By Amanda Maine, J.D.
The co-chiefs of the SEC Enforcement Division’s Asset Management Unit (AMU) spoke with Investment Adviser Association General Counsel Gail Bernstein about the SEC’s policies on enforcement and asset managers. While many examination deficiencies never get referred to the Enforcement Division, Co-Chiefs Dabney O’Riordan and Adam Aderton described instances in which violations may draw the attention of the AMU.
From examinations to enforcement. O’Riordan explained that while many of AMU’s cases result from referrals from examinations, the unit also pursues enforcement actions based on information from public complaints and tips as well as news articles. The AMU, which was formed 11 years ago, includes staff attorneys, industry experts, and paralegals who are all devoted to looking at violations committed by investment advisers
Bernstein asked how the leadership transition at the SEC has affected the AMU. While Aderton acknowledged that the Commission is in a period of transition, including at the top of the Commission itself and in the Division of Enforcement with the appointment of Melissa Hodgeman as acting director following the departure of Stephanie Avakian, he assured that the vast majority of the staff is the same and remains focused on the same issues.
Aderton also addressed a policy change announced by Acting Chair Allison Herren Lee authorizing senior enforcement officials such as himself and O’Riordan to approve the issuance of a formal order of investigation, empowering them to exercise the delegated authority of the Commission to authorize staff to subpoena documents and take sworn testimony. This policy is a deviation from the most recent administration and reverts back to the policy under the Obama Administration. According to Aderton, neither he nor O’Riordan, who have served at AMU since its inception, never had trouble obtaining a formal order, but it is a subtle change that is worth noting.
O’Riordan advised that a deficiency letter regarding exams does not automatically mean there will be a referral to enforcement. However, she explained that when AMU does get a referral, the staff begins its discussion with the examinations staff. Whether a matter is escalated from examinations to an enforcement matter depends on a number of factors, she said. One factor is exigency: if there is an issue of the dissipation of assets or if the statute of limitations is near, a matter may be referred to enforcement much sooner. More often than not, however, the examinations process is completed before the matter is referred to enforcement, she said. She also advised that a lot of cases referred by examinations end up completed without a formal order.
IA enforcement: Past, present, and future. Bernstein asked what issues AMU are looking at regarding investment advisers. Aderton said the unit will continue to focus on conflicts of interest, especially with respect to retail clients. These include undisclosed or inadequately disclosed revenue streams, he advised. On the funds side, AMU is focused on valuation issues, side-by-side management conflicts, and issues related to fees and expenses (particularly in private equity). Bringing up a recurrent theme of the conference, Aderton said that AMU is looking at investment strategies that are inconsistent with disclosures, which is where ESG fits in an enforcement context for investment advisers.
Bernstein inquired about the impact of the COVID-19 pandemic and whether firms might encounter enforcement actions related to pandemic concerns. O’Riordan noted that the new remote work environment resulting from the pandemic did create challenges for firms, such as protecting personally identifiable information (PII), monitoring communications, and maintaining books and records. However, she advised that she does not foresee it as a major area of enforcement going forward. Firms reacted well to operating in this new environment, and the SEC will not be playing "gotcha" in light of these necessary changes, she assured.
Bernstein also asked about SEC enforcement actions following the completion of the Enforcement Division’s Share Class Selection Disclosure (SCSD) Initiative, which provided investment advisers a mechanism to self-report disclosure violations related to conflicts of interest on mutual fund fees. While the SCSD Initiative has concluded, O’Riordan said that the AMU is still looking at firms who could have self-reported under the program, yet failed to do so. She did note that the SEC took into account the remedial actions of one firm that did self-report, but after the SCSD Initiative deadline. This firm’s penalty was noticeably lower than penalties imposed on other firms that did not self-report, she remarked.
Private funds and private equity. In the private fund context, Bernstein inquired about whether there are specific conflicts that should be highlighted in this space. Aderton said that the staff often sees conflicts in the private equity context where there are fees and expenses associated with a transaction and where it is unclear who is going to bear those expenses. AMU expects consistency with documents and to make it clear what the expenses were, how they were allocated, and how they were consistent with the limited partnership agreement, he advised.
CCO liability. Bernstein also asked about the personal liability of chief compliance officers (CCOs), what the Division is looking at, and how CCOs can mitigate personal risk. Aderton remarked that the prospect of personal liability for CCOs is a real concern and outlined three "buckets" the SEC’s CCO enforcement cases fall into. The first two buckets involve the most serious misconduct. Bucket one involves CCOs who affirmatively participated in misconduct, such as wearing multiple corporate "hats" or actively engaging in the fraud. The second bucket involves CCOs involved in deceiving the SEC in its exams, enforcement proceedings, or both through actions such as fabricating and backdating documents. For these first two buckets, no one has a problem with bringing enforcement actions against this type of conduct, Aderton said.
The third bucket involves failing to implement measures for which a CCO should be responsible, he said. A CCO can mitigate his or her liability in these instances is to make sure actions are documented and that they were in line with the firm’s written policies and procedures. As an example, Aderton said that the SEC upheld a FINRA enforcement action that resulted in the suspension of a CCO who had ignored a number of red flags. CCOs should approach the business side of firms for more resources to enable and encourage the documentation of how the firm deals with compliance risks, he advised.