United States: A Compilation Of Enforcement And Non-Enforcement Actions - 31 January 2014

Non-Enforcement Matters

  • Due Diligence Requirements of Investment Advisers Prior to Recommending Alternative Investments
  • Sub-Advisory Arrangements Under Scrutiny
  • Audit Committee Disclosure Enhancements
  • SEC Guidance on Fixed Income Risk Management

Enforcement Matters

  • 2013 Was a Busy Enforcement Year for the SEC
  • SEC Initiates Enforcement Action Against Hedge Fund Adviser

Non-Enforcement Matters

Due Diligence Requirements of Investment Advisers Prior to Recommending Alternative Investments

The SEC's Office of Compliance Inspections and Examinations (OCIE) recently issued a Risk Alert for registered investment advisers in connection with due diligence requirements prior to recommending to a client an investment in alternative investments such as hedge funds, real estate funds, private equity funds or funds of funds.

OCIE has from time-to-time issued Risk Alerts when questionable activities, practices or deficiencies by registered investment advisers are detected by the OCIE when it conducts examinations of registered investment advisers.

This Risk Alert lists both the deficiencies or questionable due diligence activities found during the examinations as well as steps that other advisers have taken to perform their due diligence requirements in an acceptable manner.

The deficiencies or questionable due diligence activities with respect to alternative investments noted by the OCIE include: (i) conducting due diligence activities that are different from those described in the adviser's brochure; (ii) failing to conduct adequate due diligence either prior to making a recommendation or during annual reviews of such alternative investments; and (iii) making misleading or incomplete statements about due diligence efforts to its clients.

The due diligence practices observed by the OCIE which appear to be effective include: (i) engaging third parties to validate information provided by managers of alternative investments; (ii) contacting directly the manager and key portfolio managers of the alternative investment to receive information and feedback as to performance and overall management of the investment; and (iii) performing its own quantitative analysis and risk assessment of the alternative investment.

Registered investment advisers are reminded that the OCIE will expect the investment adviser to maintain a file on due diligence activities with respect to each recommended alternative investment conducted both before making the recommendation and periodically during the time the adviser's clients hold the investment.

Sub-Advisory Arrangements Under Scrutiny

There have been a number of mutual fund firms that have been hit with lawsuits in which the plaintiffs allege the firms are charging excessive mutual fund fees in sub-advised funds. The plaintiffs argue that this is evidenced by the fact that the advisors delegate most day-to-day management duties to sub-advisors, but pocket a big portion of advisory fee revenues.

For example, in December 2012, the U.S. District Court for the District of New Jersey declined a motion to dismiss a lawsuit alleging that the fees paid by certain funds advised by Hartford Investment Financial Services, LLC ("Hartford") were excessive under Section 36(b) of the Investment Company Act of 1940. The complaint, Kasilag v. Hartford Investment Financial Services, LLC, Civil No. 11-1083 (D.N.J. Dec. 17, 2012), alleges that Hartford delegated "substantially all" of its investment management duties to sub-advisors, but retained an excessive share of the overall advisory fee thereby resulting in excessive fees being charged to fund shareholders.

Hartford disputed these allegations, noting that Hartford provides extensive administrative and investment management services that are not delegated to the sub-advisors. The court considered the plaintiffs' comparison between Hartford's fees and the fees charged by a competing mutual fund company as well as the fees charged by Hartford's affiliate to institutional clients. Viewing all the factors, the court found that the plaintiffs had raised a "plausible inference" that Hartford's fees are excessive under Section 36(b) and, based thereon, denied Hartford's motion to dismiss. This much-watched outcome has spawned a number of similar lawsuits.

In response to these developments, mutual fund boards should remain vigilant in reviewing and renewing the investment advisory and sub-advisory agreements. As part of this process, mutual fund boards should ensure that the investment advisor describes in detail which investment advisory duties have been delegated to the sub-advisor and which duties and responsibilities have been retained by the advisor. Mutual fund boards should also ensure that the investment advisor provides a rationale for why the portion of the investment advisory fee that is retained by the advisor represents fair and reasonable compensation for such retained duties and responsibilities.

