Articles Tagged with SEC Enforcement

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Recent enforcement action could signal expanding the boundaries of misappropriation theory, with significant implications for SEC-regulated entities and other market participants.

TAKEAWAYS

  • With Chair Gensler at the helm, an emboldened SEC Enforcement Division will continue to take aggressive positions in insider trading enforcement actions and is willing to test the contours of insider trading law in litigation.
  • The Panuwat enforcement action advances the novel theory that possessing confidential information about one issuer may preclude trading in the securities of competitors and other companies in a business sector.
  • In light of the increased risk posed by the Panuwat matter, regulated entities and other market participants should review their policies and procedures to ensure that they are reasonably designed and tailored to
    prevent the misuse of material nonpublic information.

On August 17, 2021, the U.S. Securities and Exchange Commission (SEC) charged a former pharmaceutical company executive with insider trading for purchasing the securities of a rival company based on confidential information he learned about his own employer’s contemplated merger with another pharmaceutical company. The SEC’s enforcement action, which is being litigated in the United States District Court for the Northern District of California, appears to confirm early predictions that the SEC, with Chair Gary Gensler at the helm, would aggressively police the securities markets for insider trading.

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Read this article and additional Pillsbury publications at Pillsbury Insights.

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On July 14, 2016, the Securities and Exchange Commission (SEC) announced an enforcement action against RiverFront Investment Group, LLC, a registered investment adviser serving as sub-adviser to clients in wrap fee programs established by various sponsors. The enforcement action resulted from RiverFront’s materially inadequate disclosure about changes in its trading practices and attendant transaction costs which exceeded wrap fees and caused millions of dollars in extra transaction costs for its clients.

In its role as sub-adviser, RiverFront had discretion to determine whether to send trades to sponsor-designated broker-dealers (whose costs were covered under the wrap fee program) or to other brokers in which case the clients would pay additional transaction costs. Wrap fee programs enable clients to pay one fee to cover a bundle of services, including, for example, trading, investment management and custody. From 2008 to 2011, RiverFront disclosed on its Form ADV that trades were “generally” executed through designated broker-dealers. It also disclosed that it may trade away in an effort to obtain best execution on behalf of its clients. A “trade away” is the practice of sending trades to a broker-dealer that has not previously been designated. In 2009, RiverFront started trading away significantly more transactions and charging clients fees that were not included in the annual wrap fee. However, in its annual Form ADV amendment filings from 2009 to 2011, RiverFront did not change its disclosures to reflect the frequency of its trade aways.

It was RiverFront’s failure to accurately and timely disclose on its Form ADV its trading practices and the potential for additional transaction costs that resulted in the SEC sanctions. The SEC held that RiverFront willfully violated Sections 207 and 204(a) of the Investment Advisers Act of 1940 and Rule 204-1(a) thereunder.

The SEC imposed sanctions against RiverFront, namely:

  • censorship; and
  • a $300,000 fine.

RiverFront also undertook to disclose quarterly on its website the volume of trades executed with non-designated brokers and the costs to be passed onto clients.

The RiverFront enforcement action serves as a reminder to investment advisers to review their Forms ADV to ensure that trading practices, costs and other material information regarding their advisory businesses are adequately and accurately disclosed.  Please contact an Investment Funds and Investment Management Group attorney for assistance with issues pertaining to Form ADV disclosure and related matters.

The SEC Press Release can be found here.

The full text of the SEC order can be found here.

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A group of related private equity (“PE”) funds were found liable for a bankrupt portfolio company’s pension plan debts in the latest and most worrisome decision in the long-running Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund dispute. The novel decision, if upheld on appeal, will trigger a reevaluation of common PE industry practices related to co-investments and management fee offset arrangements. The decision also signals increased transaction risks for PE funds, lenders who provide financing to portfolio companies, and potential buyers of portfolio companies from PE funds.

