Registered or Not, Here They Come

Investment advisers are on notice. In 2016, the SEC brought a record 160 enforcement actions involving investment advisers or investment companies.¹ Early indicators suggest that 2017 will be another year of rigorous enforcement, and investment advisers—registered or not—would do well to examine their own house before the SEC does it for them.

2016: A Record Year of Enforcement

At the close of its fiscal year, the Commission highlighted a wide range of adviser misconduct that elicited enforcement action, including:

• Eight private equity-related actions;
• Sanctions against thirteen investment advisory firms for violation of securities laws;
• Sanctions against three AIG affiliates for manipulating client investments to collect higher fees;
• Charges against Morgan Stanley Investment Management and one of its portfolio managers for unlawful pre-arranged trades; and
• Charges against Aequitas Management LLC, four affiliates, and three of the firm’s top executives for defrauding investors.²

It’s tough to find a common thread or particular area of emphasis in this litany of actions. Rather, it appears the SEC took an all-of-the-above approach to enforcement against investment advisers. Indeed, former Chair Mary Jo White noted that the SEC “expand[ed] the playbook, bringing novel and significant actions to better protect investors.”³

2017 Examination Priorities

With a new administration in the White House and SEC Chair nominee Jay Clayton yet to be confirmed, it is unclear when or if the Commission will tack in a different direction. In the meantime, SEC officials expect staffers, including those who work in enforcement, “will keep doing what they are doing.”⁴ The Commission, as currently constituted, recently released enforcement expectations in its annual announcement on examination priorities.⁵

The report highlights two major areas of focus: (1) Protecting Retail Investors and (2) Protecting Senior Investors and Retirement Investments. Both high level priorities implicate investment advisers in multiple ways. Specifically, the SEC will focus on the following classes of advisers:

• Private Fund Advisers
• Retirement and Pension Advisers
• Multi-Branch Advisers
• Never-Before Examined Investment Advisers
• Recidivists and their Employers

In addition to general enforcement against fraud, the Commission will target electronic investment advice, wrap fee programs, and conflicts of interest. Expect the SEC to further develop and utilize data analytics to uncover and prosecute violations. 

Registered or Not, Here They Come

The SEC regulates investment advisers under the Investment Advisers Act. In general, investment advisers with $25 million or more in assets under management must register with the SEC unless they qualify for an exemption or are prohibited from registration. These Registered Investment Advisers, or RIAs, must comply with the act’s disclosure requirements, recordkeeping rules, and other practice restrictions. In fact, most provisions of the act apply only to RIAs.  The act’s anti-fraud provisions, however, apply to all investment advisers. Recent charges against unregistered advisers demonstrate the SEC’s commitment to rooting out fraud at all levels.

On December 1, 2016, the SEC announced fraud charges against Onix Capital and its owner, Alberto Chang-Rajii.⁶ The SEC alleges that Chang-Rajii “for compensation, engaged in the business of advising…as to the value of securities or as to the advisability of investing in, purchasing, or selling securities,” and is, therefore, an investment adviser within the meaning of the Investment Advisers Act.⁷ While acting as an investment adviser, Chang-Rajii misrepresented his education and business background, claiming he earned a MBA from Stanford University and was an early stage investor in Google. Neither statement was true. Additionally, Chang-Rajii promised investors annual interest rates from 12-19%, represented he would personally guarantee certain promissory notes, and said he had more than $100 million in J.P. Morgan accounts. Again, these statements were false. In an interesting twist, Chang-Rajii fled to Malta where he is currently fighting extradition attempts by his home country, Chile. All the while, the SEC’s charge is pending in federal district court.

On February 2, 2017, the SEC filed a similar, albeit less sensational, charge against Mark Varacchi and his firm, Sentinel Growth Fund Management.⁸ Neither Varacchi nor Sentinel Growth was registered as an investment adviser. Like Chang-Rajii, however, their advising activity brought them under the definition of investment adviser. Varacchi allegedly orchestrated a Ponzi scheme in which he misrepresented to investors how funds would be invested and instead manipulated accounts to facilitate a $3.95 million windfall for himself. The case is currently pending in the U.S. District Court for the District of Connecticut.

While these cases represent the more extreme elements of adviser misconduct, there is no denying that the SEC is committed to investigating a wide range of adviser activity. As 2016 demonstrated and the 2017 examination priorities suggest, the Commission has a system in place that is poised to pull every lever of enforcement at its disposal, at every level.

 

Dual Registration: Duties, Risks and Rewards

This whitepaper provides an overview of the differences between an Adviser and a Broker, the friction points of being dually registered as both, and the risks and benefits of dual registration.

Disclaimer: WealthForge provides this information to our clients and other friends for educational purposes only. It should not be construed or relied upon as legal advice.

[1] U.S. Securities and Exchange Commission, SEC Announces Enforcement Results for FY 2016 (Oct. 11, 2016), http://www.sec.gov/news/pressrelease/2016-212.html.

[2] Id.

[3] Id.

[4] Hazel Bradford, SEC Expected to Come Out of Gate Slowly, Pensions & Investments (Jan. 23, 2017), http://www.pionline.com/article/20170123/PRINT/301239980/sec-expected-to-come-out-of-gate-slowly.

[5] See Office of Compliance Inspections and Examinations, Examination Priorities for 2017 (Jan. 12, 2017), http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2017.pdf.

[6] U.S. Securities and Exchange Commission, Litigation Release No. 23697 (December 1, 2016), http://www.sec.gov/litigation/litreleases/2016/lr23697.htm. See also Amended Complaint, SEC v. Onix Capital LLC, No. 16-CV-24678 (S.D. Fla. Dec. 15, 2016).

[7] Amended Complaint at ¶ 68.

[8] U.S. Securities and Exchange Commission, Litigation Release No. 23739 (February 2, 2017), https://www.sec.gov/litigation/litreleases/2017/lr23739.htm. See also Complaint, SEC v. Varrachi, No. 3:17-cv-00155 (D. Conn. Feb. 2, 2017).