40 Act Blog

SEC to Host Proxy Advisory Firm Roundtable in December

The will host a public roundtable on December 5 to discuss the use of proxy advisory firm services by institutional investors and investment advisers.  The roundtable will be held at the SEC’s Washington, D.C. headquarters and will be open to the public and webcast live on the SEC’s website.
In its press release, the SEC stated that proxy advisory firms offer services to assist investors and investment advisers in voting on matters presented to shareholders.  Some proxy advisory firms also provide consulting services, including to publicly traded companies that may use these services to help develop proposals to be put to a shareholder vote or to improve their corporate governance ratings.
It further stated that the SEC studied the role of proxy advisory firms in a 2010 concept release on the proxy voting system.  The release sought public comment on the services provided by proxy advisory firms and on potential conflicts of interest and transparency in the proxy advisory industry.  The December 5 roundtable will provide a forum to discuss these issues.
The SEC has not released information on the agenda or the participants in the roundtable.
Click here for the press release announcing the roundtable.

ICI Criticizes U.S. Treasury – OFR Study on the Asset Management Industry

The ICI, the trade group for the investment company industry, in a letter to the SEC criticized a recent report entitled “Asset Management and Financial Stability” on the asset management industry issued by the U.S. Treasury Department’s Office of Financial Research (OFR) .  The ICI stated that the study speculates about potential vulnerabilities for asset managers that the OFR study claims could pose a threat to financial stability. In the ICI’s view, the study failed to provide data or historical experience to support its claims. In its letter, the ICI focused primarily on registered funds and their advisers, offers detailed analysis of mutual fund and investor behavior during periods of market stress from 1945 through 2008. The ICI asserted that contrary to the OFR study’s suggestions investors in mutual funds do not redeem precipitously during financial market shocks.
Click here for the ICI letter.
Click here to access the study.

Adviser Charged with Engaging in an Inflated Brokerage Commissions

The SEC brought an enforcement action against Fry Hensley and Company (FHC) and its owner Nicholas L. Fry, II, each based in Cincinnati, Ohio, for obtaining undisclosed compensation in the form of payments from inflated commissions, markups and markdowns charged to their clients by the broker-dealer that FHC and Fry recommended that their clients use. FHC's agreement with clients provided that they gave Fry discretionary authority to trade in their accounts. Fry typically conducted his equity trading for clients through one of the broker-dealer's principal trading accounts, first instructing the broker-dealer to buy or sell securities with the market and then instructing it how to allocate the trades to his clients. For equity securities, Fry set the amount of the transaction charges clients paid for these trades, and he typically set them much higher than he could have. Fry's wife, who was a registered representative at the broker-dealer, received credit for 50% of the transaction charges paid by FHC's advisory clients, and between January 1, 2007 and October 2011, the broker-dealer credited Fry's wife with more than $775,669.09 from inflated transaction charges. During this time, FHC was otherwise insolvent, and Fry used hundreds of thousands of dollars from the above inflated transaction charges to support FHC, which would have otherwise gone out of business. In addition, FHC received undisclosed services from the broker-dealer partly in exchange for the inflated transaction charges. Also during this time, FHC and Fry failed to tell their clients the essential facts about the arrangement described above, and made false and misleading disclosures in documents given to clients and filed with the SEC.
Click here to access the enforcement action.

Hedge Fund Cost of Compliance Study Released

KPMG, AIM and MFA issued a study entitled “The Cost of Compliance.” The study reports the results of a survey of 200 hedge fund advisers. The study, not surprisingly, concluded that hedge fund compliance costs have risen and likely are to continue to rise as the industry becomes more regulated.
Click here to access the study.

Three Advisers Charged with Violating the Custody Rule

The SEC brought enforcement actions against three investment advisers for violating Rule 206(4)-2 under the Advisers Act, the “custody rule,” which requires them to meet certain requirements when maintaining custody of their clients’ funds or securities. The SEC found that these advisers failed to maintain client assets with a qualified custodian or engage an independent public accountant to conduct surprise exams. 
Click here to access the press release announcing the enforcement actions.

