Who cares how much effort I put in, if it doesn’t produce any results.

In a sad turn of event, Daniel “Rudy” Ruettinger was charged by the SEC with securities fraud. Ruettiger and 10 of the scheme’s other participants have agreed to settle the SEC’s charges without admitting or denying the allegations. (I guess they can still do that if you’re not in front of Judge Rakoff.)

I guess he thought his effort was better spent pumping up the stock of the penny-stock company that ran his sport drink company. I guess I have to cross Rudy off the list of inspirational sports movies to show my kids.

Sources:

• Litigation Release No. 22198
• SEC Complaint
• SEC Charges Daniel “Rudy” Ruettiger and 12 Others in Scheme to Pump Stock in Sports Drink Company

One for the money, two for the show, three because uh – uh, comes before four, and here we go!

 - Tigger

On Monday, the Securities and Exchange Commission announced not one, not two, but three actions against investment advisers for failing to put in place compliance procedures designed to prevent securities law violations. The firms charged with compliance failures in separate cases are Utah-based OMNI Investment Advisors Inc., Minneapolis-based Feltl & Company Inc., and Troy, Mich.-based Asset Advisors LLC. The SEC also charged OMNI’s owner Gary R. Beynon, who served as the firm’s chief compliance officer.

Under Rule 206(4)-7 of the Investment Advisers Act (the “Compliance Rule”) registered investment advisers are required to adopt and implement written policies and procedures that are reasonably designed to prevent, detect, and correct securities law violations. The Compliance Rule requires annual review of the policies and procedures for their adequacy and the effectiveness of their implementation. It also requires the designation of a chief compliance officer, responsible for administering the policies and procedures.

In the case of Asset Advisors, the SEC had previously warned the firm about compliance deficiencies. In 2007, the SEC examined Asset Advisors and issued a deficiency letter. The firm waited until November 2009 to update the compliance manual to incorporated the SEC comments. That happened to coincide with an announcement that the SEC was coming for another examination. The failings:

• The firm did not collect from its staff written acknowledgements that the staff received the code of ethics.
• The firm did not collect any quarterly transaction reports from any of its access persons.
• The firm did not pre-clear any of its access person’s transactions in initial public offerings or limited offerings.
• The firm failed to at least annually review its written policies and procedures and the effectiveness of their implementation.

Asset Advisors received the nuclear punishment. The SEC required the firm to close operations and transfer its advisory accounts to another SEC-registered investment adviser with a compliance program.

Feltl & Company was a dually-registered broker-dealer and investment adviser. The SEC charged the firm with failing to adopt and implement comprehensive written compliance policies and procedures. This failure resulted in Feltl engaging in hundreds of principal transactions with its advisory clients’ accounts without making the proper disclosures and obtaining consent in violation of Section 206(3) of the Advisers Act. It also resulted in Feltl charging undisclosed fees to its clients participating in Feltl’s wrap fee program by charging both wrap fees and commissions in violation of Section 206(2) of the Advisers Act. The SEC laid the blame for Feltl’s compliance breakdown on its failure to invest necessary resources in the firm’s advisory business as it changed and grew in relation to its brokerage business.

OMNI’s was penalized for a complete failure to adopt and implement a compliance program between September 2008 and August 2011. In 2007, the SEC examined OMNI and issued a deficiency letter noting several issues, including OMNI’s failure to conduct an adequate annual review of its compliance program. In November 2010, the Commission began another examination of OMNI. When the exam began, the Commission was provided with a Compliance Manual dated November 3, 2010, which was one day after OMNI responded to the examiners’ request to initiate an examination. OMNI was unable to provide the Commission with any compliance manual adopted and implemented prior to November 3, 2010. Additionally, OMNI was unable to provide any policies and procedures that would have been in effect prior to November 3, 2010. The November 3, 2010 Compliance Manual appeared to be an off-the-shelf compliance manual that included language from both broker-dealer and investment adviser regulations, and was not specifically tailored to OMNI’s business.

OMNI was owned by Gary Beynon who also served in the role of CCO after the previous CCO left in 2008. The big problem with OMNI was that Beynon left for a three-year religious mission to Brazil in 2008, leaving OMNI’s advisory representatives completely unsupervised. He wanted to keep the firm in business while he was away so he could return to the firm when his religious mission ended.

