Articles Tagged with Compliance

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Written by:  Jay B. Gould and Jessica M. Brown

The Securities and Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations released a “Risk Alert” on January 28, 2014, which focuses on the due diligence investment advisers perform in alternative investments[1] and managers for their clients. After observing an increasing trend in advisers recommending alternative investments to their clients, the SEC examined a group of SEC-registered investment advisers, who collectively manage more than $2 trillion. The purpose of the examination and the Risk Alert is to review how the advisers perform due diligence, utilize investment teams to review fund structures and complex investment strategies, and identify, control and disclose conflicts of interest.

While the Risk Alert focuses on the narrow market segment of advisers who recommend to their clients discretionary investments in alternative investments managed by outside advisers/managers, the recommendations and due diligence practices can serve as practical guidance for all investment advisers and fund managers.

Observations

The SEC notes four primary trends in the due diligence that advisers perform on alternative investments and their managers:

  1. Position-level transparency and client risk mitigation
  2. Use of third parties to supplement and validate information provided by managers
  3. Quantitative analyses and risk measures on the investment and managers
  4. Enhancing and expanding due diligence teams and policies

Warning Indicators

The SEC notes a number of red flags that advisers find with respect to managers that warrant additional due diligence. These warning signs include:

  • managers who refuse transparency requests;
  • performance returns that conflict with factors known to be associated with the manager’s strategy;
  • unclear investment and research process;
  • lack of a sufficient control environment and separation of duties between the business and investment units;
  • portfolio holdings that conflict with a purported strategy;
  • insufficiently knowledgeable personnel to carry out the strategy intended to be implemented;
  • changes in manager investment style;
  • investments that are overly complex or opaque;
  • lack of third-party administrator;
  • inexperienced auditor;
  • repeated changes in service providers;
  • unfavorable background check results;
  • discovery of undisclosed conflicts of interest;
  • insufficient compliance or operational programs; and
  • lack of sufficient fair valuation process.

Advisers should review whether their due diligence process identifies these warning indicators and whether there are additional warning indicators they should consider to meet their fiduciary obligations. 

Adviser Compliance Practices

The SEC identifies the areas in which they found material deficiencies or control weaknesses with the investment advisers. Based on the deficiencies the SEC identifies, advisers who recommend alternative investments should ensure:

  • the due diligence policies and procedures for alternative investments/managers are reviewed annually;
  • disclosures made to clients do not deviate from actual practices, are consistent with fiduciary principles and describe any notable exceptions to the adviser’s typical due diligence process;
  • marketing materials are not misleading or unsubstantiated regarding the scope and depth of the due diligence process;
  • due diligence processes are written policies that contain sufficient detail and require adequate documentation; and
  • if responsibilities are delegated to third-party service providers, periodic reviews of those service providers’ adherence to their agreements.

Conclusion

The SEC reminds advisers that they are fiduciaries and must act in the best interest of their clients. In order to meet their fiduciary obligations when selecting alternative investments for clients, an adviser must evaluate whether such investment meets the client’s investment objectives and is consistent with the strategies and principles of investment presented to the adviser by the manager.

While the Risk Alert focuses on a narrow market segment of advisers, the recommendations and due diligence practices have a broader application. Any SEC-registered adviser, exempt reporting adviser or state-registered adviser can review their own operational due diligence policies and procedures to see if they can be bolstered by incorporating any of the recommendations contained in the Risk Alert. Further, managers of alternative investments should consider whether any of their practices or policies are included in the list of warning indicators and make the changes necessary to smoothly pass an adviser’s due diligence process.

[1] Included in the SEC’s definition of “alternative investments” are hedge funds, private equity funds, venture capital funds, real estate funds, funds of private funds, and other private funds.

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As the new year is upon us, there are some important annual compliance obligations Investment Advisers either registered with the Securities and Exchange Commission (the “SEC”) or with a particular state (“Investment Adviser”) and Commodity Pool Operators (“CPOs”) or Commodity Trading Advisors (“CTAs”) registered with the Commodity Futures Trading Commission (the “CFTC”) should be aware of.

