– Magazine Names Piedmont Among Top Hedge Fund Consulting/Service Companies of 2020 –
August 17, 2020 – Piedmont Fund Services, a leading provider of fund administration services for managers of institutional and alternative investment funds, was the proud cover story feature of the June 2020 issue of Capital Markets CIO Outlook magazine. Taking the coveted spot on the annual Hedge Fund edition, the extensive article celebrates Piedmont Fund Services’ innovative technology solutions that are revolutionizing the industry and its success in reducing transaction friction to provide better investor experiences within the alternative investment space.
“It’s an honor to be featured so prominently by a leading industry magazine such as Capital Markets CIO Outlook,” said Piedmont Fund Services Co-Founder and CEO Ian Asvakovith. “For the past 15 years, we’ve worked tirelessly to provide effective solutions that provide complete transparency and accuracy for today’s savvy investors. It’s a tremendous compliment to be recognized for our team’s commitment to excellence and diligent work on behalf of alternative investment fund managers.”
Piedmont’s cover story is part of its national recognition as one of Capital Markets CIO Outlook’s Top Hedge Fund Consulting/Service companies of 2020 – an annual listing of 10 companies at the forefront of Hedge Fund consulting that are transforming businesses. The article highlights Piedmont Fund Services’ streamlined fund administration, specifically its groundbreaking cloud-based fund reporting solution, Opéra. The online reporting system provides crucial information for fund managers in this highly-competitive and regulated sector through a customized dashboard and easily navigated system that helps investors understand complex information and extract the most pertinent details in one convenient place. Now in its 3rd generation, Opéra has evolved over the past decade to consider client feedback, provide greater efficiencies and add functionalities to see a clearer and more accurate picture of fund performance.
Published monthly, Capital Markets CIO Outlook helps CIOs remain highly effective by aggregating pertinent data and communicating emerging trends within one convenient resource. Setting Capital Markets CIO Outlook apart from other magazines covering the investment space is its focus on learning from peers, taking their real-life professional experiences to help other industry professionals with decision-making and troubleshoot challenges.
The Capital Markets CIO Outlook cover story can be read in its entirety here.
What’s on Investors’ Minds: Trump, Risk & Returns
Join our esteemed panelists of institutional investors for a discussion of investment outlook, trends, risks, and opportunities in the alternative investment market. Balancing risks and rewards in an uncertain political climate.
July 19, 2017
4:30 PM Registration
5:00 PM Panel discussion
6:15 PM Networking (Cocktails and hors d’oeuvres will be served)
The Army and Navy Club
901 17th St NW
Washington, DC 20006
(Valet Parking is available)
Join industry experts for a discussion of investment outlook, trends, risks, and opportunities in the alternative investment market. Network with a select group of investment managers and institutional investors at the historic Farmington Country Club in Charlottesville, Virginia.
Piedmont Fund Services has proudly served the alternative investments industry for over a decade, offering our expertise and passion for fund administration to clients across the globe. Throughout our growth, Piedmont’s core values of trust, integrity, and superior client services has remained steadfast. Piedmont has continued to make strides in fund administration by staying true to our principles, yet maintaining the finesse and agility required for a seamless client experience. Because of this, Piedmont has been able to offer unparalleled fund administration services to our clients worldwide.
At Piedmont, we continuously strive to reach higher and go to greater lengths to become a change agent and leading innovator the fund administration industry. To reflect Piedmont’s dedication for innovation, passion for exceptional service, as well as our aspirations going forward, we decided that these qualities would be best represented by our new logo and branding.
At the heart of our new brand is the idea of dynamism influenced by trust and integrity. At Piedmont, we continue to swiftly move forward in an increasingly complex and challenging world. Our team executes fund administration services with speed and accuracy, yet tailored to perfectly fit our clients’ needs. Through this design change, we hope to reflect our commitment to innovation and excellence.
Adequate compliance policies and procedures are key to safeguarding against enforcement actions
As regulatory enforcement actions continue to proliferate and as the regulatory landscape evolves, the importance of having adequate compliance policies and procedures in place cannot be understated. Policies and procedures tailored to a firm’s business, combined with continuous oversight and modifications in conjunction with regulatory changes, and constant vigilance in ensuring that firm practices match compliance goals, play a leading role in safeguarding against violations of the AML laws and Foreign Corrupt Practices Act (FCPA). Inadequate compliance programs were at the root of two AML enforcement orders this year, are central to the burgeoning liability of Chief Compliance Officers (CCOs), and were significant factors in negative findings under the FCPA.
