising from the agreement in either its Forms ADV or to its clients.

In 2011, the adviser revised its Form ADV to indicate that it “may” receive compensation from the arrangement when it was, in fact, receiving payments from the broker. In its 2013 Form ADV, the adviser disclosed the existence of the second agreement, the associated conflict of interest, and the incentive to use the broker—but not the magnitude of the conflict. The SEC deemed these disclosures inadequate.

The SEC alleges that the investment adviser and one of its principals willfully violated Sections 206(1) and 206(2) of the Advisers Act, and its other principal aided and abetted these violations. The SEC also alleges that each willfully violated Section 207. In the Matter of the Robare Group, Ltd., Investment Advisers Act Rel. No. 3907 (Sept. 2, 2014).

On June 4, 2015, an administrative law judge issued an Initial Decision dismissing the proceedings against the Robare Group, finding that the SEC failed to carry its burden of establishing scienter, even at the lesser level of negligence required by Section 206(2) of the Adviser’s Act. Among other things, the judge found that the adviser had relied in good faith on the advice of compliance consultants in making the disclosure at issue. In the Matter of the Robare Group, Ltd., Admin. Proc. File No. 3-16047, Initial Decision Rel. No. 806 (June 4, 2015).

The Commission then denied the Respondent’s motion for summary affirmance and granted review on the grounds that the case presents “potentially important matters of public interest.” The Division had argued that the administrative law judge’s decision “shifts the burden of fully disclosing a conflict of interest from an investment adviser, who has a fiduciary duty…to a compliance consultant (who has no such connection).” In the Matter of Robare Group, Ltd., Investment Advisers Act Rel. No. 4168 (August 12, 2015).

On November 7, 2016, the Commission issued an opinion finding that the Respondent’s negligently failed to “fully and fairly disclose conflicts of interest to their clients,” imposed a cease-and-desist order on Respondents, and ordered Respondents to pay a civil penalty of $50,000 each. In the Matter of the Robare Group, LTD., Mark L. Robare, and Jack L. Jones, Jr., Investment Advisers Act Rel. No. 4566 (Nov. 7, 2016).

[29]

In In the Matter of Clean Energy Capital, LLC, Investment Advisers Act Rel. No. 3955 (Oct. 17, 2014), the SEC filed its first action arising from a focus on fees and expenses against an investment adviser and its co-founder.

The SEC alleged that the adviser committed several violations based on negligent behavior. First, the adviser and its co-founder allegedly misallocated certain expenses, including the co-founder’s compensation, to the private equity fund it advised. This allocation—a potential conflict of interest—was not disclosed to investors or in the adviser’s Forms ADV. Second, from September 2008 to September 2012, the adviser also issued unauthorized loans to the funds it advised because those funds had run out of cash to pay expenses. The loans were collateralized by securities owned by the fund and thus presented another undisclosed conflict of interest. Third, as early as 2011, the

adviser and its co-founder inadequately disclosed the they had changed the way the adviser calculated distributions, to the detriment of the investors. Fourth, the adviser induced a fund investor to invest $100,000 on the premise that both co-founders were each investing $100,000 as well. In reality, the co-founders invested only $25,000 each. Fifth, the adviser negligently omitted a co-founder’s 2002 SEC violations from offering documents for certain funds between 2008 and 2010.

The SEC also alleged compliance failures and violations of the Custody Rule. Between 2010 and 2013, the adviser allegedly failed to have a qualified custodian, failed to obtain a surprise exam, and commingled its assets with those of its clients.

In October 2014, the adviser settled with the SEC and agreed to a cease and desist order, a censure, disgorgement of $1,918,157 and prejudgment interest of $51,436.95, a civil penalty of $225,000, and certain remedial undertakings such as the hiring of an independent consultant to review its compliance and financial policies.

[30]

The SEC brought suit against the president of an investment adviser for violating Sections 17(a)(1) and (3) of the Securities Act of 1933; Section 10(b) of the Exchange Act and Rules 10b-5(a) and (c); and Sections 206(1), 206(2), and 206(3) of the Advisers Act. The DOJ brought a parallel action that led to the president’s conviction. U.S. v. Tagliaferri, No. 1:13-cr-0115 (S.D.N.Y. Verdict July 24, 2014). The president used client funds to purchase promissory notes issued by private companies who would give the president kickbacks. He failed to disclose this to investors and misrepresented the liquidity of the investment. When clients demanded payment, he would use assets from other advisory clients. The president also used funds to purchase stock of a microcap company, and the proceeds allowed him to make payments on other notes due to clients. The adviser’s president was convicted in July and sentenced to six years in prison. In March 2016, the Commission granted a motion for summary disposition and barred Tagliaferri from the industry. In the Matter of James S. Tagliaferri, Admin. Proc. File No. 3-15215, Initial Decision Rel. No. 985 (Mar. 23, 2016).

[31]

In In the Matter of Consulting Services Group, LLC, the adviser failed to disclose in its Form ADV a $50,000 personal loan between the chief executive officer and a third-party investment

adviser. CSG was an investment adviser that provided consulting services, including recommendations of third-party investment advisers to public pension accounts. CSG failed to disclose the conflict of interest created by the loan. In the Matter of Consulting Services Group, LLC, Investment Advisers Act Rel. No. 4000 (Ja. 16, 2015).

[32]

In In the Matter of Water Island Capital LLC, the SEC alleged that the fund violated Section 12(b) and Rule 12b-1(h) because the fund failed to maintain a list of approved executing brokers. The fund generally failed to implement the policies and procedures concerning Rule 12b-1(h). Related to directed brokerage and payment to certain broker-dealers, the fund also failed to maintain proper custody of fund assets. Broker-dealer counterparties held significant assets as collateral relating to various swaps in contravention of Section 17(f)(5). In the Matter of Water Island Capital LLC, Investment Co. Act Rel. No. 31455 (Feb. 12, 2015).

[33]

In In the Matter of Joseph Stillwell and Stillwell Value LLC, the SEC alleged that the adviser and principal failed to adequately disclose conflicts presented by inter-fund loans made between private funds managed by the adviser and principal. All of the loans were repaid, but the adviser and principal did not disclose any arrangements to investors. In the Matter of Joseph Stillwell and Stillwell Value LLC, Investment Co. Act Rel. No. 31504 (Mar. 16, 2015).

[34]

In In the Matter of Alpha Titans, LLC, Timothy P. McCormack, and Kelly D. Kaerser, Esq., the adviser was accused of using fund assets to pay for adviser-related expenses not clearly authorized by fund operating documents and not accurately reflected in financial statements as related party transactions. Because the financial statements did not include certain related party relationships and material transactions, the SEC alleges that the statements were not prepared in accordance with GAAP. The fund and the general counsel were each included for causing the violations. In the Matter of Alpha Titans, LLC, Timothy P. McCormack, and Kelly D. Kaerser, Esq., Securities Exchange Act Rel. No. 74828, Investment Advisers Act Rel. No. 4073, Investment Co. Act Rel. No. 31586 (Apr. 29, 2015).

[35]

In June 2015, the SEC charged a Massachusetts-based investment advisory firm and its owner with fraud, alleging that the

firm had funneled more than $17 million in client assets into four troubled penny stock companies in which the owner had undisclosed business and financial interests. SEC v. Interinvest Corp. Inc. et al., 15-CV-12350 (D. Mass. June 16, 2015), Lit. Rel. No. 23288. Interinvest’s owner had served on the board of director of these companies and was compensated about $2 million for his services. Clients may have lost as much as $12 million in the investments. The SEC’s complaint seeks to permanently enjoin Interinvest and its owner from violating the securities laws, as well as to require repayment of all ill-gotten gains with interest and penalties. The court granted a preliminary injunction to freeze the firm’s assets and prohibit the firm from exercising investment authority over client assets. See Lit. Rel. No. 23294.

[36]

Two J.P. Morgan subsidiaries settled charges that the entities preferred to invest clients in their own proprietary products without properly disclosing the conflict of interest. The two subsidiaries agreed to pay $267 million and admit wrongdoing in the settlement. Between the two subsidiaries there were several ways in which J.P. was provided with economic incentive to invest certain client assets in proprietary funds, i.e., discounted pricing. J.P. also failed to disclose to clients the availability of certain other less expensive share classes. For certain hedge funds, J.P. failed to disclose that a third-party manager shared certain fees with J.P. as well. Through these activities J.P. violated its fiduciary duty to its clients. These conflicts of interest were also inadequately discussed in Forms ADV. Further, the adviser failed to implement written policies and procedures reasonably designed to prevent the above violations. In the Matter of JPMorgan Chase Bank, N.A. and J.P. Morgan Securities LLC, Securities Act Rel. No. 9992, Securities Exchange Act Rel. No. 76694, Investment Advisers Act Rel. No. 4295 (Dec. 18, 2015).

[37]

Four affiliated private equity fund advisers settled charges that, without adequate disclosure to investors, the advisers accelerated monitoring fee payments from portfolio companies when they found out that the portfolio companies were being sold or were preparing to issue an IPO. As the recipient of the fees, the advisers could not consent to the acceleration of fees for investors because of their conflict of interest. In addition, the

Commission found that one of the advisers’ loan agreements led to materially misleading statements in the fund’s financial statements. The adviser had also failed to supervise a senior partner who charged personal items to the funds and portfolio companies. In the Matter of Apollo Management V, L.P., Apollo Management VI, L.P., Apollo Management VII, L.P., and Apollo Commodities Management, L.P., Investment Advisers Act Rel. No. 4493 (Aug. 23, 2016).

[38]

In In the Matter of WL Ross & Co. LLC, Investment Advisers Act Rel. No. 4494 (Aug. 24, 2016), the Commission found that a private equity fund adviser’s fee allocation practices resulted in the adviser’s funds overpaying the adviser for management fees. The limited partnership agreements that governed the fund’s relationship with the adviser disclosed that a percentage of the transaction fees paid by the fund would offset the fund’s management fees. The agreement did not disclose how the transaction fees would offset the management fees when multiple of the adviser’s funds and investors were invested in the same portfolio company. Without disclosing the methodology used to allocate fees, the adviser allocated the transaction fees based on the investors relative ownership percentages of each portfolio company, instead of on a pro rata basis across the funds, which resulted in higher fees paid to the adviser. The adviser voluntarily reimbursed approximately $11.8 million in management fees and interest, and paid a fine of $2.3 million.

[39]

In In the Matter of First Reserve Management, L.P., Investment Advisers Act Rel. No. 4529 (Sept. 14, 2016), the Commission found that a private equity adviser allocated certain expenses to its funds without making certain disclosures or receiving effective consent. The fees tended to relate to expenses of the adviser. The adviser also negotiated a discount from a law firm for itself, but the discount did not apply to the funds.

[40]

An adviser and certain of its principals loaned $62 million to its private equity funds’ portfolio companies to provide interim financing and working capital. Through these transactions the adviser and its principals gained senior interests to the positions held by the funds. These transactions were not disclosed to advisory boards for the funds. In the Matter of JH Partners, LLC, Investment Advisers Act Release No. 4276 (Nov. 23, 2015).