See upcoming deadlines below and in red throughout this document.

The following is a summary of the primary annual or periodic compliance-related obligations that may apply to Investment Advisers, CPOs and CTAs.  The summary is not intended to be a comprehensive review of an Investment Adviser’s securities, tax, partnership, corporate or other annual requirements, nor an exhaustive list of all of the obligations of an Investment Adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) or applicable state law.  Although many of the obligations set forth below apply only to SEC-registered Investment Advisers, state-registered Investment Advisers may be subject to similar and/or additional obligations depending on the state in which they are registered.  State-registered Investment Advisers should contact us for additional information regarding their specific obligations under state law.

List of annual compliance deadlines in chronological order:

 

State registered advisers pay IARD fee November-December (of 2013)
Form 13F (for 12/31/13 quarter-end) February 14, 2014
Form 13H annual filing February 14, 2014
Schedule 13G annual amendment February 14, 2014
Registered CTA Form PR (for December 31, 2012 year-end) February 14, 2014
TIC Form SLT Every 23rdcalendar day of the month following the report as-of date
TIC Form SHCA March 3, 2014
Affirm CPO exemption March 3, 2014
Registered Large CPO Form CPO-PQR December 31 quarter-end report March 3, 2014
Registered CPOs filing Form PF in lieu of Form CPO-PQR December 31 quarter-end report March 31, 2014
Registered Mid-Size and Small CPO Form CPO-PQR year-end report March 31, 2014
SEC registered advisers and ERAs pay IARD fee Before submission of Form ADV annual amendment by March 31, 2014
Annual ADV update March 31, 2014
Delivery of Brochure April 30, 2014
Form PF filers pay IARD fee Before submission of Form PF
Form PF (for advisers required to file within 120 days after December 31, 2013 fiscal year-end) April 30, 2014
FBAR Form TD F 90-22.1 (for persons meeting the filing threshold in 2013) June 30, 2014
FATCA registration Must be completed by April 25, 2014
Form D annual amendment One year anniversary from last amendment filingIf the fund will be using 506(c) to generally solicit, the Form D must be amended to check the box that indicates the offering will be made under 506(c) 

 

CONTINUE READING…

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Written by:  Jay B. Gould

On October 23, 2013, the Securities and Exchange Commission (“SEC”) brought charges against three different investment advisory firms for recidivist behavior.  The enforcement actions came out of the SEC’s 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.  The enforcement actions came out of the SEC’s 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.  The SEC takes the view that investment advisory firms that ignore findings in deficiency letters, or represent that corrective action will or has been taken, and then do not take such corrective action, should be provided special treatment.  The SEC Enforcement Division’s Asset Management Unit has coordinated with examiners to bring several cases since the initiative began two years ago. 

The firms charged, Modern Portfolio Management Inc., Equitas Capital Advisers LLC, and Equitas Partners LLC, agreed to settlements in which they will pay financial penalties and hire compliance consultants.  Since the adoption of Rule 206(4)-7 under the Investment Advisers Act (“Compliance Rule”), requiring an investment adviser to hire an outside compliance consultant has been a preferred remedy imposed by the SEC.  .

The SEC’s order against Modern Portfolio Management (“MPM”) and its owners found that they failed to correct ongoing compliance violations, such as failing to complete annual compliance reviews in 2006 and 2009, and making misleading statements on their website and investor brochure.  According to the SEC findings, one location on MPM’s website represented that the firm had more than $600 million in assets.  However, on its Form ADV filing to the SEC during that same time period, MPM reported that the firm’s assets under management were $359 million or less.  Asset inflation, as well as education and professional experience “enhancement” are two favorites among Advisers Act violators, and fairly easy to verify by SEC examiners. 

MPM and their owners agreed to be censured and pay a total of $175,000 in penalties.  The two principals of MPM were required to complete 30 hours of compliance training, a remedy seemingly very close to violating the 8th Amendment.  MPM also agreed to designate someone other than the two principals to be its chief compliance officer, and is also required to retain a compliance consultant for three years.

