Ratings service fined $5 million for disclosure violations, portfolio manager arrested for lobbying to make his daughter a star, and it’s déja vue again with failed revenue sharing: Lessons learned and worth reading for February 2023 | ACA Foreside


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[co-author: Heather Augustine]

SEC Fines $5 Million for Securities Fraud: Attention Service Providers! The SEC filed a securities fraud lawsuit against an independent pricing service for failing to disclose that some of its ratings were determined by a single data point. The case follows a trend from other recent SEC settlements that no investor harm was alleged. The SEC admitted that there is “no evidence to back this up [the service provider’s] Prices were in error or did not reflect the market during the relevant time period.” Instead, the SEC based its case on its finding that the pricing service’s disclosure about its methodology was misleading, albeit for a “very small fraction of the total reported valuations.” .

This case should be a wake-up call for service providers. Although the pricing service was not registered with the SEC, the Commission used its powers under Section 17(a) of the Securities Act of 1933 to bring the case. This law prohibits “any person, in the offering or sale of securities… directly or indirectly… to obtain money or property by making a false statement of a material fact, or the omission of a material fact, necessary to make the statements made , not misleading given the circumstances in which they were made.” This is a broad interpretation of the applicability of Section 17(a) because the pricing service is not directly involved in the offering or sale of securities. The SEC alleged that the provider’s price assessments are used by many mutual funds and private funds to determine the value of their holdings, including calculating the net asset value for mutual fund unit prices. This could be seen as extending the applicability of Section 17(a) beyond its normal limits.

In any case, the lesson is that the SEC has begun to focus on service providers to the mutual fund industry and appears to be using every tool in its regulatory arsenal to ensure investors are protected. Larger service providers should examine areas where they may be vulnerable. Contributed by Jaqueline Hummel, Director of Thought Leadership, Regulatory Compliance.

I’m ready for my close-up: Former Prime Minister uses investments to get his daughter into the cinema The SEC indicted a former fund portfolio manager (PM) for failing to disclose a personal relationship with a film distribution company (the Company) in which the fund he managed invested up to $85 million, and at one point had its largest holding of the fund was . The PM played a significant role in selecting and overseeing the funds’ investments, including loans made by the fund to the company’s subsidiaries. during the business relationship The prime minister also asked the company’s founder to help with his daughter’s acting career. These discussions began prior to the Fund’s investment in the company and have continued thereafter.

In 2019, the company encountered financial problems and asked the Prime Minister to consider increasing the fund’s investment in the company. Although the PM’s colleagues had previously suggested that the fund should reduce its investments, the PM’s recommendation to increase the fund’s investments was approved. Around the same time, the Prime Minister’s daughter landed a role in a 2018 film distributed by the company. At no point did the PM disclose the nature of his relationship with the company or its founder to his firm or the Board of Trustees. The adviser fired the prime minister after learning of this conflict, and the prime minister was ordered by the SEC to pay a $250,000 fine.

The co-head of the Asset Management Unit of the Enforcement Division stated that “IInvestment professionals must disclose any conflicts of interest with the companies in which they invest client money, including situations involving favors or support for family members.” and “Investors need to be able to know that the advice they receive is free from undisclosed conflicts, whether the conflict is of a financial nature.” Although this measure directly designated the PM, advisers should take appropriate steps to resolve conflicts of interest identify and mitigate and establish a process in their policies and procedures. Consultants can also highlight this lesson as a case study in conflict training sessions or before annual compliance questionnaires. Contributed by Andrea Penn, Senior Principal Consultant.

Consultant keeps revenue share at all-time low – and gets SEC smackdown. It seems at least one unfortunate company didn’t get the SEC’s memo that undisclosed revenue share will get you in hot water. The SEC collected a premium from a dual-registered adviser/broker-dealer (adviser) who received revenue share payments on cash sweep balances, margin loan interest, and mark-ups on transaction fees from two unaffiliated clearing brokers. At a clearing broker, clients had the option of using an interest-bearing FDIC-insured cash sweep vehicle or one of two uninvested cash money market funds, all of which paid the advisor a revenue share. The discretionary assets standard used the vehicle that offered the advisor the highest revenue share and incentives and the lowest rate of return for its clients. The advisor’s Form ADV Part 2A disclosure states that the cash sweep option “could be significantly more profitable for the advisor…than other options available,” when in fact it was more profitable. Not surprisingly, the SEC found this disclosure inadequate. This is just an excerpt from the long list of undisclosed payments that provided the advisor with an incentive to steer clients towards more expensive options.

With the annual Form ADV change and compliance program review underway, it’s a good time to review the company’s financials to review the revenue the company receives and disclosures and policies and procedures as needed to update. Generally, firms should continue to review disclosures for potentially inappropriate uses of “may.” Contributed by Heather Augustine, Senior Principal Consultant.

  • Paid advertising per SEC Marketing Rule: Use of Third-Party Providers for Lead Generation and Prospecting. Attorney Chris Stanley of Beach Street Legal LLC contributed to this recent Kitce blog post, Nerds Eye View.
  • ESG – Everything everywhere at once. This January 27thth Speech, SEC Commissioner Mark Uyeda Speaks to a 40-Act Fund Audience; However, his remarks are relevant to all consultants. Commissioner Uyeda highlights several common themes related to ESG, including the proliferation of ESG financial products, the lack of well-defined terminology and regulatory considerations.
  • SEC Guidance – Different Advisory Fee Waivers. In a guidance issued on February 2, 2023, the SEC reminded investment funds, their directors and legal advisers of “the impact of the Investment Company Act of 1940 (Act) on fee waiver and reimbursement arrangements resulting in different advisory fees being charged between different share classes of the same fund.” “.
  • 8 Possible consequences of not proactive risk management. Carol Williams of ERM Insights shares some powerful thoughts on the value of a strong tone at the top as a key factor in effective risk management. While it doesn’t directly focus on financial services compliance, its points are compelling.

Photo of Chris Brignola At Unsplash.

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