1. On February 27, 2023, the SEC instituted administrative proceedings against Shawn Good who was dually registered with Morgan Stanley Smith Barney, LLC (“Morgan Stanley”) as a registered representative and investment adviser representative. Good perpetrated a multi-year Ponzi scheme which involved his clients at Morgan Stanley, and that in doing so, he defrauded his clients of at least $4.8 million, resulting in more than $2 million of investor losses. Good solicited clients to transfer funds to his personal bank account, ostensibly to make low-risk investments in real-estate development projects and supposedly tax-free government bonds. But Good instead use those funds to repay other investor victims and to pay his personal expenses. Good was barred. https://www.sec.gov/litigation/admin/2023/34-96988.pdf
2. On February 21, 2023, the SECcharged HITE Hedge Asset Management LLC, a SEC registered investment adviser, for violating an SEC Rule 105 of Regulation M by purchasing stock in a public offering for five private fund clients after selling short the same stock, during a period when the SEC rule prohibited those purchases. The complaint also names the three private funds that ultimately received the profits from HITE Hedge Asset Management’s unlawful trading, HITE Hedge LP, HITE Hedge II LP, and HITE Hedge Offshore Ltd., as relief defendants. HITE Hedge Asset Management violated Rule 105, which prohibits short selling an equity security during a restricted period (generally five business days before a covered public offering) and then purchasing the same security in the covered offering, absent an exception. The Rule applies regardless of the trader’s intent, and is designed to prevent potentially manipulative short selling before the pricing of covered offerings. HITE Hedge Asset Management has agreed to pay a $103,591 penalty to settle the charges. The three funds have agreed to disgorge the profits received from HITE Hedge Asset Management’s unlawful trading, totaling approximately $111,000, plus prejudgment interest. https://www.sec.gov/litigation/litreleases/2023/lr25643.htm
3. On February 21, 2023, the SEC filed charges Candlestick Capital Management LP, a SEC registered investment adviser, for violating an SEC Rule 105 of Regulation M when it purchased stock in a public offering for two private fund clients after selling short the same stock for those clients, during a time period when the SEC rule prohibited those purchases. The complaint also names the two private fund clients, Candlestick Master Fund LP and Candlestick US F&F Fund LP, as relief defendants. Candlestick Capital violated Rule 105, which prohibits short selling an equity security during a restricted period (generally five business days before a covered public offering) and then purchasing the same security in the offering, absent an exception. The Rule applies regardless of the trader’s intent, and is designed to prevent potentially manipulative short selling before the pricing of covered offerings. Candlestick Capital has agreed to pay an $810,000 penalty to settle the charges. The two private fund clients have agreed to disgorge the profits received from Candlestick Capital’s unlawful trading, totaling approximately $1.6 million, plus prejudgment interest. https://www.sec.gov/litigation/litreleases/2023/lr25642.htm
4. On February 21, 2023, the SEC announced charges against Ensign Peak Advisers Inc., a non-profit entity operated by The Church of Jesus Christ of Latter-day Saints to manage the Church’s investments for failing to file forms that would have disclosed the Church’s equity investments and for instead filing forms for shell companies that obscured the Church’s portfolio and misstated Ensign Peak’s control over the Church’s investment decisions. Ensign Peak failed to file Forms 13F, the forms on which investment managers are required to disclose the value of certain securities they manage. The Church was concerned that disclosure of its portfolio which grew to approximately $32 billion, would lead to negative consequences. To obscure the amount of the Church’s portfolio, and with the Church’s knowledge and approval, Ensign Peak created thirteen shell LLCs, ostensibly with locations throughout the U.S., and filed Forms 13F in the names of these LLCs rather than in Ensign Peak’s name. The order finds that Ensign Peak maintained investment discretion over all relevant securities, that it controlled the shell companies, and that it directed nominee “business managers,” most of whom were employed by the Church, to sign the Commission filings. The shell LLCs’ Forms 13F misstated, among other things, that the LLCs had sole investment and voting discretion over the securities. The SEC’s order finds, Ensign Peak retained control over all investment and voting decisions. To settle the charges, Ensign Peak agreed to pay a $4 million penalty and the Church agreed to pay a $1 million penalty. https://www.sec.gov/news/press-release/2023-35?utm_medium=email&utm_source=govdelivery
