The SEC settled administrative proceedings against the former employee (the “Adviser Employee”) of an adviser for four registered funds (the “Funds”) over his failure to report personal securities transactions as required by the Funds’ and adviser’s joint code of ethics (the “Code”) and for misleading the funds’ and adviser’s chief compliance officer (the “CCO”) about his personal trading through false representations regarding compliance with the code and falsification of documents related to his personal trading. The SEC found violations by the Adviser Employee of Rule 17j-1 under Investment Company Act of 1940 (the “1940 Act”) which (i) governs the conduct of certain persons affiliated with a registered fund when they purchase or sell a security held or to be acquired by the fund and (ii) requires periodic reporting of personal securities transactions by certain personnel of a fund and its adviser. The SEC also found that the Adviser Employee had violated Rule 38a‑1(c) under the 1940 Act, which prohibits personnel of a fund or its adviser from directly or indirectly taking “any action to coerce, manipulate, mislead, or fraudulently influence the fund's chief compliance officer in the performance of his or her duties.” The SEC press release announcing the settlement noted that it was the Commission’s first settlement under Rule 38a‑1(c). This article summarizes the SEC’s findings, which the Adviser Employee neither admitted nor denied.
Relationship with the Adviser and the Funds. From December 1999 to January 2011, the Adviser Employee was employed in various capacities by the adviser, including serving as assistant portfolio manager. The Adviser Employee served as an officer and assisted in managing the portfolios of the Funds. On January 9, 2011, the Adviser Employee was placed on administrative leave, and three days later, resigned.
Trading Activity. From 2006 through 2010, the Adviser Employee engaged in 850 personal securities transactions, many involving positions that were held for only a few days. 640 of these trades were not reported as required under Rule 17j-1 or pre‑cleared as required under the Code. 14 of the unreported trades did not comply with the Code’s restrictions on trading in securities that the Funds were buying or selling. At least 91 of the unreported trades were in “Securities Held or to be Acquired by a Fund,” a defined term under Rule 17j-1 that, when applied in the context of the Funds, meant (a) any security subject to reporting under Rule 17j-1 that, within the most recent 15 days, (1) was or had been held by a Fund or (2) was being or had been considered by a Fund or the adviser for purchase by a Fund; and (b) any option to purchase or sell, and any security convertible into or exchangeable for, a security described in (a). Rule 17j-1(b) prohibits an employee of a fund’s adviser, in connection with the purchase or sale, directly or indirectly, of a security held or to be acquired by the fund, from (i) employing devices, schemes, or artifices to defraud a fund, (ii) making untrue statements of a material fact to the fund or omitting to state material facts necessary in order to make the statements made to the fund, in light of the circumstances under which they were or are made, not misleading, (iii) engaging in acts, practices or courses of business which operate or would operate as a fraud or deceit on the fund, or (iv) engaging in manipulative practices with respect to the fund.
Misrepresentations and Document Falsification. The Adviser Employee submitted false quarterly and annual reports of his personal securities transactions and falsely certified his annual compliance with the Code. In an effort to conceal his trading activity, the Adviser Employee created documents, such as false pre-clearance request approvals, and altered existing documents, such as trade confirmations and brokerage statements. In late 2010, when the CCO raised issues concerning the Adviser Employee’s compliance with the Code, the Adviser Employee claimed that he had closed certain brokerage accounts that were in fact open and in which he had executed trades that should have been pre-cleared under the Code. The Adviser Employee also accessed and altered the hard copy file of his previously submitted brokerage statements to create the false impression his trading was in compliance with the Code.
Sanctions. In addition to a cease-and-desist order, the Adviser Employee agreed to pay disgorgement of $231,169, prejudgment interest of $23,889, and a penalty of $100,000. The Adviser Employee also consented to a five-year bar industry bar, whose breadth reflects the Dodd-Frank Act’s expansion of the permitted scope of this sanction. Under the bar, the Adviser Employee is (a) barred from association with any (i) broker, (ii) dealer, (iii) investment adviser, (iv) municipal securities dealer, (v) municipal advisor, (vi) transfer agent, or (vii) nationally recognized statistical rating organization; and (b) prohibited from serving or acting as an (1) employee, (2) officer, (3) director, (4) member of an advisory board, (5) investment adviser or depositor of, or (6) principal underwriter for, (x) a registered investment company or (y) affiliated person of such investment adviser, depositor, or principal underwriter, with the right to apply for reentry after five years to the appropriate self-regulatory organization, or if there is none, to the SEC.