- On November 24, 2021, the SEC instituted administrative proceedings against Upright Financial Corp. and David Chiueh. Upright, as UPUPX’s investment adviser, and Chiueh made investments for UPUPX that were inconsistent with UPUPX’s classification as a diversified investment company, and UPUPX’s fundamental policy with respect to industry concentration as disclosed in its registration statement. Upright and Chiueh also caused Upright Trust to incorrectly state in certain filings, including in shareholder reports and certain versions of its registration statement, that UPUPX operated in compliance with these fundamental policies when in fact it was not doing so. Upright agreed to pay disgorgement of about $390,000 and $36,000 in prejudgment interest and a civil penalty of $90,000. https://www.sec.gov/litigation/admin/2021/33-11010.pdf
- On November 23, 2021, the SEC charged Ronald Molo with defrauding investors out of $800,000, which Molo used to pay personal expenses. Molo convinced the investors to transfer money out of their advisory and brokerage accounts to another bank account, purportedly to invest in tax-free bonds. In reality, the bonds did not exist, and Molo did not tell the investors that the account to which he had directed them to transfer their money was his personal bank account. Molo used it to pay personal expenses, including mortgage payments, automobile purchases, and renovations to his home. Molo tried to cover up his fraud by sending the three investors purported interest payments from the nonexistent bonds, using altered cashier’s checks drawn from funds in his personal bank account. https://www.sec.gov/litigation/litreleases/2021/lr25270.htm
- On November 22, 2021, the SEC instituted administrative proceedings against Ann Vick for misrepresenting herself to investors as an extraordinarily successful options trader, promising returns of 5-10% per month (60-120% annually), while her previous trading record was insufficient to pay the promised returns. Vick experienced significant trading losses that rendered AMV Investments insolvent, which Vick failed to disclose to investors as she solicited and accepted additional investments. Vick misappropriated hundreds of thousands of dollars of investor funds. Vick was barred. https://www.sec.gov/litigation/admin/2021/ia-5913.pdf
- On November 19, 2021, the SEC announced that an affiliate of McKinsey & Company, MIO Partners, Inc., that offers investment options exclusively to current and former McKinsey partners and employees has agreed to pay an $18 million penalty for compliance failures. The investigation found that the affiliate maintained inadequate policies and procedures to prevent McKinsey partners from misusing material nonpublic information they obtained as consultants to public companies and other McKinsey clients while they were simultaneously overseeing the affiliate’s investment decisions. McKinsey’s affiliate MIO Partners Inc. was investing hundreds of millions of dollars in companies that McKinsey was advising. Certain McKinsey partners oversaw MIO’s investment choices and also had access to material nonpublic information as a result of their McKinsey consulting work. These partners were routinely privy to confidential information like financial results, planned bankruptcy filings, mergers and acquisitions, product pipelines and funding efforts, and material changes in senior management at those companies. MIO failed to establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of its business, to prevent the misuse of material non-public information. MIO agreed to pay a $18,000,000 civil penalty. https://www.sec.gov/litigation/admin/2021/ia-5912.pdf and https://www.sec.gov/news/press-release/2021-241
- On November 18, 2021, the SEC issued their 2021 enforcement action report which disclosed that they filed 434 new enforcement actions in fiscal year 2021, representing a seven percent increase over the prior year. Seventy percent of these new or “stand-alone” actions involved at least one individual defendant or respondent. The new actions spanned the entire securities waterfront, including emerging threats. The agency filed 697 total enforcement actions in fiscal year 2021, including the 434 new actions, 120 actions against issuers who were delinquent in making required filings with the SEC, and 143 “follow-on” administrative proceedings seeking bars against individuals based on criminal convictions, civil injunctions, or other orders. In fiscal year 2021, which ended on September 30th, the SEC also obtained judgments and orders for nearly $2.4 billion in disgorgement and more than $1.4 billion in penalties, which represented a respective 33 percent decrease and 33 percent increase over amounts ordered in the prior fiscal year in these categories. https://www.sec.gov/news/press-release/2021-238
