A Compilation of Enforcement and Non-Enforcement Actions

by Foley & Lardner LLP


  • Investment Management Division Director Address to Investment Company Institute


  • CFTC Exercises New Enforcement Powers in Insider Trading Case
  • Lawyers Caught Acting as Non-Registered Securities Brokers
  • Portfolio Manager’s “Parking” Scheme Results in Enforcement Action


Investment Management Division Director Address to Investment Company Institute

Division Director David Grim addressed the ICI on December 16, 2015. In his remarks, Grim noted 2015 was the 75th anniversary of the 1940 Acts. He noted that the Division has recently proposed (i) enhanced regulation of the use of derivatives by registered funds, (ii) required implementation of liquidity risk management programs and enhanced liquidity disclosure by ETFs, (iii) and enhanced data collection for all registered funds.

Proposed Rule 18f-4
Director Grim noted that derivatives regulation at present is founded on Release 10666 dating to 1979 (and which strictly speaking addressed forward commitments, when issued securities and reverse repurchase agreements). He noted that in 2011, the SEC published a concept release, and that DERA has studied registered fund usage of derivatives. Proposed new Rule 18f-4 (http://www.sec.gov/rules/proposed/2015/ic-31933.pdf) would permit a fund to use derivatives if (i) leverage is limited, (ii) the fund holds qualifying coverage assets, and (iii) any fund with 50-percent derivatives exposure or that uses complex derivatives adopts a formalized risk management program.

Liquidity Management
Formal SEC guidance on liquidity risk management by open-end funds dates to 1992 amendments to Form N-1A. (Note that DERA’s September 2015 study pointed out the risk that due to illiquidity, funds facing redemptions might be forced to sell at “fire sale” prices). Director Grim noted that the goal of the SEC’s September 2015 “Open-End Fund Liquidity Risk Management Proposal” is to promote strong risk management across all funds. http://www.sec.gov/rules/proposed/2015/33-9922.pdf. While codifying the 15-percent illiquid securities “bucket” that exists for funds other than money market funds, this new rule would introduce the need for liquidity risk management and would offer the option of “swing pricing.” This is a mechanism to charge redeeming shareholders with the cost of liquidating positions.

Modernizing Information Reporting
The SEC published in May a proposal entitled “Investment Company Reporting Modernization,” and received 779 comments. A consistent theme was concern for the privacy of monthly portfolio holdings information filed with the SEC. Grim noted that holdings information privacy is an issue raised by many comment letters that the staff is working on.

2016 Initiatives for Registered Advisers
Registered investment advisers should anticipate rulemaking regarding “transition” planning against major disruptions in their business. This would be in addition to business continuity planning, now required by Rule 206(4)-7. Transition plans, according to Grim’s March 2015 speech to the IAA Compliance Conference, should be expected to address “key person” risk and asset liquidity risk, including the ability of clients to move assets away from their adviser. Large investment advisers should anticipate stress testing related rule making. In addition, the staff is considering a recommendation to the SEC to mandate third-party compliance reviews.


CFTC Exercises New Enforcement Powers in Insider Trading Case

Recently, the CFTC brought an enforcement action against a proprietary gasoline and energy contract trader for, among other things, insider trading violations. This marks the first enforcement action brought by the CFTC that makes use of new powers granted to the Commission under the Dodd-Frank Act. This authority is basically the same as used by the SEC in pursuing insider trading enforcement cases.

The enforcement action was brought against Arya Motazedi, a Chicago-based trader in gasoline and energy contracts. According to the CFTC, Motazedi traded in energy commodity contracts based on confidential information he gained through his employer. Specifically, the trader used that confidential information to (i) enter opposite orders to the employer’s orders at least 34 times, which gained profits for the trader but caused the employer’s account to suffer losses; and (ii) to “front run” his employer’s orders on at least 12 occasions, which allowed the Motazedi to benefit from price movements caused by the execution of the employer’s orders.

To resolve the matter, Motazedi entered into an agreement with the CFTC to (i) the issuance of a cease and desist order; (ii) pay restitution in the amount of $216,955; (iii) pay a civil penalty in the amount of $100,000; (iv) agree to a permanent ban from trading commodity interests; and (v) agree to a permanent ban from registering with the CFTC as a futures professional in any capacity.