[M] Deceptive Marketing Materials

[1]

In In the Matter of National Investment Advisors, Inc. and Douglas A. Jimerson, Investment Advisers Act Rel. No. 2689 (Dec. 27, 2007), an investment adviser allegedly marketed advisory products that guaranteed clients against loss of principal if the adviser managed their assets for a continuous five year period. The insurer covering the adviser’s guaranteed principal accounts, however, had ceased to underwrite the guarantee program and the adviser’s only insurance coverage was an errors and omissions policy. At the same time, the investment adviser allegedly retained the portion of the advisory fee allocable to prepayment of the insurance program, without disclosure to its clients. The SEC charged that the adviser’s conduct violated Sections 206(4) and Rule 206(4)-1(a)(5) under the Investment Advisers Act (deceptive marketing materials), Section 206(1) and 206(2) of the Investment Advisers Act, and the antifraud provisions of the Exchange Act.

[2]

In In the Matter of Pax World Mgmt. Corp., Investment Advisers Act Rel. No. 2761 (July 30, 2008), the SEC asserted that an investment adviser allegedly failed to comply with “socially responsible investing” (“SRI”) restrictions. Pax World Management Corp. (“Pax”) allegedly marketed mutual funds that integrated social values into their investment decisions, employing a social research department to screen and monitor fund investments to assure that they did not include companies that derived revenue from the manufacture of weapons-related products, alcohol, tobacco, military activities or gambling. The SEC alleged that the adviser purchased securities that failed the social research department’s screen and had purchased securities that had not been screened pursuant to socially responsible investing restrictions, resulting in at least ten fund portfolio holdings that were prohibited by the Funds’ SRI restrictions. As a result of its failure to adhere to its SRI-related policies and procedures, the SEC asserted that Pax violated Sections 206(2) of the Advisers Act, and Sections 13(a)(3) and 34(b) if the Investment Company Act. Without admitting or denying the SEC’s allegations, Pax consented to a cease and desist order, censure, and a monetary penalty of $500,000.

[3]

In In the Matter of Equity Services, Investment Advisers Act Rel. No. 2964 (Dec. 16, 2009), the SEC charged an investment

adviser and broker-dealer with violations of Section 203(e) of the Investment Advisers Act, and Section 15(b)(4) of the Exchange Act in connection with alleged misrepresentations in client solicitations regarding the monitoring of client portfolios. In 2003, and again in 2005, OCIE staff concluded that the adviser failed to monitor client asset allocations despite its representations that it would do so. Without admitting or denying the allegations, the adviser and its Senior Vice President responsible for performing the asset allocation monitoring agreed to (1) remediation, in the form of hiring additional staff as well as reimbursing clients for losses; (2) a censure; (3) penalties; and (4) a cease and desist order from further violations of the Investment Advisers Act. See In the Matter of Stephen A. Englese, Investment Advisers Act Rel. No. 2963 (Dec. 16, 2009).

[4]

In In the Matter of Navigator Money Management, Inc., Investment Advisers Act Rel. No. 3767 (Jan. 30, 2014), the SEC charged an investment adviser, and its President and Chief Compliance Officer, for (1) making false and misleading statements in the adviser’s advertising, widely disseminated newsletters, social media, and other communications; and (2) failing to adopt and implement written policies and procedures reasonably designed to prevent the alleged violations of the Advisers Act and Investment Company Act.

The SEC notified the adviser as early as 2008 during an examination that the newsletters could be considered advertisements under Rules 206(4)-1 and 482 of the Advisers Act, which prohibit false or misleading advertising by advisers and provide guidelines for ads containing performance data. The adviser nevertheless made false and misleading statements in those newsletters that concerned its investment advice, and selectively highlighted only the successful performance of a mutual fund managed by the adviser and the performance of model portfolios recommended by the President and Chief Compliance Officer. The President and Chief Compliance Officer also touted the performance of another model portfolio on the adviser’s Twitter account in 2011, even though the adviser allegedly had no involvement in the performance of that model for almost 3 years.

The adviser and its President and Chief Compliance Officer settled with the SEC and agreed to a $100,000 civil penalty, a

censure, a cease and desist order, and various undertakings to reform and verify their compliance with securities regulations.

[5]

One of the SEC’s early financial crisis cases related to the Primary Fund, a money market fund that “broke the buck” after Lehman, Inc. filed for bankruptcy on September 15, 2008. At the time of the bankruptcy filing, the Primary Fund held $785 million in Lehman commercial paper. Shareholders besieged the Fund, seeking to redeem their shares. Before the markets opened on the date of the bankruptcy filing, the Fund had received $5 billion in redemption requests. By noon, the Fund’s custody bank had processed $10 billion in redemptions and stopped funding redemption requests.

During the initial hours after Lehman filed for bankruptcy, the adviser to the Primary Fund prepared a marketing piece expressing its intention to support the net asset value (NAV) of the Fund, but ultimately could not support the NAV in light of the massive redemptions. By the time the adviser concluded it could not support the NAV, it already had distributed 200 copies of the marketing piece to investors. – the money market fund that held over 1% of its assets in Lehman securities and “broke the buck” when Lehman filed for bankruptcy. The SEC charged the management company and two of its principals with fraud, alleging that they failed to provide material information to the fund’s board, investors and others in the days following Lehman’s bankruptcy. The SEC alleged that the Reserve principals misrepresented that the firm would provide credit support necessary to maintain the fund’s $1.00 NAV understated the amount of redemption requests and did not provide the board with accurate information concerning the value of the fund’s Lehman holdings.

After a trial in the fall of 2012, the jury found in favor of the management company and its principals on almost all of the SEC’s claims. The jury found that the SEC had not proven that the defendants violated (i) Section 10(b) of the Exchange Act or Rule 10b-5 thereunder; (ii) Section 17(a)(2) or (3) of the Securities Act (except for a negligence violation by one of the principals); (iii) Section 206(1) or 206(2) of the Advisers Act (except for a negligence violation of Section 206(2) by the management company); or (iv) Section 206(4) of, or Rule 206(4)-8 under, the Advisers Act (except for an intentional violation by the management company). In addition, the jury found that the

principals had not aided and abetted the management company’s violations of Section 206(2) or 206(4) or Rule 206(4)-8. SEC v. Reserve Mgmt. Company, Inc., 09-CV-4346 (S.D.N.Y. May 5, 2009). The jury concluded that the President of the Fund, however, had acted negligently.

[6]

In December 2014, the SEC brought suit against an investment adviser and its CEO, alleging that the adviser passed off the historical, back-tested performance of its investments strategy as actual investor gains. In the Matter of F-Squared Investments, Inc., Investment Advisers Act Rel. No. 3988 (Dec. 22, 2014). The adviser’s marketing materials presented strikingly strong fund performance going back as far as April 2001 and stated that the results “were not back-tested in any manner.” In reality, the strategy was not even launched until February 2009. The adviser further agreed that it had calculated the historical results using a formula which artificially inflated performance. Though the firm’s head was alerted to this error in calculation early in the marketing campaign, he did not act to correct it. The SEC asserted violations of Sections 204, 206(1), 206(2), 206(4) and 207 of the Investment Advisers Act as well as Rules 204-(2)(a)(16), 206(4)-1(a)(5), 206(4)-7 and 206(4)-8. The firm consented to a $30 disgorgement and $5 million penalty as well as to engage an independent compliance consultant. The adviser admitted wrongdoing.

The SEC followed this enforcement with another in November 2015, when an investment adviser to whom F-Squared acted as subadviser settled claims that it had improperly marketed the same problematic strategy to its clients. In the Matter of Virtus Investment Advisers, Inc., Investment Advisers Act Rel. 4266 (Nov. 16, 2015). Virtus agreed to a censure along with disgorgement of $13.4 million and prejudgment interest of $1.1 million.

[7]

In In the Matter of Kohlberg Kravis Roberts & Co. L.P., the private equity firm was accused of misallocating broken deal expenses. Starting in 2006 and continuing until late 2011, KKR incurred $338 million in diligence expenses related to unsuccessful deals. KKR allocated all broken deal expenses to certain funds, but did not have co-investors to such funds share in the broken deal expenses. KKR did not expressly disclose in the fund’s partnership agreement or any related offering materials that broken deal expenses would not be allocated to co-investors, in

addition to the funds. Since KKR did not include such language in its materials it breached its fiduciary duty. KKR also did not adopt appropriate policies and procedures for its fund expense allocation practices until 2011, after an OCIE inspection. In the Matter of Kohlberg Kravis Roberts & Co. L.P., Investment Advisers Act Rel. No 4131 (June 29, 2015).

[8]

In In the Matter of Dion Money Management, LLC, the adviser failed to disclose to clients the terms of compensation arrangements through which the adviser received payments from third parties that were based on client assets invested in particular funds. The adviser disclosed the arrangement in filings with the SEC, but not to its clients. As a result, the adviser understated the maximum payment rate under its arrangements and did not disclose that it could be paid multiple times from multiple parties on the same client assets. In the Matter of Dion Money Management, LLC, Investment Advisers Act Rel. No. 4146 (July 24, 2015).

[9]

Another private equity adviser misallocated adviser expenses among funds. For nearly four years a pair of investment advisers incurred expenses in the course of registering under the Advisers Act and maintaining compliance. The advisers had disclosed in the funds’ limited partnership agreements that the funds would be charged for expenses that arose out of the operation and activities of the funds, including legal and consulting expenses, as determined to be appropriate in the good faith judgment of the general partner. There was no disclose that such expenses would include the advisers’ legal and compliance expenses. Accordingly, the advisers were deemed to have breached their fiduciary duty. The advisers also failed to conduct an annual review of their compliance policies. In the Matter of Cherokee Investment Partners, LLC and Cherokee Advisers, LLC, Investment Advisers Act Rel. No. 4258 (Nov. 5, 2015)

[10]

In In the Matter of Steven Zoernack and EquityStar Capital Management, LLC., Securities Act Rel No. 10051, Securities Exchange Act Rel No. 77318, Investment Advisers Act Rel. No. 4349, Investment Co. Act Rel. No. 32024 (Mar. 8, 2016), the Commission charged an investment adviser with providing false and misleading information to Morningstar in an attempt to gain a five-star rating. The adviser provided data showing that its assets were 40 times greater than they were, and that that

the fund had existed for years longer than it had. In addition, the Commission charged that the adviser distributed false and misleading marketing materials that did not disclose that the results shown were hypothetical, rather than based on actual fund performance. The adviser also hired a firm to distribute false and misleading information about the manager’s qualifications and to manipulate search results for the manager, while concealing that the manager had two felony fraud convictions, had filed for bankruptcy, and had other judgments against him.

[N] Short Sales

[1]

In In the Matter of Amaranth Advisors, Investment Advisers Act Rel. No. 2601 (May 9, 2007), an unregistered hedge fund adviser allegedly purchased shares in public offerings and used the shares to cover short positions within the Rule 105 restricted periods, in violation of Rule 105 of Regulation M. Without admitting or denying the allegations, the adviser consented to a cease and desist order, censure, disgorgement of approximately $600,000 and a $150,000 civil penalty. Similarly, in In the Matter of DKR Oasis Mgmt. Company, L.P., Investment Advisers Act Rel. No. 2744 (June 12, 2008), an unregistered hedge fund adviser allegedly violated Rule 105 of Regulation M by using shares purchased in a follow-on offering to cover a short position created two days prior, within the Rule 105 restricted period. Without admitting or denying the SEC’s allegations, the adviser consented to a cease and desist order, censure, disgorgement of the $185,000 in profits in made from the short sale plus pre-judgment interest, and a civil penalty of $60,000.