- On November 18, 2021, the SEC instituted administrative proceedings against Justin King, president of Elevate Investments, LLC. King and Elevate offered interests in the Elevate Investment Fund, raising at least $7.4 million from investors. In offering and selling investments in the Fund, King and Elevate made materially false and misleading statements on Elevate’s publicly-accessible website, including falsely reporting a 61% return for all accounts while actually incurring $3.8 million in trading losses. King misused investor funds. King was barred. https://www.sec.gov/litigation/admin/2021/ia-5911.pdf
- On November 16, 2021, the SEC instituted administrative proceedings against Jeremy Drake. Drake defrauded a married couple by deceiving them about the investment advisory fees they were paying. Drake deceived the couple for more than three years, telling them that they paid a special “VIP” annual rate of 0.15 to 0.20 percent of their assets under management when in fact they were paying 1 percent. Drake’s deception led the couple to pay $1.2 million more in management fees than Drake represented, a portion of which Drake received as compensation from HCR. Drake was barred. https://www.sec.gov/litigation/admin/2021/ia-5909.pdf
- On November 15, 2021, the SEC filed charges against Lina Garcia of UCB Financial Advisers, Inc. for her role in a multi-year “cherry picking” scheme in which millions of dollars were allegedly channeled to the accounts of preferred clients. Garcia worked with the other defendants to divert profitable trades to two accounts held by Sugranes’s parents, and to saddle other clients with losing trades. Garcia used a single account to place trades without specifying the intended recipients of the securities at the time they placed the trades. After Garcia established a position, if the price of the securities increased during the trading day, Garcia usually closed out the position and allocated those profitable trades to the two accounts held by Sugranes’s parents, who have been charged as relief defendants. The matter is being litigated. https://www.sec.gov/litigation/litreleases/2021/lr25265.htm
- On November 10, 2021, the SEC’s Division of Examinations (the “Division”) issued a Risk Alert on observations of investment adviser fee calculations. The Division previously published a Risk Alert highlighting compliance issues observed by the staff related to advisory fees. In this follow up Risk Alert, the Division is supplementing the prior advisory fees Risk Alert by providing greater detail on certain compliance issues observed during the recent Advisory Fees Initiative examinations, including additional details regarding the staff’s observations concerning fee-related deficiencies and fee-related compliance and disclosure issues.
The staff conducted approximately 130 examinations of SEC-registered investment advisers under this initiative and identified deficiencies related to the advisory fees charged during most of these examinations. The advisory fee-related deficiencies observed often resulted in financial harm to clients, including: (1) advisory fee calculation errors, such as over-billing of advisory fees, inaccurate calculations of tiered or breakpoint fees, and inaccurate calculations due to incorrect householding of accounts; and (2) not crediting certain fees due to clients, such as prepaid fees for terminated accounts or pro-rated fees for onboarding clients. In addition, the staff observed fee-related compliance and disclosure issues.
Notable deficiencies include:
Advisory Fee Calculations
Several examined advisers charged advisory fees inaccurately. These inaccurate calculations were due to a variety of errors, including:
- Inaccurate percentages were used to calculate advisory fees. For example, the staff identified examined advisers that, among other things:
(1) charged fees that were different from contractually agreed-upon rates;
(2) used the incorrect fee schedule (e.g., used the schedule intended for clients domiciled in a country other than the United States);
(3) failed to convert all clients to their new or updated fee schedule; and
(4) had errors in fee percentages manually entered into their portfolio management systems.
- Advisory fees were double-billed. Such errors were typically due to oversights, such as not updating a system following a change in billing practices.
- Breakpoint or tiered billing rates were not correctly calculated. Often these issues related to tiered fee schedules not being applied correctly or applied at all.
- Householding of client accounts were not correctly calculated. In such instances, the examined advisers did not aggregate client or family accounts and/or apply the declining fee schedule, as applicable.
- Incorrect client account valuations were used. For example, examined advisers included in their account valuations:
(1) assets that disclosures stated would be excluded from the fee calculations, such as legacy positions;
(2) stale account balance information as a result of the loss of data during transitions of portfolio management systems;
(3) incorrect valuation dates for client billings; and
(4) inaccurate account values due to timing differences in cash and dividend transactions in electronic custodial feeds compared to the available balance at the custodian (e.g., certain pending deposits may be excluded from available balance).