According to the SEC’s orders against New Orleans-based Equitas Capital Advisers and Equitas Partners as well as their owner, current chief compliance officer, and former owner and chief compliance officer, they failed to adopt and implement written compliance policies and procedures and conduct annual compliance reviews to satisfy the Compliance Rule.  The SEC charged the Equitas firms with making false and misleading disclosures about historical performance, compensation, and conflicts of interest, and 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.  Equitas and the named individuals failed to disclose these deficiencies to potential clients in response to questions in certain due diligence questionnaires or requests for proposals.  

The former owner of Equitas, who later went on to form Crescent Capital Consulting, an investment advisory firm, was also found to have been responsible for Compliance Rule violations at his new firm (as well as at Equitas) by inflating the amounts of assets under management of both firms their respective Forms ADV by improperly removing and retaining nonpublic personal client information when he left Equitas.

Equitas Capital Advisers and Crescent reimbursed all overcharged clients, and agreed to pay a total of $225,000 in additional penalties, but presumable did not go back after the clients that they undercharged. The Equitas firms agreed to censures, and both the Equitas firms and Crescent were required to hire an independent compliance consultant.  Perhaps the most damaging sanction was that the Equitas firms and Crescent are required to provide notice to clients regarding the SEC enforcement actions. 

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Written by: Michael G. Wu

The National Futures Association (“NFA”) recently implemented a new quarterly reporting requirement for commodity trading advisors (“CTAs”).  Under NFA Compliance Rule 2-46, CTAs must file on a quarterly basis NFA Form PR, which consists of the Commodity Futures Trading Commission’s Form CTA-PR together with additional information relating to the trading programs offered by the CTA, related monthly rates of return and assets under management for the trading programs.  The initial report will be due on November 14, 2013.  The NFA Notice to Members discussing the quarterly reports can be found here.

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Written by:  Jay B. Gould

On September 17, 2013, the Securities and Exchange Commission (“SEC”) announced enforcement actions against 23 firms for short selling violations as the agency increases its focus on preventing firms from improperly participating in public stock offerings after selling short those same stocks.  The enforcement actions are being settled by 22 of the 23 firms charged, resulting in more than $14.4 million in monetary sanctions.  

The SEC’s Rule 105 of Regulation M prohibits the short sale of an equity security during a restricted period, which is generally defined as five business days before a public offering – and the purchase of that same security through the offering.  The rule applies regardless of the trader’s intent, and promotes offering prices that are set by natural forces of supply and demand rather than manipulative activity.  The rule is intended to prevent short selling that can reduce offering proceeds received by companies by artificially depressing the market price shortly before the company prices its public offering.

The firms charged in these cases allegedly bought offered shares from an underwriter, broker, or dealer participating in a follow-on public offering after having sold short the same security during the restricted period.   

“The benchmark of an effective enforcement program is zero tolerance for any securities law violations, including violations that do not require manipulative intent,” said Andrew J. Ceresney, Co-Director of the SEC’s Division of Enforcement.  “Through this new program of streamlined investigations and resolutions of Rule 105 violations, we are sending the clear message that firms must pay the price for violations while also conserving agency resources.” 

The SEC’s National Examination Program simultaneously has issued a risk alert to highlight risks to firms from non-compliance with Rule 105.  The risk alert highlights observations by SEC examiners focusing on Rule 105 compliance issues as well as corrective actions that some firms proactively have taken to remedy Rule 105 concerns.

In a litigated administrative proceeding against G-2 Trading LLC, the SEC’s Division of Enforcement is alleging that the firm violated Rule 105 in connection with transactions in the securities of three companies, resulting in profits of more than $13,000.  The Enforcement Division is seeking disgorgement of the trading profits, prejudgment interest, penalties, and other relief as appropriate and in the public interest.  

