Greenwashing or Failure to Screen

We’ve seen this before. Funds promote themselves as investing along some standard other than explicit financial performance. But then fail to follow the screening they profess to be using.

We saw that with BNY Mellon in 2002. It represented or implied in various statements that all investments in the funds had undergone an ESG quality review, even though that was not always the case. 

We saw that with the Inspire ETFs. It represented that the ETFs followed biblically responsible investing. The SEC found it wasn’t properly screening investments.

The latest is WisdomTree. It’s a registered investment adviser to three exchange-traded funds (the “ESG Funds”) that it marketed as incorporating environmental, social, and governance (“ESG”) factors. It purported to have the capability to screen out the securities of companies that had any involvement in fossil fuels and tobacco.

WisdomTree contracted with vendors to provide the rating and research to identify companies involved in fossil fuels. The first vendor offered five data sets that addressed different aspects of fossil fuels activities: “Arctic Oil and Gas Exploration,” “Thermal Coal,” “Oil Sands,” “Shale Energy,” and “Oil and Gas.” WisdomTree only subscribed to three of the five. That left a big hole in its screening

WisdomTree contracted with a second vendor to get screening for fossil fuels companies. The second vendor did not have a data set for “fossil fuels.” It’s data set was the “Energy Sector.”

As you might expect, the ETFs ended up owning interests in companies that dealt with fossil fuels: Utility companies that distributed natural gas to residential and industrial customers, a major natural gas distributor that has also had ownership interests in shale gas extraction projects, a specialty chemical company that provides chemicals for use in offshore and onshore drilling, company that owns natural gas distributors, etc.

The problem is poor definition of the screening subject int he fund documents and the failure to implement good screening. As a result of an SEC exam WisdomTree revised the fund documents to more accurately describe the screening.

Do what you say you’re doing to your investors.

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2025 Examination Priorities

Since 2013, the Securities and Exchange Commission’s Division of Examinations has published its annual examination priorities to inform investors and the industry about key areas where the Division intends to focus resources. You can assume those area areas that the Division believes present the highest risk areas to investors and the markets. Last year marked the first time the Division published the priorities with the start of the SEC’s fiscal year.

2025 marks two years in a row: Fiscal Year 2025 Examination Priorities.

Surprisingly, real estate explicitly popped up a few times. The first was around advice.

[T]he Division will continue to focus on:

Investment advice provided to clients regarding products, investment strategies, and account types, and whether that advice satisfies the fiduciary obligations owed to their clients. In particular, the Division will focus on recommendations related to: (1) high-cost products; (2) unconventional instruments; (3) illiquid and difficult-to-value assets; and (4) assets sensitive to higher interest rates or changing market conditions, including commercial real estate.

The second related to valuation.

The Division’s review of an adviser’s compliance program may focus on or go into greater depth depending on its practices or products. For example, if clients invest in illiquid or difficult to-value assets, such as commercial real estate, examinations may have a heightened focus on valuation.

I’m sure real estate fund managers have valuation as one of their top compliance concerns and properly deal with the issues. Perhaps, non-real estate managers dabbling with real estate may not have a robust method for valuation.

Real estate also pops up in the interest rate volatility item.

Whether disclosures are consistent with actual practices and if an adviser met its fiduciary obligations in times of market volatility and whether a private fund is exposed to interest rate fluctuations. Examples of investment strategies that may be sensitive to market volatility and/or interest rate changes include commercial real estate, illiquid assets, and private credit. The Division may particularly focus on examinations of advisers to private funds that are experiencing poor performance and significant withdrawals and/or hold more leverage or difficult-to-value assets.

Clearly, interest rates have affected commercial real estate. I suspect examiners may be diving deeper into debt practices.

Other items that caught my attention:

  • A focus on post-commitment period management fee calculations
  • Disclosure around fund credit facilities
  • Alternative sources of revenue from selling non-security services to clients

Before and After Reg BI

The case against PHX Financial caught my attention because it involves actions of the firm before and after the compliance date of Regulation BI.

During the Pre-Reg BI Period, PHX failed reasonably to supervise Representative 1, within the meaning of Section 15(b)(4)(E) of the Exchange Act, with the view to preventing and detecting Representative 1’s violations of Section 17(a) of the Securities Act of 1933 (“Securities Act”) and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

Further, during the Reg BI Period, PHX violated the Reg BI Care Obligation, Exchange Act Rule 15l-1(a)(2)(ii), when Representative 1 recommended a series of transactions to retail customers without a reasonable basis to believe that the recommended transactions, even if in the customers’ best interests when viewed in isolation, were not excessive and in the customers’ best interests when taken together in light of the customers’ investment profiles.

The actions were the same. A PHX registered representative recommended a short-term, high-volume investment strategy to at least eight of PHX’s retail customers . The customers each lost money in their PHX brokerage accounts while PHX and the Representative made over $400,000 in commissions and fees.

PHX had a a process for identifying accounts with what appeared to be excessive trading. The procedures fell apart when trying to address and manage the issue.

The SEC order characterized the problem in the Pre-BI period as fraud and supervisory failure. While after BI it’s a violation of the Care Obligation under Reg BI.