5. On February 15, 2023, the SEC instituted administrative proceedings againstBradley Reifler. Reifler served as the founder, chief executive officer, or primary principal of a financial services enterprise that included asset management, investment banking, and investment advisory services all doing under the name of “Forefront.” During the time Reifler was associated with an investment advisers registered with the Commission, he was also the CEO and founder of Forefront Capital Holdings and was responsible for investing approximately $34 million of the insurance company’s assets according to guidelines contained in a trust agreement and investment advisor agreement. Rather than investing the assets in secure investment vehicles as required by the agreements, Reifler misappropriated the funds for the benefit of his own companies and then used the funds for improper purposes, such as paying for overhead expenses and repaying prior investors to whom he owed money. Reifler also diverted other funds to risky investment vehicles that did not comply with the investment guidelines. Reifler pled guilty and was sentenced to a prison term of five years, three years supervised release, and ordered to pay restitution in the amount of $20,322,220. https://www.sec.gov/litigation/admin/2023/ia-6242.pdf
6. On February 7, 2023, the SEC’s Division of Examinations announced its 2023 examination priorities. The Division publishes its examination priorities annually to provide insights into its risk-based approach, including the areas it believes present potential risks to investors and the integrity of the U.S. capital markets. Notable and new and significant focus areas begin on Page 13. https://www.sec.gov/files/2023-exam-priorities.pdf
I. NOTABLE NEW AND SIGNIFICANT FOCUS AREAS
A. Compliance with Recently Adopted Rules Under the Investment Advisers Act of 1940 (Advisers Act) and Investment Company Act of 1940 (Investment Company Act)
The SEC will assess whether RIAs have adopted and implemented written policies and procedures regarding their new Marketing Rule.
Whether RIAs have complied with the substantive requirements of the Marketing Rule, including the requirement that RIAs have a reasonable basis for believing they will be able to substantiate material statements of fact and requirements for performance advertising, testimonials, endorsements and third-party ratings.
B. RIAs to Private Funds
The SEC will continue to focus on RIAs to private funds. In particular, the SEC will focus on private fund RIAs’: (1) conflicts of interest; (2) calculation and allocation of fees and expenses, including the calculation of post-commitment period management fees and the impact of valuation practices at private equity funds; (3) compliance with the new Marketing Rule, including performance advertising and compensated testimonials and endorsements, such as solicitations; (4) policies and practices regarding the use of alternative data and compliance with Advisers Act Section 204A; and (5) compliance with the Advisers Act Rule 206(4)-2 (Custody Rule), where applicable, including timely delivery of audited financials and selection of permissible auditors.
The SEC will focus on RIAs to private funds with specific risk characteristics, such as: (1) highly-leveraged private funds; (2) private funds managed side-by-side with BDCs; (3) private equity funds that use affiliated companies and advisory personnel to provide services to their fund clients and underlying portfolio companies; (4) private funds that hold certain hard-to-value investments, such as crypto assets and real estate-connected investments, with an emphasis on commercial real estate; (5) private funds that invest in or sponsor Special Purpose Acquisition Companies (SPACs); and (6) private funds involved in adviser-led restructurings, including stapled secondary transactions and continuation funds.
C. Standards of Conduct: Regulation Best Interest, Fiduciary Duty, and Form CRS
1. Regulation Best Interest and Fiduciary Duty
The SEC will review broker-dealers and dually registered RIAs in the following focus areas: (1) investment advice and recommendations with regard to products, investment strategies, and account types; (2) disclosures made to investors and whether such disclosures include all material facts relating to the conflicts of interest associated with the advice and recommendations; (3) processes for making best interest evaluations, including those for reviewing reasonably available alternatives, evaluating costs and risks, and identifying and addressing conflicts of interest; and (4) factors considered in light of the investor’s investment profile, including investment goals and account characteristics. Also, in the case of RIAs, examiners will review whether the conflicts of interest disclosures are sufficient such that a client can provide informed consent to the conflict, whether express or implied.
- Further, examinations may focus on advice or recommendations regarding: (1) complex products, such as derivatives and leveraged exchange-traded funds (ETFs), exchange-traded notes (ETNs), and other exchange-traded products (ETPs); (2) high cost and illiquid products, such as variable annuities and non-traded REITs; (3) proprietary products; (4) unconventional strategies that purport to address rising interest rates; and (5) microcap securities. Examinations may also focus on recommendations or advice to certain types of investors, such as senior investors and those saving for retirement, and specific account recommendations, such as retirement account rollovers and 529 plans.
