The Consequences For Untimely Producing Records to Regulators

A recent SEC enforcement case illustrates again how an investment adviser’s  failure to  timely respond to SEC requests for books and records during an inspections and examinations can turn into an enforcement action.  The outcome should not surprise.  With the limited facts available, one wonders why the SEC’s restraint in bringing an action lasted as long as it did.  There are, however, a few important takeaways for advisers and their compliance professionals.

The case, In the Matter of  EM Capital Management, LLC and Seth Richard Freeman,  involves the SEC issuing an order instituting administrative and cease-and-desist proceedings against an adviser and its principal for failing, over a year and a half period, to furnish books and records to the Commission’s Investment Adviser/Investment Company examination staff.  The requested records included financial statements, e-mails, and documents relating to the adviser and a mutual fund it managed.

After repeatedly promising to produce the documents following repeated requests from the examination staff, the adviser ultimately did comply.  However,  by then, presumably, the Commision’s patience had finally worn thin, and the staff notified the adviser and its principal that the SEC was considering enforcement action against him and the firm.

The Commission alleged that the adviser violated, and the principal aided and abetted violations of Section 204 of the Advisers Act and Rule 204-2, thereunder.  These  regulations and rules require SEC-registered investment advisers to produce required books and records to the Commission’s staff. The adviser and principal were censured and jointly ordered to pay a civil penalty of $20,000.

The lessons imparted from this and similar cases brought by the Commission are at least three-fold:

  1. Never refuse to produce documents that are subject to the SEC’s inspection powers. i.e. generally, with a few exceptions, Rule 204-2(e) of the Investment Advisers Act of 1940 (“Advisers Act”) requires advisers to maintain their books and records for at least five years, and maintained in an appropriate office of the adviser for the first two years.
  2. Delaying tactics is not a good idea since it probably raise more red flags for the examination staff that’s some rule violation may have occured.  If  additional time is needed to comply bring requests to the staff’s attention and make sure it and any extensions granted are documented.
  3. Despite the lesser sanctions in this case, advisers and their compliance personnel should never forget that, under Section 217 of the Advisers Act, willful failure to permit the SEC to inspect books and records is a felony, punishable by a fine of not more than $10,000 and imprisonment up to five years or both.
  4. Nothing stated above should suggest that advisers may not seek to limit the scope of books and records sought.  This includes, where appropriate, asserting relevant privileges against producing certain documents, seeking clarifications about unclear or open-ended requests, and objecting to burdensome and unreasonable production.

 

SEC 2012 Enforcement Actions Against Investment Professionals

In a press release yesterday, the Securities and Exchange Commission  announced enforcement results for its fiscal year ending September 30, 2012.

The results include the SEC having filed 734 enforcement actions, just one case shy of last year’s record of 735.  According to the Division of Enforcement, the cases,  involved everything from highly complex products, transactions, and practices, including those related to the financial crisis, trading platforms and market structure, to insider trading by market professionals.  In addition, orders were entered in some of these cases requiring the payment of more than $3 billion in penalties and disgorgement for the benefit of investors who were harmed.

Investment Advisers

As for investment advisers, the SEC filed 147 enforcement actions in 2012 against investment advisers and investment companies.  Several cases  resulted from the Division of Investment Management’s investment adviser compliance initiative involving advisers who failed to maintain effective compliance programs designed to prevent securities laws violations.

Other actions involving advisers included the SEC

Broker-Dealers

The Commission filed 134 enforcement actions related to broker-dealers — a 19 percent increase over 2011.  Enforcement actions included an action against a Latvian trader and electronic trading firm for their involvement in an online account intrusion scheme that manipulated the prices of more than 100 NYSE and Nasdaq securities; and an action against New York-based brokerage firm Hold Brothers On-Line Investment Services and three of its executives for allowing overseas traders to access the markets and conduct manipulative trading through accounts the firm controlled.

Municipal Securities

The number of enforcement actions related to municipal securities more than doubled since 2011. The SEC filed 17 actions related to municipal securities, including charging Detroit’s former mayor and treasurer in a pay-to-play scheme involving Detroit’s pension funds.  In another action, the SEC charged Goldman Sachs for violating municipal securities rules resulting from undisclosed “in-kind” non-cash contributions that one of its investment bankers made to a Massachusetts gubernatorial candidate.

 

Renewal Time: Broker-Dealers, Advisers, Their Agents and Reps

In Regulatory Notice 12-46, FINRA has announced the start of the 2013 Renewal Program for investment advisers, broker-dealers, their agents and investment adviser representatives.  On November 12, 2012, FINRA will make the online Preliminary Renewal Statements available to all firms on Web CRD/IARD. The following dates are key in the renewal process:

  • November 1, 2012     Firms may begin submitting post-dated Form U5,  BR Closing/Withdrawal, BDW and ADV-W filings via Web CRD/IARD.
  • November 12, 2012    Preliminary Renewal Statements are available on Web CRD/IARD.
  • December 13, 2012     Full payment of Preliminary Renewal Statements is due.
  • January 2, 2013          Final Renewal Statements are available on Web CRD/IARD.
  • February 1, 2013        Full payment of Final Renewal Statements is due.

Firms can find guidance in the renewal instructions, the Renewal Program Bulletin, and the IARD Renewal Program Bulletin (if applicable) on the Investment Adviser Registration Depository (IARD) website.

FINRA warns firms that failure to remit full payment of  their Preliminary Renewal Statements to FINRA by December 13, 2012, may cause the firm to become ineligible to do business in the jurisdictions where it is registered, and subject them to late fees effective January 1, 2013.