[2]

In In the Matter of Sandell Asset Mgmt. Corp., Investment Advisers Act Rel. No. 2670 (Oct. 10, 2007), an investment adviser allegedly hedged exposure from a swap position through short sales. When the adviser was unable to locate shares to effectuate the short sale, it marked the short trade ticket as “long.” It

subsequently purchased shares in the open market at lower prices to cover the positions, generating proceeds that the firm used to offset its losses on its swap position, in violation of the then-valid “tick test” rule which provided that short sales may be effected only on a plus tick (i.e., at a price above the price at which the immediately preceding last sale was effected) or a zero-plus tick (i.e., at a price equal to the last sale if the last preceding transaction at a different price was at a lower price). The SEC alleged that the conduct violated Section 10(a) and the Exchange Act and Exchange Act Rule 10a-1 of the Exchange Act, and Section 17(a)(2) of the Exchange Act (offer or sale of securities by means of an untrue statement of material fact).

[3]

In SEC v. Lyon, No. 06 Civ. 14338 (SHS), 2008 U.S. Dist. LEXIS 9 (S.D.N.Y. Jan. 2, 2008), the district court dismissed a claim that a hedge fund adviser violated Section 5 of the Securities Act by allegedly short selling an issuer’s publicly traded securities during a period in which the adviser’s shares in unregistered Private Investments in Public Equities (“PIPEs”) could not be transferred. The court found that “a short sale of a security constitutes a sale of that security. How an investor subsequently chooses to satisfy the corresponding deficit in his trading account does not alter the nature of that sale.” The court concluded that buyers on the other side of the hedge fund’s short sale had the information required by the Securities Act with respect to the publicly traded securities. Construing a short-sale as a sale of the security eventually used to cover the short position would not further the purposes of Section 5.

[4]

The SEC’s theory that delivering previously restricted PIPE shares to close a short position transforms the short sale into a sale of unregistered securities has been rejected by other U.S. district courts. SeeSEC v. Berlacher, CA No. 07-CV-3800 (E.D. Pa. Jan. 23, 2008); SEC v. Mangan, 3:06-CV-531 (W.D.N.C. Oct. 25, 2007).

[5]

In another action involving PIPEs, SEC v. The NIR Group, LLC, 11-CV-4723 (E.D.N.Y. Sep. 28, 2011), the SEC charged an investment adviser with defrauding investors by repeatedly lying to them about the firm’s investments and trading strategy, e.g., about the liquidity of certain PIPE investments, to conceal the fact that these investments were failing during the financial

crisis. In addition, the adviser misused investor money by writing checks to pay for personal services and luxury items.

[6]

In In the Matter of AGB Partners LLC, Gregory A. Bied, and Andrew J. Goldberger, Investment Advisers Act Rel. No. 2977 (Jan. 26, 2010), the SEC charged an investment adviser with a violation of Regulation M where the short sales occurred in one account and purchases were made in a secondary offering by a different account. Although there is an exception in amended Rule 105 for trades that occur in different accounts, the SEC found that these transactions were not within the exception because of the close collaboration by the principals in the management of the two accounts. The firms and principals settled the charges, consenting to censure, disgorgement, and civil penalties.

[7]

The SEC announced an Order finding that in June 2008 and November 2008, Forrest Fontana, the sole owner of Fontana Capital, LLC, the investment adviser to as many as five hedge funds, willfully violated Rule 105 of Regulation M by participating in public offerings XL Group PLC (“XL Group”), Merrill Lynch and Company (“Merrill Lynch”) and Wells Fargo and Company (“Wells Fargo”) after having shorted each of these securities during the five business days prior to the pricing of the offerings, in violation of Rule 105 of Regulation M. By doing so, Fontana Capital obtained profits of $816,184. Fontana Capital was ordered to cease and desist from future violations of the Rule, and respondents were censured and ordered to pay disgorgement of $816,184 plus interest and a penalty of $165,000. In the Matter of Fontana Capital, LLC and Forrest Fontana, Investment Advisers Act Rel. No. 3233 (July 8, 2011).

[8]

Similar settled enforcement actions related to Regulation M include In the Matter of Harvest Capital Strategies LLC, Exchange Act Rel. No. 76144 (Oct. 14, 2015). In re Palmyra Capital Advisors LLC, Investment Advisers Act Rel. No. 2976 (Jan. 26, 2010), In re Carlson Capital, L.P., Investment Advisers Rel. No. 3086 (Sept. 23, 2010), and In the Matter of New Castle Funds LLC, Investment Advisers Act Rel. No. 3114, (Nov. 22, 2010).

[O] Code of Ethics

[P] Adviser and Fund Registration

[1]

In In the Matter of David Henry Disraeli and Lifespan Assocs., Admin. Proc. File No. 3-12288, Initial Decision Rel. No. 328 (Mar. 5, 2007), an ALJ found that an adviser with less than $25 million in assets was not eligible to register with the SEC as an investment adviser and that it had made material misrepresentations and omissions on its registration application. The principal for the adviser had registered with the SEC as an investment adviser between 1993 and 1997. After the enactment of NSMIA, the adviser voluntarily withdrew its registration because it had less than $25 million of assets under management. In 2003, the principal was advised that the Texas State Securities Board planned to oppose his application to register as an advisory representative of a state registered investment adviser based upon his disciplinary history. Therefore, the principal incorporated a successor to his previous advisory business and filed a Form ADV to register the new adviser with the SEC. The principal offered shares of the new adviser to the public.

In the new adviser’s registration application, the principal indicated that it was a newly formed adviser relying on Rule 203A-2(d) because he expected the adviser would have $25 million under management and therefore would be eligible for SEC

registration within 120 days. At the time of the application, the adviser had 25 accounts and $4 million in assets under management. The ALJ found that the adviser violated Sections 203A and 207 of the Investment Advisers Act because the principal filed a false Form ADV, did not have a “reasonable expectation” that it would meet the requirements of Rule 203A-2(d)(1) within 120 days, and because the adviser was precluded from registering with the SEC because it had less than $25 million assets under management. The ALJ further found that the principal formed the adviser and registered it with the SEC so that he could continue to do business as an investment adviser without approval from the Texas State Securities Board. The ALJ determined to revoke the principal’s investment adviser registration, bar him from association with a broker, dealer or investment adviser, order the principal and the adviser to cease and desist from future violations, disgorgement of all offering proceeds, and imposed a civil penalty of $120,000.

[2]

In In the Matter of Warwick Capital Mgmt., Inc. and Carl Lawrence, Investment Advisers Act Rel. No. 2694 (Jan. 16, 2008), the SEC issued an opinion affirming the Division of Enforcement’s allegations that an adviser and its president reported false information about the investment adviser’s assets under management and inflated performance results provided to database services that published the information. The SEC found that the adviser’s overstatement of assets on its ADV permitted it to retain it registration while maintaining less than $25 million of assets under management, in contravention of Section 203A of the Advisers Act. The misstatement of assets on the Form ADV also violated Section 207 of the Advisers Act, which makes it unlawful for any person to willfully make an untrue statement of material fact or to omit to state a material fact required to be stated in applications or reports to the SEC. The deliberate inflation of performance figures to database services additionally misrepresented a material fact to current and prospective investors, thereby violating Sections 206(1), 206(2) and 206(4) of the Advisers Act. The SEC issued cease and desist orders and barred the adviser’s president from any future association with any investment adviser.

[3]

In SEC v. UBS AG, 09-CV-00316 (JR) (D.D.C. Sept. 23, 2010), UBS AG was charged with violating Section 15(a) of the

Exchange Act and Section 203(a) of the Investment Advisers Act in connection with the provision of services to U.S. clients which assisted the clients’ maintenance of undisclosed offshore accounts and avoiding taxes. The bank employed offshore client advisers in this role who were not associated with a registered investment adviser in the U.S. The SEC alleged that the bank was aware of its registration violations and concealed the conduct. UBS agreed to disgorge $200 million and consented to an injunction against future violations. UBS also entered into a deferred prosecution agreement, agreeing to pay $180 million in disgorgement and $400 million in tax-related payments.

[4]

In a rare and possibly unprecedented enforcement action, the SEC revoked the registration of a Georgia-based investment adviser and transfer agent with no clients, revenue or assets under management in In the Matter of Freedomtree Mutual Funds and Asset Mgmt., LLC, Investment Advisers Act Rel. No. 3202 (May 13, 2011). The SEC found that the adviser made false statements to the SEC regarding the amount of assets under management. Between August 2008 and November 2009, the adviser claimed to have $7 million, $25 million, and eventually $235 million in assets under management. In reality, the adviser had no advisory clients, revenues or assets that would require or permit registration with the SEC. In addition, despite indicating on its initial Form ADV that it was a newly formed adviser, the adviser represented on its website that it had “27+ years of unparalleled leadership” in the industry. After the adviser and transfer agent failed to appear at routine examinations and other scheduled meetings with the SEC, the owner eventually admitted that the adviser had no advisory clients or revenue. The SEC found that the conduct violated various fraud and recordkeeping provisions of the Advisers Act, as well as Section 17(b)(1) and 17A(d)(1) of the Securities Exchange Act and Rule 17Ad-6 thereunder. In a default judgment against the respondents, due to a failure to answer or otherwise defend the proceeding, the SEC revoked the registration of the adviser and the transfer agent, and ordered each to pay a civil penalty of $325,000.

[5]

See also In the Matter of Anthony Fields, supra (registrant falsely indicated on its Form ADV that it had $400 million under management) and In the Matter of Delta Global Advisers

and Charles P. Hanlon, Investment Advisers Act Rel. No. 3282, Investment Co. Act Rel. No. 29795, (Sept. 20, 2011) (registrant misrepresented in its Form ADV that it was eligible for SEC registration on the basis that it served as an investment adviser to a registered investment company).

[6]

In In the Matter of Sands Brothers Asset Mgmt., LLC, Investment Advisers Act Rel. No. 3099 (Oct. 22, 2010), an adviser and its principals settled claims that inaccurate and outdated Form ADV disclosure violated Sections 204 and 207 of the Advisers Act and Rule 204-1 under the Act, in addition to claims that they failed to comply with numerous recordkeeping provisions and that they failed to comply with the custody rules. Among other inaccuracies, the Form ADV indicated that the adviser did not have custody of client assets. Also the adviser failed to file an annual update for its Form ADV. Although the adviser sought to take advantage of the exception in the custody rule that does not require quarterly client account statements if fund investors receive audited financial statements, the fund financial statements had a disclaimer of auditor’s opinion, rather than the required opinion. The adviser agreed to an undertaking to engage an independent compliance consultant and to pay a $60,000 penalty, and all the respondents agreed to a cease and desist order and censure.

In October 2014, the SEC again instituted proceedings against the investment adviser and its principals for failing to comply with both the Custody rule and with the SEC’s 2010 order. The adviser, in the years that followed, did not submit to a surprise examination, did not distribute its audited financials within the 120-day window, and took no remedial action to implement policies or procedures designed to ensure compliance with the custody rule. The SEC alleged, in particular, that the Chief Compliance Officer did not effectively oversee compliance with the Custody rule and made no attempts to notify the SEC of any difficulties that the adviser was encountering in meeting its deadlines. In the Matter of Sands Brothers Asset Management, LLC, Investment Advisers Act Rel. No. 3960 (Oct. 29, 2014).