Mutual fund boards should also ensure that they are confident that the investment advisor is actively monitoring and exercising appropriate oversight of the sub advisor's compliance with the sub-advisory agreement and applicable regulatory requirements. Set forth below is a checklist of matters that the investment advisor would typically engage in with regard to overseeing the sub-advisor:

  • Ongoing review and approval of sales and marketing materials used by the sub-advisor;
  • Periodic onsite visits (ideally, annually) to meet with senior executive personnel and portfolio management personnel (more frequent visits may be necessary where there have been changes in key personnel, initiation of litigation, or other significant events);
  • Quarterly compliance monitoring - the advisor should receive reports/certifications at least quarterly regarding compliance with the following, among other items:

    • Prospectus limitations, including fundamental and non-fundamental policies and Subchapter M of the Internal Revenue Code (unless the advisor has assumed this responsibility);
    • Rule 12d3-1;
    • Rule 17a-7;
    • List of persons authorized to place trades;
    • Code of Ethics;
    • Proxy Voting;
    • Fair value determinations; and
    • Liquidity determinations, including Rule 144A securities;
    • Annual compliance monitoring—the advisor should receive reports/certifications at least annually regarding compliance with the following, among other items:
    • Form 13F filings;
    • Code of Ethics;
    • Updated insurance coverage (including copies of insurance certificates); and
    • Updated financial statements.

Audit Committee Disclosure Enhancements

The National Association of Corporate Directors (NACD) has issued a paper encouraging audit committees of public companies to critically evaluate public disclosures regarding the committee and carefully consider whether improvements can be made to provide investors with more relevant information that conveys that an informed, actively engaged and independent audit committee is carrying out its duties. The NACD calls for this disclosure enhancement in the context of the audit committee report that public companies are required to file.

While the call for enhanced committee disclosure was not expressly directed at mutual funds, the NACD's suggestions are relevant to mutual funds. Specifically, the suggestions serve as a good reminder to all audit committees of the actions they should take in performing their oversight responsibilities. Mutual funds might also consider whether enhanced disclosure in the statement of additional information regarding the audit committee is desirable.

The NACD's suggestions are based upon the simple premise that, given the importance of the audit committee's responsibilities for broadly overseeing the financial statement process, including the work of the external and, if applicable, internal auditors, it is important for investors and others with a stake in our financial markets to understand and have confidence in the audit committee's work.

The disclosure in a mutual fund's statement of additional information is the principal source of audit committee-related information for the fund, and, as the NACD notes, public disclosures are the primary channel through which audit committees can educate investors and other stakeholders about their critical responsibilities, and demonstrate their effectiveness in executing those responsibilities.

Enhancements to the disclosure in the statement of additional information that funds could consider include the following:

  • Clarify the scope of the audit committee's duties;
  • Provide relevant information about:

    • Factors considered when selecting or reappointing an audit firm;
    • Selection of the lead audit engagement partner;
    • Factors considered when determining auditor compensation;
    • How the committee oversees the external auditor; and
    • How the committee evaluates the external auditor

SEC Guidance on Fixed Income Risk Management

The Securities and Exchange Commission's Division of Investment Management has issued guidance to fund advisors and boards on Risk Management in Changing Fixed Income Market Conditions. IM Guidance Update 2014-1 (Jan. 2014). The guidance warns of the importance of sound risk management and disclosure practices by fixed income mutual funds and exchange traded funds (ETFs).

The IM Guidance Update notes that fixed income markets experienced increased volatility during June 2013 as investors considered the prospect of a tapering of the Federal Reserve Board's quantitative easing program and a general rise in interest rates. The Staff notes this example of market volatility is a timely reminder of the importance of sound risk management and disclosure practices by fixed income mutual funds and ETFs, in particular as the Federal Reserve Board contemplates the possible end of both quantitative easing and the period of near zero interest rates that has persisted for the last five years.

The IM Guidance Update recommends several steps that fixed income fund advisors may consider taking, as outlined below. It also notes that fund boards may want to consider discussing with the funds' investment advisor the steps the advisor is taking in this area.

  • Assess and Stress Test Liquidity. In light of potential market volatility, fund advisors may consider assessing fund liquidity needs during both normal and stressed environments, including assessing their sources of liquidity (such as cash holdings and other assets that would not require selling into declining or dislocated markets if volatility or market stress increases). The assessments may include, for example, needs and sources of fund liquidity over 1 day, 5 days, 30 days, and potentially longer periods.
  • Conduct More General Stress-Tests/Scenario Analyses. Fund advisors may consider assessing the impact (beyond just liquidity) of various stress-tests and/or other scenarios on funds. For example, they may consider stress-tests involving interest rate hikes, widening spreads, price shocks to fixed income products, increased volatility and reduced liquidity.
  • Risk Management Evaluation. Fund advisors may want to consider using the outcomes of any assessments, analyses, and conversations to evaluate what risk management strategies and actions are most appropriate, if any, in response to changing fixed income market conditions at a fund and/or the complex level. These may include decisions around portfolio composition, concentrations, diversification and liquidity.
  • Communication with Fund Boards. Fund advisors may consider what information should be provided to fund directors so that they are informed of the risk exposures and liquidity position of the fund, and the fund's ability to manage through changing interest rate conditions and potentially increased fixed income market volatility.
  • Shareholder Communications. Funds should also assess the adequacy of their disclosures to shareholders in light of any additional risks due to recent events in the fixed income markets and the potential impact of tapering quantitative easing and/or rising interest rates, including the potential for periods of volatility and increased redemptions. If a fund determines that its risk disclosure to shareholders is not sufficient in light of these recent events, the fund should consider the appropriate manner of communicating risks to shareholders (for example, prospectus, shareholder reports).

