Monthly Archives: March 2014

Important Reminders About Pay-to-Play

Even though spring has only just begun, politicians are already starting to gear up for the November elections.  Not only will the election for the US Senate be held this year, but also a myriad of state and local elections will take place.  With this backdrop, it’s the perfect time to revisit the Securities and Exchange Commission’s (“SEC’s”) Rule 206(4)-5 (the “Rule”) of the Investment Advisers Act of 1940 (the “Advisers Act”), more commonly referred to as the “pay-to-play” rule.  “Pay-to-play” generally refers to various arrangements whereby an investment adviser may seek to influence the award of advisory business by making or soliciting political contributions to government officials who have the ability to award such business. While this rule has been in effect since 2011, this article will serve as a reminder of the key components of the Rule and discuss updates promulgated by the SEC since the Rule’s adoption.

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JLG Legal Risk Management Tip – Important Reminders About Pay-to-Play – 03.2014

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Law Firm Charged with Fraudulent Bond Offering to Generate Funds During Financial Crisis

The ripple effects of the 2008/2009 financial crisis still echoes throughout most US industries today. Fraudulent acts of certain “bad actors” – both individuals and firms in the financial industries during this time – are also still being discovered today. Take for example the now-defunct international law firm Dewey & LeBoeuf, who according to a March 6, 2014 press release issued by the Securities and Exchange Commission (“SEC”), has been charged with creating a $150 million fraudulent private bond offering. According to the release, this offering misled investors on the financial health of the law firm, which was struggling as a result of the recession, “steep costs from a merger”, and surmounting fear of severed credit lines from bank lenders.

Accounting fraud lies at the center of the scheme, with five (5) high-level executives and financial personnel – from the chairman and executive director, to the CFO, financial director and controller – participating in manipulative accounting-related actions which “artificially inflated income” by $36 million (15 percent) in 2008 and $23 million in 2009, and “distorted financial performance” to create “blatantly falsified financial results”. These results were then reported to investors in order to sell bonds, giving the illusion that Dewey & LeBoeuf was “a prestigious law firm that had weathered the financial crisis and was poised for growth.” The culture of accounting fraud at the firm was so rampant, the SEC alleges, that email correspondence evidence showed admissions of bonuses and misdealings throughout upper management – and even a $7.5 million line item deduction labeled “Accounting Tricks.” Though many suffered major financial losses during the Great Recession, the executives and finance professionals associated with the now non-existent Dewey & LeBoeuf will likely experience a wealth of regulatory woes in the post-financial-crisis age of 2014.

For further information on this and other related subjects, please contact us at info@jackolg.com or (619) 298-2880.

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AZ Private Equity Fund’s Misallocation Scheme Uncovered, Spurs SEC Charges

As an Arizona-based private equity fund and its manager discovered at the end of February 2014, paying one’s expenses with client’s assets is both problematic and liable to receive prosecution by the Securities and Exchange Commission (“SEC”).  Clean Energy Capital, LLC (“CEC”) and its private equity fund manager Scott Brittenham were issued charges by the SEC on February 25, which detailed how $3 million of the fund’s expenses were paid “improperly” with assets from 19 funds that invest in private ethanol production plants.

Disclosure issues, along with interest-rated loans offered back to clients when the funds ran out of money for CEC’s expenses, underlie the broader misallocation charges in this case. According to the SEC, CEC and Brittenham failed to disclose “any such payment arrangement [to pay the fund’s expenses] in fund offering documents,” thereby masking the misallocation of funds to their constituent clients. In addition, by using fund assets towards fund expenses, CEC’s overall cash reserves diminished, which led to Brittenham and CEC forcing unauthorized “loans” onto their fund clients, with interest rates as much as 17 percent attached to them. CEC’s expenses that were paid by the misallocated fund assets included “rent, salaries, and other employee benefits such as tuition costs, retirement, and bonuses”, with part of the funds used towards paying a reported $100,000 bonus to Brittenham himself on top of the “millions more” [in] “management fees” that the funds also paid to CEC. This sustained misrepresentation of the fund’s true assets, as well as its back-handed efforts to recover funds through high-interest loans to its clients (with fund assets being pledged as collateral to the loans), represent a particularly egregious example of insufficient disclosures, fraud, and securities law violations involving “compliance, custody and reporting.”

For further information on this and other related subjects, please contact us at info@jackolg.com  or (619) 298-2880.

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New Initiative at SEC’s OCIE Targets RIAs with No Examination Experience

RoundIcons-Free-Set-26A new initiative with the Office of Compliance Inspections and Examinations (“OCIE”) at the Securities and Exchange Commission (“SEC”) is aimed at registered investment advisers who have never undergone examination by the SEC. According to a February 20, 2014 press release, this demographic of advisers primarily includes those who have been registered with the SEC for “three or more years” and who have not been examined since their initial registration. The so-called Never-Before Examined Initiative (the “Initiative”) seeks to conduct examinations on “a significant percentage” of these advisers, with the goal of providing both examination experience and education in the process.

In a letter to newly-registered RIAs, also dated February 20, 2014, OCIE outlined its guidance for the National Exam Program (NEP) designed for such never-examined advisers. The letter explains the Commission’s “two distinct approaches” to examinations: risks assessment and focused reviews. The “risk assessment approach” is “designed to obtain a better understanding of the registrant,” while the “focused review approach” aims to conduct “comprehensive, risk-based examinations” on certain high-risk business areas, including the adviser’s compliance program, filings and disclosures, marketing, portfolio management, and the safety of client assets.

OCIE also plans to hold regional meetings later in 2014 that will provide more in-depth information on the examination process. This may provide a meaningful exchange so that Never-Before Examined advisers are prepared before the SEC staff’s arrival.

For further information on this and other related subjects, please contact us at info@jackolg.com  or (619) 298-2880.

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Rule Approved by FINRA to Restrict Language in Conditioning Settlements Allowing CRD Expungement

A further turn in the arena of regulations toward client disclosures and agreements has taken place at the Financial Industry Regulatory Authority (“FINRA”), where a newly-approved rule on conditioning settlement agreements was detailed in a February 13, 2014 press release. According to the release – which will be brought to the Securities and Exchange Commission (“SEC”) for public comment and review/approval – FINRA’s Board of Governors approved a rule proposal that will restrict firms and “associated persons” from using client agreements to condition settlements of customer disputes that prevent a customer from opposing an expungement request for information in an associated person’s Central Registration Depository (“CRD”) record.

FINRA’s rule proposal aims to “help ensure that the CRD system continues to contain information that is critical to investor protection,” while also preventing unwanted pressures for a firm’s clients to sign agreements allowing CRD expungement. As stated by Richard Ketchum, FINRA Chairman and Chief Executive Officer, “expungement of customer dispute information shouldn’t be ‘bargained for’ through settlement negotiations or otherwise.” The operations of the CRD, run by FINRA as an online registration and licensing system, catalogues the registration, employment and criminal history of an individual and allows for certain details of firm members and their associated individuals, such as regulatory and disciplinary actions, to be expunged from a record with the help of a court order or through confirmation of an arbitration award containing expungement relief. While expunging a record is allowable in these circumstances, FINRA has decided, in this case, that conditioning a settlement within client agreements does more harm than good for the relationships between firms and their clients.

For further information on this and other related subjects, please contact us at info@jackolg.com  or (619) 298-2880.

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