In November 2015, the adviser settled with the SEC, agreeing to pay a $1 million penalty and consenting to a yearlong suspension from raising money from new or existing investors. The adviser also agreed to engage an independent monitoring

firm for a period of three years. In the Matter of Sands Brothers Asset Management, LLC, Investment Advisers Act Rel. No. 4273 (Nov. 19, 2015).

[7]

In SEC v. Cowgill, Case No. 2:14 CV 396 (S.D. Ohio Filed May 5, 2014), the SEC continued its enforcement of the Custody rule by bringing suit against an investment adviser and its Chief Compliance Officer. The Custody rule requires advisers who are in custody of client funds implement controls to protect the assets from misappropriation, loss, or the adviser’s insolvency. A qualified custodian should maintain the assets and the adviser should give notice to the clients regarding how the funds are held. The Custody rule also requires a surprise accounting inspection once a year and the filing of Form ADV. From 2010 to 2013, the adviser did not file any such forms with the SEC. When confronted by the SEC in September 2013, the Chief Compliance Officer dismissed the failing as an administrative error and stated that the investment adviser was withdrawing from the SEC to register with the State of Ohio. The adviser never registered with Ohio, yet continued to have custody of client funds. A November 2013 exam by the SEC found that client balances were consistently overstated for one fund. The Chief Compliance Officer allegedly altered the accounts, provided the staff with false reports and took additional steps to conceal the shortfall in the funds.

In June 2014, a consent judgment was entered against the Chief Compliance Officer permanently restraining him from violating Section 10(b) of the Exchange Act and Section 203(a), 204(a), 206(1), (2), and (4) and 207 of the Advisers Act and Rules 204-2, 206(4)-2, and 206(4)-7 thereunder. He was also ordered to pay disgorgement and a civil penalty to be determined by the court upon motion of the SEC.

[8]

The SEC has also pursued registration claims against unregistered investment companies.

[9]

The Commission brought its first enforcement action against a private equity adviser for failing to register as a broker-dealer in order to receive portfolio company transaction fees. In In the Matter of Blackstreet Capital Management, LLC. And Murry N. Gunty, Securities Exchange Act Rel. No. 77959, Investment Advisers Act Rel. No. 4411 (June 1, 2016), the Commission found that a private equity fund advisory firm and its owner performed its own brokerage services, including acquiring and disposing portfolio companies, instead of engaging an investment bank or broker-dealer to perform brokerage services. The advisory firm failed to properly register as a broker-dealer. In addition, the Commission found that the advisory firm failed to properly disclose fees and expenses, and engaged in conflicted transactions. The advisory firm was censured, and the firm and its owner agreed to pay $2.339 million in disgorgement, $283,737 in interest, as well as a $500,000 penalty.

[Q] Broker Interpositioning

[1]

In In the Matter of Kelmoore Investment Company, Inc., Investment Advisers Act Rel. No. 2581 (Jan. 18, 2007), the SEC alleged that an investment adviser understated the total fees it charged for managing mutual funds because it did not disclose that its advisory fee of 1% of assets under management did not include the brokerage commissions that the dually registered adviser/broker-dealer charged. The provision of brokerage charges, the SEC alleged, in the context of providing advice to mutual funds, would be deemed advisory services. The SEC alleged that adviser’s disclosures were misleading and had the effect of obscuring the full cost of the investment advisory services. On the basis of these deficiencies, the adviser was found to have willfully violated Section 17(a)(3) of the Securities Act (transaction, practice or course of business which operates or would operate as a fraud or deceit upon shareholders), Section 34(b) of the Investment Company Act (untrue statements of material fact in a prospectus) and ordered to pay a $100,000 civil penalty, engage a consultant to review its advisory fees and commissions and the relevant rules and regulations governing fees and commissions, submit a copy of the consultant’s report to the SEC, mail a copy of the Order to each of the fund shareholders; and post a link to the Order on the adviser’s website for one year.

[2]

In In the Matter of Value Line, Inc., Investment Advisers Act Rel. No. 2945 (Nov. 4, 2009), the SEC charged an investment adviser, its broker-dealer, its President and its Chief Compliance Officer with violations of Section 17(a) of the Securities Act, Section 10(b) and Rule 10b-5 of the Exchange Act, Sections 206(1) and (2), and 207 of the Investment Advisers Act, and Sections 15(c), 17(e)(1), and 34(b) of the Investment Company Act in connection with the use of an interpositioned broker-dealer for mutual fund trades. The SEC alleged that the adviser arranged for unaffiliated brokers to execute, clear, and settle trades for funds at discounted commission rates but nonetheless charged the funds undiscounted rates. The unaffiliated brokers were allegedly instructed to charge the fund $0.488 per share and rebate $0.288 to $0.0388 per share to the affiliated broker-dealer. The SEC further alleged that the adviser failed to disclose the commission recapture program to shareholders or the funds’ board. Without admitting or denying the allegations,

the adviser consented to the issuance of an administrative order, censure, a cease and desist order, and $24,168,979 in disgorgement, $9,536,786 in interest, and a $10 million penalty. The officers agreed to a penalty of $1 million and $250,000 and were permanently barred from further association with any broker, dealer, investment adviser, or investment company.

[3]

See also In the Matter of Portfolio Advisory Services, LLC, and Cedd L. Moses, Investment Advisers Act Rel. No. 2038 (June 20, 2002) (adviser interposed broker-dealer between clients and market maker to compensate broker-dealer for referrals to adviser).

[R] Section 13 Filings

[S] Portfolio Pumping

[1]

In In the Matter of MedCap Mgmt. & Research LLC and Charles Frederick Toney, Jr., Investment Advisers Act Rel. No. 2802 (Oct. 16, 2008), Charles Toney, who through the registered investment adviser, MedCap Management & Research LLC (“MMR”) managed the hedge fund, MedCap Partners, L.P. (“MedCap”), allegedly violated various anti-fraud provisions under the securities laws by engaging in “portfolio pumping” to inflate the fund’s reported value. The SEC alleged that Toney drove up the price of a thinly-traded over the counter Bulletin Board stock in which MedCap was heavily invested by placing large orders for the stock through a separate, off-shore fund he managed. The SEC asserted that MMR’s conduct violated Sections 206(1) and 206(2) of the Advisers Act, as the adviser allegedly breached its fiduciary duties both to MedCap, which paid higher management fees due to the inflated quarter-end asset value, and to the off-shore fund used to purchase the OTC stock, which paid artificially inflated share prices. The SEC additionally alleged that Toney, who handled all of MMR’s investment decisions, aided and abetted MMR’s violations. Without admitting or denying the allegations, MMR and Toney consented to cease and desist orders, the censure of MMR, a bar order prohibiting Toney’s association with any investment adviser, approximately $70,000 in disgorgement and interest, and a civil monetary

penalty of $100,000. See alsoSEC v. Lauer, No. 03-80612-Civ., 2008 U.S. Dist. LEXIS 73026 (S.D. Fla. Sept. 24, 2008).

[2]

The SEC charged two securities professionals, a hedge fund trader, and two firms involved in a scheme that manipulated several U.S. microcap stocks and generated more than $63 million in illicit proceeds through stock sales, commissions and sales credits. SEC v. Todd M. Ficeto, CV-11-1637 GHK (Rzx) (C.D. Cal. Feb. 24, 2011). They allegedly engaged in “portfolio pumping” by taking microcap companies public through reverse mergers, and manipulating the stock prices upward before selling shares at magnified prices, one of the co-conspirators succeeded in overstating his hedge funds’ performance by at least $440 million. They concealed their communications in order to place matched orders, orders that set the closing price for the day, and conducting wash sales. One of the professionals, a compliance officer, agreed to a $20,000 penalty and a one-year suspension from being a supervisor with a broker or dealer.

[T] Civil Penalties

[1]

Monetary Penalties for Aiding and Abetting Liability Under Advisers Act 209(e)

In May 2008, in a case of first impression, a federal district court held that the SEC lacked authority to seek monetary penalties against secondary violators of the Advisers Act. In SEC v. Bolla, 519 F. Supp. 2d 76 (D.D.C., May 6, 2008), the U.S. District Court for the District of Columbia held that Section 209(e) of the Advisers Act, as then in effect, did not grant the SEC the authority to seek, or the Court jurisdiction to impose, monetary penalties for aiding and abetting violations of the Advisers Act. The Court had previously determined that the defendant, an executive of an investment adviser, had aided and abetted the adviser’s violation of Sections 203(f), 206(1) and 206(2) of the Advisers Act.

The Dodd-Frank Act effectively reversed this result. See discussion under Statutory Basis of SEC Enforcement Proceedings against Investment Advisers.

[2]

Application of the “Discovery Rule” to SEC’s Claims for Civil Penalties

In Gabelli v. SEC, 133 S. Ct. 1216 (2013), the United States Supreme Court ruled that the statute of limitations barring the Securities and Exchange Commission (“SEC”) from seeking civil penalties more than five years from the date a claim accrued begins to run when the fraud occurs and is not subject to the discovery rule. The SEC’s action related to allegations of market timing that had concluded in 2002. In 2008, however, the SEC sought civil penalties for market timing, arguing that the “discovery rule” applied to extend the statute of limitations. The Supreme Court rejected the SEC’s argument, holding that a claim accrues when the fraud occurs and that the discovery rule does not apply to delay accrual. The Court noted that using the date the fraudulent conduct occurred as the accrual date is the most natural reading of the statute because it advances “the basic policies of all limitations provisions.”

The Court rejected the SEC’s attempt to apply the discovery rule to the five-year statute of limitations. First, the Court explained that there was no precedent for such an action because it had never applied the discovery rule to delay accrual of the statute of limitations in a Government enforcement action for civil penalties. Unlike a private party who is not in a constant state of investigation or continuously searching for evidence of fraudulent activity, the SEC’s central mission is to “investigat[e] potential violations of the federal securities laws” and it is well equipped with the legal tools to assist in its mission. For this reason, the SEC does not resemble the “defrauded victim” the discovery rule is designed to protect. Applying the discovery rule, however, would leave defendants exposed to liability for an uncertain amount of time. Furthermore, determining when the statute of limitations accrued under the discovery rule (e.g., when the Government knew or should have known of a claim) would be difficult to ascertain in the context of federal agencies because of their size, multiple offices, levels of leadership, and overlapping responsibilities.

[3]

Application of Civil Monetary Penalty Provisions of Section 20(d) of the Securities Act and Section 209(e) of the Investment Advisers Act

In SEC v. Reserve Mgmt. Co., Inc., Case No. 09 Civ. 4346 (PGG) (S.D.N.Y. Sept. 30, 2013), the district court denied the SEC’s application for substantial penalties against the adviser

and a fund officer of the Primary Fund, a money market fund that “broke the buck” after Lehman, Inc. filed for bankruptcy on September 15, 2008. At the time of the bankruptcy filing, the Primary Fund held $785 million in Lehman commercial paper. Shareholders besieged the Fund, seeking to redeem their shares. Before the markets opened on the date of the bankruptcy filing, the Fund had received $5 billion in redemption requests. By noon, the Fund’s custody bank had processed $10 billion in redemptions and stopped funding redemption requests.