In February, Miami-based brokerage firm E.S. Financial Services (now Brickell Global Markets) settled with the SEC for $1 million for breaking AML protocols. The SEC order found that E.S. Financial committed a willful violation of AML rules in allowing foreign entities to buy and sell securities without verifying the identities of their non-citizen beneficial owners, and by failing to provide the required books and records of the foreign customers upon request. Importantly, there was no finding of fraud here. Instead, liability rested on the finding that their Customer Identification Program (CIP) was deficient, with “significant holes” that left it susceptible to illegality. Furthermore, in neglecting to satisfy the requirements for their existing foreign customers, they failed to comply with their CIP altogether. In addition to their $1 million penalty, E.S. Financial agreed to hire an independent monitor to review its CIP/AML program for two years.
In an enforcement action by the Financial Crimes Enforcement Network (FinCEN) at the end of February, a $4 million civil money penalty was assessed against Gibraltar Private Bank and Trust Company for willfully violating AML laws due to substantial deficiencies in their AML program. Deficiencies included a failure to implement and maintain a suitable AML/CIP program and adequately report suspicious transactions, ultimately leading to Gibraltar’s failure to monitor and detect suspicious activity despite numerous red flags, including transactions surrounding Scott Rothstein’s $1.2 billion Ponzi scheme. The shortcomings in Gibraltar’s compliance programs included a defective Transaction Monitoring System, which contained incomplete and inaccurate account information and customer risk profiles, and ineffective procedures for monitoring, detecting, and reporting suspicious activities. Notably, the bank was informed of and warned of their deficiencies years in advance, but failed to take appropriate remedial measures until much later.
FinCEN determined that the lack of internal controls that could ensure BSA compliance, inadequate staff training, and inappropriate CIP constituted a violation of AML laws. This resulted in Gibraltar servicing high-risk customers without effectively monitoring those accounts and filing late SARs.
Findings of liability against CCOs based on compliance program deficiencies are becoming a trend, even where no harm occurred to clients or where the compliance officer had no involvement in misconduct, as illustrated by the SEC action against SFX Financial Advisory Management Enterprises. In SFX, the SEC used a negligence standard in finding the CCO liable for compliance failures and not adequately supervising the former president, who misappropriated $670,000 from client accounts. Furthermore, FinCEN’s proposed AML Rule for Registered Investment Advisers, expected to be finalized this summer, will expand the scope of CCO liability by ensuring that SEC registered investment advisors are subjected to current AML rules, such as requiring the establishment of an AML program and designation of a compliance officer.
In New York, the Department of Financial Services (DFS) has added another layer of scrutiny with new regulations, accompanied by the possibility of criminal prosecution, that add greater specificity to existing compliance programs by requiring ongoing risk assessments and removing the ability to limit alerts generated by monitoring programs. Part 504 of the Superintendents Regulations would require the CCO of a DFS-regulated institution to personally certify on an annual basis that the financial institution has maintained a transaction monitoring program to detect AML violations, instituted a watch list filtering program to identify prohibited transactions, and enacted measures to ensure the integrity of those two programs.
Enforcement of the FCPA continues to be a high priority for the SEC, which has already brought six FCPA enforcement actions this year. In 2015, nine FCPA enforcement actions were brought, compared to eight in both 2013 and 2014. According to the SEC’s 2015 Annual Report on the Dodd Frank Whistleblower Program, tips concerning FCPA violations were the highest yet in the history of the program, with a total of 186 tips.
The FCPA cases brought this year illustrate the need for companies to include and maintain strong internal procedures and controls, especially in high risk markets or industries. In their order against software manufacturer SAP SE, the SEC found that insufficient internal controls enabled a former SAP executive to bribe Panamanian government officials, disguising the bribes as discounts. In the orders against SciClone Pharmaceuticals and PTC, the SEC found that various sales practices were in violation of the anti-bribery provisions of the FCPA, underscoring the SEC’s emphasis on maintaining vigorous internal controls and the need for sound policies relating to business entertainment.
As the dust begins to settle in the aftermath of the U.S. presidential election, which saw Republican candidate Donald Trump unexpectedly prevail against Democrat Hillary Clinton, the time has come for firms to prepare for the Trump administration. Given the lack of clarity that has surrounded many of Trump’s policies, concerns of contradictory and unpredictable policy directions have been increasingly prevalent.
For the alternative investments industry, hedge funds and private equity have been lumped into the unfortunate caricature of the Wall Street “enemy” during this past election cycle. Trump’s campaign rhetoric drew a striking contrast to the traditional pro-business line of establishment Republicans, to the extent of even echoing the far-left sentiments of Democratic primary candidate Bernie Sanders. As the presidential inauguration draws near, tensions are exacerbated by the uncertainty of what is to come, as any Trump administration policies remain merely speculative.