The SEC charged the following firms in this series of settled enforcement actions:

  • Blackthorn Investment Group – Agreed to pay disgorgement of $244,378.24, prejudgment interest of $15,829.74, and a penalty of $260,000.00.
  • Claritas Investments Ltd. – Agreed to pay disgorgement of $73,883.00, prejudgment interest of $5,936.67, and a penalty of $65,000.00.
  • Credentia Group – Agreed to pay disgorgement of $4,091.00, prejudgment interest of $113.38, and a penalty of $65,000.00.
  • D.E. Shaw & Co. – Agreed to pay disgorgement of $447,794.00, prejudgment interest of $18,192.37, and a penalty of $201,506.00.
  • Deerfield Management Company – Agreed to pay disgorgement of $1,273,707.00, prejudgment interest of $19,035.00, and a penalty of $609,482.00.
  • Hudson Bay Capital Management – Agreed to pay disgorgement of $665,674.96, prejudgment interest of $11,661.31, and a penalty of $272,118.00.
  • JGP Global Gestão de Recursos – Agreed to pay disgorgement of $2,537,114.00, prejudgment interest of $129,310.00, and a penalty of $514,000.00.
  • M.S. Junior, Swiss Capital Holdings, and Michael A. Stango – Agreed to collectively pay disgorgement of $247,039.00, prejudgment interest of $15,565.77, and a penalty of $165,332.00.
  • Manikay Partners – Agreed to pay disgorgement of $1,657,000.00, prejudgment interest of $214,841.31, and a penalty of $679,950.00.
  • Meru Capital Group – Agreed to pay disgorgement of $262,616.00, prejudgment interest of $4,600.51, and a penalty of $131,296.98.00.
  • Merus Capital Partners – Agreed to pay disgorgement of $8,402.00, prejudgment interest of $63.65, and a penalty of $65,000.00.
  • Ontario Teachers’ Pension Plan Board – Agreed to pay disgorgement of $144,898.00, prejudgment interest of $11,642.90, and a penalty of $68,295.
  • Pan Capital AB – Agreed to pay disgorgement of $424,593.00, prejudgment interest of $17,249.80, and a penalty of $220,655.00.
  • PEAK6 Capital Management – Agreed to pay disgorgement of $58,321.00, prejudgment interest of $8,896.89, and a penalty of $65,000.00.
  • Philadelphia Financial Management of San Francisco – Agreed to pay disgorgement of $137,524.38, prejudgment interest of $16,919.26, and a penalty of $65,000.00.
  • Polo Capital International Gestão de Recursos a/k/a Polo Capital Management – Agreed to pay disgorgement of $191,833.00, prejudgment interest of $14,887.51, and a penalty of $76,000.00.
  • Soundpost Partners – Agreed to pay disgorgement of $45,135.00, prejudgment interest of $3,180.85, and a penalty of $65,000.00.
  • Southpoint Capital Advisors – Agreed to pay disgorgement of $346,568.00, prejudgment interest of $17,695.76, and a penalty of $170,494.00.
  • Talkot Capital – Agreed to pay disgorgement of $17,640.00, prejudgment interest of $1,897.68, and a penalty of $65,000.00.
  • Vollero Beach Capital Partners – Agreed to pay disgorgement of $594,292, prejudgment interest of $55.171, and a penalty of $214,964..
  • War Chest Capital Partners – Agreed to pay disgorgement of $187,036.17, prejudgment interest of $10,533.18, and a penalty of $130,000.00.
  • Western Standard – Agreed to pay disgorgement of $44,980.30, prejudgment interest of $1,827.40, and a penalty of $65,000.00.
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This article was published by The FCPA Report and is reprinted here with permission.

More and more, venture capital firms are investing in start-ups seeking to expand internationally or with nascent cross-border operations in place.  Such investments offer opportunities for lucrative returns but also carry significant anti-corruption risk that VC firms are often ill-equipped to manage.  For many businesses, managing anti-corruption risk is a necessary cost center.  But VC firms are uniquely positioned to use that risk to drive a better deal and gain greater control over management and direction of the business.

The overlapping and increasingly aggressive anti-corruption regimes, including the FCPA, the U.K. Bribery Act, the anti-bribery laws in China, Germany and the newly enacted law in Brazil, coupled with the heightened risk of corruption in emerging economies, can quickly derail an otherwise strong investment.  Not only are VC firms subject to fines, penalties and reputational harm through the conduct of the start-up, but the conduct itself may have occurred before the VC firm even considered taking a stake.