During the initial hours after Lehman filed for bankruptcy, the adviser to the Primary Fund prepared a marketing piece expressing its intention to support the net asset value (NAV) of the Fund, but ultimately could not support the NAV in light of the massive redemptions. By the time the adviser concluded it could not support the NAV, it already had distributed 200 copies of the marketing piece to investors.

Against the adviser, the SEC sought a $130 million penalty, which represented $650,000 penalty for each of 200 copies of the marketing piece that had been distributed to investors. The court denied the SEC’s motion, noting that “third tier penalties” require proof of substantial losses or significant risk of substantial losses to other persons. The SEC could not meet this standard because there was no connection between the false marketing piece and investor losses, which the court observed were the result of the Lehman bankruptcy and not a “false message of support.” The court opted to award a “second tier penalty” for a single act, stating: “These entities were in business for decades and committed few regulatory violations. Their wrongful conduct took place over a period of less than 36 hours and during a time of enormous economic stress. Indeed, these defendants confronted conditions not seen since the Great Depression. The markets were in chaos and the ramifications of Lehman’s bankruptcy were not initially well understood, even by sophisticated fund managers and Government regulators. Finally, these entities are now defunct.”

The district court also rejected the SEC’s request for first tier penalties – totaling $1.3 million – against the Fund’s president. The court noted that the jury had rejected every charge of scienter against the officer and found him liable on only a single violation based on negligent conduct. In light of the circumstances, the court imposed a civil monetary penalty of $100,000.

The court further denied the SEC’s request for an injunction against all of the defendants from committing future violations of the statutes that the jury found the defendants had violated. The court concluded that a permanent injunction was not warranted. The corporate entities and the adviser were defunct and not reasonably likely to commit future violations. The corporate entities had operated for several decades without significant regulatory sanction, rendering the events surrounding the collapse of the Primary Fund “isolated occurrence[s].” With respect to the Fund officer, the court concluded that he had engaged in negligent conduct for a short period of 36 hours and had no track record of misconduct. For these reasons, the court concluded that no injunctive relief was appropriate with respect to that officer.

[U] The 2008 Collapse of the Auction Rate Market

[1]

In 2009, the SEC filed an action against Morgan Keegan alleging misrepresentations concerning the liquidity of auction rate securities (“ARS”). Morgan Keegan contested the SEC’s case and on June 28, 2011, prevailed when the Northern District Court in Georgia granted Morgan Keegan’s motion for summary judgment and dismissed the SEC’s action, finding that the SEC failed to produce sufficient evidence that the defendant had a policy of misstating the risks of ARS. SeeSEC v. Morgan Keegan & Co., Inc., 806 F. Supp. 2d 1253 (N.D. Ga. 2011). The SEC had alleged that brokers advised customers that ARS were safe, highly liquid securities akin to money market funds even as the market for ARS was collapsing. In support of its allegations, the SEC presented testimony from four customers who stated that brokers told them the ARS were safe. The district court granted Morgan Keegan’s motion for summary judgment. The district court analyzed Morgan Keegan’s distribution of its written disclosures about liquidity risk and concluded they were adequately distributed. Id. at 1260-62. As to materiality, the district court noted that the moral misrepresentations were not immaterial because proper written disclosures existed, but the “oral statements of four brokers out of hundreds would not lead a rational jury to believe that Morgan Keegan, as a whole,

misrepresented the risks of ARS investments to its customers.” Id. As 1265.

On appeal, the United States Court of Appeals for the Eleventh Circuit vacated and remanded. SEC v. Morgan Keegan & Co., Inc., 678 F.3d 1233 (11th Cir. 2012). The court concluded that brokers’ representations must be assessed in the “total mix” of information available to reasonable investors. A review of Morgan Keegan’s oral and written disclosures, the court concluded, was an issuer for the trier of fact. The court stated: “The way information is disclosed can be as important as its content. Thus, in evaluating the effect of Morgan Keegan’s written disclosures, we must consider not only the content of the written disclosures but also the way in which the disclosures were made. After record review, we conclude that, even if a brokerage company’s written disclosures might render its individual brokers’ oral misstatements immaterial in some cases, Morgan Keegan’s manner of distribution of its written disclosures in this particular case was insufficient to warrant summary judgment for Morgan Keegan.”

[2]

Also in 2011, the SEC settled an action against Raymond James & Associates and Raymond James Financial Services for allegedly misstating the liquidity of ARS and failing to adequately disclosure the risks of ARS and their dependence on auctions for liquidity. In the Matter of Raymond James & Assoc., Inc., Securities Act Rel. No. 9228, Investment Advisers Act Rel. No. 3227 (June 29, 2011). Among other things, representatives did not provide customers with adequate and complete disclosures regarding the complexity and risks of ARS, including their dependence on successful auctions for liquidity. Raymond James agreed to a settlement that allows its customers the opportunity to sell back to the firm any ARS that they bought prior to the collapse of the ARS market in February 2008.

[3]

State regulators separately have pursued ARS issuers and dealers. In 2009, NYAG Cuomo sued Charles Schwab & Co., Inc. for alleged violations of Executive Law Section 63(12) of the Martin Act, and General Business Law Section 349, accusing the company of falsely describing ARS as liquid investments without disclosing the risks. On October 31, 2011, the New York Supreme Court granted Schwab’s motion to dismiss, finding that the complaint is “devoid of any allegation of

misrepresentations made that were untrue when made.” SeeThe People of the State of New York v. Charles Schwab & Co., Inc., No. 453388/09 (N. Y. Co. Sup. Ct. Aug. 17, 2009, amended Oct. 31, 2011).

See also Assurance of Discontinuance, In the Matter of TD Ameritrade, Inc. (N.Y. Co. Sup. Ct. July 20, 2009) (alleging violations of the Martin Act, Section 349 of the General Business Law, and Section 63(12) of the Executive Law); The People of the State of California v. Wells Fargo Investments, LLC, Case No. CGC 09-487641 (S.F. Co. Super. Ct., Apr. 23, 2009) (alleging violations of Sections 25401 and 25216 of the California Corporations Code).

[V] Rumor-Mongering

[W] Disclosures Regarding Selection Criteria for Advisers

[1]

In In the Matter of Morgan Stanley & Co., Investment Advisers Act Rel. No. 2904 (July 20, 2009), the SEC alleged that Morgan Stanley breached its fiduciary duty to clients by recommending managers in a manner inconsistent with its disclosures regarding the criteria it applied in the selection and approval of money managers for participation in its managed account program, in violation of Sections 206(2), 204, and 203(e)(6) of the Investment Advisers Act and Rules 204-2(a)(7) and 204(2)(a)(10) of the Investment Advisers Act. Morgan Stanley allegedly recommended money managers who were not part of the firm’s managed account program and who had not been subject to Morgan Stanley’s due diligence process. Financial advisers allegedly received commissions for transactions with unapproved managers, which was an undisclosed conflict of interest. Without admitting or denying the allegations, Morgan Stanley agreed to a censure, a cease and desist order for further violations of Sections 204, 206(c), and Rules 204-2(a)(7) and 204-2(a)(10) of the Investment Advisers Act, and a fine of $500,000.

[2]

See also In the Matter of Hennesee Group LLC and Charles J. Gradante, Investment Advisers Act Rel. No. 2871 (Apr. 22, 2009, amended Mar. 31, 2011) (adviser’s failure to perform due diligence on hedge fund as represented to investors); In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Investment Advisers Act Rel. No. 2834 (Jan. 30, 2009) (adviser’s misleading pension fund clients about adviser’s money manager identification process); and In the Matter of Jeffrey Swanson, Investment Advisers Act Rel. No. 2835 (Jan. 30, 2009) and In the Matter of Michael A. Callaway, Investment Advisers Act Rel. No. 2833 (Jan. 30, 2009) (Merrill Lynch investment advisory representatives allegedly involved in adviser’s misleading pension fund clients).

[X] Misstatements to Regulators

[1]

In In the Matter of Diane M. Keefe, Admin. Proc. File No. 3-13337, Initial Decision Rel. No. 374 (Apr. 3, 2009) the SEC filed an administrative complaint against a portfolio manager for violations of Section 34(b) of the Investment Company Act in connection with the creation of false investment committee notes. The portfolio manager allegedly fabricated notes for

investment committee meetings that did not take place, then forwarded the notes to the investment adviser’s headquarters, in response to an OCIE examination. The SEC alleged that the fabricated notes, which purported to record three-way conversations regarding investment advice, were “untrue statements of material facts.” An ALJ found that Ms. Keefe willfully violated Section 34(b) and she was suspended from association with an investment adviser or broker-dealer for 12 months. Keefe appealed the ALJ’s decision, and on April 10, 2010, an order was issued remanding the action to an ALJ for further fact-finding and examination of witnesses. In the Matter of Diane M. Keefe, Rel. No. 61928, Investment Advisers Act Rel. No. 3016, Investment Co. Act Rel. No. 29207 (Apr. 16, 2010).

[2]

In In the Matter of Thrasher Capital Mgmt., LLC and James Perkins, Investment Advisers Act Rel. No. 3108 (Nov. 16, 2010), the SEC alleged that the Chief Executive Officer and managing member of an investment adviser failed to make available to the Commission’s staff books and records that he was required to make available under Section 204 of the Advisers Act. In fact, Respondents failed to produce for inspection any files whatsoever until the Commission’s Enforcement staff issued a subpoena for such records. In addition, the SEC alleged that the firm’s Form ADV contained untrue statements of material facts concerning its client base and the ownership of the adviser in violation of Section 207 of the Advisers Act. The Order found that the adviser willfully violated Sections 204(a) and 207 of the Advisers Act and that its Chief Executive Officer willfully aided and abetted and caused the firm’s violations of Sections 204(a) and 207 of the Advisers Act. The Order required respondents to cease and desist from committing or causing any violations or future violations of Sections 204(a) and 207 of the Advisers Act, suspended the Chief Executive Officer from association with any investment adviser for nine months and revoked the firm’s registration as an investment adviser. Respondents consented to the issuance of the order without admitting or denying any of the findings.

[3]

On June 30, 2011, the District Court for the District of Rhode Island granted the SEC’s motion for summary judgment and entered a final judgment against Locke Capital Management, Inc., an investment adviser and Leila C. Jenkins, its founder and

sole owner who served as its President, Chief Executive Officer, and Chief Investment Officer, in SEC v. Locke Capital Mgmt., Inc. and Leila C. Jenkins, 09-CV-100-WES (D. R.I. Mar. 9, 2009). The Complaint alleged that Locke and Jenkins invented a billion-dollar client in order to gain credibility and attract legitimate investors; tried to perpetuate the scheme by lying to the SEC about the existence of the fictitious client and furnishing the staff with fake documents in 2008; and claimed that the “confidential” client accounts that she invented and managed contained more than $1 billion in assets. From 2003 to 2009, lies about the fake accounts were made in brochures, meetings, submissions to online databases that prospective clients used to select money managers, and in SEC filings. In addition, the SEC alleged Jenkins also misrepresented Locke’s performance for years and deceived clients about the makeup of the firm. See also In the Matter of Locke Capital Mgmt., Inc., Investment Advisers Act Rel. No. 3234 (July 8, 2011); In the Matter of Leila C. Jenkins, Investment Advisers Act Rel. No. 3235 (July 8, 2011) (order instituting administrative proceedings against defendant for her role in the scheme described above).

