Investment Fund Law Blog

InvestmentFundLawBlog

Updates and Insights on Legal Issues Facing Fund Managers and Investors

HEDGE FUND ADVISER, TWO EXECUTIVES AND OUTSIDE AUDITOR CHARGED FOR IMPROPER EXPENSE ALLOCATIONS AND MISLEADING FINANCIAL STATEMENTS

Posted in Advisory, Investment Advisers, Private Funds

The expense provisions of many private fund governing documents are becoming longer and more detailed for good reason – increased Securities and Exchange Commission (SEC) scrutiny and prosecution relating to expense allocation and disclosure.

On April 29th, the SEC announced charges against Alpha Titans LLC, a hedge fund advisory firm, its principal, Timothy P. McCormack and its general counsel, Kelly D. Kaeser, for improper use of fund assets to pay expenses that were not previously disclosed to fund investors. According to the SEC, office rent, employee salaries and benefits and other expenses totaling more than $450,000 were paid by two affiliated private funds without adequate disclosure or authorization. The SEC further alleged that Alpha Titans, McCormack and Kaeser sent investors audited financials that did not disclose that approximately $3 million of expenses pertained to transactions involving affiliates of McCormack.

According to the SEC, the funds’ outside auditor, Simon Lesser, was aware of the manner in which expenses and assets were allocated, yet approved audit reports containing unqualified opinions that the financial statements were presented fairly. He was charged with engaging in improper professional conduct in connection with an audit of the funds’ financial statements. The advisory firm also was charged with custody rule violations relating to its distribution on non-GAAP-compliant financial statements.

All of the charges were settled without admission or denial of responsibility; however, not without significant cost. McCormack and Kaeser will be barred from the securities industry for one year and Kaeser will be unable to represent an SEC-regulated entity for one year. Lesser will be suspended from providing accounting services on behalf of an entity regulated by the SEC for at least three years. Substantial monetary penalties also were assessed and the advisory firm and its principal agreed to pay disgorgement and prejudgment interest.

The lesson for private funds, their advisers and outside auditors is simple. First, fund documents should clearly, accurately and thoroughly disclose the types and amounts of expenses to be charged to the fund or its investors. Second, fund managers must allocate expenses and use fund assets strictly in accordance with the relevant provisions in the fund documents. Finally, outside auditors must be diligent in reviewing expense allocations and the use of fund assets to determine compliance with fund documents.

There should be no doubt that the risk of non-compliance is real.

Cybersecurity Guidance Issued by the SEC’s Division of Investment Management

Posted in Advisory, Investment Advisers, Registered Investment Companies

The Division of Investment Management (the “Division”) of the Securities and Exchange Commission issued a cybersecurity guidance identifying cybersecurity of registered investment companies (“funds”) and registered investment advisers (“advisers”) as an important issue. Recognizing the rapidly changing nature of cyber threats and consequently, the necessity for funds and advisers to protect sensitive information including information of fund investors and advisory clients, the Division is suggesting a number of measures that funds and advisers may wish to consider in addressing the issue. To mitigate cybersecurity risk, the Division suggests that funds and advisers: 1) conduct a periodic assessment of their technology system and security controls and processes to identify potential cybersecurity threats and vulnerabilities, 2) create a strategy that is designed to prevent, detect and respond to cybersecurity threats, and 3) implement the strategy through written policies and procedures, training of officers and employees, and investor and client education. In addition, the Division also suggests that funds and advisers may wish to consider reviewing their operations and compliance programs whether they have measures in place that mitigate their exposure to cybersecurity risk, as well as assessing whether protective cybersecurity measures are in place at service providers that they rely on in carrying out their business operations.

A full version of the cybersecurity guidance is available HERE.

Please call an Investment Funds and Investment Management attorney with your inquiries regarding your firm’s cybersecurity risks and compliance procedures that address them.

INVESTMENT ADVISER CONFLICTS OF INTEREST – BlackRock Censured; Compliance Officer Personally Liable

Posted in Advisory, Investment Advisers, Private Funds

On April 20, 2015, the Securities and Exchange Commission (“SEC”) issued an order against an investment advisory firm and its former chief compliance officer, for violating Sections 206(2) and 206(4) and rule 206(4)-7 of the Investment Advisers Act and rule 38a-1 of the Investment Company Act. The SEC charged BlackRock Advisors LLC with breaching its fiduciary duty by failing to disclose a conflict of interest involving the outside business activity of one of its top-performing portfolio managers, Daniel J. Rice III. BlackRock agreed to be censured and to settle the charges by paying a $12 million penalty and engaging an independent compliance consultant to conduct an internal review.

During his tenure as an energy sector portfolio manager at BlackRock, Rice founded an oil and gas exploration and production company, formed a joint venture with a public company held in his managed funds, and acquired a second public company also held in BlackRock portfolios. BlackRock learned of Rice’s outside business activity, but allowed him to continue his involvement. The SEC found that BlackRock failed to report the conflicts of interest to the board of directors of the affected registered funds or advisory clients and failed to monitor and reassess Rice’s outside business activity after discovering the conflicts of interest. The SEC also censured BlackRock for failing to maintain and implement internal policies regarding the outside activities of employees. While Blackrock’s policies required employees to report potential conflicts and to seek pre-approval before serving on a board of directors, the firm failed to outline how employees’ outside activities would be assessed for conflicts purposes or to identify the individuals responsible for assessing outside activities.

Additionally, the SEC found BlackRock’s former chief compliance officer personally liable for causing the failure by BlackRock funds to report material compliance matters—namely Rice’s violation of BlackRock’s private investment policy—to their board of directors. The ex-officer agreed to pay a $60,000 civil penalty to settle the charge.

If you have question concerning your firm’s internal policies on the outside business activities of employees, please reach out to your Pillsbury attorney contact.

DOL Issues Proposal on ERISA Fiduciaries

Posted in Advisory, Investment Advisers, Private Funds

On April 14, 2015, the Department of Labor issued its much anticipated re-proposal of regulations defining and expanding the persons who are treated as ERISA fiduciaries.  Under the proposal, subject to certain exceptions, all persons who  provide investment advice or recommendations for a fee to an employer-sponsored  retirement plan, plan fiduciary, plan participant, IRA or IRA owner would be deemed “fiduciaries”.  Other than investment education and “order taking”, most other investment sales related activities will result in fiduciary status.  Some of these advisors are subject to federal securities laws, others are not.

Being a fiduciary means that the advisor must provide impartial advice and put the client’s best interest first and must not accept any compensation payments creating conflicts of interest unless the payments qualify for an exemption (newly proposed) intended to ensure that the customer is adequately protected.  If the regulations are finalized, compliance with the terms of the new exemption will be a necessary condition for continuing many of the compensation practices currently in use by the investment industry.

We expect to issue a Client Alert on the Proposal and new Rule.  If you have any questions, please feel free to contact our Funds or Employee Benefits attorneys.

Five Things to Know about New Jersey’s Taxation of Convertible Virtual Currency

Posted in Advisory, Guest Post

On March 10, 2015, the New Jersey Division of Taxation issued Technical Advisory Memorandum TAM-2015-1, explaining its policy regarding convertible virtual currency.1

  1. The IRS has held that convertible virtual currency (CVC), such as Bitcoin, is treated as property for U.S. federal income tax purposes. Consequently, transactions involving CVC are treated as barter transactions. In general, each party in a barter transaction is viewed as both a buyer (of the goods or services acquired) and a seller (of the goods or services given in exchange). See our client alert of March 26, 2014. New Jersey conforms to the federal treatment of CVC for corporate and personal income tax purposes, including wage withholding and reporting of payments to independent contractors.

READ MORE…

Read this article and additional publications at pillsburylaw.com/publications-and-presentations.

 

New Leadership for Pillsbury’s Investment Funds & Investment Management Team

Posted in Uncategorized

Pillsbury’s Investment Funds & Investment Management (IFIM) group is a vital and strategic part of our platform. We are pleased to announce new leadership and structure for the group.

Partners Kimberly Mann in Washington, DC and Ildiko Duckor in San Francisco will co-lead the IFIM group. The group now integrates all investment management and funds professionals across the firm’s offices. Our interdisciplinary approach also draws on the experience of other practices that enhance the depth and scope of our services to clients. The IFIM group now comprises more than two-dozen business and litigation attorneys in London, Los Angeles, New York, San Francisco, Silicon Valley, Tokyo, and Washington, DC. Together, the group’s experience extends across the following disciplines: manager and fund formation and compliance, private equity, hedge funds, registered funds, tax, ERISA, complex transactions, finance and derivatives, employment, bank regulation, real estate, estate planning, regulatory investigations, and civil and criminal litigation. Our London office provides U.K. legal capabilities and a window into the E.U. Our offices in Tokyo, Beijing and Shanghai provide access to the Asian markets.

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SEC Guidance on Fund Advisory Personnel Receiving Gifts and Entertainment

Posted in Investment Advisers, Registered Investment Companies

In a February 2015 Guidance Update, the Securities and Exchange Commission’s Division of Investment Management (“SEC”), provided guidance on the acceptance of gifts or entertainment by fund advisory personnel under Section 17(e)(1) of the Investment Company Act of 1940 (the “Act”). Section 17(e)(1) provides that any affiliated person of a registered investment company, or any affiliated person of such person acting as agent, is prohibited from receiving any compensation, outside of regular salary or wages, for the purchase or sale of any property to or for the registered company or any controlled company thereof. The SEC has found that gifts or entertainment meet the definition of “compensation” as it is used in Section 17(e)(1), and proof of any intended or actual influence is not required. Pursuant to Rule 38a-1 of the Act, a fund must implement written policies and procedure designed to prevent the fund and its service providers from violating securities laws. The Guidance Update suggests that the policies and procedures concerning the receipt of gifts or entertainment should be included in the fund’s compliance policies and procedures, though it defers to the fund to determine whether there should be an outright ban, or a type of pre-clearance to determine if the gift or entertainment would violate Section 17(e)(1).

Breaking All the Rules

Posted in Advisory, Investment Advisers, Registered Investment Companies

The Securities and Exchange Commission (“SEC”) issued a cease-and-desist order on February 19, 2015 against SEC-registered Logical Wealth Management, Inc. and owner, Daniel J. Gopen, (together, “Respondents”).  The list of violations the SEC found the Respondents committed is extensive and includes improper registration, compliance, and recordkeeping. The SEC found the Respondents exaggerated their assets under management in order to register with the SEC, falsely reported their place of business as Wyoming, a state in which advisers are not regulated, and did not have compliance policies and procedures in place or books and records available to the SEC.  The SEC has ordered the Respondents to cease and desist, revoked Logical Wealth’s registration, barred Mr. Gopen from any advisory activity and imposed a $25,000 civil penalty.

Reminder: Required annual Form ADV amendment by March 31, 2015

Posted in Advisory, Investment Advisers, Private Funds

We want to remind you of your firm’s annual investment adviser registration amendment (Form ADV annual amendment) which must be filed on the IARD system on or before March 31, 2015.  This deadline applies to all SEC and State registered advisers as well as Exempt Reporting Advisers (ERAs) with a December 31, 2014 fiscal year end.

Please let us know as soon as you can if you need our assistance in preparing and submitting your Form ADV annual amendment filing this year.

Also, for SEC registered advisers and ERAs, please note that your annual IARD fee must be paid before you can submit your annual amendment.  The fees are based on your firm’s regulatory assets under management as follows:

Regulatory Assets
Under Management
Initial
Registration Fee
Annual Updating
Amendment Fee
$100 million or more $225 $225
$25 million to $100 million $150 $150
Less than $25 million $40 $40
SEC Exempt Reporting Adviser $150 $150

To view FINRA’s current IARD Account Payment Methods and Addresses, please click HERE.

If you or your compliance officer is handling your Form ADV filing and you would like us to review your drafts, please feel free to contact us also.

Insider Trading, Once Removed

Posted in Advisory

The Securities and Exchange Commission (“SEC”) charged Charles L. Hill Jr. with insider trading in connection with his purchase of shares of Radiant Systems stock the day before a merger was announced. Mr. Hill became aware of the material non-public information through a friend who obtained the information from his close friend, the Radiant COO. Mr. Hill had made no equity purchases in over four years before buying $2.2 million of Radiant stock before the announcement. The day after the merger was announced Mr. Hill sold his entire equity interest for a profit of approximately $744,000. In the eyes of the SEC, trading on material nonpublic information learned from a third party is no different from trading on information received directly from an insider.