Insight into Trump’s transition team will shed more light on how his policy agenda will manifest for the alternative investment industry. In an organizational chart of the Trump transition team that was leaked in mid-November and made the rounds amongst K Street lobbying firms, the individuals tapped may offer valuable clues of what to expect in 2017.
At the forefront of the Economic Issues team are Bill Walton and David Malpass. Walton is the chairman of private equity firm Rappahannock Ventures, a senior fellow of the Center on Wealth, Poverty and Morality at the Discovery Institute, and vice president of the Council for National Policy. Walton’s involvement in private equity may bode well for the alternative funds industry. Malpass is a Trump economic adviser and former Republican Senate candidate for New York, and the founder and president of economic research and consulting firm Encima Global.
Heading the SEC team will be Paul Atkins, who currently serves as the CEO of Patomak Global Partners LLC, a strategic advisory firm, and was previously an SEC Commissioner from 2002-2008. Atkins has been a vocal proponent of deregulation and a strong critic of Dodd Frank.
In the Policy Advisory team, Brian Johnson is expected to head the financial services team. Johnson currently serves as the Chief Financial Institutions Counsel for the House Natural Resources Committee, Oversight and Investigations Subcommittee.
Policy areas of particular interest for alternative funds are Trump’s plans for tax and regulatory reform.
We are likely to see an attempt at tax reform at the beginning of 2017. Trump’s tax reform proposal includes the following:
Trump has been vocal about his desire to dismantle Dodd Frank, which he feels is too stifling for the economy. Dodd Frank imposes a significant regulatory burden that critics contend is unfair to community banks and smaller businesses. However, Trump’s transition team has privately indicated that some individual provisions will be scaled back instead. Indeed, a total overhaul of Dodd Frank is something that many firms are opposed to, especially considering the extent to which Wall Street and foreign investment banks have already invested in compliance. Additionally, industry groups favor the retention of certain provisions such as Title VII, which creates a framework for the regulation of swap markets and business conduct standards that increase transparency.
With the involvement of Paul Atkins on the transition team, we can expect a push for deregulation and the repeal and replacement of certain provisions in Dodd Frank which are seen to be particularly onerous. This will certainly result in a marked contrast with the current state of affairs in the SEC. However, one area of common ground lies in Atkins’ preference to hold individuals accountable in enforcement actions, a stance that accords with the current push towards individual accountability in the SEC and FINRA.
Indications from the transition team selections and a softening of Trump’s rhetoric after the election point to a move towards the center in his policy agenda. However, investors are likely to be on high alert for protectionism and Wall Street vilification, among other things, which may result in economic risks that would undermine business confidence and weaken the dollar. But despite the most thorough analyses from pundits and academics alike, if there is one lesson to be gleaned from this election, it is that of the illusion of certainty.
In an extensive document leak that has come to be known as the Panama Papers, materials released by the International Consortium of Investigative Journalists (ICIJ) in April has cast a spotlight on the use of offshore companies and their connection to global tax evasion and serious financial crimes. The Panama Papers leak is the largest data leak to date on offshore companies, and consists of 40 years of financial data and over 11.5 million financial and legal records from Panamanian-based law firm Mossack Fonseca. A full, searchable database was made public on May 9, 2016, allowing visitors to search almost 320,000 offshore companies linked to over 200 countries.
The anonymous individual who leaked the documents posted a manifesto in April, outlining their motivation in leaking the documents and advancing the policy reforms they see as necessary in confronting the wrongdoing the Panama Papers purport to reveal, describing it as a “glaring symptom of our society’s progressively diseased and decaying moral fabric.” The manifesto begins with the premise that income inequality is furthered by pervasive corruption, with offshore shell companies carrying out a “wide array of serious crimes that go beyond evading taxes.” The policy reforms demanded include: 1) Stronger whistleblower protections and complete immunity from government retribution for “legitimate whistleblowers who expose unquestionable wrongdoing”; 2) Full disclosure of corporate registers, with detailed data on ultimate beneficial owners and standard setting for disclosure and public access; and 3) Ending the practice of self-regulation in the legal industry.
