This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
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Court Enters Final Judgments Against Principals of Hedge Fund
March 28, 2008 1:41 PM
On February 6th, the U.S. District Court for the Southern District of Florida entered final judgments against Peter and Sheldon Krieger and John Madey. The SEC had filed a complaint on April 15, 2005, alleging that the three individuals, as principals of a hedge fund, had misappropriated nearly half the money the fund had raised. The complaint alleged that the defendants diverted funds to pay for the operations of a broker-dealer the defendants also controlled. The SEC’s complaint claimed the defendants concealed their misappropriation of funds and trading losses in the fund by issuing false account statements.
SEC Enters Civil and Administrative Orders in Market Timing Case
March 28, 2008 1:36 PM
On March 14th, the SEC announced that the U.S. District Court in Massachusetts had entered a final judgment against Marc J. Bilotti, a defendant in a civil injunctive action brought by the SEC. The complaint had charged that Bilotti defrauded mutual fund companies and fund shareholders by making market-timing trades on behalf of his customers at Prudential Securities, Inc. The district court's order, entered March 3, 2008, permanently enjoins Bilotti from violating the antifraud provisions of the federal securities law and orders Bilotti to pay a penalty of $20,000. In a separate related action, the SEC issued an order barring Bilotti from associating with any broker, dealer or investment adviser, with a right to reapply after three years. Bilotti consented to the orders without admitting or denying the allegations.
SEC Charges TV Infomercial Personalities with Fraud
March 28, 2008 1:30 PM
On March 11th, the SEC filed civil fraud charges against Linda Woolf and David Gengler, alleging they illegally profited through sales of a stock trading system. The SEC’s complaint alleges the promoters preyed on the elderly and others who had attended free introductory seminars at hotels in dozens of cities nationwide. According to the complaint, Woolf and Gengler lied about their success with the trading program to persuade victims to pay as much as $40,000 for the system. Instead, the Commission alleges, Woolf had never declared a trading profit on her federal tax returns and Gengler typically declared losses or no profits. The SEC alleges that through false stories of their own trading success and bogus claims of a 96.5 percent success rate for students who purchased personal mentoring, courses and software, Woolf and Gengler convinced attendees that they would make extraordinary profits in the stock market if they followed trading strategies that emphasized options trading and short-term swing trading.
Hedge Fund Manager Indicted on Conspiracy and Wire Fraud Charges
March 28, 2008 1:28 PM
On February 19th, the U.S. Attorney’s Office for the Southern District of Florida unsealed an indictment charging a hedge fund founder and manager and four associates with conspiracy to commit mail, wire and securities fraud in connection with their efforts to manipulate the month-end closing prices of shares of thinly-traded shell company securities and overstate the value of the funds’ holdings. According to the indictment, the manager purchased large quantities of restricted stock at pennies per share in private transactions and then purchased small amounts of the same securities for the funds he managed in order to drive up the price by the end of the trading day. Those securities held by the funds were then valued at the higher closing price to pump up the performance fees paid to the management companies, attract new investors, and induce current investors to remain.
SEC Disciplines Former Vice President of Investment Adviser for Referral Fee Payments
March 28, 2008 1:16 PM
On March 11th, the SEC settled administrative proceedings against Michael R. Donnell, a former vice president of a registered investment adviser, Mercantile Capital Advisors, Inc. Donnell had recommended to Mercantile the hiring of a subadviser for Mercantile’s new funds of hedge funds. The subadviser in turn paid referral fees in excess of $78,000 to Donnell’s mother. Donnell’s supervisor discovered the arrangement when he received a letter from the subadviser stating that the subadviser was going to pay a referral fee to Donnell’s mother. Donnell denied knowledge of the payment. However, in March 2004, Mercantile’s parent company received an anonymous letter disclosing the payments to Donnell’s mother by the subadviser. Soon thereafter Mercantile terminated both Donnell and the agreement with the sub-adviser.
SEC Addresses Applicability of Insider Trading Laws to Unregistered Advisers
March 28, 2008 1:10 PM
The SEC issued a “Report of Investigation” on the Retirement Systems of Alabama (“RSA”), a system managing a retirement plan for state employees, and exempt from investment adviser registration pursuant to Advisers Act Section 202(b). In the report, the SEC alleged that RSA purchased securities while in possession of material, non-public information about a pending acquisition. At the time of the transaction, RSA had no program, policy, practice or training to ensure that its investment staff understood and complied with the federal securities laws in general, or insider trading laws in particular. RSA also did not have a compliance officer, and the responsibilities of its general counsel did not include oversight of RSA’s investment activities. The SEC, however, did not charge RSA with insider trading. It noted that the system cooperated in the SEC’s investigation and that no individual had personally profited from the insider trading.