SEC Brings Enforcement Actions Against Advisers for Having Inadequate Compliance Programs

The SEC brought enforcement actions against three investment advisers for repeatedly ignoring problems with their compliance programs. The SEC stated that the enforcement actions arise from its “Compliance Program Initiative,” which targets firms that have been previously warned by SEC examiners about compliance deficiencies but failed to effectively act upon those warnings. Had the problems been addressed, the firms could have prevented their eventual securities law violations. The SEC Enforcement Division's Asset Management Unit had coordinated with OCIE examiners to bring several cases since the initiative began two years ago. The firms charged were Modern Portfolio Management Inc., Equitas Capital Advisers LLC and Equitas Partners LLC.
The SEC charged Modern Portfolio Management (MPM) and its owners G. Thomas Damasco II and Bryan Ohm finds with failing to correct ongoing compliance violations at the firm despite prior warnings from OCIE examiners. In particular, the SEC found that the firm failed to complete annual compliance reviews in 2006 and 2009 and made misleading statements on MPM's website and investor brochure. For instance, one location on MPM's website misleadingly represented that the firm had more than $600 million in assets. However, on its Form ADV filing with the SEC during that same time period, it reported that the firm's assets under management were $359 million or less.
The SEC charged New Orleans based Equitas Capital Advisers and Equitas Partners as well as owner David S. Thomas, Jr., chief compliance officer Susan Christina, and former owner and chief compliance officer Stephen Derby Gisclair, for failing to adopt and implement written compliance policies and procedures and conduct annual compliance reviews to satisfy Rule 206(4)-7 under the Advisers Act. The Equitas firms made false and misleading disclosures about historical performance, compensation, and conflicts of interest, and they inadvertently yet repeatedly overbilled and underbilled their clients. Many of these violations occurred despite warnings by SEC examiners during examinations of the Equitas firms in 2005, 2008, and 2011. The firms failed to disclose these deficiencies to potential clients in response to questions in certain due diligence questionnaires or requests for proposals. Gisclair also caused Rule 206(4)-7 violations and the incorrect billing of clients at Crescent Capital Consulting LLC, an investment advisory firm that he opened in late 2010. Gisclair inflated the amounts of assets managed by Equitas and Crescent in their Form ADV filings to the SEC, and he improperly removed and retained nonpublic personal client information when he left Equitas.
Click here to access the press release announcing the enforcement actions.

SEC Proposes Crowdfunding Rule

The SEC  proposed rules under the JOBS Act to permit companies to offer and sell securities through crowdfunding. Crowdfunding is an evolving method of raising capital that has been used outside of the securities arena to raise funds through the Internet for a variety of projects ranging from innovative product ideas to artistic endeavors like movies or music.  The JOBS Act created an exemption under the securities laws so that this type of funding method can be easily used to offer and sell securities as well.  The JOBS Act also established the foundation for a regulatory structure for this funding method.
Click here to access the proposing release.

SEC Division of Investment Management Director Speaks at Independent Directors Conference

Norm Champ, the SEC’s Director, Division of Investment Management, spoke at the Annual Fall Meeting of the Independent Directors Council.  He began by speaking about the role of independent directors. He stated that mutual fund directors must abide by the duty of care and the duty of loyalty they owe to shareholders.  The duty of care requires independent directors to act with the care that an ordinarily prudent person in a similar position would use under similar circumstances.  In satisfying the duty of care, directors should be well informed. He further noted that a director’s responsibilities under the 1940 Act flow from the same underlying purpose as does the director’s duties under state law -- to protect the fund’s shareholders.

