July 2021 SEC Updates

  1. On July 30, 2021, Coburn & Meredith, a dually-registered investment adviser and broker-dealer, settled charges for its disclosure failures and misleading statements to clients regarding (1) fees received for advising clients to purchase and hold mutual fund share classes that paid fees pursuant to Rule 12b1 under the Investment Company Act of 1940 (“12b-1 fees”) instead of lower-cost available share classes that did not charge these fees; and (2) mark-ups on the rate of margin interest charged by Coburn & Meredith’s unaffiliated clearing broker (“Clearing Broker”) to its advisory clients as a result of advisory clients’ use of margin. Coburn & Meredith consented to pay disgorgement, prejudgment interest and a civil penalty of $299,340.  https://www.sec.gov/litigation/admin/2021/34-92526.pdf

 

  1. On July 30, 2021, the SEC announced charges against recidivist Michael Shustek, the CEO of several Las Vegas real estate investment trusts (REITs), and his wholly owned investment advisory firm, Vestin Mortgage LLC.  Shustek fraudulently enriched himself and one of the REITs he controlled, The Parking REIT, at the expense of two publicly traded REITs that he earlier had founded, Vestin Realty Mortgage I (VRTA) and Vestin Realty Mortgage II (VRTB).   Shustek drained $29 million from VRTA and VRTB in order to funnel the money into The Parking REIT and later directed VRTA and VRTB to enter into a series of money-losing transactions in which the same six buildings were repeatedly re-sold, all to benefit himself and The Parking REIT. Shustek deceived the boards of directors of VRTA and VRTB—and violated his fiduciary duties to those companies—in two separate securities transactions to get the companies to pay him almost $10 million. Shustek repeatedly misled investors by causing VRTA and VRTB to make false and misleading statements in their public filings, which hid his self-dealing.  https://www.sec.gov/news/press-release/2021-142

 

  1. On July 28, 2021, the SEC announced charges against Joshua L. Rupp of Michigan for engaging in securities fraud and for acting as an unregistered broker-dealer. Rupp engaged in a fraudulent investment scheme which included misstatements, false documents and misappropriation of investor funds.  Rupp raised over $2.2 million from about 20 investors who lacked significant investment experience by misrepresenting that he was a licensed securities professional, he would generate profits for investors by trading on their behalf, and investors’ principal was protected from losses.  In addition, Rupp allegedly provided investors fake documents purporting to show he was associated with a licensed broker-dealer, and false account statements and trading data to make it appear that his trading on their behalf was generating as much as 115 percent increase in value.  The complaint further alleges that, in reality, Rupp was not affiliated with any brokerage firm or licensed in the securities industry, his securities trading resulted in significant losses, and he misappropriated and misused hundreds of thousands of dollars of investor funds.  https://www.sec.gov/news/press-release/2021-140

 

  1. On July 26, 2021, the SEC announced settled charges against 21 investment advisers and 6 broker-dealers that they failed to timely file and deliver their client or customer relationship summaries – known as Form CRS – to their retail investors. On June 5, 2019, the SEC adopted Form CRS and required SEC-registered investment advisers and SEC-registered broker-dealers to file their respective Forms CRS with the SEC, begin delivering them to prospective and new retail investors by June 30, 2020, and deliver them to existing retail investor clients or customers by July 30, 2020.  The SEC also required firms to prominently post their current Form CRS on their website, if they had one.  According to the SEC’s orders, each of the firms charged today missed those regulatory deadlines.  The orders find that none of the firms filed or delivered its Form CRS, or posted it to its website, until being twice reminded of the missed deadlines by their regulators—in the case of investment advisers, by the SEC’s Division of Examinations, and in the case of broker-dealers, by the Financial Industry Regulatory Authority. https://www.sec.gov/news/press-release/2021-139

 