SEC Creates New Risk Surveillance Team
March 28, 2008 1:07 PM
The SEC has recently created a six-person surveillance group within OCIE to identify risky investment advisers. OCIE Director Lori A. Richards stated that the team will examine advisory firm information, including public news reports, information contained in Form ADV filings, and private, subscriber-based information, to assess risk, and pass on relevant public and non-public information to SEC examiners.
SEC Announces 2008 Regional CCOutreach Seminars
March 28, 2008 1:04 PM
The SEC has released a schedule for upcoming CCOutreach Regional Seminars for 2008. Discussion topics include the compliance rule, information processing and protection, performance advertising and marketing, personal trading, brokerage arrangements and execution, information disclosures, reporting and filings, and portfolio management. Some seminars will feature a session addressing concerns specific to smaller and newly registered advisers.
OCIE Chief Counsel Walsh Explains Reg. S-P Proposal, Announces New Technology Office
March 28, 2008 1:01 PM
On March 12, 2008, OCIE chief counsel John Walsh addressed the ACA Compliance Group conference. Mr. Walsh noted that the SEC’s recent proposal to enhance Regulation S-P regarding the privacy of consumer financial information aims at harmonizing the standards for advisers that are dual-registrants or are affiliated with a broker-dealer.
OCIE Director Richards Discusses Investment Adviser Compliance Concerns
March 28, 2008 12:46 PM
On March 20th, Lori A. Richards, the Director of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”), addressed the IA Compliance Best Practices Summit 2008. Ms. Richards noted that the number of registered investment advisers has grown by over 40% since 2001, but that OCIE staffing has not increased over the same period. As a result, OCIE has tried to direct its attention to the most significant areas that pose the greatest potential harm to investors and markets. She provided an overview of OCIE’s risk-based exam program and detailed the top ten compliance concerns surrounding investment advisers, including (1) valuation controls, particularly as these controls relate to the pricing of structured products or illiquid securities; (2) controls over non-public information, personal trading, and codes of ethics; (3) firm dealings with senior/elderly investors; (4) compliance and supervision, including the broad issue of a reasonably designed, risk-focused compliance program and more specific issues such as addressing conflicts posed by revenue sharing arrangements, gifts and gratuities, and the supervision of remote offices; (5) portfolio management issues, including determining whether securities recommendations and investments made for clients and funds are consistent with the adviser’s disclosures and the client’s investment objectives and restrictions; (6) brokerage arrangements and best execution, including determining whether brokerage arrangements are consistent with fiduciary obligations and whether soft dollar and other arrangements are adequately disclosed; (7) allocation of trades; (8) performance advertising, marketing and fund distribution activities; (9) safety of fund and client assets; (10) information processing and protection, including effective policies and procedures for capturing, compiling, maintaining, and reporting relevant and timely information in books and records (including email and instant messages), and in reports to clients and regulators.
Commissioner Atkins Addresses Market Volatility, Prospectus Reform
March 28, 2008 12:39 PM
On March 17, 2008, SEC Commissioner Paul S. Atkins addressed the 2008 ICI Mutual Funds and Investment Management Conference. He discussed recent efforts by regulators to respond to market volatility and the collapse of Bear Stearns, but cautioned that regulators must “not give in to the urge to do something if that something would be harmful.” Commissioner Atkins’s speech also focused on the interaction between the U.S. and global markets, including regulatory cooperation. To this end, he suggested that it may be time to reconsider amending Section 7(d) of the Investment Company Act of 1940 to allow for mutual recognition of certain high quality foreign regulatory regimes and products. Commissioner Atkins concluded his speech with praise for ICI’s efforts to survey investors on potential improvements to mutual fund prospectus disclosure. He promised that the SEC will focus on a number of issues identified by the ICI and other commenters, such as potential difficulties associated with the quarterly update requirement, prescriptions for a standardized format, the advisability of multiple-fund summary prospectuses, and the meaning of “greater prominence” in the requirement that the summary prospectus be given greater prominence than other materials with which it is mailed.
Massachusetts Secretary of the Commonwealth Investigates Auction Rate Securities
March 14, 2008 2:37 PM
According to news reports, the Massachusetts Secretary of the Commonwealth, William Galvin, has begun an investigation into certain investment managers’ actions with respect to auction rate securities. A Reuters news story reported that Brian McNiff, a spokesman for the Secretary’s office, said that “the inquiry seeks to learn if there have been any redemption problems in closed-end funds, and if they have used auction rate markets for leverage.” Secretary Galvin gave the firms being investigated until March 7th to respond to his request regarding information about what the firms are telling their clients in the wake of apparent liquidity problems in the auction rate securities markets.