Eligible Introducer Loophole
The Panama Papers fallout brought to light a loophole whereby suspicious accounts were created while hiding the identity of the true beneficial owner by using an eligible introducer. An eligible introducer is a third party intermediary (e.g. professional service providers such as law firms, accounting firms, or financial institutions) that can incorporate an offshore company in a client’s name and open a bank account in the company’s name. The idea of using eligible introducers is to avoid duplication of due diligence efforts where doing so would be unhelpful or onerous, and instead rely on the verification of a third party. As the premise behind conducting due diligence procedures in the first place is to establish a client’s identity to ensure that they are not a bad actor, the eligible introducer signals to regulators the completion of requisite due diligence checks on the client, essentially vouching for their integrity. The benefit of this approach is that it reduces operational inefficiency by not requiring institutions to start the due diligence process from scratch with each client. However, the use of eligible introducers has also facilitated the avoidance of anti-money laundering (AML) laws in obscuring the identification of beneficial owners. Mossack Fonseca often did not store information on beneficial owners, thus creating an opportunity for bad actors to hide money in offshore shell companies while being protected by the layer of secrecy granted by Mossack Fonseca’s role as an eligible introducer.
Due Diligence Implications
The release of the Panama Papers was instantly followed by overwhelming public outcry, precipitating multiple tax fraud charges, including against soccer star Lionel Messi, and even the resignation of Icelandic Prime Minister Sigmundur David Gunnlaugsson. In the U.S., the Department of Justice has launched a criminal investigation into the tax avoidance schemes exposed by the Panama Papers. The Treasury Department issued proposed regulations in May that aim to increase transparency and strengthen disclosure requirements, including beneficial ownership legislation and regulations on foreign-owned single-member LLCs. The beneficial ownership legislation would require companies formed within the U.S. to file beneficial ownership information with the Treasury Department, while the latter would subject foreign-owned disregarded entities to certain reporting requirements and require them to obtain an employer-identification number with the IRS.
The fallout from the document release has already subject AML compliance to further scrutiny, especially in light of the glaring due diligence gaps exposed through the eligible introducer loophole. While the regulatory response is evolving as more information surfaces, this event underscores the importance of maintaining constant vigilance in compliance procedures, and the necessity of enhanced due diligence when attending to offshore transactions.
Amidst a climate of heightened scrutiny and suspicion of the financial services industry, anti-money laundering (AML) regulations continue to rapidly evolve, leaving companies to scramble as they attempt to ensure their compliance efforts are up to snuff. With continuous enforcement actions being brought against a backdrop of new scandals, rules and regulations, it is more important than ever for firms to keep their eyes on the compliance ball.
Customer Due Diligence (CDD) Rule
The U.S. Treasury Department finalized their Customer Due Diligence (CDD) rule in July, which introduces a new requirement for covered financial institutions to determine beneficial ownership and amends Bank Secrecy Act regulations to clarify and strengthen the obligations of financial institutions. As such, when a legal entity customer such as a corporation or partnership opens an account with a financial institution, the customer would have to provide and the financial institution would have to verify the personal information of the individuals who own or control 25% or more of the legal entity customer. Covered financial institutions include federally regulated banks and federally insured credit unions, mutual funds, brokers or dealers in securities, futures commission merchants, and introducing brokers in commodities. Legal entity customers include corporations, limited liability companies, limited partnerships, general partnerships, business trusts, and other entities created by making a public filing.
The CDD rule aims to combat money laundering and other financial crimes by making legal entities more transparent (and thus less attractive to criminals) and strengthening anti-money laundering program requirements by developing customer risk profiles and conducting ongoing monitoring.
New York’s New Anti-Money Laundering Rule
The Empire State has taken additional measures to maintain constant vigilance against financial crimes in the adoption of AML and anti-terrorism legislation by the New York Department of Financial Services (NY DFS). The final regulation requires institutions regulated by the NY DFS to actively monitor for potential Bank Secrecy Act and AML violations by maintaining transaction monitoring and watch list filtering programs. In addition, regulated institutions must adopt either an annual board resolution or finding by a senior compliance officer to certify that they have adhered to the final regulation, which may open them to individual criminal liability should controls prove inadequate. The final regulation will be effective January 1, 2017, and compliance will be required by April 15, 2018.
Changes to Form ADV
The SEC released a final rule regarding amendments to Form ADV and Investment Adviser Act rules, which will require advisers to provide greater disclosure and report additional information, including that of advisers’ use of social media. The goal of these amendments is to increase the depth and breadth of information provided, and by doing so, increase transparency and facilitate the SEC’s examination programs and enforcement initiatives.
The final amendments relate to the following:
1) Information regarding separately managed accounts — Advisers will be required to provide additional information about their separately managed accounts, including the types of assets held and the use of derivatives and borrowings in those accounts.
2) Additional information regarding investment advisers — Advisers will be required to disclose information about their branch office operations and whether they have one or more social media accounts where the adviser controls the content, including profile information for each account.
3) Umbrella registration — These amendments codify and simplify the umbrella registration procedure for registered fund advisers that operate a single advisory business through multiple legal entities.