[4]

The SEC settled with an auditing and accounting firm and its founder on charges that the auditor failed to comply with auditing standards. In In the Matter of Sam Kan, CPA and Sam Kan & Co., Securities Exchange Act Rel. No. 71585 (Feb. 20, 2014), the SEC cited numerous violations of the Public Company Accounting Oversight Board (“PCAOB”) standards. According to the order, the auditor failed to comply with requirements for engagement quality reviews because the engagement quality reviewer served as the engagement partner during one of the two previous audits. The firm also failed to follow up on subsequent events by reviewing documents and interviewing relevant employees of the companies. The founder also failed to properly document the evaluation of financial statements, failed to properly supervise audits conducted by staff, and did not obtain sufficient evidence to support audit findings. In addition to these cited failings, the SEC also found that each audit report was falsified because the auditor falsely claimed the audits were conducted in accordance with PCAOB standards. The order required the firm and its founder to pay $40,000 in disgorgement and a $40,000 civil penalty. In addition, the founder was denied the privilege of practicing before the Commission and

could be eligible for re-admittance only after three years and the hiring of an independent CPA consultant. See alsoSEC v. Hovan, CV11-4795 (N.D. Cal. Sept. 28, 2011).

[Y] Anti-Money Laundering Rules and FCPA

[1]

In In re Pinnacle Capital Markets LLC and Michael Paciorek, Lit. Rel. No. 62811 (Sept. 1, 2010), the SEC charged Pinnacle with failing to comply with an anti-money laundering rule that requires broker-dealers to identify and verify the identities of its customers and document its procedures for doing so. The SEC also charged Pinnacle’s managing director Michael A. Paciorek with causing Pinnacle’s violations. The SEC found that Pinnacle established, documented and maintained a customer identification program (“CIP”) that specified it would identify and verify the identities of all of its customers. However, during a six-year period, Pinnacle failed to follow the identification and verification procedures set forth in its CIP, leading to significant money-laundering risks. The SEC’s order found that Pinnacle willfully violated Section 17(a) of the Securities Exchange Act and Rule 17a-8 thereunder. Pinnacle and Paciorek agreed to settle the action without admitting or denying the allegations, and Pinnacle agreed to pay $25,000 in financial penalties. As part of an action taken by FINRA in February 2010, Pinnacle also agreed to certain undertakings, including extensive AML training for its employees, as well as the hiring of an independent consultant to review its anti-money laundering compliance program.

[2]

The SEC charged Garth Peterson, a former executive at Morgan Stanley’s real estate investment and fund advisory business, with violating the Foreign Corrupt Practices Act and Sections 206(1) and (2) of the Advisers Act by acquiring real estate investments for himself and a Chinese official who referred business to the Morgan Stanley funds. Peterson, among other things, made undisclosed arrangements for the funds to pay finders’ fees that were actually payments to himself and the Chinese official and to transfer a real estate interest to himself and the Chinese official. Peterson settled the SEC’s charges by paying disgorgement of over $250,000, relinquishing the real estate interest (valued at over $3 million) and agreeing to an industry bar. SEC v. Peterson, 12-CV-2033 (E.D.N.Y. Apr. 25, 2012), Lit. Rel. No. 22346.

[Z] Pay-to-Play

[1]

The SEC pursued its first case under pay-to-play rules for investment advisers, which was created in 2010 by the Dodd-Frank Act. In In the Matter of TL Ventures Inc., Investment Advisers Act Rel. No. 3859 (June 20, 2014), the SEC alleged that an investment adviser violated Sections 203(a), 206(4), and 208(d) of the Advisers Act and Rule 206(4)-5. The SEC also filed an administrative action against a related investment adviser. In re Penn Mezzanine Partners Mgmt., L.P., Investment Advisers Act Rel. No. 3858 (June 20, 2014). The pay-to-play rule prevents advisers from providing paid advisory services to a government client or an investment vehicle where the government invests for two years after a covered employee makes a campaign contribution. An unregistered investment adviser would not be subject to this rule. However, the investment adviser and its related entity were under common control and operationally commingled such that they should have been analyzed for exemption together. Since the combination of both entities would have mandated registration, the investment adviser was required to abide by the pay-to-play rule. However, a covered employee of the adviser made contributions to candidates for Mayor of Philadelphia and Governor of Pennsylvania. Since these two elected positions had the ability to appoint officials to state boards that managed funds within the adviser’s control, the pay-to-play rule was violated.

The adviser, without admitting or denying the allegations, settled with the SEC and agreed to a cease and desist order, a censure, a disgorgement of $256,697, and a $35,000 civil penalty.

[2]

In SEC v. Henry Morris, David Loglisci, Nosemote LLC, Pantigo Emerging LLC and Purpose LLC, 09-CV-2518 (S.D.N.Y. Mar. 19, 2009), the SEC alleged that David Loglisci, former Deputy Comptroller and Chief Investment Officer of the New York State Common Retirement Fund, and Henry Morris, the top political advisor and chief fundraiser for former New York State Comptroller Alan Hevesi, extracted kickbacks from investment management firms seeking to manage the assets of the New York State Common Retirement Fund, resulting in violation of Sections 10(b) and 20(e), and Rule 10b-5 of the Exchange Act, as well as Section 17(a) of the Securities Act and Sections 206(1) and 206(2) of the Investment Advisers Act. In

its complaint, the SEC alleged that Loglisci repeatedly directed investment managers to Morris or certain other individuals and signaled to the investment managers that they first needed to “hire” Morris or the other individuals as a “finders” or “placement agents.” The complaint contends that Loglisci rewarded those firms that paid the placement agent fees with lucrative contracts, while denying fund business to those who refused. The SEC further alleged that the Loglisci and Morris concealed the improper payments from the Comptroller’s investment staff and fund’s Investment Advisory Committee by funneling payments through a third party. The SEC is seeking a permanent injunction against future violations, disgorgement, interest, and civil penalties.

[3]

In April 2010, in a related matter, the SEC charged Quadrangle Group LLC and Quadrangle GP Investors II, L.P. in connection with the kickback to obtain investments from the Retirement Fund. SEC v. Quadrangle Group LLC and Quadrangle GP Investors II, L.P., No. 10-CV-3192 (S.D.N.Y Apr. 15, 2010). The SEC alleged that the Quadrangle defendants entered into undisclosed financial arrangements that benefited Morris and Loglisci in order to win investment business from the Retirement Fund, including payment of placement agent fees. The Quadrangle defendants settled the SEC’s charges without admitting or denying the allegations; they consented to the entry of a judgment that permanently enjoins them from violating Section 17(a)(2) of the Securities Act and agreed to pay a $5 million penalty.

[4]

In November 2010, in another related matter, the SEC charged former Quadrangle Group principal, Steven Rattner, with participating in the kickback scheme to obtain investments from the Retirement Fund, including payment of political contributions. Rattner settled the SEC’s charges without admitting or denying the allegations; he consented to the entry of a judgment that permanently enjoins him from violating Section 17(a)(2) of the Securities Act and agreed to pay $3.2 million in disgorgement and a $3 million penalty; and he further consented to a two-year bar from associating with any investment adviser or broker-dealer. SEC v. Steven L. Rattner, 10 CV 8699 (S.D.N.Y. Nov. 18, 2010). See also Political Contributions by Certain Investment Advisers, Investment Advisers Act Rel. No. 3043, July 1, 2010, adopting

rules to curtail investment advisers’ making contributions or other payments to elected officials to influence contracts for the management of public pension plans.

[5]

Among the numerous actions related to this matter on the New York state side, Morris pleaded guilty to a felony violation of the Martin Act, a class E felony, and agreed to forfeit $19 million and be permanently barred from the securities industry in New York. On February 17, 2011, he was sentenced to four years in prison. See NYAG Press Release, available at http://www.ag.ny.gov/media_center/2011/feb/feb17a_11.html. NYAG Cuomo, in a November 22, 2010 press release announcing the Morris guilty plea, noted that his investigation of corruption at the Retirement Fund had led to eight guilty pleas and agreements with 16 firms (including Quadrangle, other private fund firms and a law firm) and three individuals and had produced more than $158 million in recoveries for the state. See NYAG Press Release, available at http://www.ag.ny.gov/media_center/2010/nov/nov22a_10.html.

On November 18, 2010, NYAG Cuomo filed two lawsuits related to the Retirement Fund against Rattner - one seeking forfeiture of $19 million and the other under the Martin Act and the New York Executive Law, seeking various remedies, including civil penalties and a lifetime bar from the securities industry in New York. A deal was reached on December 30, 2010, in which Rattner agreed to pay $10,000,000 in restitution to the State of New York and be banned from appearing in any capacity before any public pension fund within the State of New York for five years. The agreement ended the two lawsuits previously filed against Rattner by NYAG Cuomo relating to the pay-to-play scheme. Cuomo also secured settlements with several of the investment firms involved in the scheme in December 2010. See NY AG Press Release, available at http://www.ag.ny.gov/media_center/2010/dec/dec15a_10.html. In addition, on April 15, 2011, former New York comptroller Alan Hevesi was sentenced to four years in prison his role in the pay-to-play scheme, after pleading guilty to accepting nearly $1 million in exchange for approving $250 million in pension fund investments. See NYAG Press Release, available at http://www.ag.ny.gov/media_center/2011/apr/apr15a_11.html.

[AA] Board Oversight of Funds

[1]

In June 2013, the Directors of five Morgan Keegan bond funds agreed to a cease and desist order from committing or causing any violations or future violations of Rule 38a-1 of the Investment Company Act of 1940. The SEC alleged that the Directors caused the Funds’ violation of Rule 38a-1 of the Investment Company Act in connection with the adoption and implementation of written policies and procedures reasonably designed to prevent violation of the federal securities laws by the funds, including procedures providing for the oversight of compliance of the fund’s investment adviser.

In particular, the SEC alleged that the Directors did not specify a fair valuation methodology pursuant to which below-investment grade debt securities should be valued, did not continuously review how each issue of security in the funds’ portfolios were valued, and delegated their responsibilities to determine fair value to the adviser’s Valuation Committee without providing “meaningful substantive guidance on how those determinations should be made.” The SEC further alleged that the Directors did not learn how fair values were actually determined, and had received only limited information on the factors the adviser considered in making fair value determinations. The fair valued securities accounted for “upwards of 60%” of the funds’ net asset values between January 2007 and August 2007. In the Matter of J. Kenneth Alderman, et al., Investment Co. Act Rel. No. 30557 (June 13, 2013).