FINRA Settles with Broker-Dealer for Alleged Market Timing; Over 60 Mutual Fund Companies to Receive Restitution
March 14, 2008 2:33 PM
FINRA settled with a broker-dealer in connection with alleged supervisory and other failures resulting in improper market timing of mutual fund shares in 2003. FINRA alleged that the broker-dealer failed to prevent a group of five traders from market timing mutual funds on behalf of hedge fund customers.
SEC Issues an Order Under Section 6(c) of the Investment Company Act Granting a Family of Registered Funds of Funds an Exemption from Rule 12d1-2(a)
March 14, 2008 2:24 PM
On February 25th, the SEC issued an order to a family of open-end registered investment companies that invest in other registered investment companies (“Registered Funds of Funds”). The Registered Funds of Funds rely on Section 12(d)(1) of the Investment Company Act and Rule 12d1-2 under the Act to acquire securities issued by other registered investment companies. Prior to receiving the order, the Registered Funds of Funds were only permitted to invest in (1) securities issued by other affiliated and unaffiliated registered investment companies, (2) government securities, (3) short-term paper, (4) other securities as defined in Section 2(a)(36) of the Act and (5) securities issued by money market funds. The order permits the Funds of Funds to also invest in futures contracts, options on futures contracts, swap agreements, derivatives, and certain other financial instruments that are not securities as defined in Section 2(a)(36) of the Act. The order was conditioned on the Funds of Funds’ continued compliance with all other aspects of Rule 12d1-2. The ETF Rule proposal discussed above also contains a proposed amendment to Rule 12d1-2 that would eliminate the need for exemptive relief for those investments.
SEC Approves FINRA Rule Proposal to Eliminate Principal Pre-Approval Requirement for Mutual Fund Sales Material Previously Filed by Another Member
March 14, 2008 2:19 PM
The SEC has approved amendments to NASD Rule 2210 that create an exception from the principal pre-approval requirements for sales materials, including mutual fund sales material, previously filed by another FINRA member. The amendments create an exception to Rule 2210’s pre-approval requirements allowing a FINRA member to use sales material without principal pre-approval if another FINRA member had already filed the sales material and received an approval from FINRA for its use. A FINRA member relying on the new exception may not materially alter the sales material or use it in a manner inconsistent with the FINRA advertisement review letter.
SEC Settles with Chief Financial Officer, Chief Compliance Officer and Registered Representative of a Broker-Dealer for Alleged Market Timing
March 14, 2008 2:12 PM
On February 14th, the SEC issued orders settling with a chief financial officer, chief compliance officer and a registered representative of a broker-dealer for their participation in a scheme to defraud mutual funds through, among other misconduct, deceptive market timing. The CFO, CCO and registered representative did not admit or deny the SEC’s findings on the orders. The SEC alleged that the broker-dealer employed deceptive tactics on behalf of its hedge fund customers to evade mutual funds’ efforts to restrict market timing. The SEC further alleged that several mutual funds notified the broker-dealer that frequent trading by the broker-dealer’s customers violated prohibitions in the mutual funds’ prospectuses, and the mutual funds instructed the broker-dealer to stop permitting its customers to trade those funds. The broker-dealer then employed deceptive tactics to continue trading the mutual funds that had requested the broker-dealer’s customers to stop.
SEC Proposes to Strengthen Regulation S-P
March 14, 2008 2:08 PM
On March 4th, the SEC voted unanimously to propose amendments to Regulation S-P, which sets forth privacy obligations for entities regulated by the SEC. The proposed amendments are intended to help prevent and address security breaches at the institutions the SEC regulates, such as identity theft and intrusions into online brokerage accounts.
SEC Proposes to Streamline ETF Registration Process
March 14, 2008 2:02 PM
On March 4th , the SEC voted unanimously to propose two new rules under the Investment Company Act to permit exchange-traded funds (“ETFs”) to operate without the need to obtain individual exemptive orders from the SEC. The SEC also proposed amendments to Form N-1A to include additional information for ETF investors who purchase shares in the secondary markets.
SEC Re-proposes New Part 2 of Form ADV
March 14, 2008 1:45 PM
On March 3rd, the SEC released its reproposal of a new Part 2 to Replace the Current Part II of Form ADV and proposed related rules under the Investment Advisers Act of 1940 (the “Advisers Act”). If adopted as proposed, the new Part 2 of Form ADV would require registered investment advisers to provide current and prospective clients with narrative brochures containing “plain English” descriptions of their businesses, services, fees, risks, conflicts of interest and disciplinary history. The proposal would also require advisers to electronically file their brochures in PDF format through the Investment Adviser Registration Depository, and the brochures would be available to the public through the SEC’s web page.