This article offers an assessment of the opportunities and risks that VC firms should consider, and concludes with four strategies for maximizing returns while limiting anti-corruption risks.

READ MORE…

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Written by:  Kimberly V. Mann

The Security and Exchange Commission’s recent enforcement action against Lawrence D. Polizzotto serves as a reminder to all issuers that Regulation FD enforcement is alive and well.

The Polizzotto Case

Polizzotto, the former vice president of investor relations at First Solar, Inc. (and, ironically, a member of the company’s Disclosure Committee, which is responsible for ensuring the company’s compliance with Regulation FD), was found by the SEC to have violated Section 13(a) of the Exchange Act of 1934 (the “Exchange Act”) and Regulation FD by selectively disclosing material nonpublic information to certain analysts and investors before the information was publicly disclosed.  The selective disclosures were made to reassure certain analysts and investors about the company’s prospects of obtaining two loan guarantees and to correct information that was previously disclosed about another loan guarantee. Polizzotto knew that First Solar had not yet issued a press release containing information about the status of the guarantees, but went forward with the selective disclosures in any event to counter adverse research reports about the company and stem substantial declines in the company’s stock price. The SEC also determined that Polizzotto directed a subordinate to make similar selective disclosures in advance of the public announcement. First Solar did not publicly disclose the information about the guarantees until the morning after the selective disclosures were made and the company’s stock price declined by 6% on the news.

Polizzotto’s selective disclosure caused First Solar to violate Section 13(a) and Regulation FD. Because First Solar provided what the SEC described as “extraordinary cooperation,” and because the company demonstrated a culture of compliance, it was not charged with any violations. The SEC’s order can be found at www.sec.gov/litigation/admin/2013/34-70337.pdf.

Regulation FD Basics

  • Under Regulation FD, an issuer or any person acting on its behalf that intentionally discloses material nonpublic information to (i) broker-dealers or their associated persons, (ii) investment advisers or their associated persons,
    (iii) investment companies or entities such as hedge funds that would be investment companies but for their reliance on exceptions available under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940 or their affiliated persons or (iv) any of the holders of the issuer’s securities, where it is foreseeable that the recipient of the information would purchase or sell the issuer’s securities on the basis of the information disclosed is required to make simultaneous public disclosure of the information. Disclosure is intentional if the disclosing person knows or is reckless in not knowing that the information being disclosed is material and nonpublic.
  • If selective disclosure is unintentional, public disclosure is required to be made promptly following the selective disclosure. Public disclosure is made promptly by a fund if it is made as soon as reasonably practicable after a senior official of the fund or of the fund’s investment adviser learns that there has been unintentional disclosure of material nonpublic information. In no event will public disclosure be deemed promptly made if it is made after the later of (i) 24 hours after the senior official learns of the unintentional disclosure and
    (ii) commencement of trading on the New York Stock Exchange on the trading day after the senior official learns of the unintentional disclosure.
  • In the context of an investment fund, the term “issuer” means a closed-end fund that (i) has a class of securities registered under Section 12 of the Exchange Act (for example, a fund that has more than $10 million in assets and at least 2000 record holders of any class of its equity securities, or has at least 500 record holders of such securities that are not accredited investors) or (ii) is required to file reports under Section 15(d) of the Exchange Act. Open-end and other types of investment companies are not issuers for purposes of Regulation FD. Foreign private issuers also are not subject to Regulation FD.
  • A “person acting on behalf of a closed-end fund” would include a senior official of the fund or of the fund’s investment adviser or any other officer, employee or agent of the fund that regularly communicates with any person to whom selective disclosure of material nonpublic information is prohibited. An agent of a closed-end fund would include a director, officer or employee of the fund’s adviser or another service provider that is acting as an agent of the fund.
  • The requirements of Regulation FD do not apply to disclosures made by a fund  (i) to its attorneys or any other person that owes a duty of trust or confidence to the fund, (ii) to any person that is subject to an obligation to keep the disclosed information confidential, or (iii) in connection with most primary registered offerings of securities under the Securities Act of 1933. The requirements of Regulation FD apply to disclosures made in connection with unregistered private offerings; however, information may be disclosed privately to select recipients if the recipients are bound by a confidentiality agreement.
  • Public disclosure may be made by way of public filings under the Exchange Act, such as on Form 8-K, or by using any other method reasonably designed to provide broad, nonexclusionary public distribution (such as press releases through wire services with wide circulation, news conferences that are open to the public or publication on the issuer’s website).  In 2008, the SEC issued guidance on public disclosure through company websites, which can be found at   http://www.sec.gov/rules/interp/2008/34-58288.pdf.
  • On April 2, 2013, the SEC issued guidance indicating that social media outlets are permitted to be used to disseminate material information publicly in compliance with Regulation FD. The principles outlined in the 2008 guidance on company websites should be used to determine whether a particular social media outlet is an appropriate channel of distribution for purposes of Regulation FD. In order to use a company website or social media to disclose information publicly, investors must be notified of the specific website or social media channel to be used to provide information to the public. The SEC’s investigative report on social media and Regulation FD can be found at http://www.sec.gov/litigation/investreport/34-69279.pdf.

