Chief Compliance Officers
The SEC brought charges against two CCOs consistent with the SEC’s messaging around CCO liability — that is, the SEC will charge CCOs where their conduct rises to the level of a wholesale failure of their compliance responsibilities or they make efforts to obstruct SEC matters or are involved in the underlying violative conduct. Often such charges are against individuals who wear multiple hats and the conduct was not in their capacity as CCO. SEC officials continue to alert the industry that CCOs who exercise their responsibilities in good faith are not in the line of fire.
- The SEC charged the CCO of an investment adviser for aiding and abetting and causing the firm’s violations of the federal securities laws. The firm was also charged for primary violations. The SEC found that the CCO knew, or should have known, that the compliance program was inadequately implemented but failed to make sufficient changes to its design or implementation where the CCO was aware or on notice of numerous instances of noncompliance with the firm’s policies and procedures relating to outside business activities.1 Commissioner Hester M. Peirce issued a statement in which she stated, “the CCO had the opportunity to improve the compliance program, but did not do so despite frequently recurring reminders that the program was not working effectively.”2 To settle the matter, the CCO agreed to a bar from acting in a supervisory or compliance capacity and to a $15,000 civil monetary penalty, and the adviser agreed to a $150,000 civil penalty.
- The SEC filed charges against the CCO, chief risk officer, and head of operations of a private fund adviser that was separately charged with fraudulent fund valuations. The SEC alleged that the respondent ignored red flags with respect to the CEO’s alleged scheme to overvalue fund assets by more than $1 billion, negligently made misrepresentations to investors, helped submit misleading documents to the SEC staff, and helped to mislead the fund auditor, among other things.3 The CEO allegedly inflated fund performance by manipulating a third-party pricing service’s valuation models and inputs.4 The respondent agreed to a proposed settlement, with monetary penalties and an officer-and-director bar to be determined by the court at a later date.5
Recent and Ongoing Sweeps
The SEC has been actively using market-wide “sweeps” as a way to investigate efficiently similar conduct by multiple investment advisers. During the fiscal year-end, the SEC brought charges against 14 investment advisers through three such enforcement sweeps.
- Pay-to-Play Rule. The SEC completed its first pay-to-play sweep since its actions in 2017, bringing charges against four advisers, including three exempt reporting advisers to venture capital funds. The SEC charged these advisers with violating the SEC’s Pay-to-Play Rule6 by continuing to receive investment advisory fees from government entities following campaign contributions made by associates.7 The parties agreed to pay civil penalties in amounts ranging from $45,000 to $95,000. Of note, in her statement regarding the settlements, Commissioner Pierce described the rule as “an exceedingly blunt instrument” that “does not require any evidence of an actual quid pro quo, or even evidence that the adviser was seeking a quid pro quo,” nor does it require “any assessment of whether the official receiving the contribution realistically could influence the decision to hire an investment adviser, or whether the contribution itself reasonably could be expected to influence the official.”8
- Custody Rule. The SEC charged nine private fund advisers with failing to comply with the Custody Rule,9 including because they failed to (i) have audits performed, (ii) timely deliver audited financials to investors, and/or (iii) promptly file an amended Form ADV to reflect that they had received audited financials.10 One of the advisers was charged solely for failure to update its Form ADV to reflect a subsequent receipt of audited financials. In total, the advisers agreed to pay over $1 million in penalties. Commenting on the sweep, SEC Enforcement Director Gurbir S. Grewal stated that while the sweep “presented a unique circumstance for promptly resolving” the investigations, “[c]ounsel should not assume that the Division will recommend similar resolutions going forward.”11 The press release indicated that failures to promptly update the Form ADV “make it harder for the SEC to identify firms with possible on-going issues regarding the Custody Rule.”12 Relatedly, one day prior to announcing the sweep, the SEC announced a separate settlement with a private fund adviser that included a $100,000 penalty, suggesting more widespread investigation than just the sweep.13
- Off-Channel Communication Recordkeeping. On the eve of the fiscal year-end, the SEC and the Commodity Futures Trading Commission (CFTC) charged 15 broker-dealers and one affiliated investment adviser for “widespread and longstanding failures” to maintain and preserve electronic communications, namely through “pervasive” off-channel communications on personal devices.14 The SEC penalties alone totaled over $1.1 billion, including $125,000 for the investment adviser.15 Since then, the SEC’s Division of Enforcement has launched a market sweep to investigate investment advisers for off-channel recordkeeping failures.
Demonstrating its continued focus on SPACs, the SEC charged a private fund adviser for failing to disclose conflicts of interest regarding its personnel’s ownership of sponsors of SPACs into which the respondent advised its clients to invest and for making misleading statements to fund investors that it had sponsored all of the SPACs without disclosing that some of the sponsors were partially owned by the adviser’s personnel.16 The SEC also charged the adviser with violating Section 13(d) of the Securities Exchange Act and Rule 13d-1 thereunder concerning beneficial ownership of stock in a public company. The SEC found that the adviser failed to timely convert its Schedule 13G filing to a Schedule 13D when it could no longer certify under the former that the securities “were not acquired and are not held for the purpose of or with the effect of changing or influencing the control of the issuer of the securities.” The adviser agreed to pay a $1.5 million penalty to settle the charges.