Post Reg BI, the SEC appears to hang its hat on the accounts having cost-to-equity ratios in excessive of 40% and turnover rates from 7 to 53 in the affected accounts.

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The One Without the Magic in the Mushrooms

Was Robert Shumake a shaman or a securities fraudster? Or Both?

On one hand he was the shaman of Soul Tribes in Detroit that was trying to “safe and sacred space for individuals to explore the healing benefits of sacred plants.” That apparently included storing over 99 pounds of mushrooms believed to be psilocybin and over 120 pounds of “material believed to be marijuana” from the church. Shumake claimed he was protected under the Religious Freedom Restoration Act. Detroit claimed it was a distribution center for unlawful controlled substances, poorly masquerading as a church. (Soul Tribes was apparently not a licensed marijuana dispensary.)

On the federal side, the Securities and Exchange Commission and the Department of Justice claim that Shumake was running a securities fraud on Minerco. The company claimed to be “first publicly traded company focused on the research, production and distribution of psilocybin mushrooms.”

Minerco was largely defunct company in 2019. According to the SEC complaint, Mineco got his hands on old debt owed by the company that was convertible into Minerco stock. That conversion of stock gave Shumake and his co-conspirator control of the company, gave control of the company to them and the power to issue more shares.

Then they had Minerco issue a bunch of press releases and advertising to pump up the value of the company. The company claimed that it had been reviewed by a third-party and was worth $1 billion.

At the start of the scheme, Minerco’s stock closed at $ 0.000001. Four months later Minerco’s stock closed at $0.0127, a 1,269,900% increase. Trading volume likewise skyrocketed from approximately 22 million shares to nearly 3 billion shares.

During the Relevant Period, Defendants’ pump-and-dump scheme inflicted pecuniary harm on investors who traded Minerco shares. Investors who bought Minerco stock in reliance on the public announcements that were either misleading or false, or that created a false appearance of fact, were duped. They paid a higher price than the shares were worth, and they suffered losses when they tried to sell their shares. Moreover, Minerco’s issuance of one billion additional shares diluted existing stockholders’ equity.

During this time, Shumake and his co-conspirator sold the stock they had acquired for at least $7 million.

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The One Without its Biblical Strategy

Inspire Investing advertises its ETF as “biblically responsible investing.” The obvious problem is how you define what is biblical. If it were so easy to define would we would not have so many sects and theologies of Christianity and Judaism.

Inspire came up with its own methodology for excluding companies. A company is automatically given a negative score for having any “exposure” to fourteen categories. Alcohol is on the list, but weapons are not. Other factors are used to develop a positive score.

Inspire touts a scientific approach in its marketing. It looks like Inspire was not able to prove that it was actually using this approach.

10. For example, certain companies were excluded from Inspire’s investment universe for donating to certain advocacy organizations or sponsoring certain events that Inspire considered to be Prohibited Activities. At the same time, multiple companies held within the Inspire ETF portfolios donated to organizations or sponsored events that were the same or similar.

I suppose these Inspire ETFs would be prohibited investments by some of the 35 states that prohibit ESG investing. The Inspire ETFs take into account factors other than pecuniary factors, which is prohibited by many of those anti-ESG laws. Its “positive score” factors are typical of ESG funds.

The Inspire BIBL ETF also consistently underperforms the market.

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The One With Pig Butchering

What’s with the fake profiles on Facebook, Instagram, or your social networking platform of choice reaching out to you? It’s likely the first step in a “relationship investment scam” or “pig butchering.” The scammer starts with casual conversations, try to build trust, maybe even a little romance. After building some trust/relationship over an extended period of time, they introduce an investment tip. Usually a crypto. Money doesn’t go your new friend, its just a tip. You move the money and then its gone.

The SEC charged two outfits NanoBit and CoinW6 with fraud involved pig butchering.

The Scheme Participants contacted prospective investors through social media platforms, such as LinkedIn and Instagram, and then pursued romantic relationships with them over the messaging platform, WhatsApp. After developing online romantic relationships with prospective investors, the Scheme Participants introduced the investors to so-called “cryptocurrency,” claiming that they had earned hundreds of thousands of dollars through crypto asset products that CoinW6 offered and sold on its websites through an online crypto trading platform (“CoinW6 Platform”). The CoinW6 Platform promised two to three percent passive returns per day from crypto asset staking, mining, or yield farming products that the Defendant purportedly operated.

Of course, it was all fictious and the money disappeared.

The scams slap financial fraud onto a catfishing scam.

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The One with the “Official Wealth Management Partner of”…

Of the nine marketing cases released by the SEC recently, one caught me off-guard and has left me concerned.

Say you’re a proud alumni of Notre Dame. You want to be associated with the athletic program and give some money back to the school. All you ask is that you get to be the official ____ of program. That works for most industries. But if you’re a registered investment adviser…

Is this a problem? The SEC said this was an endorsement that lacked proper disclosure.

The first step is whether this affiliation is advertising for purposes of the Marketing Rule. That is obviously “yes.”