  1. On July 22, 2021, the House Financial Services Committee approved legislation that would require family offices with assets above $750 million to file Form Ds with federal regulators. Offices with assets below the threshold will have to register as exempt reporting advisers if they’re “highly leveraged or engage in high-risk activities” under the proposed new law. The bill, HR 4620, is sponsored by Rep. Alexandria Ocasio-Cortez (D-NY). It was part of a suite of new bills the committee passed in mark-up July 28. Ocasio-Cortez’ legislation comes just as SEC Chairman Gary Gensler is promising his own reforms to family office regulation. The recent meltdown of the Archegos Capital Management,” committee staff write in their memo summarizing the new legislation, “demonstrated that family offices can be deeply interconnected with the rest of the financial markets and their activities could affect the stability of financial markets” https://www.congress.gov/bill/117th-congress/house-bill/4620/text?q=%7B%22search%22%3A%5B%22HR+4620%22%5D%7D&r=1&s=1 and hmkp-117-ba00-20210728-sd008.pdf (house.gov)

 

  1. On July 22, 2021, the Order Flow Improvement Act (H.R. 4617), a bill by Representative Brad Sherman (D-CA), passed the House Financial Services Committee by a vote of 28-22. This bill directs the SEC to study and consider banning or limiting the payment for order flow (PFOF) in the form of exchange rebates or payments from market centers to broker dealers, conflicts of interest based on PFOF arrangements, and the impact of PFOF on the quality of order execution. https://www.govtrack.us/congress/bills/117/hr4617/text

 

  1. On July 21, 2021, the SEC’s Division of Examinations issued a Risk Alert on observations regarding fixed income “principal” and “cross trades” by investment advisers from an examination initiative.  Nearly two-thirds of the examined advisers received staff-issued deficiency letters. Common problems concerned undisclosed conflicts, weak compliance programs and faulty disclosures. The most embarrassing evidence examiners uncovered was firms that prohibited such trades yet were unaware that “these trades had occurred.” The risk alert encourages best practices, such as testing to monitor whether your traders are complying with your own compliance policies and procedures as well as the rules around cross and principal trades. Other problems uncovered through the exams included failing to have specific policies governing the trades or procedures to maintain documentation showing the required client consents. In some instances, advisers required written approval of cross trades yet staff neglected to secure the documentation. Disclosures revealing clients have five days to revoke permission for a principal trade appeared only in trade confirms. The fiduciary duty shortfalls were seen in firms lacking procedures for staff to document that such trades actually were in the client’s best interest. Firm conflicts were not “fully disclosed,” e.g., that the trades could be subject to markups or other fees.  The risk alert describes best practices encountered during the exams under a new section for risk alerts that reads “Staff Observations on Ways to Improve Compliance.” Favored practices included:

 

§  Defining for staff what are cross and principal trades. Specific and detailed definitions were more likely to be consistently followed.

 

§  Setting standards for staff, e.g., describing the pricing methodologies that were to be used to execute the transactions, requiring periodic reporting to compliance; alerting clients of what “capacity in which the advisers acted,” and insisting traders get advanced written approval from compliance before executing these trades.

 

§  Prohibiting such trades for ERISA clients. ERISA doesn’t permit them, yet examiners found advisers serving retirement investors who took part in cross or principal trades.

 

§  Disclosing to clients when an adviser may engage in cross or principal trades and the “costs associated with these transactions.

 

§  Communicating with clients. Some “advisers discussed their rationale for executing principal trades during oral conversations with their clients.

 

  1. On July 21, 2021, the SEC’s Division of Examinations issued a Risk Alert on observations from examinations of investment advisers managing client accounts that participate in wrap fee programs.  The alert discusses the results from more than 100 exams of advisers that sponsor or use a third-party wrap fee program. Examiners are concerned with advisers placing clients in wrap fee programs that engage in “trading less frequently than may be in the client’s best interest.”  Higher fees related to “trading away” (executing with a broker outside of the wrap fee program) and undisclosed charges reside high on the list of examiner concerns.  Examiners found deficiencies related to inadequate disclosures and compliance programs that failed to measure up. For instance:

 

§  Some advisers didn’t monitor “the trading activity in clients’ accounts” or instances of trading away.

 

§  “Infrequent trading in wrap fee accounts was also identified at several examined advisers, raising concerns that clients whose wrap fee accounts are managed by portfolio managers with low trading activity are paying higher total fees and costs than they would in non-wrap fee accounts,”.

 

§  The alert suggests advisers should conduct “on-going assessments” to judge whether a client would continue to benefit from being in a wrap fee program. Perhaps life situations have changed for the client for one reason or another and a brokerage or an asset-based advisory account would better suit the client.

 

§  Disclosures were cited for not fully describing wrap fee program expenses, e.g., fixed income mark ups and trade-away fees.

 

§  Some disclosures were clearly inconsistent. Advisory agreements alerted clients that they would pay brokerage commissions yet the wrap fee program brochure stated they wouldn’t. Some advisers failed to apply promised discounts, causing wrap fee program clients to pay 12b-1 fees and other charges that should have been rebated.

 

The wrap fee alert includes compliance best practices that examiners encountered:

 

§  Disclosing that “accounts with low trading volumes, high cash balances, or significant fixed income weightings may be able to receive similar services at a lower cost outside of a wrap fee program.”

 

§  Conducting best execution analyses on trades. Other suggested reviews could look at reps’ documentation and for signs of “excessive trading, infrequently traded accounts, wash sales, inappropriate recommendations of affiliated products, and inappropriate charges of commissions for wrap fee clients.”

 

§  Evaluating “clients’ financial situations, risk tolerances, and investment objectives; and (2) determine the appropriateness of the account types, portfolio manager selections, and asset allocation recommendations, both when onboarding client accounts and periodically thereafter.”

 

§  Collecting data on “clients’ personal and financial situations: retirement goals, current employment status, investment time horizon, stated financial objectives (e.g., capital appreciation), risk tolerances (e.g., conservative or aggressive), amount to invest, age, income, investment income needs, net worth, savings, planned spending from the account, dependents, liabilities, and other investment assets not managed by the adviser.”

 

§  Periodically remind clients through a variety of means (in-person, video chat, phone, e-mail, text, etc.) to alert their adviser of changes to their financial situation.

 

§  Disclosing that that the firm has “financial incentives to not migrate infrequently traded wrap fee accounts to brokerage or non-wrap advised accounts.”

 

  1. On July 21, 2021, the SEC announced settled charges against Suneet Singal, the Chief Executive Officer and chairman of the board of First Capital Real Estate Trust Inc. (“FC REIT”), a public, non-traded REIT, from September 15, 2015, until December 17, 2019. Singal also held several positions relating to First Capital Investment Corporation (“FCIC”), a closed-end management investment company that elected to be regulated as a business development company, including serving as an interested member of its board of directors.  Singal engaged in two separate frauds. First, the Commission alleged that Singal knowingly made numerous material misrepresentations and omissions in FC REIT’s public filings concerning his and FC REIT’s ownership of certain hotel properties he contributed to FC REIT as part of the agreement whereby Singal purchased the advisor to FC REIT and subsequently misstated FC REIT’s net asset value (“NAV”). Second, Singal violated his fiduciary duty as an investment adviser to FCIC and committed other violations of the Federal securities laws by, among other things, misappropriating at least $1.3 million from FCIC’s investment in a company Singal secretly controlled, and failing to disclose to FCIC’s independent directors the conflicts of interest that Singal’s acts created.  Singal was barred.  https://www.sec.gov/litigation/admin/2021/ia-5783.pdf

 

  1. On July 19, 2021, the SEC announced settled charges against UBS Financial Services Inc. for compliance failures relating to sales of a volatility linked exchange-traded product (ETP).  This is the sixth matter arising from the Enforcement Division’s ETP Initiative.  The ETP at issue is designed to track short-term volatility expectations in the market as measured against derivatives of a volatility index.  The issuer of the product warned UBS that it was not appropriate to hold the product for extended periods, and the product’s offering documents made clear that the product was more likely to decline in value when held over a longer period.  The order finds that UBS prohibited brokerage representatives from soliciting sales of the product and placed other restrictions on sales of the product to brokerage customers, but did not place similar restrictions on certain financial advisers’ use of the product in discretionary managed client accounts.  The order further finds that UBS adopted a concentration limit on volatility-linked ETPs, but failed to implement a system for monitoring and enforcing that limit for five years.  According to the order, UBS prohibited the financial advisers from making additional recommendations of this ETP prior to being contacted by the Commission staff.  Certain financial advisers had a flawed understanding of the appropriate use of the volatility-linked ETP and failed to take sufficient steps to understand risks associated with holding the product for extended periods.  These financial advisers, the order further finds, purchased and held the product in client accounts for lengthy periods, including hundreds of accounts that held the product for over a year, resulting in meaningful losses.  UBS will pay disgorgement and prejudgment interest of $112,274 and a civil penalty of $8 million.  https://www.sec.gov/news/press-release/2021-130