[2]

In In the Matter of Northern Lights Compliance Services, LLC, Investment Co. Act Rel. 30502 (May 2, 2013), the SEC brought disclosure, reporting, recordkeeping and compliance charges against the trustees, the administrator that prepared shareholder reports and drafted meeting minutes, and a compliance affiliate that provided CCO services and administered the compliance program for two open-end series trusts. The trusts included up

to 71 series managed by different, unaffiliated advisers and sub-advisers. In the order instituting proceedings, in which the defendants neither admitted nor denied the findings, the SEC asserted that the trusts’ shareholder reports included misleading statements regarding the Board’s 15(c) evaluation process. The disclosures indicated that in evaluating Fund advisory fees, the Trustees reviewed advisory fee peer group information and other materials that were not allegedly supplied to or reviewed by the Trustees. Additionally, the disclosures implied that certain series were paying fees that were not materially higher than the Fund’s peer group when, the SEC alleged, the advisory fee was higher than all 74 funds in the peer group and nearly double the peer group’s median fee. The SEC alleged that the Board meeting minutes contained the same boilerplate language that was misleading or inaccurate in the shareholder reports. The SEC alleged that the administrator failed to ensure that certain shareholder reports contained the required disclosures concerning the Trustees’ evaluation process and failed to ensure that certain series within the Trusts maintained and preserved their Section 15(c) files in accordance with Investment Company Act recordkeeping requirements. These lapses, the SEC alleged, caused the trusts to violate Sections 30(e) and 31(a) of the Investment Company Act and Rules 30e-1 and 31a-2(a)(6) thereunder.

The consent order alleged violations of Section 34(b) of the Investment Company Act, Rule 38a-1 (for failure to implement procedures reasonably designed to assure that the Trustees could adequately assess the compliance programs of the trusts’ various investment advisers), Section 31(a) and Rule 31a-2 of the Investment Company Act against the administrator for failing to maintain records considered by the Trustees in renewing advisory contracts, and Section 30(e) of the Investment Company Act and Rule 30e-1 for failure to include required disclosures regarding the Trustee’s 15(c) deliberations in the trusts’ shareholder reports.

The order instituting cease and desist proceedings included undertakings; in particular, the retention of an independent compliance consultant to review the procedures applicable to the 15(c) and compliance program review process, disclosure and recordkeeping obligations. The trustees agreed to cease and desist from future violations of Section 34(b) of and Rule 38a-1(a)(1) under the Investment Company Act. The administrator

and compliance affiliate agreed to pay a $50,000 penalty. See In the Matter of Northern Lights Compliance Services, LLC, Investment Co. Act Rel. 30502 (May 2, 2013), available at http://www.sec.gov/litigation/admin/2013/ic-30502.pdf.

[3]

In In the Matter of Chariot Advisors, LLC and Elliott L. Shifman, the SEC alleged that the investment adviser of an absolute return currency portfolio made misrepresentations to the fund’s board in the 15(c) process. The SEC alleged that Chariot Advisors and its control person misrepresented to the Board its ability to conduct algorithmic currency trading insofar as it had no devised or otherwise possessed any algorithms or computer models capable of engaging in the currency trading that the adviser described during the 15(c) process. The adviser further represented that it would use 20% of the fund assets to engage in algorithmic currency trading. Instead, the adviser hired an individual trader who was allowed to use discretion on trade selection and execution. The action is on-going. In the Matter of Chariot Advisors, LLC and Elliott L. Shifman, Securities Exchange Act Rel. No. 70239, Investment Advisers Act Rel. No. 3653, Investment Co. Act Rel. No. 30655 (Aug. 21, 2013).

[4]

In In the Matter of Commonwealth Capital Management, LLC, Commonwealth Shareholder Services, Inc., John Pasco, III, J. Gordon McKinley, III, Robert R. Burke, and Franklin A. Trice, III, the SEC alleged that the adviser and the funds’ board failed to satisfy duties imposed by Section 15(c). The independent directors requested reasonably necessary information from the adviser, but in some instances the responses did not provide all of the requested information and in some instances the information provided was inaccurate. The board then did not have, and did not evaluate, all the information it requested as necessary to approve the advisory contract. The parties settled the action. In the Matter of Commonwealth Capital Management, LLC, Commonwealth Shareholder Services, Inc., John Pasco, III, J. Gordon McKinley, III, Robert R. Burke, and Franklin A. Trice, III, Investment Co. Act Rel. 31678 (June 17, 2015).

[5]

In In the Matter of Kornitzer Capital Management, Inc. and Barry E. Koster, the SEC alleged that the adviser provided inaccurate and incomplete information in the 15(c) process. The board routinely requested an analysis of the adviser’s profitability in managing the funds, including an explanation of the

adviser’s methodology for allocating expenses. The board considered such information to be reasonably necessary for the board’s evaluation of the advisory contracts. Mr. Koster, the CFO and CCO, prepared the analysis and explanation which represented that the employee compensation costs were allocated “based on estimated labor hours.” However, Mr. Koster adjusted the chief executive officer’s cost allocation to achieve consistency year over year – this method was not disclosed to the board. Therefore, the adviser failed to furnish such information as was reasonably necessary for the board to evaluate the advisory contracts. In the Matter of Kornitzer Capital Management, Inc. and Barry E. Koster, Investment Co. Act Rel. 31560 (Apr. 21, 2015).

[BB] Compliance Programs

[CC] Non-Prosecution Agreements

[DD] Aberrational Performance

[EE] Ponzi Schemes

[FF] Fee Cases

[1]

In the first enforcement case involving mutual fund advisory fees since the announcement, the SEC settled charges with Morgan Stanley Investment Management (“MSIM”), the primary investment adviser to Malaysia Fund, a registered mutual fund, for “wholly inadequate” monitoring of Malaysia Fund and an improper fee arrangement that allegedly charged the fund and its investors for advisory services they were not actually receiving from a third party. The SEC alleged that MSIM represented to investors and the fund’s Board of Directors that it contracted a third-party sub-adviser to provide advice, research and assistance to MSIM for the benefit of the fund. However, according to the complaint, the sub-adviser never provided these services; yet the fund’s board renewed the contract for 12 years, at a cost of $1.845 million to investors. Morgan Stanley agreed to repay the entire amount to the Malaysia Fund, plus a $1.5 million penalty to the SEC. It also agreed to cease and desist from

committing or causing any future violations Sections 15(c) and 34(b) of the Investment Company Act and Sections 206(2) and (4) of the Investment Advisers Act and Rule 206(4)-7 thereunder. Finally, MSIM agreed to implement policies and procedures specifically governing the Section 15(c) process and its oversight of service providers. SEC v. Morgan Stanley Investment Mgmt., Investment Advisers Act Rel. No. 3315, Investment Co. Act Rel. No. 29862 (Nov. 16, 2011). See alsoSEC v. AMMB Consultant Sendirian Berhad, 1:12-CV-01052 (D.D.C., June 26, 2012), Lit. Rel. No. 22402 (June 27, 2012), for the SEC’s related action against the Malaysian sub-adviser.

[2]

In In the Matter of Northern Lights Compliance Services, LLC, Investment Co. Act Rel. 30502 (May 2, 2013), the SEC brought disclosure, reporting, recordkeeping and compliance charges against the trustees, the administrator that prepared shareholder reports and drafted meeting minutes, and a compliance affiliate that provided CCO services and administered the compliance program for two open-end series trusts. The trusts included up to 71 series managed by different, unaffiliated advisers and sub-advisers. In the order instituting proceedings, in which the defendants neither admitted nor denied the findings, the SEC asserted that the trusts’ shareholder reports included misleading statements regarding the Board’s 15(c) evaluation process. The disclosures indicated that in evaluating Fund advisory fees, the Trustees reviewed advisory fee peer group information and other materials that were not allegedly supplied to or reviewed by the Trustees. Additionally, the disclosures implied that certain series were paying fees that were not materially higher than the Fund’s peer group when, the SEC alleged, the advisory fee was higher than all 74 funds in the peer group and nearly double the peer group’s median fee. The SEC alleged that the Board meeting minutes contained the same boilerplate language that was misleading or inaccurate in the shareholder reports. The SEC alleged that the administrator failed to ensure that certain shareholder reports contained the required disclosures concerning the Trustees’ evaluation process and failed to ensure that certain series within the Trusts maintained and preserved their Section 15(c) files in accordance with Investment Company Act recordkeeping requirements. These lapses, the SEC alleged, caused the trusts to violate Sections 30(e) and 31(a) of the Investment Company Act and Rules 30e-1 and 31a-2(a)(6) thereunder.

The consent order alleged violations of Section 34(b) of the Investment Company Act, Rule 38a-1 (for failure to implement procedures reasonably designed to assure that the Trustees could adequately assess the compliance programs of the trusts’ various investment advisers), Section 31(a) and Rule 31a-2 of the Investment Company Act against the administrator for failing to maintain records considered by the Trustees in renewing advisory contracts, and Section 30(e) of the Investment Company Act and Rule 30e-1 for failure to include required disclosures regarding the Trustee’s 15(c) deliberations in the trusts’ shareholder reports.

The order instituting cease and desist proceedings included undertakings; in particular, the retention of an independent compliance consultant to review the procedures applicable to the 15(c) and compliance program review process, disclosure and recordkeeping obligations. The trustees agreed to cease and desist from future violations of Section 34(b) of and Rule 38a-1(a)(1) under the Investment Company Act. The administrator and compliance affiliate agreed to pay a $50,000 penalty. See In the Matter of Northern Lights Compliance Services, LLC, Investment Co. Act Rel. 30502 (May 2, 2013), available at http://www.sec.gov/litigation/admin/2013/ic-30502.pdf.

[GG] Social Media

[HH] Distribution-in-Guise

[1]

The first enforcement to arise out of the distribution-in-guise initiative was In the Matter of First Eagle Investment Management, LLC, Investment Advisers Act. Rel. No. 4199 (Sept. 21, 2015). The adviser, First Eagle, and its affiliated distributor allegedly used fund assets to pay almost $25 million for distribution-related services. Such payments would only have been permissible if authorized by a written Rule 12b-1 approved by the funds’ boards. Instead, the SEC alleged that the adviser treated the payments as if they were for sub-transfer agent fees which would have been permissible without a plan. The adviser allegedly reported to the funds’ boards that the distribution and marketing fees were sub-transfer agent fees. The adviser further stated in the fund prospectuses, also inaccurately, that the distributor would be bearing all distribution expenses not covered by the funds’ 12b-1 plan. The SEC order found that First Eagle had willfully violated Section 206(2) of the Investment Advisers Act and Section 34(b) of the Investment Company Act. First Eagle also caused the Funds to violate Section 12(b) of the Investment Company Act and SEC Rule 12b-1. First Eagle agreed to pay disgorgement of approximately $25 million plus prejudgment interest of $2.3 million, along with a penalty of $12.5 million. The distributor agreed to retain an independent compliance consultant.

[II] Whistleblower-Related Actions

[A] Massachusetts

[1]

In November 2008, the Secretary of the Commonwealth of Massachusetts settled an administrative complaint against Bear Stearns Asset Management, Inc. (“BSAM”) for conduct related to the collapse of two hedge funds BSAM managed (the same hedge funds at issue in SEC v. Ralph R. Cioffi and Matthew M. Tannin, discussed supra. The Complaint alleged that BSAM had significant exposure to conflicts of interest due to its routine securities transactions with its affiliated broker-dealer and with special purpose vehicles it structured. The Secretary asserted that BSAM lacked risk management controls sufficient to manage these conflicts. It further alleged that the adviser misrepresented to investors the extent of the control procedures it had implemented. BSAM agreed to cease and desist from future violations of M.G.L. c. 110A, §§ 101-102, a censure and the payment an administrative fine. In the Matter of Bear Stearns Asset Mgmt., Inc., Docket No. E-2007-0064 (Mass. Nov. 1, 2007).