The SEC expects more when you are responsible for other people’s money.

Sources:

• SEC Order: Asset Advisors, LLC
• SEC Order: Feltl & Company, Inc.
• SEC Order: OMNI Investment Advisors Inc. and Gary R. Beynon
• SEC Penalizes Investment Advisers for Compliance Failures – SEC Press Release
• Rule 206(4)-7 — Compliance Procedures and Practices

You’ve probably heard the charges made by politicians and activists that the Securities and Exchange Commission is ineffective and not bringing charges against those who caused the 2008 financial crisis.

“YOU’RE WRONG!” says the SEC.

The SEC has begun publishing “Enforcement Actions Addressing Misconduct That Led to or Arose From the Financial Crisis.”

^* In settlements with Evergreen, J.P. Morgan, State Street, and TD Ameritrade

In the prism of the enormous losses of  the 2008 financial crisis this may not seem by much. I think most people, though rightly upset, will have a hard time finding criminal conduct among those activities subject to the jurisdiction of the SEC. Sure, the proliferation of CDOs in 2007 can be seen as suspect. But criminal?

Sources:

• SEC Enforcement Actions Addressing Misconduct That Led to or Arose From the Financial Crisis
• SEC Compiles List of Financial Crisis Cases; Says More on the Way Soon
  by Bruce Carton in Compliance Week’s Enforcement Action

The SEC examined all 10 firms registered Nationally Recognized Statistical Rating Organization (.pdf 23 pages) and found all 10 had “apparent failures”. The SEC has requested remediation plans from each of the agencies within 30 days and is continuing its investigation.

The issues found included “apparent failures in some instances to follow ratings methodologies and procedures, to make timely and accurate disclosures, to establish effective internal control structures for the rating process and to adequately manage conflicts of interest.”

Personally, I think the rating agencies have not gotten enough of the blame for their roles in the events leading up to the 2008 financial crisis. Without the golden top rating they issued to the toxic mortgage-backed securities,  I think the popping of the housing bubble would not have been so vicious.

In 2006, the Credit Rating Agency Reform Act granted the authority to establish a registration and oversight program for credit rating agencies to the SEC and gave them oversight over those credit rating agencies that register with the Commission as Nationally Recognized Statistical Rating Organizations (“NRSROs”). However, it expressly prohibits the SEC from regulating the substance of credit ratings or the procedures and methodologies by which an NRSRO determines credit ratings.

The Dodd-Frank Wall Street Reform and Consumer Protection Act enhanced the regulation and oversight by imposing new reporting, disclosure, and examination requirements. The new law also requires the SEC to conduct an examination of each NRSRO at least annually.  The 2011 Summary Report of t Commission’s Staff Examinations of Each Nationally Recognized Statistical Rating Organization (.pdf 23 pages) is the first to look at the ten under the new framework.

1. A.M. Best Company, Inc.
2. DBRS Inc.
3. Egan-Jones Rating Company
4. Fitch, Inc.
5. Japan Credit Rating Agency, Ltd.
6. Kroll Bond Rating Agency
7. Moody’s Investors Service, Inc.
8. Morningstar Credit Ratings, LLC
9. Rating and Investment Information, Inc.
10. Standard & Poor’s Ratings Services

The SEC did not determine that any finding discussed in this Report constitutes a “material regulatory deficiency”. That would have meant a referral to the Division of Enforcement and gotten more lawyers involved. The SEC does not single out by name any credit-rating agency for questionable actions in the report, but it does describe specific problems it found.

It will be interesting to see what happens next year. As most compliance people know, the failure to fix a problem pointed out by the SEC is likely to lead to trouble the next time they show up.

Sources:

• SEC Staff Issues Summary Report of Commission Staff’s Examinations of Each Nationally Recognized Statistical Rating Organization
• 2011 Summary Report of t Commission’s Staff Examinations of Each Nationally Recognized Statistical Rating Organization (.pdf 23 pages)
• SEC finds failures at credit raters – Reuters

Nationally Recognized Statistical Rating Organization (.pdf 23 pages)

Private equity transactions are not outside the scope of enforcement by the Securities and Exchange Commission. The SEC filed a case against a former principal of an investment adviser that manages private equity funds. The charge is that he “usurped …[a] lucrative investment opportunity in a private company.” At this point, the SEC has only filed for a cease and desist order and has not proven the allegations against Matthew Crisp.