4) Clarifying, technical and other amendments to Form ADV — These amendments are intended to make the filing process clearer and more efficient so that advisers are better able to understand and complete the Form.
5) Amendments to the Books and Records Rule of the Investment Advisers Act—Advisers will be required to “maintain additional materials related to the calculation and distribution of performance information.”
In its latest effort to improve regulatory safeguards for the asset management industry, the SEC proposed a new rule at the end of June that would require SEC-registered investment advisers (RIAs) to adopt business continuity and transition plans in the event of business disruptions such as natural disasters, cyber-attacks, technology failures, terrorist attacks, and similar events. The proposed rule would make it unlawful for RIAs to provide investment advice “unless the adviser adopts and implements a written business continuity and transition plan and reviews that plan at least annually.” In its press release, the SEC noted that “[the] proposed rule is designed to ensure that investment advisers have plans in place to address operational and other risks related to a significant disruption in the adviser’s operations in order to minimize client and investor harm.” It is worth noting that under the Investment Advisers Act, RIAs are already required to implement policies and procedures reasonably designed to prevent violations of the Act.
The SEC also remarked that there is a fiduciary element in the context of business continuity plans—as fiduciaries owning duties of care and loyalty to clients, investment advisers are “obligated to take steps to protect client interests from being placed at risk as a result of the adviser’s inability to provide advisory services.” However, the proposed rule takes business continuity plans past the realm of merely owing a fiduciary duty, and ventures that the failure to adopt appropriate business continuity plans is tantamount to fraud or deceit.
The proposed rule reasons that because of this fiduciary duty owed by investment advisers, “…clients are entitled to assume that advisers have taken the steps necessary to protect those interests in times of stress, whether that stress is specific to the adviser or the result of broader market and industry events,” and that “it would be fraudulent and deceptive for an adviser to hold itself out as providing advisory services unless it has taken steps to protect clients’ interests from being placed at risk as a result of the adviser’s inability (whether temporary or permanent) to provide those services.”
Worded as such, and without clarification or legal support, the proposed rule appears to encourage an overbroad application of defining fraud. This could have troubling implications for investment advisers, who may be subject to enforcement actions even with an appropriate business continuity plan in place, should unforeseen circumstances render a temporary inability to provide services. Industry groups have voiced concerns that this rule is overly prescriptive and may leave advisers open to fraud, even if advisers took reasonable steps to prevent against incidents, and have suggested that the rule should instead be framed as guidance.
Under the proposed rule, plans would be required to address the following: “(i) maintenance of critical operations and systems, and the protection, backup, and recovery of data; (ii) pre-arranged alternate physical locations of the advisers’ offices and employees; (iii) communications with clients, employees, service providers, and regulators; (iv) identification and assessment of third-party services critical to the operation of the adviser; and (v) transition plan that accounts for the possible winding down or transition of the adviser’s business to others in the event the adviser is unable to continue providing advisory services.”
In June 2016, the SEC adopted a higher net worth threshold for “qualified clients” under the Investment Advisers Act of 1940 (the Advisers Act), raising it from $2 million to $2.1 million. Investment advisers are exempted under the Advisers Act from the prohibition against charging client performance fees when the client is a “qualified client”. Under section 205(e) of the Advisers Act, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC is to adjust assets under management and net worth thresholds for inflation. The SEC did not make any changes to the current assets under management threshold, which remains at $1 million. The increased net worth amount became effective on August 15, 2016.
Now that the threshold to be a qualified client has been altered, it remains to be seen whether the SEC will modify the requirements for accredited investors. In December 2015, the SEC issued a staff report analyzing various approaches for adjusting the definition of an accredited investor under Regulation D of the Securities Act of 1933 (the Securities Act). This past February, the House of Representatives voted to expand the accredited investor definition in its approval of H.R. 2197, the “Fair Investment Opportunities for Professional Experts Act.” This would amend section 2(a)(15) of the Securities Act to include in the definition of “accredited investor” the following:
The last notable change in the accredited investor definition occurred in 2010, which excluded the inclusion of primary residence in calculating net worth. The current financial thresholds for accredited investors have not changed in 30 years. To qualify as an accredited investor, an individual must meet one or more of the following criteria:
Gatekeeper failures in recent enforcement action raises potential of additional regulation
In June 2016, a U.S. based fund administrator (referred hereto as “ABC Fund Administrator” for anonymity), was charged with gatekeeper failures for neglecting to heed red flags and correct faulty accounting for two of its clients, both of which have since been charged with fraud by the SEC. ABC Fund Administrator settled with the SEC for $350,000.