He next reviewed the initiatives the Division of Investment Management undertook in 2013. He reported that the Division completed its first priority, which was the adoption of the “Identity Theft Red Flags Rules,” which are rules to detect and prevent theft of the identities of mutual fund investors and clients of asset managers. He next reviewed two  regulatory projects that the staff is focused on now. 
The first is additional money market fund reform.  He stated that the SEC proposed additional money market fund reforms in June, 2013.  The comment period officially closed on September 17, 2013. He stated that the staff is currently reviewing and analyzing the more than 1300 letters we have received to date.
The second rulemaking initiative involves ETFs.  Director Champ stated that the SEC in 2008 proposed a rule that would basically codify certain exemptive relief that the SEC routinely grants to ETFs. The proposed exemptive rule would have allowed certain ETFs to launch without having to file an exemptive application, a process that, while important for novel products, can be costly and time-consuming.  If ETFs of new sponsors could come to market without having to obtain their own exemptive relief, the Division could reallocate staff resources from the review of these “plain vanilla” applications to more novel applications.  He stated that the Division is considering how to advance consideration of this type of ETF rule.
He next spoke about the newly created Risk and Examinations Office (REO).  REO supports the Division’s work primarily through two functions.  REO is a multi-disciplinary office staffed with analysts with strong quantitative backgrounds, along with examiners, lawyers and accountants.  REO maintains an industry monitoring program that provides ongoing financial analysis of the investment management industry.
He next noted that the Division is working to enhance its communications with the outside.  He spoke about the recent issuance of guidance updates in addition to the SEC’s traditional no-action and interpretive letters.
He concluded his remarks by discussing fund governance, including actions taken in this area by the Division of Investment Management over the past 20 years. He discussed recent meetings between SEC officials and independent directors.
Click here to access the speech.

SEC Chairman Speaks at Compliance Conference

SEC Chairman Mary Jo White spoke at the NSCP’s National Membership Meeting in Washington, D.C.  After reviewing the role of a CCO at an adviser, she stated that the SEC has 450 professionals to examine investment advisers and investment companies. They are tasked with inspecting nearly 11,000 registered advisers who advise approximately 9,700 mutual funds and ETFs and 30,000 private funds. She noted that this results in a 24-to-1 ratio of examiners to registrants and a nearly 90-to-1 ratio of examiners to funds.
Besides CCOs, she noted that there are others at an investment adviser who play a key role in compliance including:
• The managers of business units who, in striving to meet their targets, must also manage risks and stay in compliance with their firms’ own policies and the law.
• The internal auditors who need to have the skills, stature and independence to effectively review the books, ensure that the numbers are bona fide and that there are no control deficiencies.
• The CEO and senior executive team, who in addition to focusing on the bottom line must instill a culture in the biggest producer and the most junior employee that they are expected and encouraged to do the right and ethical thing, and escalate problems if they are not resolved.
She added that the board of directors must oversee all of it.
She next stated that she had the following basic questions for advisers:
• Do you have the necessary resources and access to training to enable you to advise your firms as they navigate competitive, highly complex, rapidly changing markets?
• Do you have the tools to test for, detect and address compliance failures?
• Do you have the necessary independence, access, authority and support to do your jobs effectively, and ensure that your firms adopt, implement and enhance effective compliance controls?
• In short, are you empowered by your firms to do what you need to do?
She encouraged CCOs to pay attention to the “Risk Alerts” issued by the SEC.
Chairman White next spoke about the SEC’s first-ever charge against an individual for misleading and obstructing a compliance officer of an investment adviser. She noted that the action came about after SEC examiners discovered that an assistant portfolio manager had forged and altered brokerage statements, trade pre-approvals and other documents. He also attempted to conceal from his firm’s chief compliance officer his involvement in more than 600 unauthorized personal trades – many of which involved securities held or acquired by funds managed by the firm.  She stated that this was an important case because it held the portfolio manager directly accountable, not only for his substantive violations, but also for obstructing the compliance officer’s work.
Lastly, she discussed the collaboration between OCIE examiners and the SEC’s enforcement staff. They are teaming up in the Compliance Program Initiative to identify and recommend enforcement actions against registered advisers who have failed to adopt or implement an adequate compliance program after being notified repeatedly of deficiencies by our staff.
Click here to access a copy of her speech.

SEC Chairman Speaks About Hedge Fund Transparency

SEC Chairman Mary Jo White spoke at the 2013 Managed Funds Association Outlook Conference in New York about the transparency and openness of hedge funds. She stated that hedge funds have entered into a new era of transparency as a result of the Dodd-Frank Act and the JOBS Act.