Background of the Sun Capital Dispute

In 2006, Scott Brass Inc. (SBI) was acquired by three investment funds linked to the Sun Capital Partners Inc. group for approximately $7.8M ($3M invested by the funds and $4.8M funded by debt). SBI participated in an underfunded multiemployer (or union) defined benefit pension plan, and when SBI declared bankruptcy in 2008, the pension plan assessed $4.5M in withdrawal liabilities against SBI. The pension plan pursued payment of the withdrawal liabilities from the deep pockets of the three Sun Capital funds who owned SBI: Sun Capital Partners III, LP (SCP-III), its parallel fund Sun Capital Partners III QP, LP (SCP-IIIQ) and Sun Capital Partners IV, LP (SCP-IV).

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(This article was published in the first February 2016 issue of “The Review of Securities and Commodities Regulation” and is reprinted here with permission.)

The last half of 2015 has been characterized by a lot of debate and press attention on the role of the Chief Compliance Officer (“CCO”) at investment advisers. It has attracted attention within the highest levels at the SEC as reflected in a series of public statements and speeches, including the public disagreement of two Commissioners on whether or not there is a new trend targeting CCOs. While this debate has been unusual, it has led to a healthy and productive discussion about the CCO’s role. Below, we will discuss in turn: (a) recent statements over the past six months by SEC leaders about CCOs and whether or not there is a new trend targeting them, (b) what qualities are essential to an effective CCO and whether or not the job should be outsourced, and (c) how an effective compliance leader can prevent and detect any problems and be truly effective in preparing the firm for SEC examinations.

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On November 3, 2015, an Illinois federal jury convicted Michael Coscia, a high-frequency commodities trader, of six counts of commodities fraud and six counts of spoofing—entering a buy or sell order with the intent to cancel before the order’s execution.1 Coscia’s conviction was the first under the criminal anti-spoofing provisions added to the Commodity Exchange Act (CEA) by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. In the press release touting its victory, the prosecution announced: “The jury’s verdict exemplifies the reason we created the Securities and Commodities Fraud Section in Chicago, which will continue to criminally prosecute these types of violations.” High-frequency traders should take note that the conviction on all six counts of spoofing charged in Coscia’s case may embolden prosecutors across the nation to pursue other spoofing cases with vigor. Given the real possibility of a felony indictment and conviction for spoofing—the latter of which exposes a defendant to imprisonment for up to ten years and significant monetary fines—high-frequency traders should carefully evaluate their strategies and conduct.2

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Read this article and additional publications at pillsburylaw.com/publications-and-presentations.  You can also download a copy of the Client Alert.

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On December 1, 2015, the Securities and Exchange Commission (SEC) charged GAW Miners, LLC (“GAW Miners”), ZenMiner, LLC (“ZenMiner”) and Homero Joshua Garza (“Garza”) the managing member of both GAW Miners and ZenMiner (together the, “Defendants”) with fraud under (i) Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and (ii) Section 17(a) of the Securities Act of 1933 (“Securities Act”). The Defendants were also charged with engaging in the offer and sale of unregistered securities under Sections 5(a) and 5(c) of the Securities Act for selling $20 million worth of shares in their virtual currency digital mining contract called a “Hashlet”.

The charges stem from the Defendants’ operation as a virtual currency “miner” which uses computing power to be the first to solve complex algorithms. The first virtual currency miner to solve a complex algorithm that confirms a transaction is rewarded with newly-issued bitcoins by the bitcoin protocol.

While virtual currency mining is not illegal, the SEC found:

  • Hashlets were touted as always profitable and never obsolete and had more than 10,000 investor purchases.
  • The Hashlet contract purportedly entitled the investor to control a share of computing power that GAW Miners claimed to own and operate while Hashlets were depicted in marketing materials as a physical product or piece of mining hardware.
  • GAW Miners directed little or no computing power toward any mining activity and misled investors to believe they would share in returns.
  • Garza and his companies owed investors a daily return that was larger than the actual return they were making on their limited mining operations because they sold far more computing power than they owned.
  • Investors were paid back gradually over time with “returns” out of funds collected from other investors.

The Press release is available HERE.

A full copy of the SEC order is available HERE.