By providing accurate reporting of fund assets, administrators serve an important gatekeeper function for the alternative investments industry. In this instance, however, ABC Fund Administrator failed to fulfill its gatekeeper responsibilities by ignoring red flags that were related to their contractual duties, and enabling their clients’ fraud by not taking appropriate actions after discovering them. Red flags included undisclosed brokerage and bank accounts, undisclosed margin and loan agreement, transfers made in violation of fund offering documents, misrepresentation of withdrawals, and other indicia of the misappropriation of assets. In their failure to take reasonable steps after discovering these red flags, ABC Fund Administrator enabled their clients’ fraud by continuing to prepare inaccurate statements that were sent to investors.
Because of this, the SEC determined that ABC Fund Administrator was a cause in their clients’ violations of Sections 206(2) and 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. Section 206(2) prohibits investment advisers from engaging in any transaction which operates as a fraud or deceit upon clients or prospective clients. Section 206(4) and 206(4)-8 make it unlawful for investment advisers to a pooled vehicle to make untrue statements of material fact or to omit the statement of material facts necessary to make the statements not misleading to any investor or prospective investor in the pooled investment vehicle.
Previous Administrator Liability
In the United States, regulatory enforcement actions against fund administrators have been uncommon, but past SEC charges against fund administrators appear to center on compliance and recordkeeping violations. The ABC Fund Administrator Order seems to indicate regulatory intent to expand gatekeeper responsibilities, and may be the first step in the path towards regulating fund administrators.
Civil claims against fund administrators have centered around the issues of gross negligence, misrepresentation, and breach of fiduciary duty. In the civil claims, administrators’ gatekeeper liability and duty to investors has largely been limited by their contractual obligations with funds, under which the scope of services are varied.
Path Towards Regulation?
Overseas, fund administrators are already regulated. In the United Kingdom, fund administrators are regulated and must be authorized by the Financial Conduct Authority. In Ireland, fund administrators are authorized and supervised by the Central Bank of Ireland. In Bermuda, fund administrators are regulated under the Investment Funds Act 2006. In addition, overseas administrators are expected to implement best practices and are subject to various reporting requirements.
With intensifying scrutiny on the alternative investments industry and growing need for fund administrators, greater responsibility has been placed on administrators in middle-office support, reporting, and risk management functions. However, in light of the ABC Fund Administrator enforcement action, it follows that administrators will also need to adapt to expanded gatekeeper duties.
Given the current regulatory environment and the fact that fund administrators are already largely regulated overseas, U.S. regulators may follow suit and sweep administrators under their purview, especially in the event of mounting concerns over gatekeeper failures.
 In the Matter of Morgan Stanley Investment Management Inc., available at: <https://www.sec.gov/litigation/admin/2011/ia-3315.pdf>; In the Matter of Deloitte & Touche, LLP, ALPS Fund Services, Inc., and Andrew C. Boynton, available at: <https://www.sec.gov/litigation/admin/2015/34-75343.pdf>
 Bradshaw v. Maiden, 2015 NCBC 76.
Over the past few years, the SEC has increased their focus on private equity and continues to do so. Given the legal structure of private equity funds, it is difficult for investors to withdraw their capital from private equity investments should issues arise, making it critically important that all material information such as conflicts of interest are disclosed to investors at the time their capital is committed. In his speech at the Securities Enforcement Forum in May, Andrew Ceresney, Director of the SEC’s Enforcement Division, emphasized the fiduciary duties owed to investors by advisers, and the vulnerability of investors to fraud in situations where fees or conflicts of interest have not been disclosed, and where expenses have been misallocated. These areas—receipt of undisclosed fees and expenses, misallocation of expenses, and failure to adequately disclose conflicts of interest—comprise the bulk of the SEC’s actions against private equity fund advisers.
In a recent enforcement action reflecting the SEC’s focus on private equity funds and breaches of fiduciary duty, private equity firm Apollo Global Management was charged with disclosure and supervisory failures, ending in a $52.7 million settlement. The SEC found that Apollo had breached its fiduciary duty by failing to adequately disclose accelerated monitoring fees and making materially misleading disclosures about the allocation of interest on a loan. Finally, the SEC found that Apollo failed to reasonably supervise a partner who improperly charged personal items and services to Apollo-advised funds and their portfolio companies.
Enforcement in these areas is certainly not limited to private equity; inadequate fee disclosures and nondisclosure of conflicts of interest remain a target across the board, as demonstrated by the recent SEC action against Momentum Investment Partners. In this case, an advisory firm was charged with fraud for failing to disclose additional fees and material conflicts of interest. During its investigation, the SEC found that the firm moved some of its existing clients into new mutual funds, but failed to disclose that this shift would increase their advisory fees without a corresponding change in the clients’ investment strategy or additional services. As a result of the move, clients paid approximately $111,000 in additional fees.