- The SEC will seek to identify and understand the economic incentives that a firm and its financial professionals have to recommend products, services, or account types, such as the source and structure of compensation, revenue, or other benefits. Part of this inquiry will look at whether the firm has established written policies and procedures to identify such conflicts of interest and periodically reviewed and updated their policies and procedures, as appropriate. The Division will also review whether compliance policies and procedures are tailored to the firm’s particular business model, compensation structure, and product menu and customer base and are sufficient to support compliance with the standards.
- Such economic incentives may include revenue sharing, commissions (including markdowns and markups), or other incentivizing revenue arrangements (e.g., conflicts often exist if firms use the services of, or invest in the products offered by, an affiliate, particularly when these arrangements result in additional or higher fees to investors). Examinations will review how firms are managing conflicts of interest, including mitigating or eliminating the conflicts of interest, when appropriate.
- Lastly, examinations will review whether firms have customer or client agreements that purport to inappropriately waive or limit their standard of conduct, such as through the use of hedge clauses.
2. Form CRS
Compliance with Form CRS will continue to be prioritized and incorporated into the SEC’s core examinations of broker-dealers and RIAs. SEC rules require that firms deliver their relationship summaries to new and prospective retail investors, as well as to existing retail investors, file their relationship summary with the Commission and post the current relationship summary on the firm’s public website, if the firm has one.
D. Environmental, Social, and Governance (ESG) Investing:
RIAs and registered funds are competing for the rising investor demand for ESG-related investments and strategies that incorporate certain ESG criteria, and, thus are increasingly offering and evaluating investments that employ such strategies and investments. Therefore, the Division will continue its focus on ESG-related advisory services and fund offerings, including whether the funds are operating in the manner set forth in their disclosures. In addition, the Division will assess whether ESG products are appropriately labeled and whether recommendations of such products for retail investors are made in investors’ best interest.
II. INFORMATION SECURITY AND OPERATIONAL RESILIENCY
The SEC will continue to review broker-dealers’ and RIAs’ practices to prevent interruptions to mission critical services and to protect investor information, records, and assets. The current risk environment related to cybersecurity is considered elevated given the larger market events, geopolitical concerns, and the proliferation of cybersecurity attacks, particularly ransomware attacks. Given these risks and concerns, cybersecurity remains a perennial focus area for registrants, including RIAs, broker-dealers, investment companies, municipal advisors, transfer agents, exchanges and clearing agencies.
The Division will focus on firms’ policies and procedures, governance practices, and response to cyber-related incidents, including those related to ransomware attacks, and broker-dealers’ and RIAs’ compliance with Regulations S-P and S-ID, where applicable. The focus on policies and procedures will include a review as to whether they are reasonably designed to safeguard customer records and information—both information residing in registrants’ systems and stored through a third-party provider—as well as whether the location of such records has been properly disclosed to the Commission, where required.
Examinations of broker-dealers and RIAs will continue to look at firms’ practices to prevent account intrusions and safeguard customer records and information, including personally identifiable information, while recognizing that personnel may continue to access information in a remote environment. Additional focus will be on the cybersecurity issues associated with the use of third-party vendors, including registrant visibility into the security and integrity of third-party products and services. The Division’s focus will also include reviewing whether there has been an unauthorized use of third-party providers, particularly for transition assistance when departing RIA personnel attempt to migrate client information to another firm.
Lastly, the Division will continue to assess systemically significant registrants’ operational resiliency planning, such as their efforts to consider and/or address climate-related risks.
III. CRYPTO ASSETS AND EMERGING FINANCIAL TECHNOLOGY
The Division continues to observe the proliferation of certain types of investments (e.g., crypto assets and their associated products and services) and emerging financial technology (e.g., broker-dealer mobile apps and RIAs choosing to provide automated digital investment advice to their clients). To address these observations, the Division will conduct examinations of broker-dealers and RIAs offering new products and services or employing new practices. These new practices include technological and on-line solutions to meet the demands of compliance and marketing and to service investor accounts (e.g., on-line brokerage services, internet advisers, and automated investment tools and trading platforms, including RIAs referred to as “robo-advisers”).