The main lessons to be learned from this enforcement action are that the CFTC now has the authority to take action against those persons who take advantage of material non-public information and use that information to their gain; and that the CFTC is not reluctant to investigate such activities and administer enforcement action against inside traders.

Lawyers Caught Acting as Non-Registered Securities Brokers

The SEC recently announced enforcement actions against several lawyers across the country for acting as securities brokers without being registered with the SEC. All of the lawyers cited were involved with clients conducting EB-5 investment offerings. One lawyer and his firm were also charged with defrauding foreign investors in connection with an EB-5 offering.

The EB-5 Immigrant Investor Program provides non U.S. persons with a quicker path to obtaining U.S. citizenship through investments in a U.S. program that is intended to create or preserve at least 10 jobs for workers in the United States.

Generally, persons who are engaged in the business of effecting transactions in securities and receive a commission or other remuneration directly or indirectly for raising investor funds in connection with such transactions are first required to be registered as a “broker” with the SEC under the Securities Exchange Act of 1934.

In the cases brought by the SEC against these lawyers involved in EB-5 offerings, the SEC found that:

  • Certain EB-5 regional centers across the United States and their managers paid commissions to attorneys or their law firm for each investor who invested in the EB-5 offering sponsored by the center
  • Such payments were apart from the legal fees paid to the lawyers for their clients
  • The lawyers, in addition to receiving a securities commission, also conducted other broker-like activities such as recommending EB-5 investments to investors, and otherwise facilitating the transaction by transferring the funds as payment for the transactions

One of the lawyers and his law firm are the subject of a criminal complaint filed in federal district court in Los Angeles, in which the New York-based lawyer and law firm are accused of acting as an unregistered broker and defrauding clients by failing to disclose the commissions they were receiving by selling securities to such clients.

Each of the attorneys and law firms charged by the SEC agreed to settle the enforcement matters by agreeing to the issuance of cease and desist orders and, in some cases, payment of disgorgement and penalties.

These actions serve to further spotlight the SEC’s concerns in general about the conduct of EB-5 securities offerings across the country which has been the subject of a recent number of SEC enforcement actions.

Portfolio Manager’s “Parking” Scheme Results in Enforcement Action

An SEC-registered investment adviser recently agreed to settle an SEC enforcement matter involving allegations that one of its portfolio managers illegally conducted prearranged trading or “parking” in order to favor certain advisory clients over others.

The portfolio manager, who is no longer employed with the investment advisory firm, conducted the prearranged trading in 2011 – 2012. The advisory firm was cited for its failure to uncover the portfolio manager’s illegal activities and to conduct reasonable supervision designed to detect such activities.

The SEC found that the portfolio manager arranged the sales of certain securities that needed to be liquidated in various client accounts with a broker-dealer trader at predetermined prices that would allow the portfolio manager to buy back the positions at a small mark-up into other managed accounts. The portfolio manager also sold additional securities at above-market prices to avoid incurring losses in certain accounts, and then repurchased the securities at above-market prices in a private fund managed by the portfolio manager. In all, the portfolio manager moved about $400,000 in previously unrealized losses from some client accounts to the private fund that took on those positions. All of these transactions were prearranged through the broker-dealer’s trader. The portfolio manager generally ignored the advisory firm’s internal controls with respect to conducting cross-trades.

The SEC’s allegations cited violations by the portfolio manager of the “anti-fraud” provisions under the Investment Advisers Act of 1940 and under the Securities Act of 1933. The portfolio manager agreed to pay a $125,000 penalty and to be barred from the securities industry for at least five years. The trader at the broker-dealer who assisted the portfolio manager with the pre-arranged trading also agreed to a securities industry bar. The investment advisory firm agreed to pay an $8.8 million penalty and to reimburse affected clients a total of $857,534.

The broker-dealer agreed to pay an $800,000 penalty and $211,093 in disgorgement and interest. The broker-dealer trader agreed to pay a $25,000 penalty, and be barred from the securities industry for three years.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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