 

  1. On July 15, 2021, the SEC instituted administrative proceedings against David Aaron Rockwell. Rockwell was previously charged with six counts of wire and two counts of bank fraud for which he was sentenced to 63 months in prison and forfeiture of $1,018,000.  Rockwell applied for and obtained two lines of credit at a bank in the total amount of $700,000 in his clients’ names without their knowledge or permission, using his clients’ assets as collateral.  Rockwell caused the bank to transfer the loan proceeds to an account at another bank in the name of his clients but that Rockwell controlled. Between November 2017 and July 2018, he wrote checks on this bank account payable to a shell company totaling approximately $695,000. Rockwell used approximately $400,000 of the misappropriated funds to purchase a home in Fort Myers, FL with his then girlfriend.  https://www.sec.gov/litigation/admin/2021/34-92423.pdf

 

  1. On July 14, 2021, the SEC announced that Peter Driscoll, the Director of the Division of Examinations, will depart the SEC effective August 14th.  Daniel Kahl, the Division’s Deputy Director, will be named Acting Director upon Mr. Driscoll’s departure.  We are uncertain whether Mr. Driscoll’s departure was a result of the new SEC Chairman, Gary Gensler.   If Gensler was behind the move, it could signal significant changes with the Division of Examinations.  https://www.sec.gov/news/press-release/2021-126?utm_medium=email&utm_source=govdelivery

 

  1. On July 14, 2021, the SEC announced settled charges against Cascade Investment Group, Inc., a dually-registered broker-dealer and investment adviser for failing to disclose conflicts of interest arising out of its mutual fund share class selection practices.  Cascade failed to adequately disclose that it was purchasing, recommending, or holding for advisory clients mutual fund share classes that charged 12b-1 fees instead of lower-cost share classes of the same funds. Cascade breached its duty to seek best execution for those transactions by causing certain advisory clients to invest in mutual fund share classes that charged 12b-1 fees when other share classes of the same funds that presented a more favorable value for these clients under the particular circumstances in place at the time of the transactions were available to the clients.  Cascade consented to cease and desist from future violations of these provisions, to be censured, and to pay a civil penalty of $125,000.  https://www.sec.gov/enforce/34-92390-s

 

  1. On July 14, 2021, the SEC instituted administrative proceedings against Stockman, Kast, Ryan, & Co. LLP. (SKR), an audit firm based in Colorado Springs, Colorado, and two audit partners, Ellen Fisher, CPA, and David Kast, CPA, to determine whether SKR, Fisher, and Kast engaged in improper professional conduct in connection with audits of private funds advised by an SEC-registered investment adviser.  The SEC alleges that Fisher, the audit engagement partner, and SKR failed to obtain sufficient appropriate audit evidence regarding the valuation and existence of certain hard to value assets held by the private funds.  The allegations state that Fisher and SKR failed to meet applicable auditing standards related to audit planning, evaluating audit results, audit documentation, and supervision and review, and that Kast, as the engagement quality review partner, reviewed and approved work papers that failed to obtain sufficient appropriate audit evidence regarding the valuation and existence of assets.  The allegations further state that SKR was not independent because an SKR partner served as trustee or general partner for trusts that invested in funds audited by SKR. The SEC alleges that SKR, Fisher, and Kast engaged in improper professional conduct and caused the investment adviser to violate Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-2.  https://www.sec.gov/enforce/34-92382-s

 

  1. On July 13, 2021, the SEC announced settled charges against TIAA subsidiary for violations in retirement rollover recommendations.  The SEC and N.Y. Attorney General secured significant relief for investors and reforms at TIAA.  TIAA-CREF Individual & Institutional Services LLC (TC Services), a subsidiary of Teachers Insurance and Annuity Association of America (TIAA), will pay $97 million to settle charges of inaccurate and misleading statements and a failure to adequately disclose conflicts of interest to thousands of participants in TIAA record-kept employer-sponsored retirement plans (ESPs).  TC Services and its Wealth Management Advisers (WMAs) did not adequately disclose the full nature and extent of their conflicts of interest in recommending to clients that they roll over their retirement assets into a managed account program called “Portfolio Advisor.”  TC Services failed to adequately disclose compensation practices that incentivized the firm and its WMAs to recommend Portfolio Advisor for reasons other than a client’s particular investment needs.  Further, TC Services trained its WMAs to make, and its WMAs made, representations that they offered “objective” and “non-commissioned” advice, “put the client first,” and acted in the client’s best interest while holding themselves out as fiduciaries.  This was misleading because TC Services’ financial incentives for WMAs rendered their advice non-objective and TC Services did not ensure that WMA’s recommendations were, in fact, in the best interest of its clients.  TC Services simultaneously applied continual pressure to compel WMAs to prioritize the rollover of ESP assets into Portfolio Advisor over lower cost alternatives.  TC Services failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Investment Advisers Act in connection with rollover recommendations.   https://www.sec.gov/news/press-release/2021-123

 

  1. On July 9, 2021, the SEC charged “TheBull” with selling “Insider Trading Tips” on the Dark Web.  Apostolos Trovias, a Greek national, was charged with perpetrating a fraudulent scheme to sell what he called “insider trading tips” on the Dark Web. The Dark Web, which facilitates anonymity by obscuring users’ identities, allows users to purchase and sell illegal products and services, and in this case, insider trading tips.  According to the SEC’s complaint Trovias—operating under the pseudonym “TheBull”—engaged in a deceptive scheme to offer and sell so-called “insider trading tips” on Dark Web marketplaces to purchasers whom Trovias offered an unfair advantage for trading securities in the public markets. As alleged in the complaint, Trovias claimed that the information he was selling consisted of order-book data from a securities trading firm that was provided to Trovias by an employee of the firm. Trovias allegedly sold those “tips” through one-off sales, as well as weekly and monthly subscriptions. Trovias allegedly sold over 100 subscriptions to investors via the Dark Web over the course of the scheme. The complaint alleges that, in addition to order-book information, Trovias sold the pre-release earnings reports of publicly traded companies.   In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Trovias.  https://www.sec.gov/news/press-release/2021-122

 

  1. On July 9, 2021, the SEC announced settled charges against Kestra Advisory Services, LLC and Kestra Private Wealth Services, LLC (collectively, the Kestra Advisers) for failing to disclose compensation received by their affiliated broker-dealer. The Kestra Advisers invested advisory client assets in certain mutual funds for which their affiliated broker-dealer received revenue sharing payments from its clearing broker. Certain of the mutual funds that paid revenue sharing were more expensive than lower-cost options available to clients, including instances when there were lower-cost share classes of the same mutual funds available to clients that did not result in any revenue sharing. The Kestra Advisers’ affiliated broker-dealer received compensation resulting from transaction fees charged on mutual fund trades and non-transaction fees for certain services provided to the Kestra Advisers’ advisory clients, which were greater than the amount charged to their affiliated broker-dealer by the clearing broker for those trades and services (collectively, fee markups). The Kestra Advisers breached their fiduciary duties to advisory clients by failing to provide full and fair disclosure regarding the two types of compensation received by their affiliated broker-dealer and the related conflicts of interest.  Kestra Advisory Services will pay disgorgement of $7,229,802, prejudgment interest of $1,273,370, and a civil penalty of $1,500,000. Kestra Private Wealth Services will pay disgorgement of $208,187, prejudgment interest of $31,382, and a civil penalty of $60,000.  https://www.sec.gov/enforce/ia-5771-s

 