Enforcement Matters

2013 Was a Busy Enforcement Year for the SEC

According to a recent report by the SEC, the SEC's fiscal year that ended on 9/30/2013 included SEC enforcement actions in a record $3.4 billion in monetary fines against persons who violated the federal securities laws. In total, the SEC filed 686 enforcement actions during the year. The monetary penalties are 10 percent higher than in 2012 and 22 percent higher than in 2011.

According to the SEC's annual report, the SEC focused on a wide range of wrongdoers including:

  • Stock Exchanges – the SEC brought enforcement action against NASDAQ (a $10 million penalty) for its "poor systems and decision making" during the infamous Facebook initial public offering and the CBOE and an affiliate for "various systematic breakdowns."
  • Gatekeepers – the SEC took action against so-called gatekeepers such as attorneys and accountants who failed to adequately safeguard investors' interests. Among the gatekeepers, the SEC took action during the year against trustees and corporate directors for failing to uphold their responsibilities under the law.
  • Insider Trading – the SEC stepped up its enforcement actions against those persons who trade on material nonpublic information. During the 2013 fiscal year, the SEC filed dozens of cases alleging insider trading violations.
  • Municipal Securities – the SEC initiated enforcement actions in 2013 against municipalities and other participants for violations of anti-fraud provisions in connection with municipal securities offerings.
  • New Policy on Admissions – the SEC now requires admissions of misconduct in settlement of most enforcement cases. This is a material change from prior years when almost all settlements in enforcement actions resulted in the respondents neither admitting nor denying any violations.

During the fiscal year, the SEC also employed certain new measures in order to increase its enforcement capabilities including the formation of new task forces to target certain problem areas within the industry, the increased sharing of information with other federal and state regulatory agencies to help such agencies bring enforcement actions against common targets, and improvement in applying its analytical capabilities to better detect fraudulent activities.

The results from 2013 appear to indicate that the SEC will continue to build on its growing enforcement capabilities and actions. According to Mary Jo White, the SEC's Chair, "a strong enforcement program [serves] to [help] produce financial markets with integrity and transparency, and [helps] to reassure investors that they can invest with confidence."

SEC Initiates Enforcement Action Against Hedge Fund Adviser

The SEC initiated an administrative proceeding on January 8, 2014 against Patrick G. Rooney ("Rooney"), the sole owner and managing partner of Solaris Management LLC ("Solaris Management"), for various violations alleged by the SEC, including among other things, the "anti-fraud" provisions under the Investment Advisers Act of 1940 by Rooney and Solaris Management.

Solaris Management, an unregistered investment adviser, has been since 2003, the general partner and investment adviser to the Solaris Opportunity Fund, LP ("Solaris Fund"), a privately offered investment fund. Rooney, on behalf of Solaris Management, was responsible for managing the assets of the Solaris Fund and its offshore counterpart, Solaris Offside Fund.

Last month, a judgment was entered against Rooney enjoining him from future violations of the anti-fraud provisions under the Advisers Act and under the Securities Act of 1933. Rooney consented to the issuance of the injunction (see also SEC v. Patrick G. Rooney, et al, Civil Action No. 11-CV-8264, USDC for the ND of Illinois).

The SEC's complaint against Rooney alleges that he and Solaris Management materially changed the investment strategy of the Solaris Fund without advanced notice to investors and in opposite to what was described in the private placement offering materials of Solaris Fund. According to the SEC, Rooney caused all of the assets of Solaris Fund to be invested in Posetron Corp., an entity that was financial impaired and for which Rooney was chairman of the board and an investor. Rooney did not disclose the investments in Posetron to Solaris Fund investors for over a four year period and never disclosed to the investors the fact that by being an officer and shareholder in Posetron, had a conflict of interest. The investment in Posetron Corp. by the Solaris Fund resulted in Solaris Fund having all of its assets invested in a cash-poor company, and was a highly illiquid investment.

The SEC administrative hearing in the matter will be scheduled in the near future, to determine if the SEC's allegations are true, and if so, the administrative penalties for committing the alleged violations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions