Weekly RoundUp
September 24, 2014

Financial Services Weekly News

In this Issue:  Last week brought news of several enforcement actions by the SEC against investment advisers on a number of issues: Rule 105 of Regulation M, improper withdrawals characterized as management fees, violation of rules on principal trading and advertising and the allocation of shared expenses between funds managed by a private equity fund manager. The SEC has been signaling its interest in these issues for months. Andrew Bowden, the Director of the SEC’s Office of Compliance Inspections and Examinations (OCIE), said in a speech on May 6, 2014 (Spreading Sunshine in Private Equity): “By far the most common observation our examiners have made when examining private equity firms has to do with the adviser’s collection of fees and allocation of expenses.  When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50% of the time.” Eventually those observed violations turned into enforcement matters.

Editor’s Note

The Goodwin Procter Financial Services Weekly News Roundup, introduced last week, provides headlines and brief summaries of developments affecting the financial services industry, with links to primary sources. The developments covered include legislation, rulemaking, the publication of interpretive guidance by regulatory agencies, litigation and enforcement matters and industry news. The Roundup will also provide links to client alerts and other articles by and about Goodwin Procter lawyers.

Regulatory Developments

FINRA Requests Comment on a Revised Proposal to Adopt Consolidated FINRA Rule 2231 (Customer Account Statements)

FINRA seeks comment in Regulatory Notice 14-35 on a revised proposal to transfer current NASD Rule 2340 (Customer Account Statements) and incorporated NYSE Rule 409 (Statements of Accounts of Customers) into the consolidated FINRA rulebook as FINRA Rule 2231. The revised proposal includes changes made in response to comments on the prior proposal, which was subsequently withdrawn. The key changes in the revised proposal from the prior proposal are to (1) maintain the quarterly delivery requirement in the current rule and (2) allow customers to direct the transmission of customer account statements and other documents to third parties, provided the firm sends duplicates of such account statements and other documents directly to the customer. 

Enforcement & Litigation

SEC Settles with Advisory Firms Over Short Sales During Restricted Period Prior to Offerings

The SEC announced settled administrative proceedings against 19 investment advisory firms and one individual trader for violations of Rule 105 of Regulation M under the Securities Exchange Act, which prohibits short selling during the restricted period prior to certain public offerings and then purchasing the same security in the public offering.  The respondents agreed to disgorge profits, and pay civil penalties and prejudgment interest, totaling more than $9 million.   The settlements are part of an ongoing initiative announced last year to enhance enforcement of Rule 105.

SEC Settles with Adviser, Files Proceeding Against Portfolio Manager, Over Improper Withdrawals from Hedge Fund Characterized as Management Fees

The SEC announced that it had settled administrative proceedings against a registered adviser over amounts withdrawn from a hedge fund by its portfolio manager purportedly as management fees that were in fact for his own personal use.  Among other violations, the SEC found that the adviser had failed to reasonably supervise the portfolio manager who had sole authority to transfer money from the fund and was not subject to any controls in the exercise of that authority.  The adviser agreed to pay a $150,000 civil penalty.  In a related action,  the SEC commenced administrative proceedings against the portfolio manager.

SEC Settles with Adviser Over Principal Transactions and Performance Advertising Violations

The SEC announced that it had settled administrative proceedings against an investment adviser and the adviser’s CEO over (1) principal transactions between clients and the adviser’s affiliated broker-dealer, (2) related best execution and disclosure violations, (3) misleading performance advertising and (4) related compliance program implementation violations.  Among other sanctions, the Adviser agreed to pay nearly $600,000, including approximately $368,000 to be distributed to affected clients in disgorgement of profits realized by the affiliated broker-dealer from the principal transactions in question.  The CEO agreed to pay a $50,000 penalty.

SEC Settles with Private Equity Fund Manager Over Allocation of Shared Expenses Between Portfolio Companies

The SEC announced that it had settled administrative proceedings against a private equity fund adviser over the improper allocation of shared expenses between two portfolio companies that were operated on an integrated basis.  Each portfolio company was owned by a separate fund managed by the adviser.  The SEC found that a general policy of allocating expenses that benefitted both companies based on relative revenue was not followed in certain instances when one portfolio company (and, indirectly, the fund that owned it) paid more than its share of certain shared administrative expenses, joint employee salaries, and subsidiary overhead and salary expenses.  On this basis, the SEC found that the adviser had breached its fiduciary duty to the funds in violation of Section 206(2) of the Investment Advisers Act of 1940.  The adviser agreed to pay $1.5 million in disgorgement plus $358,112 in prejudgment interest and a $450,000 civil penalty.

Goodwin Procter News

Goodwin Procter Expands Fintech Platform

Goodwin Procter announced yesterday the expansion of its Fintech Practice, naming practice area leaders and consolidating under a single platform its market-leading experience in both the technology and financial services industries and its established presence in key industry markets. The Fintech Practice is backed by a cross-disciplinary team of more than 60 attorneys with expertise in financial services, private equity, technology, investigations, and intellectual property, consumer financial services, business and securities litigation. The practice is led by partnersRobert BishopAmber Dolman, and Brian McPeake.