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The regulatory environment for SEC-registered advisers has become more complex as the result of a more aggressive and interconnected Securities and Exchange Commission (SEC). The connecting hub within the SEC is the Office of Compliance Inspection and Examination (OCIE), which serves as the “eyes and ears” of the SEC. The OCIE often is the first line of contact between an investment adviser and a potential referral to the SEC Enforcement Division’s Asset Management Unit (AMU), which is devoted exclusively to investigations involving investment advisers, investment companies, hedge funds and private equity funds.

The OCIE’s three main areas of focus for their 2015 exam priorities are (i) protecting retail investors, (ii) issues related to market-wide risks, and (iii) data analysis as a tool to identify registrants engaging in illegal activity.

Overlapping with the OCIE’s frontline examination role is the Compliance Program Initiative, which began in 2013 by sanctioning three investment advisers for ignoring problems within their compliance programs. The Compliance Program Initiative is designed to address repeated compliance failures that may lead to bigger problems. As such, any issues raised in a deficiency letter resulting from an examination are ripe for follow-up as the starting point of a subsequent examination. In the current regulatory environment—where violations of compliance policies and procedures can serve as the basis of enforcement actions—investment advisers and their compliance professionals need to pay close attention to the implementation, follow-through and updating of every aspect of their compliance program.

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Read this article and additional publications at pillsburylaw.com/publications-and-presentations.  You can also download a copy of the Client Alert.

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On November 3, 2015, the Securities and Exchange Commission (SEC) announced that Fenway Partners, LLC (Fenway Partners), a private equity fund adviser, agreed to pay more than $10 million to settle charges that it failed to disclose conflicts of interest to a fund client and omitted material facts to investors.

SEC Findings

Fenway Partner’s current and former principals as well as the chief financial officer did not:

  • Disclose to Fenway Capital Partners Fund III, L.P. (the Fund) or its investors that Fenway Partners caused certain portfolio companies of the Fund to cancel management services agreements—subject to management fee offsets—between Fenway Partners and portfolio companies.
  • Disclose to the Fund or its investors the creation of the affiliated entity Fenway Consulting Partners, LLC (Fenway Consulting).
  • Disclose to the Fund or its investors that Fenway Consulting received $5.74 million for providing services to portfolio companies similar to those previously provided by Fenway Partners and often using the same employees—without a management fee offset against the fees paid to Fenway Partners.
  • Disclose in its capital call notice to investors in connection with a portfolio company investment that $1 million of the $4 million total capital call would be used to pay Fenway Consulting fees.
  • Disclose to the advisory board or the investors the conflict of interest concerning cash incentive plan payments to current and former Fenway Partner principals.
  • Disclose, as related party transactions, in the financial statements provided to investors, those payments received by Fenway Consulting for its services to portfolio companies.

The press release is available HERE.

A full copy of the SEC order is available HERE.

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Strategy shifts now the focus, the SEC extracts another pound of flesh from a fund adviser. In a recently settled administrative proceeding, UBS agreed to return $8.2 million of advisory fees to investors, compensate investors for $4.9 million of investment losses and pay $4.4 million in interest and penalties to the SEC for allegedly failing to disclose an investment strategy shift and failing to supervise disclosures. UBS neither admitted nor denied culpability.

Investment advisers are advised to periodically review the description of their strategy and adjust the disclosure if their practices materially diverge from the described strategy over time. In addition, advisers should consider what manner of disclosure is appropriate in light of the facts and circumstances of a major strategy shift – whether, for example, to disclose promptly in an investor letter, prior to the strategy shift with an opportunity to redeem, and whether and when to involve the board of directors and/or outside counsel.

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The SEC, again, makes it clear:  all aspects of fee, expense and other arrangements must be disclosed accurately and in detail before commitments are accepted.

The SEC recently announced a settlement with three investment advisor affiliates of The Blackstone Group (the Advisors) that were accused of breaching their fiduciary duty to funds they manage or managed, failing to make necessary disclosure to the funds’ investors and failing to adopt and implement policies and procedures reasonably designed to prevent violations of the Investment Advisers Act of 1940 and its rules. The charges leveled against the Advisors centered on conflicts of interest involving monitoring fees and legal fee discounts. At the time the alleged violations occurred, each of the Advisors was an SEC-registered investment advisor. Although the Advisors neither admitted nor denied the SEC’s findings, they made several changes to existing business practices, agreed to pay the SEC a $10 million penalty and agreed to remit to their funds fees and interest approximating $29 million in response to allegations of violations of Section 206(2) and Section 206(4) of the Investment Advisers Act and Rules 206(4)-8 and 206(4)-7 thereunder.