IV. INVESTMENT ADVISERS AND INVESTMENT COMPANIES
A. Focus Areas for Examinations of RIAs
The Division remains focused on whether the various aspects of RIAs’ operations and compliance practices have appropriately adopted and considered current market factors, such as those that might impact valuation and the accuracy of RIA regulatory filings. During a typical examination, the Division reviews the compliance programs and related disclosures of RIAs in one or more core areas, such as custody and safekeeping of client assets, valuation, portfolio management, and brokerage and execution. Often examinations also include a review for conflicts, compliance issues and the oversight and approval process related to RIA fees and expenses, including: (1) the calculation of fees; (2) alternative ways that RIAs may try to maximize revenue, including revenue earned on clients’ bank deposit sweep programs; and (3) excessive fees.
In addition to reviewing these core focus areas, examinations will review RIA policies and procedures for retaining and monitoring electronic communications and selecting and using third-party service providers.
As in previous years, the Division prioritizes RIAs that have never been examined, including recently registered firms, and those that have not been examined for a number of years. Typically, these examinations focus on firms’ compliance programs.
B. Focus Areas for Registered Investment Companies, Including Mutual Funds and ETFs
The Division prioritizes examinations of registered investment companies, including mutual funds and ETFs, given their importance to retail investors. The perennial focus areas for such examinations include, among other topics, an assessment of registered investment companies’ compliance programs and governance practices, disclosures to investors, and accuracy of reporting to the SEC.
The Division will focus on the fiduciary obligations of RIAs to registered investment companies, particularly with respect to their receipt of compensation for services, or other material payments made by such registered investment companies and other sources. As part of its review of registered investment companies’ compliance programs and governance practices, the Division will continue to evaluate boards’ processes for assessing and approving advisory and other fund fees, particularly for funds with weaker performance relative to their peers. In addition, the Division will assess the effectiveness of funds’ derivatives risk management programs and liquidity risk management programs, as applicable.
The Division will also focus on funds with specific characteristics, such as: (1) turnkey funds, to review their operations and assess effectiveness of their compliance programs;3 (2) mutual funds that converted to ETFs, to assess governance and disclosures associated with the conversion to an ETF; (3) non-transparent ETFs, to assess compliance with the conditions and other material terms of their exemptive relief; (4) loan-focused funds, such as leveraged loan funds and funds focused on collateralized loan obligations, for liquidity concerns and to review whether the funds have been significantly impacted by, and have adapted to, elevated interest rates; and (5) medium and small fund complexes that have experienced excessive staff attrition, to focus on whether such attrition has affected the funds’ controls and operations. The Division will also monitor the proliferation of volatility-linked and single-stock ETFs, and may review such funds’ disclosures, marketing, conflicts, and compliance with portfolio management disclosures, among other things.
As with RIA examinations, the Division will prioritize registered investment companies that have never been examined, including recently registered investment companies, and those that have not been examined in a number of years. These examinations often focus on corporate governance, the advisory contract approval process, fund code of ethics, practices that deviate from disclosures, and the implementation and effectiveness of the fund’s compliance program, including the oversight of service providers through which the fund conducts its activities.
If a fund relies on the Derivatives Rule, the SEC will assess whether funds have adopted and implemented policies and procedures reasonably designed to manage the funds’ derivatives risks and to prevent violations of the Derivatives Rule pursuant to Investment Company Act Rule 38a-1; and (2) review for compliance with Rule 18f-4, including the adoption and implementation of a derivatives risk management program, board oversight, and whether disclosures concerning the fund’s use of derivatives are incomplete, inaccurate or potentially misleading.
The SEC will assess compliance with Investment Company Act Fair Valuation Rule 2a-5 including: (1) assessing funds’ and fund boards’ compliance with the new requirements for determining fair value, implementing board oversight duties, setting recordkeeping and reporting requirements, and permitting the funds’ board to designate valuation designees to perform fair value determinations subject to oversight by the board; and (2) review whether adjustments have been made to valuation methodologies, compliance policies and procedures, governance practices, service provider oversight, and/or reporting and recordkeeping.
Municipal advisors provide advice to, or on behalf of, a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities or municipal financial products. The Division will continue to examine whether municipal advisors have met their fiduciary duty to municipal entity clients as well as whether municipal advisors have complied with MSRB Rule G-42, which establishes the core standards of conduct and duties applicable to municipal advisors when engaging in municipal advisory activities. The Division will also continue to examine whether municipal advisors have disclosed conflicts of interest and have met their relationship documentation, registration, professional qualification, and supervision requirements.
