'Enforcement wave' heading for advisers: Ex-SEC official

Dec 4, 2011 @ 12:01 am

By Mark Schoeff Jr.

The SEC's move to step up enforcement actions against investment advisers is only the tip of the iceberg, according to one former SEC official.

“An enforcement wave is coming,” said Jordan Thomas, a partner at Labaton Sucharow LLP and former assistant director at the Securities and Exchange Commission's asset management unit. “The world is about to change for investment advisers.”

Last week was a good example of the SEC's newfound aggressiveness. Three advisory firms were charged with having inadequate or nonexistent compliance programs and agreed to pay a total of $262,000 in fines and reimbursements.

Later in the week, the SEC charged three hedge fund advisory firms and six individuals with improper use of fund assets, fraudulent valuations and lying about fund returns.

On Nov. 16, Morgan Stanley agreed to a $3.3 million settlement with the SEC over charges that the fee arrangement for its Malaysia Fund violated securities laws. The same day, Robert Khuzami, director of the SEC's enforcement division, told a Senate panel that the commission has begun an initiative to catch investment advisers who lie on their registration forms.

In a speech last week, Mr. Khuzami, a former federal prosecutor, compared the effort to former New York Mayor Rudy Giuliani's program in the 1990s that targeted people committing small infractions to prevent them from growing into dangerous criminals.


“For Rudy, it was a focus on subway turnstile jumpers and squee-gee men,” Mr. Khuzami said. “For us, it's advisers who lie about graduating Phi Beta Kappa, conceal their association in a past failed business venture or inflate their assets under management, who might well be the same persons who outright steal your money when the markets turn against them.”

The SEC's latest enforcement moves come shortly after the agency reported that it filed a record 146 actions against investment advisers in fiscal 2011, a 30% increase over the previous year. Those efforts were part of 735 enforcement actions overall, also a record, that produced $2.8 billion in penalties and repayments to investors.

The results are evidence that the efforts of the SEC's asset management unit are beginning to bear fruit at a time when the commission is still receiving withering criticism from Congress for failing to detect the Bernard Madoff Ponzi scheme that bilked $50 billion from investors.

In addition, Congress is considering establishing a self-regulatory organization for investment advisers. The SEC has acknowledged that it examines only about 8% of the nearly 12,000 registered advisers annually.

In the face of this pressure, the asset management unit is making its presence felt.

The group was one of five national specialized investigative units established in January 2010 in the SEC's enforcement division. It has the largest staff — 65 — of any of the units.

“We feel like we're really hitting our stride as a unit,” said Robert Kaplan, co-chief of the asset management unit.

The SEC is placing a special emphasis on enforcement in the $43 trillion investment management industry because investment advisers are the portal to the financial markets for so many investors, he said.

“That's where the investors are,” Mr. Kaplan said. “The decision to be active in this space is recognition that this is where there are risks, and this is where we should be allocating more resources.”

In addition to lawyers, the unit's staff includes a former private-equity analyst, a former hedge fund portfolio manager, a former wirehouse trading-desk manager and a former compliance official at a fund of funds.

The unit is just revving up, according to Jordan Thomas, who was on its staff from its inception until July.

“The full impact of the asset management unit hasn't been felt yet,” he said.

The unit is concentrating on asset valuation, performance and ADV misrepresentation, disclosure of conflicts of interest, and compliance infrastructure, according to Mr. Kaplan.

Few suspect that the SEC is picking on investment advisers. Instead, they are being caught up in a general enforcement push.

“The enforcement division under Bob Khuzami is extremely active right now,” said Todd Cipperman, principal at Cipperman Compliance Services LLC. “Investment advisers are going to feel some of the pain of the enforcement activity.”

By Wall Street standards, the penalties levied in the compliance procedure cases weren't huge.

Omni Investment Advisors Inc. was charged with failing to institute written compliance policies and procedures after being warned by the SEC to do so. It also lacked a written code of ethics.

Omni's owner, Gary R. Beynon, agreed to pay a $50,000 penalty.


Feltl & Co. Inc. agreed to pay a $50,000 penalty and return $142,000 to investors after the SEC found that it didn't adopt and implement written compliance procedures. Asset Advisors LLC paid a $20,000 fine for failing to adopt a compliance program.

Although the fines were minimal, their psychological impact could be substantial, said Steve Thomas, director of Lexington Compliance.

“The press release is going to do more for the SEC than the actual actions,” said Mr. Thomas, chief compliance examiner in the South Dakota Division of Securities.

But even modest penalties could rock tiny investment advisory firms.

“If you dished out a $50,000 fine and $100,000 in customer restitution to a small firm, they're done,” Mr. Thomas said.

The best way for investment advisers to protect themselves from stepped-up SEC enforcement is to take compliance seriously, Mr. Cipperman said.

“It's not enough to say: "We do the right thing,'” he said. “You have to have documented policies and procedures, a good testing program and professional staff.”

“If you don't [self-]report, there is now a much higher probability the SEC will find out,” Jordan Thomas said.



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