Accelerated Monitoring Fees

According to the SEC, the Advisors entered into monitoring agreements with each portfolio company owned by their funds and received, in addition to the annual management fees paid by their funds, monitoring fees from the portfolio companies. In accordance with the funds’ limited partnership agreements, fifty percent of the Advisors’ monitoring fees was used to offset the annual management fee otherwise payable by the funds. Under certain of the monitoring agreements, in the event of a private sale or initial public offering of a portfolio company, monitoring fees could be accelerated for the remaining years of the agreements’ terms (including extension periods), discounted to present value and paid in advance upon termination of the agreements. Notwithstanding that fifty percent of the accelerated monitoring fees inured to the benefit of the funds and their limited partners, the SEC found the arrangements problematic because the value of the funds’ assets was reduced by the net amount of the accelerated monitoring fee payments when the portfolio companies were sold or taken public, thereby reducing amounts available for distribution to the limited partners.

The SEC was particularly offended by the fact that, in certain instances, fees were accelerated beyond the period during which a fund owned the relevant portfolio company or beyond the period during which services were performed by the Advisors. In addition, the SEC alleged that, although the Advisors disclosed their ability to collect monitoring fees to the funds and the funds’ limited partners before capital was committed to the funds, the Advisors did not disclose the practice of accelerating monitoring fees prior to the time the Advisors received the accelerated fees. The SEC conceded, however, that monitoring fee acceleration was disclosed in distribution notices, quarterly management fee reports and, where there were public offerings of portfolio companies, in SEC filings on Form S-1. The SEC further acknowledged that the funds’ limited partner advisory committees could have objected to acceleration and arbitrated the matter, but never took such action. The problem, according to the SEC, is that, because of the conflict of interest, the Advisors could not effectively consent to the acceleration.

Disparate Discounts on Legal Fees

The Advisors also negotiated a single agreement with legal counsel pursuant to which legal counsel provided services to the funds and the Advisors.  According to the SEC, although the funds generated significantly more work than the Advisors, the Advisors received substantially greater discounts than the funds. In addition, the difference in the discounts was not disclosed to the funds, the funds’ advisory committees or limited partners. Again, because of the conflict, the Advisors could not consent effectively.

Takeaways

The findings made and penalties imposed by the SEC in the Blackstone matter highlight the SEC’s disdain of conflicts of interest between advisors and the private funds they manage. More importantly, the matter makes clear the SEC’s intention to go after even the most common business practices in private equity, if the SEC determines that aspects of those practices are not disclosed fully prior to the time capital commitments are accepted. Nothing is sacrosanct.

As was the case with Blackstone, a fund’s private placement memorandum typically discloses that the fund’s management entities and affiliates of those entities may receive fees to which the fund will not be entitled. It also customarily discloses actual and potential conflicts involving fund counsel. The SEC has made clear that those disclosures will not be sufficient if they do not describe all aspects of the relevant conflicts clearly, accurately and completely. Broad and generalized disclosures, even where sophisticated and experienced fund investors are able to discern the nature of the conflict, will not protect against violations of Sections 206(2) and 206(4) of the Investment Advisers Act and the rules promulgated under those sections of the Act. Further, disclosures made after investors’ capital commitments are accepted may not be sufficient.

This case also highlights the fact that the SEC will push back against attempts by an SEC-registered investment advisor to limit its fiduciary duty to the funds it advises. In addition, it appears that the SEC will apply Section 206(2) and Section 206(4) of the Investment Advisers Act broadly and with a big stick.

As is always the case, cooperation with the SEC in connection with an examination or investigation is critical. In addition, as is evidenced in the Blackstone matter, taking remedial action to eliminate or ameliorate conflicts can be very helpful to an advisor that is under SEC scrutiny and seeking to minimize exposure to punitive action.