Crisp worked for Adams Street Partners, a private equity firm registered with the SEC as an investment adviser. In 2006 and 2007, Adams Street was looking at investing in TicketsNow. Crisp was assigned as the lead sponsor of the possible investment. They decided to go ahead, but the investment was greater that their typical investment amount so Crisp decided to syndicate a portion of the committed investment.

Crisp decided to create his own investment fund and take a portion of the  syndication. Adams Street contends that Crisp was not authorized to syndicate the investment to his own fund. He also increased the size of his fund’s allocation.

The SEC contends that the resulting decrease in the size of the Adams Street’s collective investment in TicketsNow was a misappropriation of a lucrative investment opportunity that should have gone to Adams Street. The SEC alleges that Crisp did not disclose his involvement to Adams Street. That would include failing to report the involvement on his periodic compliance disclosures. Failure to disclose such information was a violation of the Adam Street’s fiduciary duties and of it’s policies.

It turned out to be a good investment because TicketsNow was sold to a competitor a year later.The investment tripled their invested capital.

The SEC alleges that this was not a single instance of malfeasance. They claim that Crisp tried again with an investment in Sherman’s Travel. He took a syndication in that investment in his own investment fund.

Adams Street discovered the problem and, after conducting an internal investigation, terminated Crisp. Thy also took the next step and self-reported the matter to the SEC.

The SEC alleges that Crisp violated Sections 206(1), 206(2), and 206(4) of the Advisers Act. They extend this through Rule 206(4)-8 which prohibits fraudulent activity by advisers to pooled investment vehicles with respect to investors or prospective investors.

In the alternative, the SEC contends that Crisp aided and abetted Adams Street’s violation of Sections 206(1), 206(2), and 206(4) of the Advisers Act, extended through Rule 206(4)-8.

Further, the SEC alleges that pursuant to the actions outlined above, Crisp willfully violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.

The cease and desist proceeding is being instituted to determine whether the allegations noted are true and what remedial action is appropriate. Crisp already returned a large portion of his returns to Adams Street.

As more private equity fund managers are going to be registered with SEC in the next six months, I found this case to be an interesting example of SEC enforcement in the industry. Assuming that Crisp actually did what the SEC alleges, such activity should be a violation of the firm’s conduct policy and a violation of it’s funds’ partnership agreements. Investors generally will impose a contractual obligation on the fund manager to not divert investment opportunities to employees and principals of the fund manager.

So how does SEC enforcement help in this area? I suppose it adds the scare factor of a government investigation on top of losing your job and professional reputation.

Sources:

• Administrative Order in the Matter of Matthew Crisp (.pdf 10 pages)

Robbery Not Allowed is by Anders Sandberg

The Big Short highlighted some of the difficulties of taking an investment position in a real estate downturn. The situation was taken a step further with Goldman Sachs’ help in putting together mortgage backed securities with the primary purpose of helping a client take an investment position that the securities will default. It turned out very well for Goldman’s client and terrible for the purchasers of the securities.

Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act prohibits an underwriter, placement agent, initial purchaser, or sponsor, or any affiliate or subsidiary of any such entity, of an asset-backed security from engaging in a transaction that would involve or result in certain material conflicts of interest. It then leaves it up to the Securities and Exchange Commission to issue rules for the purpose of implementing this new prohibition.

The SEC published a proposed rule at its Open Meeting on Sept. 19, 2011: Prohibition against Conflicts of Interest in Certain Securitization (.pdf).

The proposed rule could — if certain conditions are otherwise met — prohibit a firm from packaging Asset Backed Securities, selling them to an investor, and subsequently shorting the Asset Backed Securities to potentially profit at the same time as the investor would incur losses.

Sources:

• Prohibition against Conflicts of Interest in Certain Securitization (.pdf)

• SEC Proposes Rule to Prohibit Conflicts of Interest in Certain Asset-Backed Securities Transactions

On July 11, 2011, the President issued Executive Order 13579, “Regulation and Independent Regulatory Agencies,” which states that independent regulatory agencies should promote the goals set forth in Executive Order 13563 of January 18, 2011 that applies to executive agencies. He is asking the SEC, CFTC and other independent agencies to focus on a regulatory system that protects “public health, welfare, safety, and our environment while promoting economic growth, innovation, competitiveness, and job creation.” The Securities and Exchange Commission responded to Executive Order 13579 by inviting “interested members of the public to submit comments to assist the Commission in considering the development of a plan for the retrospective review of its regulations.”