  1. On July 9, 2021, the SEC announced settled charges against Hilltop Securities Inc. and Daniel C. Tracy, a Hilltop municipal trader, for improperly obtaining retail priority allocations of new issue municipal bonds when Hilltop, a broker-dealer, was not entitled to such priority. Municipal issuers hold retail order periods to give first priority to orders from retail investors in the bond allocation process.  Tracy, on behalf of Hilltop, submitted new issue bond orders to a registered representative at a co-managing underwriter during retail order periods, when Tracy should have known that the representative was improperly submitting these orders as retail customer orders.  Hilltop consented to a cease-and-desist order finding that it willfully violated the fair dealing and supervisory provisions of MSRB Rules G-17 and G-27, and failed reasonably to supervise within the meaning of Section 15(b)(4)(E) of the Securities Exchange Act of 1934. The order imposes a censure and requires Hilltop to pay an $85,000 civil penalty, $206,606 in disgorgement and $48,587 in prejudgment interest. Without admitting or denying the SEC’s findings, Tracy consented to an order finding that he violated MSRB Rule G-17, requiring him to pay a $25,000 civil penalty, and imposing a 12-month limitation on his ability to offer, purchase, or sell negotiated new issue municipal securities.  https://www.sec.gov/enforce/34-92370-s

 

  1. On July 8, 2021, the SEC announced settled charges St. Germain Investment Management for breach of its fiduciary duty to advisory clients related to the receipt of revenue in connection with clients’ cash sweep accounts. An unaffiliated clearing broker St. Germain used for client accounts (the “Clearing Broker”) offered various cash sweep vehicles for uninvested cash. Under the terms of an agreement between the Clearing Broker and St. Germain’s affiliated broker-dealer, St. Germain Securities, Inc. (“St. Germain Securities”), the Clearing Broker made revenue sharing payments to St. Germain Securities based on the amount of St. Germain’s clients’ cash invested in the cash sweep vehicle St. Germain used for most client accounts. This presented a conflict of interest because the Clearing Broker offered a cash sweep vehicle that did not result in revenue sharing payments. During the Relevant Period, St. Germain did not adequately disclose the revenue sharing arrangement or the related conflicts of interest to its advisory clients.  In addition, St. Germain failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder related to its disclosure of cash sweep revenue sharing and the associated conflicts.  St. Germain agreed to disgorgement, prejudgment interest, and a civil penalty totaling $1,925,250. https://www.sec.gov/litigation/admin/2021/ia-5767.pdf

 

  1. July 2, 2021, the SEC charged Sean Wygovsky, a trader at a major Canada-based asset management firm, in connection with a long-running and lucrative front-running scheme that Wygovsky perpetrated in the accounts of his close family members, netting more than $3.6 million in illicit gains.  According to the SEC’s complaint, Wygovsky repeatedly traded in his family members’ accounts held at brokerage firms in the United States ahead of large trades that were executed on the same days in the accounts of his employer’s advisory clients. On over 600 occasions, Wygovsky allegedly bought or sold a stock for one his relatives’ accounts either before the client accounts began executing a large order for the same stock on the same side of the market, or during the time period when tranches of such a large order were being executed.  Then, typically before the client accounts completed their executions, Wygovsky allegedly closed out the just-established positions in his relatives’ accounts, nearly always at a profit.  In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Wygovsky. https://www.sec.gov/news/press-release/2021-118

 

  1. On July 2, 2021, Raj Rajaratnam, founder and managing general partner of Galleon Management, LP (“Galleon”), an investment adviser to the Galleon hedge funds, agreed to a bar.  By way of background, on May 11, 2011, after a jury trial in the criminal action Rajaratnam was convicted and sentenced to a prison term of 132 months plus two years of supervised release, ordered to pay $53,816,434.00 in forfeiture, and ordered to pay a $10,000,000 fine.  https://www.sec.gov/litigation/admin/2021/ia-5764.pdf

 

22.   On June 3, 2021, President Biden signed an Executive Order to further address the ongoing national emergency with respect to the threat posed by the military-industrial complex of the People’s Republic of China.   The Executive Order prohibits investing in certain Chinese companies that undermine the security or democratic values of the United States and our allies. The President’s Executive Order goes into effect on August 2 2021.  https://www.whitehouse.gov/briefing-room/statements-releases/2021/06/03/fact-sheet-executive-order-addressing-the-threat-from-securities-investments-that-finance-certain-companies-of-the-peoples-republic-of-china/

 

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