SEC Enforcement

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Fines

A chief compliance officer (“CCO”) for a registered investment adviser (“RIA”) found himself barred from any compliance or supervisory role in the future because he willfully refused to fix a number of compliance issues.  See https://www.sec.gov/litigation/admin/2017/34-82397.pdf. 

The RIA had conducted a review that uncovered numerous compliance problems.  Despite having notice of the results of this review, the CCO simply ignored it, and did not address any of the problems, including, among other things, the failure to retain emails, electronic information, or protect customer information.  The CCO also failed to update the compliance manual or conduct an annual review.

Such a step by the SEC is in keeping with its belief that CCOs are on the front lines of ensuring that the public are protected.  Here, it seems that the CCO ignored those responsibilities, and was punished severely.

We are regularly approached by both our RIA (and BD too) clients, who inquire, usually around election time, how they should make political contributions. Our advice is usually do not make the political contribution and you can blame your lawyer!

However, those persons, ignoring that advice, should be concerned that the SEC, recently, fined an investment adviser for violating the Investment Advisers Act of 1940’s pay-to-play rule prohibiting an RIA from accepting compensation for 2 years following a political contribution to an official that may influence, who obtains an investment contract.  See https://www.sec.gov/litigation/admin/2018/ia-4960.pdf.  Although in this case the significant investment in the RIA’s managed fund preceded the campaign contribution, it simply did not matter. The RIA could no longer do business with the entity once the campaign contribution was made, it was simply strict liability.

Thus, we are always reluctant to recommend that a client should make a political contribution since it could cost the RIA business.

Today, the United States Supreme Court sent shock waves through the securities industry as well as the United States Securities and Exchange Commission’s (“SEC”) enforcement program when it held that SEC administrative law judges (“ALJ”) are “inferior officers,” and must be chosen pursuant to the appointments clause of the United States Constitution.  That is, the President with the advise and consent of the United States Senate may appoint “all other Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.”  See United States Constitution Article 2, Section 2, Clause 2.  Although this decision was centered on an appeal involving an SEC ALJ, it may also effect other federal agencies that use in-house judges.

Initially, the case involved a former investment adviser who was sanctioned by an SEC ALJ.  See Lucia v. SEC, https://www.supremecourt.gov/opinions/17pdf/17-130_4f14.pdf.  The United States Court of Appeals for the District of Columbia had held that SEC ALJs were not subject to the appointments clause; however, the United States Court of Appeals for the 10th Circuit had found differently.  Justice Elena Kagan authored the opinion and found that the SEC’s ALJs were very similar to tax court trial judges where the Supreme Court had previously found those judges to be inferior officers subject to the appointments clause.

Now that the Supreme Court has opened this door with the finding ALJs are inferior officers, the SEC’s ALJ’s will have to be appointed pursuant to the appointments clause in the future, and it calls into question what, if anything, will happen to the ALJs at other federal agencies.  Further, there will be the question of prior SEC cases, the Supreme Court stated that not every appointments clause violation requires a new hearing.  However, time will tell.

Additionally, although Justice Kagan specifically said it was not being addressed in this case, we may also shortly see that, since the SEC’s ALJs are now considered inferior officers subject to the appointments clause, they may also now be subject to removal by the SEC Chairman for good cause.  Such a result may provide significant power to the president to fire such ALJs at will, maybe even in a Tweet.  As for Mr. Lucia, well, he now gets a re-trial before either the full SEC or a new ALJ appointed pursuant to the appointments clause, who will determine if his “Buckets of Money” program is real or made-up.

In short, the Supreme Court has upended how the SEC does business.  Of course, we will follow how the SEC responds.

 

 

In rapid succession, the SEC has issued warnings and announced sanctions against registered investment advisers for fee and expense practices, false statements regarding assets under management, and misleading performance data.  No one should be surprised that the SEC is actively seeking to uncover transgressions in the RIA field.

Initially, the SEC’s Office of Compliance Inspections and Examinations issued a Risk Alert outlining a variety of RIA failures concerning the proper calculation and disclosure of fees and expenses.   See https://www.sec.gov/ocie/announcement/risk-alert-advisory-fee-expense-compliance.  In particular, the alert detailed a series of failures that OCIE found in its examinations of RIAs, among other things, RIAs failed to properly value assets, overbill, use incorrect fees or time periods.

Similarly, the SEC also sanctioned a principal of a closed RIA for falsely stating it was subject to SEC registration.  See https://www.sec.gov/litigation/admin/2018/ia-4875.pdf.  Although we believe it admirable for someone to want to achieve SEC RIA registration status, you want to be accurate when you make this claim.  Apparently, this individual was not, and lying to the SEC will always incur its wrath.

Finally (and this is a pet peeve with us), the SEC also sanctioned a RIA for using misleading performance data.  See https://www.sec.gov/litigation/admin/2018/ia-4885.pdf.  The RIA was caught using hypothetical back-tested performance data– a pretty big no-no.  We are constantly advising RIA clients of the pitfalls in using any type of performance data, and this case illustrates how closely the SEC will look at its use.

In sum, RIAs have to be careful the SEC is watching.

 

 

In a recent speech, new SEC Chairman Jay Clayton warned lawyers, who advice clients on bitcoins and initial coin offerings (“ICOs”), to be aware the SEC is lurking out there waiting to pounce.  Of course, he did not say it exactly like that, but he might as well have used those exact words.

Clayton stated that the SEC Staff is monitoring (he called it being on “high alert”) lawyers, who advice clients on these transactions.  Apparently, the SEC believes that certain lawyers may be advising clients to skirt the federal securities laws in the process.  In particular, he mentioned that ICOs were becoming more problematic.  ICOs are essentially mechanisms to raise capital for start-ups.  Additionally, despite the SEC’s pronouncement to the contrary that ICOs and bitcoins are governed by the federal securities laws, Clayton claims the SEC Staff has seen lawyers structure ICOs resembling securities transactions, and then claim the bitcoins are not securities.  For the record, the SEC has already brought several enforcement actions in this space to stop fraudulent activity.

Nonetheless, Chairman Clayton’s remarks are extraordinary because, given the lack of a judicial or statutory framework in this area, he is essentially suggesting lawyers have to be more certain as a legal matter in their opinions than Congress, the courts, and even his own agency.  Such a position is remarkable, and represents a titanic shift in the SEC’s previous policy of only going after lawyers who engage in fraudulent conduct.  I warned of this very possibility in an article I wrote several years ago, and the new administration apparently wants to continue the practice.  See http://www.foxrothschild.com/publications/the-empire-strikes-back-the-secs-new-assault-on-lawyers/.

Finally, Chairman Clayton’s warning is a sad commentary on the failure of a government regulator to actually address the real issue, and instead scapegoat a likely target.  Instead of twisting and misinterpreting Shakespeare’s famous and often misused quote “let’s kill all the lawyers” (Henry VI,” Part II, act IV, Scene II, Line 73), it would have been probably more worthwhile for Chairman Clayton to outline a set of new SEC specific rules or regulations in this area so that lawyers would be able to provide a definitive framework for their clients, who undertake ICOs or other bitcoin transactions.

 

The SEC recently upheld a statutory disqualification that FINRA imposed where the representative filed a false U-4 and falsely answered compliance questionnaires. It appears as though the registered representative failed to disclose tax liens and a bankruptcy on his U-4. So is statutory disqualification the proper punishment for this misdeed.

According to FINRA and the SEC, the answer is a resounding yes and, unfortunately for the registered representative, this makes sense. After all, the U-4 is the lynchpin of what must be disclosed to FINRA and members firms. The answers serve as the basis for whether a registered representative will be hired, retained and supervised.

24752961 – grunge rubber stamp with text disclosure,vector illustration

Similarly, firms use compliance questionnaires to determine if there are compliance issues that need to be addressed. The firm cannot satisfy that purpose when the responses are a lie.

The moral of the story, do not lie on your U-4 and compliance questionnaires. It is only a matter of time before you are caught, and you will be caught. Why throw away your career when the true answers may not have had any impact on the person’s career or position with the member firm.

The SEC recently announced an enforcement initiative that will target retail investor harm. The agency’s task force will use data analytics to find widespread problems regarding fee disclosures and unsuitable investment recommendations. In addition to data analytics, the SEC will rely upon tips, complaints and referrals that come into the SEC.

This heightened analysis of the retail investor market should be a wake-up call to firms who service the retail investor space. There are a few questions that you should be asking as you move forward:

  1. Do I have a rigid supervisory system to make sure clients are receiving suitable investment advice for the fee being paid?
  2. If my firm does not have a robust supervisory system over retail investment advice, what is the firm doing to develop and deploy such a system?
  3. What does you supervisory system provide if it finds unsuitable investment recommendations?

There are certainly additional questions that firms can ask themselves, but the point is made. What are you doing to make sure the SEC does not have an issue with the retail investment advice that you are giving to your clients? If you cannot answer that question, you had better go back to the drawing board.

It is almost axiomatic that the SEC “enjoys” bringing enforcement actions against lawyers.  The SEC believes that lawyers have a special duty to protect and police the securities markets, and, when a lawyer fails, the SEC is right there to pounce.

In fact, the SEC fined and barred an attorney from practicing before the Commission because the attorney failed to conduct proper due diligence when acting as underwriter’s counsel in misleading municipal bond offerings.  See https://www.sec.gov/litigation/admin/2017/33-10335.pdf.  The SEC claimed that the lawyer prepared erroneous documents regarding on-going disclosure obligations. The SEC stated the lawyer never went beyond relying upon the issuer’s claims, and ignoring red flags concerning the inaccuracy of the disclosure.

If you are lawyer, you cannot outrun the long-arm of the SEC, please take precautions!

Core Values

Despite numerous warnings, some people just do not get it.   The SEC barred a broker from the industry because the broker used personal email and text messages to obtain client investments.  See the Commission’s website.

The SEC found these personal communications were never submitted to the firm for review.  As a result, the broker aided and abetted his firm’s books and records violations.  Further, the broker also made numerous other violations as well.

This scenario demonstrates the critical requirement to only use firm sponsored media for client communications.