7. On February 13, 2023, the SEC instituted administrative proceedings against Jason Sugarman a director and an indirect owner of broker-dealer and investment adviser Burnham Securities, Inc., registered with the Commission. Sugarman, along with others, engaged in a scheme to defraud various pension funds out of $43 million. Sugarman and others gained control of two registered investment advisers, Hughes Capital Management LLC and Atlantic Asset Management LLC and used their discretionary control over pension fund clients’ money to buy the limited recourse bonds issued by a Native American tribal corporation, in placements for which Burnham Securities acted as placement agent. While the proceeds of the issuances were intended by the bonds’ indentures to be invested in annuities issued by a foreign insurer that Sugarman and others controlled, the amended complaint alleges that the proceeds were never used to buy any annuities and were instead diverted to Sugarman and others and used to pay their personal and corporate expenses. Sugarman was barred. https://www.sec.gov/litigation/admin/2023/34-96901.pdf
8. On February 6, 2023, the SEC charged Joshua Coleman, a former investment adviser, for perpetrating a fraudulent scheme that yielded him over $200 million in illicit loan proceeds. Coleman entered into six successive loan transactions and diverted the proceeds for his personal use including financing personal investments and paying outstanding business expenses. Coleman’s scheme involved a wide range of misconduct including forging signatures on loan documents, lying to advisory clients and fabricating and altering emails, bank statements, and other documents. Coleman obtained the initial loans in part by pledging as collateral over $160 million in advisory client assets, a portion of which were seized by Coleman’s lender after Coleman defaulted. To repay these clients, Coleman procured additional loans by pledging his own securities as collateral while misleading his new lenders concerning the purpose of the loans and the value of certain pledged collateral. Coleman defaulted on those loan transactions and owes over $50 million in proceeds. The matter is actually being litigated. https://www.sec.gov/litigation/litreleases/2023/lr25633.htm
9. On February 2, 2023, the SEC instituted administrative proceedings against Satyajeet Mitraa resident of Florida age 65 engaged in the fraudulent offer and sale of securities to retail investors and did so without registration to operate as a broker-dealer. Mitra violated the antifraud provisions of Florida’s securities laws between 2014 and 2016 when he knowingly sold REIT securities to investors while not registered as a broker-dealer. Mitra advertised in newspapers, obtained account documentation from investors, met with investors and made investment recommendations and received transaction-based compensation. Mitra engaged in fraud by failing to inform investors about the non-traded and illiquid nature of these REITs and falsely telling investors they could withdraw their principal in less than a year and sometimes after only four to six months when in truth they had to hold the investment for at least a full year. Mitra also failed to disclose to investors who was the true registered representative and the broker-dealer for the REIT purchase transactions. Mitra was barred. https://www.sec.gov/litigation/admin/2023/34-96804.pdf
10. On February 2, 2023, the SEC charged Steve Susoeff, LLC (dba Meritage Financial Group), a Henderson, Nevada-based investment adviser, and Steven Susoeff, its sole owner and principal for conducting a cherry-picking scheme that defrauded their clients. Susoeff placed securities trades using Meritage’s omnibus trading account which is intended to facilitate purchases of securities for multiple client accounts. Hobbs placed the securities trades early in the trading day but did not allocate the trades to specific clients or Susoeff’s personal accounts until later in the day. Susoeff disproportionately allocated profitable trades to himself and two favored clients and unprofitable trades to his other clients’ accounts. The matter is being litigated. https://www.sec.gov/litigation/litreleases/2023/lr25629.htm
11. On February 2, 2023, the SEC instituted administrative proceedings against Nathaniel Clay a registered representative associated with various broker-dealers registered with the Commission. Clay violated his duty to have a reasonable basis for the recommendations he made to his customers by recommending to at least eight customers, a pattern of high cost, in-and-out trading without any reasonable basis to believe that his recommendations were suitable for anyone. These recommendations resulted in losses for the customers and ill-gotten gains for Clay. Clay knew or recklessly disregarded that his recommendations, for which he had no reasonable basis, were not suitable for anyone; and that Clay made material misrepresentations and omissions to customers in connection with his recommendations. Clay was barred. https://www.sec.gov/litigation/admin/2023/34-96795.pdf