[2]

In 2009, the Secretary of the Commonwealth filed an administrative complaint against an adviser to the Reserve money market fund that “broke the buck.” Among other violations, the Secretary alleged that the adviser made material misrepresentations regarding its ability and intent to backstop the fund and regarding the fund Board’s valuation of the fund’s holdings of Lehman Brothers Holdings Inc.’s commercial paper at the time of the Lehman bankruptcy. The complaint seeks to impose cease and desist orders, an accounting of and restitution to all Massachusetts investors in the Fund, censure, and administrative fines. See In the Matter of Reserve Capital Mgmt., Inc., Admin. Complaint No. E-2008-0079 (Jan. 13, 2009), available at http://www.sec.state.ma.us/sct/archived/sctreserve/reservecomplaint.pdf.

[3]

In Bulldog Investors Gen. P’ship v. William F. Galvin, No. 07-1261-BLS2 (Suffolk Co., Sept. 30, 2009), the court held that the state was permitted to prevent an adviser from providing access by unqualified investors to a website that offered investment information on a firm’s funds. A decision by the Massachusetts Supreme Judicial Court on September 22, 2011 affirmed a finding that a hedge fund manager, Bulldog Investors General Partnership, and its principals, violated the Massachusetts Securities Act by offering unregistered securities to all visitors through its operation of an interactive website with investment information, in violation of the Massachusetts Securities Act. The Court rejected the hedge fund’s argument that the Secretary’s order violated the hedge fund’s First Amendment right to communicate information to consumers. Bulldog Investors General Partnership v. Secretary of the Commonwealth, No. SJC-10756 (Mass. S. Jud. Ct. Sept. 22, 2011).

[4]

On July 20, 2011, the Massachusetts’ Secretary of the Commonwealth Securities Division brought charges against RBC Capital Markets, LLC and its former registered representative, alleging that the parties sold leveraged, inverse and inverse-leveraged ETFs to clients who had limited to no understanding of these products and the unique risks associated with them, in part due to supervisory failures by the firm which allowed registered representatives to make numerous unsuitable recommendations to investors. In the Matter of RetBC Capital Markets, LLC & Michael D. Zukowski, Docket No. E-2009-0059, E-2011-0001 (Mass. Sec. Div. July 20, 2011).

[5]

On October 26, 2011, the Massachusetts Security Division of the Secretary of the Commonwealth brought an action against The Bank of New York Mellon Corp. (BNY) with fraud for allegedly overcharging the state’s pension fund for currency trades for more than a decade, through undisclosed markups in currency trading while acting as a custodian for the state’s pension fund. In the Matter of The Bank of New York Mellon Corp., Docket No. E-2011-0044 (Mass. Oct. 26, 2011). BNY faces similar lawsuits brought by the state of New York, State v. Bank of New York Mellon, Index No. 99/114735 (N.Y. Co. Sup. Ct. Oct. 5, 2011) and Florida, State v. Bank of New York Mellon, Complaint (Fla. Cir. Ct. Aug. 11, 2011). The U.S. Attorney’s office for the Southern District of New York has also brought civil fraud charges against BNY relating to this conduct. USA v. The Bank of New York Mellon Corp, 11-CV-6969 (S.D.N.Y. Oct. 5, 2011).

[6]

In February, 2012, State Street Global Advisors settled allegations that it violated Massachusetts securities laws in connection with a CDO for which it acted as investment manager. The consent order states that State Street violated Massachusetts securities laws because the marketing materials for the CDO failed to disclose material information relating to a hedge fund’s involvement in the transaction. In the Matter of State Street Global Advisors (Carina CDO, Ltd.), Docket No. 2011-0023 (Mass. Sec. Div. Feb. 28, 2012).

[7]

In October 2012, Massachusetts filed an administrative complaint alleging violations of Massachusetts securities laws in connection with a CDO for which Putnam Advisory Co., LLC acted as collateral manager. Allegations in the complaint include omission of material facts, engaging in acts that operated as a fraud while registered as an investment adviser and engaging in dishonest conduct as an adviser. In the Matter of Putnam Advisory Co., LLC (Pyxis ABS CDOs), Docket No. 2011-0035 (Mass. Sec. Div. Oct. 17, 2012).

[B] Oregon

[C] California

[A] Challenges to Compulsory Reductions in Advisory Fees

[B] Challenges to Compulsory Prospectus Revisions

[1]

Zuri-Invest AG v. Natwest Fin. Inc.

The federal district court for the Southern District of New York affirmed that NSMIA does not preempt state common law fraud claims. In Zuri-Invest AG v. Natwest Fin. Inc., private investors in a steel mill operating company sued an adviser and underwriters alleging both securities fraud and state common law fraud. 177 F. Supp. 2d 189 (S.D.N.Y. 2001). The defendants moved for summary judgment, arguing that NSMIA preempted the plaintiffs’ state claims.

In rejecting the defendants’ argument regarding express preemption, the court observed that the NSMIA preempts state laws regarding registration requirements and associative disclosures, not general allegations of fraud. The court also analyzed NSMIA’s savings clause and its legislative history, and concluded that Congress intended to preserve states’ ability to protect investors through state anti-fraud laws. The court observed that “legislative history indicates … the … ‘Committees’ intention not to alter, limit, expand or otherwise affect in any way any State statutory or common law fraud or deceit … in connection with securities or securities transactions’” and concluded that “[a] more clear cut statement against preemption would be hard to find.” The court also found persuasive Congress’ decision not to amend the savings clauses of the Securities Act or the Exchange Act, both of which preserve rights and remedies existing at state law.

The court further held that NSMIA did not impliedly preempt state common law fraud claims because Congress did not evidence its intent to displace state causes of action for fraud. Defendants could not overcome the presumption that areas of law traditionally within the primacy of the states would remain with them absent a clear and manifest intent by Congress to preempt state action. Finally, the Court found that state fraud claims did not conflict with the regulatory mandates of NSMIA. The court concluded: “the purpose underlying state common law fraud actions – to deter fraudulent practices – is consistent with federal securities law, including the NSMIA, as both seek to deter fraud.”

[2]

Capital Research and Management Co. v. Brown

In Capital Research and Mgmt. Co. v. Brown (the “American Funds Litigation”), LASC Case No. BC330770 (Mar. 24, 2005),

California Attorney General Bill Lockyer alleged that Capital Research and Management Company, an investment adviser, and American Funds Distributors, Inc., a registered broker-dealer and wholesale distributor, failed to disclose to purchasers and prospective purchases of American Funds’ shares shelf-space agreements into which the parties entered for the distribution of the American Funds. The California Attorney General asserted that the undisclosed agreements violated the California Corporations Code and sought injunctions enjoining defendants from engaging in any conduct in violation of the Code.

Defendants demurred to the enforcement complaint, contending NSMIA expressly or impliedly preempts any action challenging the adequacy of the American Funds’ disclosures. The Superior Court found in favor of American Funds, and ruled that NSMIA impliedly preempted the California Attorney General from regulating the content of mutual fund prospectus disclosures. Permitting states to regulate prospectus disclosures “would place Investment Company Act Funds in the untenable position of having to seek review of their offering statements by regulators in all states in which their shares are sold. Such would be the antithesis of the national regulation of securities offerings contemplated by NSMIA.” The court also concluded that the California action would impose disclosure requirements beyond those deemed necessary by the SEC in the current registration form. California’s action thus impeded national uniformity and exceeded federal regulatory requirements, both of which militated in favor of preemption.

On January 26, 2007, the California Court of Appeals reversed, holding that NSMIA’s savings clause is sufficiently broad to permit the California Attorney General to pursue injunctive relief and penalties against a covered security’s investment adviser and wholesale broker-dealer who allegedly made inaccurate or inadequate representations to purchasers. Capital Research and Mgmt. Co. v. Brown, No. B189249 (Cal. Ct. App., 2nd App. Div. Jan. 26, 2007) (“Slip Op.”). The Appeals Court reasoned that NSMIA barred the Attorney General from suing registered investment companies to force them to change their disclosure documents, but did not bar the Attorney General from suing an investment adviser or broker-dealer to force them to disclose their shelf-space agreements. Slip Op. at 11. In support of this analysis, the Appeals Court observed that the

adviser and distributor’s disclosures were false and misleading because the practice of entering shelf-space agreements was intentionally concealed from investors and also from the American Funds’ directors. Id. The Appeals Court concluded that its ruling was required in order to give effect to a second Congressional purpose in enacting NSMIA – “to encourage the continued participation of the states in preventing fraud in securities transactions, particularly with regard to broker-dealers.” Id. at 15.

Capital Research and Management Company entered into a settlement agreement with the California Attorney General on February 15, 2008, ending the three-year-old litigation. The Attorney General acknowledged the voluntary measures Capital Research took to alleviate the State’s concerns, including “waiv[ing] 10 percent of its management fees, . . . improv[ing] its corporate governance practices[,] . . . [and] eliminat[ing] the practice of directed brokerage . . . .” Press Release, Office of the Attorney General, Brown and American Funds End Litigation (Feb. 15, 2008), available at http://agica.gov/newsalerts/release.php?id=1524. The settlement agreement also includes commitments by American Funds to enhance prospectus disclosures of revenue-sharing policies, encourage shareholders to opt out of paper in favor of electronic delivery (at a projected savings of up to $20 million), and to provide greater supervision and oversight of managers involved in revenue-sharing activities.

[3]

People v. Edward D. Jones & Co., L.P.

In People v. Edward D. Jones & Co., L.P., Case No. 04AS05097 (Sacramento Superior Court, May 25, 2006), California Attorney General Lockyer alleged that a broker-dealer that received directed brokerage and cash payments from an investment adviser violated disclosure obligations imposed by the California Corporations Code by failing to disclose its arrangements to its customers. As with the American Funds Litigation, the Superior Court found that NSMIA preempted state regulation of mutual fund offering documents, and granted defendants’ demurrer. The court noted, “assertion of California’s authority in this manner conflicts with the federal regulation of information provided in mutual fund prospectuses and hence is preempted by such.”

Lockyer disputed the court’s conclusion that he was seeking to regulate prospectus disclosures, and appealed the order of

dismissal. The North American Securities Administrators Association filed an Amicus Brief in support of the California Attorney General. The Court of Appeals, Third District, reversed, holding that the California action was not preempted by NSMIA. The People of CA v. Edward Jones, 65 Cal. Rptr. 3d 130, 139 (App. Dep’t Super. Ct., Aug. 24, 2007). The court stated NSMIA includes an exception (“[e]xcept as otherwise provided in this action” (15 U.S.C. § 77r(a)(2)(A))) which preserves state authority to bring enforcement actions for fraud. The court determined that the plain meaning of NSMIA permitted California to proceed with the action and, in light of the unambiguous statutory language, a review of legislative history was unnecessary.

On September 2, 2008, without admitting or denying the allegations, Jones settled, agreeing to pay $7.5 million, which included the Attorney General’s fees, and a civil penalty of $4.8 million.