Several examined advisers either did not refund prepaid fees on terminated accounts or did not assess fees for new accounts on a pro-rata basis. The staff identified the following issues, among others, related to refunding prepaid fees:
- Inconsistently refunding unearned fees. The examined advisers were obligated – by disclosures, advisory contracts, or both – to refund unearned advisory fees, but the examined advisers were inconsistent in providing refunds to clients (i.e., provided refunds to some clients, but not others) or were unnecessarily delayed in providing such refunds, sometimes for several years post termination.
- Requiring clients to provide written requests to refund unearned advisory fees. In these instances, the examined advisers had policies to refund prepaid advisory fees only upon written notice from clients. Thus, the examined advisers kept the unearned advisory fees for clients that: (1) terminated the advisory relationship through their custodians, rather than notifying the adviser directly; or (2) did not specifically request a refund of prepaid fees when terminating the relationship.
False, Misleading or Omitted Disclosures
Several of the examined advisers were identified as having a range of disclosure issues. The issues identified were related to incomplete or misleading Form ADV Part 2 brochures and/or other disclosures, including disclosure that:
(1) did not reflect current fees charged or whether fees were negotiable;
(2) did not accurately describe how fees would be calculated or billed; and
(3) was inconsistent across advisory documents, such as stating the maximum fee in an advisory agreement that exceeded the fees disclosed in the adviser’s brochure. The staff also identified examined advisers that did not have any written agreements or documentation establishing the client fee amount.
Examples of issues with fee-related disclosures the staff observed, include:
- Cash flows and their effect on fees. The staff observed disclosures that were inconsistent with the examined advisers’ practices or were insufficient in describing how cash flows (e.g., deposits and withdrawals) may impact client advisory fees, such as how a client will be billed for large deposits made mid-billing cycle.
- Timing of advisory fee billing. The staff observed examined advisers that provided inaccurate disclosures regarding the timing of their fee billing. In some cases, advisers disclosed that advisory fees would be billed in advance, but elected to have some or many clients billed in arrears (and vice versa). In addition, although some examined advisers’ fee disclosures stated that clients would be billed based on the average-weighted daily capital balances during the quarter, many of the clients’ advisory agreements stated that fees were calculated in arrears based on the value at quarter-end. Lastly, some examined advisers did not disclose any information about the timing of advisory fee billing.
- Valuations for fee calculations. Some examined advisers provided inaccurate disclosures about the values used to calculate advisory fees, such as using the month end account values rather than the disclosed average daily account values.
- Minimum fees, extra fees, and discounts. Some examined advisers did not fully disclose a variety of other fee-related topics. Examples include examined advisers that did not disclose:
(1) platform administration fees assessed (and that the fees could be avoided if clients elected to have their advisory accounts managed without using the platforms);
(2) actual or minimum asset-based fee rates charged to clients;
(3) the negotiability of fees or falsely disclosed that fees were not negotiable when they, in fact, could be negotiated;
(4) the process for implementing householding and eligibility criteria; and
(5) fees related to participating in wrap fee programs and non-wrap accounts.
Missing or Inadequate Policies and Procedures
Many of the examined advisers did not maintain written policies and procedures addressing advisory fee billing, monitoring of fee calculations and billing, or both. Although some of these advisers had informal or unwritten practices in these areas, the staff considered such issues to be relevant to the operations of the adviser, and thus should be captured in written policies and procedures. Below are some examples of the staff’s observations in this area:
- Policies and procedures that specifically address fee calculations. The staff identified examined advisers with policies and procedures that were generic in nature and did not address specifics related to the processes for computing, billing, and testing advisory fees. In some cases, the examined advisers had no policies for testing or monitoring fee calculations.
- Policies and procedures to address material advisory fee components. The staff observed examined advisers’ policies and procedures missing a variety of critical advisory fee components that were relevant to the firms’ businesses, including:
(1) valuation of illiquid or difficult-to-value assets included in the assets for the calculation of advisory fees;
(2) fee offsets, such as those offered for 12b-1 fees;
(3) fee reimbursements for terminated accounts, where the client prepaid fees;
(4) prorating fees for additions or subtractions of assets in accounts; and
(5) family account aggregation (householding) or the application of breakpoints for fee calculations.
Inaccurate Financial Statements
The staff observed issues or inaccuracies with financial statements at several examined advisers with respect to advisory fees. These issues included examined advisers in potential financial distress (e.g., substantial balances on loans or lines of credit) and examined advisers not properly: (1) recording pre-paid advisory fees as liabilities; or (2) maintaining their financial statements. Some examples include:
- Not recording all advisory fee income, administrative fee revenue, and compensation expenses in general ledgers and on financial statements. These examined advisers did not record such gross revenue and expenses in their books and records because they were exchanged for other goods and services (e.g., IT support) or did not record advisory fees paid directly to investment adviser representatives.
- Using a cash and modified cash basis of accounting, but preparing financial statements on an accrual basis of accounting. These examined advisers incorrectly classified client advisory fees as “accounts receivable.”
Advisory fee calculation and billing has been, and continues to be, an area that warrants routine review during investment adviser examinations. The staff’s observations and examination findings often lead to advisers returning money owed to clients due to fee billing and calculation errors, or to the improvement of advisers’ compliance programs, policies, and procedures that foster prevention of future advisory fee issues. https://www.sec.gov/files/exams-risk-alert-fee-calculations.pdf
10. On November 8, 2021, jurors in Boston federal court returned a verdict in the SEC’s favor against a hedge fund adviser and his investment advisory firm. Gregory Lemelson and Lemelson Capital Management LLC were charged with fraud in September 2018 for reaping more than $1.3 million in illegal profits by making false statements to drive down the price of Ligand Pharmaceuticals Inc. The SEC’s evidence at trial showed that after establishing a short position in Ligand through his hedge fund, Lemelson made a series of false statements to shake investor confidence in Ligand and lower its stock price, increasing the value of his fund’s position. The false statements include assertions that Ligand’s investor relations firm had agreed that Ligand’s most profitable drug was on the brink of obsolescence and that Ligand had entered into a sham transaction with an unaudited shell company in order to pad its balance sheet. The evidence also showed that Lemelson had boasted about bringing down Ligand’s stock price through his “multi-month battle” against the company. The court will determine remedies at a later date. https://www.sec.gov/litigation/litreleases/2021/lr25258.htm
11. On November 8, 2021, the SEC announced that it obtained an asset freeze and other preliminary injunctive relief against Swapnil Rege and his company SwapStar Capital, LLC. Rege and SwapStar solicited Rege’s friends, neighbors, and other referrals to be the defendants’ investment advisory clients. Rege and SwapStar allegedly misrepresented to their clients that client money would be invested in securities for guaranteed returns. Rege and SwapStar instead used client money to pay fictitious gains to other clients, return original investment amounts to other clients, and to pay for some of Rege’s personal expenses. This matter is being litigated. https://www.sec.gov/litigation/litreleases/2021/lr25259.htm
12. On November 5, 2021, the SEC announced charges against Steven Muntin for defrauding one of his investment advisory clients out of more than $314,000. Muntin solicited one of his elderly advisory clients to write checks totaling $305,750 to Executive Asset Management for purported investments in securities. Muntin did not invest the client’s money in securities, but spent it for his own benefit, including to pay his mortgage, real estate taxes, health insurance, boat and car loans, and credit card bills. Muntin also overcharged the client for at least $9,000 in assets under management fees. The matter is being litigated. https://www.sec.gov/litigation/litreleases/2021/lr25255.htm
13. On November 1, 2021, the SEC instituted administrative proceedings against John Jones, Jr. Jones misrepresented to potential fund investors that their funds were protected such that investors could only lose 10-15% of their principal investment, that investors’ principal was insured, and that his investment strategy was created in concert with a national financial organization. None of these things were true. He gave investors the false impression that the investment opportunities that he offered would be lucrative and have the protection of quantifiable downside risk. The securities of the funds sold by Jones were unregistered. Jones was barred. https://www.sec.gov/litigation/admin/2021/ia-5900.pdf
14. On November 1, 2021, the SEC charged a former New Jersey broker and investment adviser representative Kenneth Welsh with stealing nearly $3 million from his advisory clients and brokerage customers, which he used to buy gold coins and other precious metals, and funneled to family credit card accounts that he controlled. The matter is being litigated. https://www.sec.gov/litigation/litreleases/2021/lr25251.htm