Before you get too excited and submit a comment about repealing your most hated SEC rule, the SEC’s comment request is only for general comments on what the scope and elements on the development of a plan for retrospective review of existing significant regulations. So it’s just comments on the plan to review existing regulations.

1. What factors should the Commission consider in selecting and prioritizing rules for review?
2. How often should the Commission review existing rules?
3. Should different rules be reviewed at different intervals? If so, which categories of rules should be reviewed more or less frequently, and on what basis?
4. To what extent does relevant data exist that the Commission should consider in selecting and prioritizing rules for review and in reviewing rules, and how should the Commission assess such data in these processes? To what extent should these processes include reviewing financial economic literature or conducting empirical studies? How can our review processes obtain and consider data and analyses that address the benefits of our rules in preventing fraud or other harms to our financial markets and in otherwise protecting investors?
5. What can the Commission do to modify, streamline, or expand its regulatory review processes?
6. How should the Commission improve public outreach and increase public participation in the rulemaking process?
7. Is there any other information that the Commission should consider in developing and implementing a preliminary plan for retrospective review of regulations?

The Commission is not soliciting comment in this notice on specific existing Commission rules to be considered for review. Hopefully, that will come soon.

Sources:

• SEC Request for Information
• SEC to Seek Comment on Review of Existing Regulations
• Executive Order 13579
• Executive Order 13563
• The SEC is Seeking Input on the Process for Conducting Retrospective Reviews of Its Existing Regulations in 100 F Street
• President Issues Executive Order Asking SEC, CFTC and Other Independent Agencies to Identify Excessively Burdensome Regulations in Jim Hamilton’s World of Securities Regulation

The SEC now recognizes “spousal equivalents” defined as “cohabitants occupying a relationship generally equivalent to that of a spouse.” Before wondering if the federal government is making big strides, keep in mind that this recognition is limited to the new Family Office Rule (.pdf).

Dodd-Frank created a new exemption for Family Offices. Previously they typically operated under the 15 clients rule that was repealed by Dodd-Frank or a private ruling from the SEC. Dodd-Frank left it up to the SEC to define a “family office.”

Rule 202(a)(11)(G)-1 contains three general conditions to fitting into the Family Office Exemption. First, the family offices may only provide advice about securities to certain “family clients.” Second, family clients must wholly own the family office and family members and/or family entities must control the family office. Third, a family office cannot hold itself out to the public as an investment adviser.

Th rule inevitably leads to a definition of “family.” Too narrow and many family offices would be excluded. Too broad and every investor will find an ancestor from the Mayflower. The SEC decided on a 10 generation limit.

The rule treats lineal descendants and their spouses, spousal equivalents, stepchildren, adopted children, foster children and persons who were minors when another family member became their legal guardian as family members.

I think it was bold move of the SEC to include spousal equivalents. They brush aside the Defense of Marriage Act argument: Because the term “spouse” is not defined in the rule and a “spousal equivalent” is identified as a category of person, separate and distinct from a “spouse,” that meets the definition of a “family member”….  DOMA provides that in “determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States…the word ‘spouse’ refers only to a person of the opposite sex who is a husband or wife.” 1 U.S.C. 7.

The failure of a family office to be able to meet the conditions of the new rule will not preclude the office from providing services to family members. But, the family office will need to find another exemption, register under the Advisers Act or seek an exemptive order from the SEC.

Sources:

• Release No. IA-3220 – Family Offices (.pdf)
• The SEC and Non-Traditional Marriage by Alexandra Poe in Reed Smith’s Private Funds Law Update

The image is the Spousal Equivalent Badge available from Zazzle.

At an open meeting on June 22, the Securities and Exchange Commission adopted new rules under the Investment Advisers Act of 1940 aimed at investment advisers, private fund managers, venture capital funds, and family offices.

Based on the statements at the meeting, there will be three new rules would:

Delay Registration Deadline and a New Form ADV. The new registration/reporting deadline for new Advisers Act registrants and “exempt reporting advisers” will be March 30, 2012. Previously exempt private advisers, particularly those to hedge funds and private equity funds, will not be required to register until March 30, 2012. All advisers will be required to make a filing in the first quarter of 2012. Those previously registered advisers who no longer qualify for SEC registration will be required to withdraw by June 28, 2012.

The SEC staff pointed out that 2012 is a leap year, so the 90 day deadline is March 30 instead of March 31 in 2012.

Form ADV is going to change. No surprise. Under the amended adviser registration form, advisers to private funds will have to provide:

• Basic organizational and operational information about each fund they manage, such as the type of private fund that it is (e.g., hedge fund, private equity fund, or liquidity fund), general information about the size and ownership of the fund, general fund data, and the adviser’s services to the fund.
• Identification of five categories of “gatekeepers” that perform critical roles for advisers and the private funds they manage (i.e., auditors, prime brokers, custodians, administrators and marketers).
• More information about conflicting or potential conflicting relationships.

Define Venture Capital Funds. Under the definition, a venture capital fund is a private fund that:

• Invests primarily in “qualifying investments” (generally, private, operating companies that do not distribute proceeds from debt financings in exchange for the fund’s investment in the company); may invest in a “basket” of non-qualifying investments of up to 20 percent of its committed capital; and may hold certain short-term investments.
• Is not leveraged except for a minimal amount on a short-term basis. Borrowing is limited in time as well.
• Does not offer redemption rights to its investors.
• Represents itself to investors as pursuing a venture capital strategy.
• Is not registered under the Investment Company Act.

There will be a rule on grandfathering substantially as proposed in November, with the three conditions that the fund had been represented to be a “venture capital fund,” that the first closing was prior to December 31, 2010 and that no new capital commitments are made after July 21, 2011.

The new category of venture capital fund advisers and other “exempt reporting advisers” will file portions of Part 1 of Form ADV. Commissioner Schapiro noted that there was no current intention to subject exempt reporting advisers to routine examinations, while also noting that the SEC retains the authority to examine those advisers in its discretion. The Staff noted that the Form ADV will include a uniform calculation for “assets under management.”

Family Office Exemption. This exemption should be consistent with no-action relief previously provided and the proposed rule. It sounds like there will be some expansion to address a broader universe of permitted family clients and ta longer transition period (through December 31, 2013) for the termination of relationships with charitable entities that were not exclusively funded by the family.

These rules will have completed most of the rulemaking required under Title IV of Dodd-Frank, the Private Fund Investment Advisers Registration Act.

My printer is still cranking out the text of the new rules and I need to dive deeper into the details.

Sources:

• IA-3222 – Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers (.pdf)
• IA-3221 – Rules Implementing Amendments to the Investment Advisers Act of 1940 (.pdf)
• IA-3220 – Family Offices (.pdf)
• Webcast Archive SEC Open Meeting Wednesday, June 22, 2011
• SEC Adopts Dodd-Frank Act Amendments to Investment Advisers Act – SEC Press Release
• SEC Adopts Rule Under Dodd-Frank Act Defining “Family Offices” – SEC Press Release

Finally, the SEC is going to take some action today on the regulation of investment advisers, venture capital funds, and private fund managers.

For years, they’ve been trying to get regulatory control of private funds. Now they are going to get it.

Do they really want it?

Sometimes what you want to do is not a good a choice. As a case in point, I give you a kitten crawling inside a hamster ball.

Sure it’s cute. But you end up with a pissed-off kitten.

The Open Meeting for June 22 is all about the Investment Advisers Act.

Agenda:

Item 1: The Commission will consider whether to adopt new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to give effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration of investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and address reporting by certain investment advisers that are exempt from registration.

Item 2: The Commission will consider whether to adopt rules that would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to venture capital funds and advisers with less than $150 million in private fund assets under management in the United States. These exemptions were enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules also would clarify the meaning of certain terms included in a new exemption for foreign private advisers.

Item 3: The Commission will consider whether to adopt a rule defining “family offices” that will be excluded from the definition of an investment adviser under the Investment Advisers Act of 1940.

The word I’ve heard is that the July 21, 2011 deadline will be extended to March 31, 2012.