Fees and Expenses
The SEC continues to bring enforcement actions against fund managers related to fees and expenses. Although this is a perennial issue for the SEC, one of the enforcement actions resulted in a far larger fine than is typical for these types of matters. Here are the SEC’s primary findings in recent fee-and-expense actions:
- Undisclosed Fees. The SEC charged two private fund advisers for including one founder’s anticipated income tax liability as an undisclosed component of the ancillary and underwriting fees charged to private equity funds they managed.17 The advisers agreed to pay $11.2 million in civil penalties to settle the charges. Prior to any contact with the SEC staff, the advisers had conducted an internal review, determined to end the practice, and made disclosures to the funds and their limited partner advisory committees, and the founder reimbursed $68.5 million to the affected funds, which included interest on the undisclosed tax liabilities.
- Fee Offsets. The SEC charged a private equity fund adviser for failing to offset management fees properly to repay fund clients for borrowed money used to pay third-party placement agent fees and for failing adequately to disclose to investors information concerning management fee offsets.18 The order noted the adviser’s remedial acts, including fully repaying the loan with interest, hiring a new CCO, engaging an outside compliance consultant, and convening a management committee for compliance program oversight. The adviser agreed to pay $325,000 to settle the charges.
Best Interest / Duty of Care
The SEC continues to charge investment advisers for fiduciary duty breaches, in particular for breaching the advisers’ duty of care by failing to undertake a best-interest analysis.
- The SEC charged an investment adviser for violating its duty of care by failing to undertake any analyses to determine whether share classes it selected were in its clients’ best interests and for violating its duty of best execution by causing its clients to invest in certain higher-cost share classes, including share classes for which its investment adviser representatives would have personally borne the transaction costs, rather than other available share classes of the same funds that presented more favorable value to the clients.19 The adviser agreed to pay a $5.8 million civil penalty in addition to multiple, potentially costly undertakings, including evaluating existing clients’ share class sections and reviewing and updating relevant policies, procedures, and disclosures.
- The SEC charged a former registered investment adviser, among other things, with failing to fulfill its duty of care where the adviser failed to convert certain client accounts in its wrap fee program to brokerage accounts, as required by its compliance policies, after compliance monitoring flagged them for potential “reverse churning” (where a client is charged a fee that covers all advisory services and trading costs even though the client trades infrequently).20 The adviser settled the matter by paying a $200,000 penalty and over $575,000 in disgorgement and prejudgment interest.
- The SEC charged an investment adviser for engaging in misconduct related to a wrap fee program, including by failing to review client accounts to determine whether such programs remained suitable for each client and by failing to disclose that clients would be charged for certain transaction costs in addition to wrap fees.21 The adviser settled to a $700,000 civil money penalty and almost $200,000 in disgorgement and prejudgment interest. During the course of the SEC investigation, the adviser hired outside counsel and a compliance consultant to assist with enhancing its disclosures and written compliance policies and procedures.
- The SEC charged a mutual fund adviser for failing to disclose adequately its share selection practices and resulting conflicts of interest when it invested clients in share classes that resulted in fees to its broker-dealer affiliate instead of lower-cost share classes without such fees.22 The adviser agreed to pay a $225,000 civil money penalty, nearly $714,000 in disgorgement and prejudgment interest, and certain undertakings.
Venture Capital Fund Advisers
While venture capital firms are traditionally exempt reporting advisers, they are still subject to the antifraud provisions of the Advisers Act. As a result, the SEC recently charged venture capital fund managers with unauthorized and undisclosed interfund loans and improper management fees.
- The SEC charged two venture capital fund managers and their owner for directing certain clients to make over 50 unauthorized loans to other managed funds or to affiliates and without disclosing conflicts of interest arising from the loans and loan terms.23 The settlement included civil penalties in the amounts of $200,000 for the advisers and $25,000 for the owner. Prior to settling, the respondents also established limited partner advisory committees for all active affected funds, hired a full-time controller to monitor compliance, and adopted policies against interfund loans.
- The SEC charged a venture capital fund adviser for erroneously overcharging the funds more than $678,000 in management fees over the course of an over two-year period.24 The adviser agreed to pay a $175,000 civil penalty.
- As described above, the SEC charged three venture capital advisers under the SEC’s Pay-to-Play Rule.
Registered investment advisers are required to make proxy voting disclosures on their Form ADV Part 2A brochures. If they have authority to vote client securities, advisers must disclose their voting policies and how they address associated conflicts. These disclosures must of course accurately reflect proxy voting practices. Advisers should consider reviewing and, if needed, enhancing their policies and procedures and ensuing that disclosures match actual practices.
- The SEC charged a registered fund adviser that had a standing instruction to its proxy voting service provider to vote in favor of issuer proposals and against shareholder proposals with violating the Advisers Act and the Proxy Voting Rule by casting proxy votes in over 200 shareholder meetings without any substantive review to determine whether the votes were cast in its clients’ best interests — contrary to its Form ADV disclosure and its compliance manual — and without implementing policies and procedures reasonably designed to ensure that it did so.25 The adviser revised its policies and procedures and agreed to pay a $150,000 civil penalty.
6Section 206 of the Advisers Act and Rule 206(4)-5 thereunder.
9Section 206 of the Advisers Act and Rule 206(4)-2 thereunder.
14Links here and here.
15CFTC penalties totaled over $710 million.
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