Regulation FD Compliance Measures 

The following is a partial list of measures that funds and their advisers might implement to assist with Regulation FD compliance.

  • Review existing Regulation FD policies with counsel and update them from time to time as appropriate. Indicate in the Regulation FD compliance policy the names and titles of those persons that are authorized to speak to investors on behalf of the fund.
    • Establish procedures for responding to inquiries from investors and market professionals.
    • Develop a definition of “material information” and incorporate it in the Regulation FD policy.
    • Establish procedures for handling one-on-one discussions with investors and market professionals.
    • Develop policies and procedures for the use of a website or social media to disseminate information to the public.
    • Maintain records of prior disclosures of material information.
  • Conduct periodic Regulation FD training for persons acting on behalf of the fund.
  • Conduct periodic Regulation FD compliance audits.
  • Establish accountability for Regulation FD compliance at top management levels.

Establishing effective policies and procedures designed to ensure compliance with Section 13(a) and Regulation FD may, in addition to reducing the risk of violations, have the effect of reducing the risk of liability in the event a violation occurs.

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Written by:  Jay B. Gould

On June 21, 2013, the Securities and Exchange Commission (“SEC”) entered a cease and desist order (technically called an “Order Instituting Administrative and Cease-and-Desist Proceeding”) against the former President of Stanford Capital Management, Jason A. D’Amato.  You may read the full SEC Order here.  Because this case is part of the broader case of former knight turned Ponzi purveyor, Allen Stanford, it would be easy to dismiss this order as an outlier and not readily applicable to other investment advisers and fund managers.  That would be a mistake.  The D’Amato Order provides useful insight into the SEC’s concerns with the use and misuse of hypothetical and back tested performance information as well as certain compliance failings that all fund manager should understand and appreciate.

To briefly summarize the facts, in 2000, Stanford began offering a mutual fund allocation program to its advisory clients.  D’Amato was hired in 2003 as an assistant analyst to track performance and create personalized pitchbooks for use by Stanford financial advisers in one-on-one presentations with prospective clients.  D’Amato calculated the performance returns for each strategy by back testing then existing allocations in each strategy against historical market data for the previous five years (i.e., if a client held a particular allocation of mutual funds from 2000 through September 2004, the pitchbook showed how it would have performed).  The pitch materials all contained charts showing the performance of each strategy dating back to 2000 with charts variously labeled “Hypothetical Performance,” “Hypothetical Historical Performance,” or “Model Performance.”  Amazingly enough, the back tested performance outperformed the index as well as actual performance in every strategy and, in some cases, by substantial margins.  In fact, the numbers were so skewed that the financial advisers who had to use these materials in front of prospective clients began complaining to Stanford management because none of their clients had ever achieved the returns disclosed on the performance charts.  So, Stanford hired an outside consultant to come in and verify the numbers, or not. 

