Compliance is a key issue for all firms. Many companies use the U.S. sentencing guidelines as a starting point. In other instances, regulators craft a starting point with rules that direct the creation of programs. This is true, for example, for investment advisers registered with the Commission. In either case, the critical point is to craft the policies and procedures so that they effectively monitor the business and evolve with it.

OCIE – the Commission’s Office of Compliance Inspections and Examinations – published a Risk Alert on November 19, 2020 discussing key issues for registered investment advisers. OCIE: Observations: Investment Adviser Compliance Programs (here). The Alert provides a good discussion of key issues in crafting and maintaining an effective compliance program.

The basics: For registered investment advisers, compliance begins with the Commission’s Rule. It is written in broad strokes and thus does not detail specific elements that the advisers must incorporate into its policies and procedures. Rather, as the Alert states: “Each adviser should adopt policies and procedures that take into consideration the nature of the firm’s operations. The policies and procedures should be designed to prevent violations from occurring, detect violations that have occurred, and correct promptly any violations that have occurred.”

The Commission’s Rule does, however, require that an annual review be conducted and a CCO designated. The review should include new compliance issues, consider changes in the business of the adviser or its affiliates and examine the impact of changes in regulations or the environment. While the Rule only requires an annual review, the Alert suggests that more frequent reviews may be useful and necessary.

Although the precise obligations of the CCO are not designated, that person’s function is to administer the policies and procedures adopted. The designated CCO should thus have full responsibility for the program and be empowered to properly implement it.

Deficiencies and key points: The Alert details a series of deficiencies and weaknesses that have been observed by the Office. Those include:

Inadequate resources: Resources are critical to developing and maintaining an effective compliance system. Information technology and staffing are key. Yet OCIE observed several important deficient and weakness in this area. Included are CCOs who had multiple duties which interfered with effectively allocating sufficient time to compliance. Also included in this area is a lack of adequate training, insufficient staff to for, example, conduct a proper annual review and update Form ADV. And, a number of advisers failed to properly add resources as the advisory grew, a situation which in turn resulted with inadequate staff and resources.

Insufficient CCO authority: The CCO position is critical. Yet in a number of instances OCIE observed CCO’s that did not have information critical to advisory agreement. In other instance CCOs either did not have adequate interface with senior management or were not consulted.

Deficiencies in annual review: The annual review is one of the few elements of the program specifically mandated by the Rule. Its importance cannot be overstated. In many instances, however, OCIE encountered situations in which the adviser claimed to have conduct the review, but there was inadequate evidence of it. In other instances, the adviser failed to identify or review key risk areas of the advisory such as conflicts. Similarly, advisers frequently failed to review and analyze important areas of the business in connection with the review.

Implementing actions required by written policies and procedures: In a number of instances OCIE observed advisers that either failed to implement policies and procedures or failed to comply with them. This occurred in a number of areas such as employee training, implementing procedures regarding trade errors, not reviewing advertising materials, failing to adhere to checklists and other processes and not properly reviewing client accounts to assess consistency with client objectives.

Maintaining or establishing written policies: It is critical that the advisory maintain up-to-date written policies and procedures. The staff has observed situations in which certain provisions were outdated or inaccurate, however. Similarly, in a number of instances the adviser failed to maintain policies and procedures that are written, properly implemented and complete.

Equally important is tailoring the policies and procedures adopted to the specifics of the advisor’s business. Areas to consider include: 1) Portfolio management, including due diligence, oversite of managers and compliance with regulatory requirements, advisory provisions and client limitations; 2) Marketing which requires careful oversight and the prevention of misleading statements; 3) Trading practices, including arrangements regarding soft dollars, best execution and those regarding restricted securities; 4) Disclosures, including those in Form ADV and with clients; 5) Advisory fees and valuation, including billing procedures and the valuation of assets; 6) Privacy safeguards for clients such as Regulations S-P and S-ID, physical security for client information and data and those for electronic material and cyber security. Finally, it is critical that the advisory maintain the required records and have an adequate business continuity plan.

Comment: The Alert was prepared by OCIE to encourage compliance. Proper compliance is in fact not just a matter of following the Rule but good business. It is good business for clients who are assured that their assets are properly invested and handled. It is good business for the advisory since it helps ensure a proper functioning business. Advisers would thus be well advised to carefully review their operations in view of the checklist included in this Alert.