Anti-money laundering (AML) violations continue to be pursued at all levels across regulatory agencies.
In the Financial Industry Regulatory Authority’s (FINRA) largest fine to date for AML failures, independent broker dealer Raymond James Financial Services was fined $17 million. During their investigation, FINRA found that Raymond James missed multiple red flags of potentially suspicious activity, and that its AML policies and procedures were inadequate for the firm’s size. Notably, these AML failures were a recurring offense. Raymond James was sanctioned in 2012 for having inadequate procedures, and as part of their settlement agreed to review their program to meet the relevant compliance requirements. Additionally, the firm’s AML compliance officer received a $25,000 fine and was suspended for three months, reflecting the regulatory trend of increased individual liability for compliance failures.
In June, the SEC charged New York brokerage firm Albert Fried for AML failures, settling for $300,000. The SEC found that the firm ignored numerous red flags that should have triggered the filing of suspicious activity reports (SARs). This was the first action brought against a firm solely for failing to file SARs.
SEC enforcement actions this year have surpassed the record levels from 2015, with a total of 868 actions and over $4 billion in disgorgement and penalties ordered. As such, anything less than constant vigilance in a fund’s compliance efforts is ill-advised.
 Andrew Ceresney, Securities Enforcement Forum West Keynote Address: Private Equity Enforcement (May 12, 2016) <https://www.sec.gov/news/speech/private-equity-enforcement.html>
 In the Matter of Apollo Management V, L.P., Apollo management VI, L.P., Apollo Management VII, L.P., and Apollo Commodities Management, L.P. Release No.4493, AP File No.3-17409, available at: <https://www.sec.gov/litigation/admin/2016/ia-4493.pdf>
 Securities and Exchange Commission v Momentum Investment Partners LLC (D/B/A Avatar Investment Management) and Ronald J. Fernandes, <https://www.sec.gov/litigation/complaints/2016/comp23549.pdf>
 Financial Industry Regulatory Authority Letter of Acceptance, Waiver and Consent No. 2014043592001 Re: Raymond James & Associates, Inc, available at: <https://www.finra.org/sites/default/files/RJFS_AWC_051816_0.pdf>
 In the Matter of Albert Fried & Company, LLC, Release No. 77971, June 1, 2016, AP File No.3-17270, available at: <https://www.sec.gov/litigation/admin/2016/34-77971.pdf>
 Press Release, ’SEC Announces Enforcement Results for FY 2016’ (October 11, 2016) <https://www.sec.gov/news/pressrelease/2016-212.html>
Reforms to the SEC’s adjudicative process may be a Pyrrhic victory in light of Lucia decision
In July 2016, the SEC approved reforms to its in-house adjudicative process for administrative proceedings. SEC administrative proceedings are conducted by administrative law judges (ALJs) employed by the SEC, which has given rise to multiple complaints about bias and lack of fairness for respondents, in addition to the constitutionality of the ALJs themselves. A common complaint amongst respondents in SEC cases it hat administrative proceedings give the SEC a “home court advantage”, with almost a 90% success rate for the SEC. The current reforms, according to the SEC, “are intended to update the rules and introduce additional flexibility into administrative proceedings, while continuing to provide for the timely and efficient resolution of the proceedings.” The amendments include more preparation time for parties involved in a case, allow parties to take depositions, expansion of recovery, and motions for summary disposition. Although these changes seem to make the process somewhat fairer for respondents, a question remains about the inherent fairness of having a case tried by an employee of the SEC.
A case regarding the constitutionality of the appointment of SEC judges was recently heard in the U.S. Court of Appeals for the D.C. Circuit, in Lucia v. SEC, with the court deciding in favor of the SEC. at issue was whether the ALJs employed by the SEC were constitutional Officers who were not appointed pursuant to the Appointments Clause of the U.S. Constitution. For an appointee to be considered an Officer, they need to exercise “significant authority pursuant to the laws of the United States.” The court used a three-prong test to distinguish between Officers and employees not covered by the clause: 1) the significance of the matters resolved; 2) the discretion exercised in reaching their decisions; 3) the finality of the decisions.
The court’s decision turned on the third prong of this test—whether or not the decisions reached by the ALJs were final. Given that the SEC has discretion to review initial decisions and the decisions are subject to a finality order issued by the SEC, the SEC must make a final action by either making a new decision or embracing the ALJ’s initial decision as its own. Thus, the court concluded that the SEC retained full decision-making powers, and that the act of issuing the finality order is what makes an ALJ’s decision “final”. As the third prong was not satisfied, the court ruled that ALJs are not Officers within the meaning of the Appointments Clause.