For at least 2005 and 2006, the consultant concluded that: (i) actual returns earned by Stanford clients were, in most cases, hundreds of basis points lower than the returns published in the pitchbooks; and (ii) D’Amato and his team of analysts did not keep sufficient records to show contemporaneous changes in each of the Stanford strategies prior to 2005, so the consultant could not verify the advertised performance numbers before 2005.  But no problem, even though performance data for 2000 through 2004 could not be verified, Stanford management chose to continue using those figures in the pitchbooks using terms like “historical performance” to describe numbers for which no backup existed.  Additionally, the unaudited and unverified “data” was blended with other audited and composite data from different time periods and then published alongside actual performance.  You might think that crafting appropriate disclosures or disclaimers that would make this potpourri of numbers understandable to clients would be difficult or even impossible.  Apparently, so did Stanford because they decided not to include any.    

During this time, D’Amato began holding himself out to coworkers, clients, prospective clients, financial advisers, and others as a Chartered Financial Analyst (“CFA”).  Sadly, D’Amato was not, and had never been, a CFA and, in fact, he had failed the CFA Level I exam the first and only time that he took it.  Not to be deterred by minor details, D’Amato used the CFA designation in his e-mail signature block on thousands of e-mails and on his business cards.  He also fabricated an e-mail that he purportedly received from the CFA Institute that congratulated him on passing the Level III CFA exam and on achieving charterholder status.  D’Amato then passed that e-mail to Stanford’s human resources department, which in turn passed it along to Stanford’s compliance department which in turn threw him a party, or at least did not verify the authenticity of the “CFA” e-mail.  And what does this behavior get you in the near term?  Sir Allen Stanford was so impressed by how carefully D’Amato polished up the handle, that he was promoted to President of the Stanford investment adviser.  Simply by using totally bogus performance numbers and misrepresenting his qualifications and background, D’Amato increased assets under management from less that $10 million in 2004 to over $1.2 billion by the end of 2008, generating $25 million in management fees in 2007 and 2008.  And then Sir Allen’s Ponzi scheme came crashing down, taking D’Amato in its wake.

For fund managers and investment advisers, there are a number of takeaways from the D’Amato case.  First, when back tested or hypothetical “performance” is used in marketing materials, full and accurate disclosure must be made to investors and potential investors.  The methodology used must be sound and records must be kept.  Similarly, with respect to actual performance, calculations must be accurate and verifiable and must be presented in a context that does not make otherwise accurate information misleading in any material way.  Fund managers, in particular, should not dismiss the D’Amato case because it occurred in the context of mutual funds and more “retail” type investors.  The SEC and state regulators are willing to go back and look at past marketing presentations for inflated or inaccurate claims, all of which are required to kept as part of an adviser’s books and records.

For compliance personnel, remember, you have personal liability under Rule 206(4)-7 under the Investment Advisers Act of 1940 for the proper administration of the firm’s compliance policies and procedures.  Verifying past educational accomplishments, and confirming duties, titles, and responsibilities at former employers of advisory personnel is a basic function of the compliance role.  Even if the employee is the president of the organization, and especially if this particular executive officer ordered or condoned the use of misleading marketing materials after other employees complained about them.

The consequences to D’Amato for his role in this scheme is also worth noting.  D’Amato was fined $50,000, but more importantly, he was barred from the industry for five years and must apply to the SEC for the ability to associate with an investment adviser, broker dealer or any other regulated entity at the conclusion of that bar, should he believe that he has a future in the securities business. 

 

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REGISTER NOW!

Pillsbury and the California Hedge Fund Association invite you to join us on Thursday, April 25, 2013 for an educational program featuring Ms. Jan Lynn Owen, the Commissioner of the California Department of Corporations (DOC) and Person to be Announced from the U.S. Securities and Exchange Commission.

The Commissioner and her staff will discuss the new investment adviser registration rules that were recently adopted by the DOC, including the “exempt reporting adviser” provisions, the interplay between the DOC rules and those of the post-Dodd-Frank rules of the Securities and Exchange Commission.

This program will provide startup hedge fund managers and new investment advisers with the information they need to navigate the registration process, regulatory requirements, and examination focus of the DOC and the SEC, including:

  • Eligibility for reliance on the “exempt reporting adviser” provisions and what that means in the registration process
  • What the DOC and SEC expect to see in hedge fund manager and investment adviser compliance programs
  • Examination and enforcement by the DOC and the SEC and coordination efforts between the two agencies
  • Tax planning and compliance for fund managers at the state, local and federal levels
  • New DOC and SEC rules in the concept or proposal stage aimed at investment advisers

Date & Time
4/25/2013

3:30 pm – 4:00 pm PT
Registration

4:00 pm – 4:30 pm PT
Keynote: Jan Lynn Owen

4:30 pm – 5:45 pm PT
Panel Discussion

5:45 pm – 7:30 pm PT
Reception

Location
Pillsbury’s San Francisco Office
Four Embarcadero Center
22nd Floor
San Francisco, CA 94111

Event Contact
Juliana Curmi 

Featured Speaker
Jan Lynn Owen, Commissioner, California Department of Corporations

Host and Moderator
Jay B. Gould, Partner, Pillsbury

Additional Speakers
Jerry Twomey, Deputy Commissioner, Division of Securities Regulation, California Department of Corporations

Doug Bramhall, Tax Managing Director, KPMG

Kristin A. Snyder, Associate Regional Director–Examinations, Securities and Exchange Commission, San Francisco Regional Office 

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Last month, the Securities and Exchange Commission (the “SEC”), published its examination priorities for 2013.  As we suggested in our Blog posting at that time, the SEC is fixated on examining and bringing enforcement against its newest class of investment adviser – managers of private equity funds.  Fast forward four weeks, and we should not be surprised to see that the SEC is doing what they said they would do.  Today, the SEC charged two investment advisers at Oppenheimer & Co. with misleading investors about the valuation policies and performance of a private equity fund of funds they manage.

The SEC investigation alleged that Oppenheimer Asset Management and Oppenheimer Alternative Investment Management disseminated misleading quarterly reports and marketing materials, which stated that the Oppenheimer Global Resource Private Equity Fund I L.P.’s holdings of other private equity funds were valued “based on the underlying managers’ estimated values.”  The SEC, however, claimed that the portfolio manager of the Oppenheimer fund actually valued the Oppenheimer fund’s largest investment at a significant markup to the underlying fund manager’s estimated value, a change that made the performance of the Oppenheimer fund appear significantly better as measured by its internal rate of return.  As part of the Order entered by the SEC, and without admitting or denying the regulator’s allegations, Oppenheimer agreed to pay more than $2.8 million to settle the SEC’s charges and an additional $132,421 to the Massachusetts Attorney General’s office.

In its press release, the SEC reiterated its focus on the valuation process, the use of valuations to calculate fees and communicating such valuations to investors and to potential investors for purposes of raising capital.  The SEC’s order also claimed that Oppenheimer Asset Management’s written policies and procedures were not reasonably designed to ensure that valuations provided to prospective and existing investors were presented in a manner consistent with written representations to investors and prospective investors. This claim gave rise to an alleged violation of Rule 206(4)-8 (among other rules and statutes) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), the rule that the SEC passed after the Goldstein case permitted many funds to de-register as investment advisers from the SEC.

This case illustrates the new regulatory landscape for private equity fund managers.  Many private equity fund managers have not dedicated the time and resources to bringing their organizations in line with the fiduciary driven rules under the Advisers Act.  Many of these managers have not implemented the compliance policies and procedures required by the Advisers Act, nor have their Chief Compliance Officers been empowered to enforce such compliance policies and procedures when adopted.  Much of this oversight goes to the fact that many private equity fund managers do not have a history of being a regulated entity nor have they actively sought out regulatory counsel in their typical business dealings.  Private equity fund managers generally use outside counsel to advise them on their transactional or “deal” work and they often do not receive the advice that a regulated firm needs in order to meet its regulatory obligations.  Oppenheimer serves notice that failing to meet these regulatory obligations can have dire consequences.