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Last week as everyone celebrated the Thanksgiving holiday, the Commission continued to schedule meetings regarding proposed rule revisions. The rules to be considered involve select offerings tied to compensation.
The Enforcement Division filed two new actions in advance of the holiday.
Be safe and healthy this week
Proposed rules: The Commission proposed on November 24, 2020 to modify Rule 701 and Form S-8 regarding compensatory securities offerings in view of the evolving market. Specifically, the proposal seeks to exempt transactions over $10 million, revise the disclosures and raise two of the three caps. There are also proposals related to Form S-8 and to simplify counting and fee payments (here).
Proposed rules: The agency proposed to adopt certain temporary rules to facilitate participation for “platform workers” in compensation offerings under Rule 701 and Form S-8, on November 24, 2020 (here). The proposal would permit issuers to provide equity compensation to certain platform workers who provide services available through the issuer’s technology based platform or system.
Statement: Commissioners Hester M. Peirce and Elad L. Roisman filed statements on November 24, 2020 suggesting an additional expansion of the revisions in view of the development of the gig economy (here). The statement was issued on November 24, 2020.
Statement: Commissioners Allison Herren Lee and Caroline A. Crenshaw issued a statement regarding the modifications to Rule 701 and Form S-8 in view of the gig economy. Essentially, they argued that the data used to support the amendments is much broader than what was used in connection with the modifications (here).
SEC Enforcement – Filed and Settled Actions
The Commission filed 2 civil injunctive actions and no administrative proceedings last week, excluding 12j, tag-along proceedings and other similar matters.
Conflicts/misrepresentations: SEC v. Rumbaugh, Civil Action No. 5:19-cv-01517 (CD Cal.) is a previously filed action which named as defendants Craig Rumbaugh and his two controlled entities, one of which is a state registered investment adviser. The action centers on the recommendation of the adviser to clients that they invest in a firm which supposedly would place the money in short term, high interest notes. In fact, the eight clients who put in over $3 million later learned that the entity was a Ponzi scheme. In addition, Defendants received over $140,000 in concealed commissions. Defendants also made misrepresentations regarding the claimed investments. To resolve the action each Defendant consented to the entry of a permanent injunction based on Securities Act Sections 5(a), 5(c) and 17(a), Exchange Act Sections 10(b) and 15(a) and Advisers Act Sections 206(1) and 206(2). Defendants also agreed to pay, on a joint and several basis, disgorgement in the amount of $676, 000, prejudgment interest of $137,808 and a penalty of $192,768. In a related administrative proceeding Mr. Rumbaugh consented to the entry of an order which bars him from the brokerage business. See Lit. Rel. No. 24969 (Nov. 24, 2020).
Offering fraud: SEC v. Benja Inc., Civil Action No. 3:20-cv-8328 (N.D. Cal. Filed Nov. 23 2020) is an action which names as defendants the firm, supposedly an on-line marketer, and its CEO Andrew J. Chapin. Defendants raised several million dollars from investors and banks by representing that Benja had contracts with major vendors such as Nike, Patagonia and Franatics, all of which helped make the firm profitable. In reality the firm had no contracts and was not profitable. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The complaint is pending. See Lit. Rel. No. 24968 (Nov. 23, 2020).
Insider trading: SEC v. Sullivan, Civil Action No. 2:20-cv-811 (W.D. Pa. Filed Nov. 20, 2020) is an action which names as a defendant Michael Sullivan, an employee at a publicly traded sporting goods store chain. In two instances when Mr. Sullivan was subject to blackout periods, he engaged in insider trading, purchasing options in advance of an earnings announcement. The first instance was in advance of the announcement for the second financial quarter of 2018. Defendant purchased 100 put options. Following the announcement of results the share price declined 9%. Mr. Sullivan had profits of $11,500. The second centered on the results for the third quarter of 2019. In advance of the announcement of the results Mr. Sullivan purchased 132 call options. In this instance the share price increased over 18%. Mr. Sullivan had trading profits of over $26,000. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24967 (Nov. 23, 2020).
Offering fraud: SEC v. Winston Reed Investments, LLC, Civil Action No. 1:20-cv-38 (W.D.N.C.) is a previously filed action which named as defendants Mark N. Pyatt and his firm, Winston Reed Investments. Defendants raised millions of dollars by representing to investors that they would employ the funds in a sophisticated strategy employing futures contracts. In fact, most of the funds were misappropriated. To resolve the matter each Defendant consented to the entry of a permanent injunction based on Securities Act Section 17(a) and Exchange Act Section 10(b). Defendants also agreed to pay, on a joint and several basis, disgorgement of $255,850 subject to offset by the amount paid as restitution in a parallel criminal against Mr. Pyatt. In the criminal case Mr. Pyatt pleaded guilty to one count of wire fraud and was sentenced to serve 37 months in prison followed by three years of supervised release. See Lit. Rel. No. 24966 (Nov. 20, 2020).
Hong Kong
Consultation: The Securities and Futures Commission concluded a consultation on changes to the REIT Code, according to an announcement made on November 27, 2020 (here). The changes are designed to permit the Hong Kong REIT market to facilitate long term growth while enduring investor protection.
Remarks: Ravi Menon, Managing Director of the Monetary Authority of Singapore, delivered remarks titled “growing Timber” at the MAS-IBF Webinar on November 26, 2020 (here). His remarks focused on job opportunities and readiness in the coming market.

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