What’s less obvious to me is whether this is an “endorsement” under the Marketing Rule. (Section 206(4)-1(e)(5))

(5) Endorsement means any statement by a person other than a current client or investor in a private fund advised by the investment adviser that:
(i) Indicates approval, support, or recommendation of the investment adviser or its supervised persons or describes that person’s experience with the investment adviser or its supervised persons;
(ii) Directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or
(iii) Refers any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser.

Does being the “official wealth management partner” indicate support by Notre Dame Athletics? I suppose “partner” does indicate some level of endorsement.

What if you replaced “partner” with “firm”?

Howard Bailey agreed to the SEC’s position and agreed to remove advertisements or add disclosure to advertisements. So now there is this footnote at the bottom of the website:

University of Notre Dame and University of Notre Dame Athletics (“Notre Dame”) are not current clients of Howard Bailey Securities, LLC nor Howard Bailey Financial, Inc. Legends / JMI Rights Holders, on behalf of Notre Dame, was compensated for this Endorsement, as such term is defined under SEC Rule 206(4)-1. More Information

Yes, that “more information” exposes all of the monetary details.

Let’s move down to the local level. How does this work for an investment advisory firm that sponsors the local little league team?

Notre Dame Athletics is a non-profit. Does this carry over to other non-profit sponsorships?

I was looking at the back of my Pan-Mass Challenge jersey with all of the corporate logos. If any of them are RIAs, should they be concerned that the logo placement has created an “endorsement” under the Marketing Rule?

I didn’t sleep well last night thinking about all of the possible implications of this case.

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Cut Those Pennies in Half

I’m old enough to remember when stock prices were quoted in eights. They had been marked that way for 200 years on the New York stock exchange. Then they were shifted to decimals. That pushed the bid-ask spread for many stocks to $.01. Now that penny limit is being cut in half.

The Securities and Exchange Commission just enacted changes to Rule 612 which will reduce the tick size to $.005.

Now we have to figure out what systems and spreadsheets will break because trading is happening in half-pennies.

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The One With No Conflicts

Can an investment adviser really say that they don’t have any conflicts of interest? You certainly can’t say that the firm “provides conflict-free advice” on the website when your Form ADV discloses conflicts of interest.

The SEC released orders against nine investment advisers for violations of the Marketing Rule, claiming the firms made untrue claims, unsubstantiated claims, or made statement that lacked required disclosures.

One of these, Droms Strauss, clearly had a disconnect between compliance and marketing.

Compliance put this statement in the firm’s ADV Part2:

The payment of commissions to DSRM may result in a potential conflict of interest. In order to mitigate this conflict DSRM fully discloses such commission arrangements to Droms Strauss clients before the client purchases any such products. Further, all commissions received by Droms Strauss will be contributed to a non-profit charitable organization selected by the client who purchased the commissionable product from a list of charitable organizations selected by Droms Strauss. Droms Strauss’ policy is always to act in the best interest of its clients. Commissions received by DSRM do not offset advisory fees paid to Droms Strauss. Clients are not contractually obligated to use the services of DSRM.

Marketing published an advertisement on the firm’s public-facing website containing the material statement of fact that one of its investment adviser representatives “provides clients with conflict-free advice” without providing any context for this claim.

Interestingly, the SEC order does not take the position that the statement is false. Not (a)(1) “untrue statement of material fact”. But an (a)(2) violation that the firm made a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate upon demand by the SEC.

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The One With $11 Trillion

There are a few different ways to calculate Assets Under Management. The SEC has prescribed ways to calculate Regulatory Assets Under Management. Often AUM and RAUM will differ depending on an adviser’s business model and client base.

But you can’t just make up RAUM.

Rubin Cedric Williams did so at his firm Vista Financial Advisors. He registered Vista Financial with the Securities and Exchange Commission in December 2021. He filed an update in April 2022 which listed the firm’s RAUM as $10 billion.

This large amount caught the attention of the SEC and started a “newly registered” exam with Vista Financial to kick the tires. During the exam Mr. Williams said his RAUM had grown to $180 billion and his sole client was a foreign trust. In April 2023, Vista Financial filed an updated Form ADV listing its RAUM as $11 trillion.

During the examination, Vista Financial produced a spreadsheet and delivered it to the SEC that was supposed to back up its claimed RAUM. One item was a bank account with 140 billion Euros. The SEC checked with the bank. That account never had more than $3500.

The spreadsheet listed $42 billion in a single issuance of US Treasury Bonds. That would have made the firm likely owning every bond in the issuance. Assuming the issuance was even that big. The SEC found no evidence that Vista Financial held any treasury bonds.

Then there is the fraud-ier stuff. Vista Financial purported to hold $3 billion in bonds from a corporation (unnamed in the filings). Vista Financial tried to open a brokerage account with a margin loan allowance using some of those bonds as collateral and citing Vista Financial’s registration with the SEC to support its legitimacy.

I was waiting to find some details behind this 2023 case hoping there would be some explanation for this craziness. Alas, the case has settled and no more detail have emerged. Mr. Williams agreed to be barred from any SEC registered firm.

Was Mr. Williams the scammer or was he being scammed? I was hoping to get an answer.

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