Four lessons from SEC enforcement actions

We assess the agency’s priorities through the lens of recent cases.

The Securities and Exchange Commission continues to hold errant private fund managers to account and at least eight firms have settled cases in the past two months alone. The average SEC investigation takes between six and 12 months, so inquiries into most of the recently concluded cases likely began long before the agency published its 2017 exam priorities. However, these cases mainly reflected the new priorities, suggesting the agency’s focus is largely unchanged.

Fund managers can learn from the mistakes of their peers to avoid falling foul. Here are four lessons:

1. Conflicts of interest simply must be disclosed
Advisors must remember that they are fiduciaries to all the funds that they manage, and any action that benefits them may create a conflict of interest. Full disclosure to investors of anything that may be classified as such is essential.
Two firms were fined over conflicts of interest in July. The SEC alleged that undisclosed conflicts of interest inherent in Ohio-based Resilience Capital Partners’ structure enabled management to take unauthorized loans from three private equity funds. In the second case, real estate firm Paramount Group was fined in relation to claims it failed to reimburse agreed costs following an asset sale from one of its funds to another.

2. Fees and expenses remain on the radar
There are no excuses for failing to adopt and implement appropriate compliance procedures, including multiple levels of expense review, escalation procedures and oversight.
A pair of fee-related cases concluded in August. In the first, a firm paid $1.6 million in fines and client reimbursement for misallocating expenses to its fund. The SEC alleged the firm unlawfully charged legal, hiring and employee consulting expenses to the fund, and interpreted the firm’s policy to only permit “normal operating expenses”. In the second, a long-standing fund was fined after the agency alleged it double-dipped advisory fees by moving assets into a reserve fund it built so it could distribute consistent returns.

3. SEC registration requirements cannot be circumnavigated
Falsely reporting assets under management to qualify or disqualify your firm from SEC registration will result in enforcement action. The only instance in which AUM doesn’t matter is in the case of affiliated investment advisors, which in most cases will have to register if they are operated by the same team.
Three advisors have allegedly fallen foul of registration rules in the past few months. Chief compliance officer Brian Kimball Case, who operated a registered investment advisor, was fined after creating an affiliate advisor and claiming exemption because the funds it managed had AUM below $150 million. The regulator said the affiliate was required to register because it was under common control with the registered advisor.
In a second case, a chief executive was fined and barred after the SEC alleged he falsely claimed registration eligibility, apparently to give potential investors faith in the firm as an investment manager. The SEC said he filed multiple Form ADVs claiming over $100 million in AUM, despite only having $4 million under management. The third case was similar except the advisor inflated its AUM to $500 million when in reality, the SEC maintained, it had none.

4. Ensure the accuracy of figures on Form ADV
The SEC will rigorously check numbers submitted, and estimated values are not sufficient.
A former private equity CCO was fined and suspended from the industry for 12 months in August for allegedly filing an inaccurate Form ADV on behalf of Circle One Wealth Management. The SEC alleged the outsourced CCO was given the figures as an estimate by the firm’s chief financial officer and did not check their validity.
Speculation still abounds over the future direction of the SEC and whether indeed private fund firms will continue to fall within its scope. These recent rulings are a timely reminder that, right now, managers need to keep their eye on the compliance ball.