Thus, despite the progress made with the SEC reforms, the Lucia ruling was a significant victory for the SEC and has vindicated its ever increasing use of in-house courts.
 Jean Eaglesham, The Wall Street Journal, ‘SEC Wins with In-House Judges’ (May 6, 2015) <http://www.wsj.com/articles/sec-wins-with-in-house-judges-1430965803>.
 Press Release, ‘SEC Adopts Amendments to Rules of Practice for Administrative Proceedings’ (July 13, 2016) <https://www.sec.gov/news/pressrelease/2016-142.html>
 U.S. Const. art. II, §2, cl. 2.
 Raymond J. Lucia Co. v. SEC (D.C. Circ. 2016), quoting Buckley v. Valeo, 424 U.S. 1, 132 (1976) at 9
 Lucia, citing Landry v. FDIC, 204 F.3d 1125 (D.C. Circ. 2000), Freytag v. Comm’r Internal Revenue, 501 U.S. 868, 880 (1991)
Expect more aggressive SEC enforcement in 2016.
After an active year in 2015 with a record number of enforcement actions brought, the SEC shows no signs of slowing down in 2016 as it aggressively pursues its “broken windows” approach to enforcement. The SEC touted its “aggressive and innovative approach to enforcement” in its 2015 Annual Report, ending the year with 807 enforcement actions and orders for $4.2 billion in penalties and disgorgement. In addition, there was a 23% rise in independent administrative proceedings and civil injunctive actions, with 507 actions being brought.
The SEC’s Office of Compliance Inspections and Examinations (OCIE) released its 2016 Examination Priorities in January, organized around the thematic areas of (i) protection of retail investors and investors saving for retirement; (ii) assessing market-wide risks; and (iii) identification of illegal activity. In assessing market-wide risks, cybersecurity remains a top priority. The SEC will continue their efforts in scrutinizing cybersecurity practices, including testing and conducting assessments of firms’ procedures and controls. In addition, they will focus on liquidity controls and examine funds that have exposure to potentially illiquid fixed income securities. With ever-improving technological and data analysis capabilities, the SEC has substantially increased its capacity to detect illegal activity. Anti-money laundering (AML) programs will continue to be examined, with particular attention to firms that have inadequate testing programs, weak internal policies and procedures, and to spot inconsistencies or deficiencies in suspicious activity reports (SARs).
SEC scrutiny on private placements will likely intensify. In particular, the SEC will concentrate on whether legal requirements for due diligence, disclosure and suitability are being met. Notably, the SEC will prioritize conducting examinations on never-before-examined investment advisers and investment companies. Private fund advisers can also expect to be examined at some point, with the SEC maintaining a focus on fees and expenses, and evaluating controls and disclosures.
The sharp rise in SEC enforcement has also put a spotlight on conflicts of interest and disclosure, and has evinced a trend in imposing individual accountability for corporate wrongdoing. The SEC has demonstrated increasing vigor in these areas, such that enforcement actions have been brought as a result of weaknesses in internal controls and technical violations that markedly did not include any allegations of fraud.
Individual accountability for corporate wrongdoing is also expected to increase. The Yates Memo, which promulgated the Department of Justice’s policy on corporate cooperation with criminal investigations, noted that in investigations of corporate wrongdoing, focus should be maintained on the responsible individuals, and that “criminal and civil corporate investigations should focus on individuals from the inception of the investigation.” The Yates Memo also put significant emphasis on the importance of self-disclosure, stating that in order for a company to be eligible for any cooperation credit whatsoever, they “must identify all individuals involved in or responsible for the misconduct at issue, regardless of their position, status or seniority, and provide to the Department all facts relating to that misconduct.” Not only is full disclosure required, the Yates Memo puts the onus on companies to learn of the relevant information in the first place, explaining that where a company has failed to learn of relevant facts, “its cooperation will not be considered a mitigating factor” in an investigation. Self-disclosure will also be of heightened enforcement in FCPA investigations. SEC Director of the Division of Enforcement, Andrew Ceresney, noted in his Keynote Address at the ACI’s 32nd FCPA Conference that in order for companies to be eligible for a Deferred Prosecution Agreement (DPA) or Non-Prosecution Agreement (DPA), companies must self-report.
The SEC will also benefit from increased funding, furthering their enforcement capabilities. In the Budget of the United States Government for Fiscal Year 2017, the President proposed to double the funding of the SEC and Commodity Futures Trading Commission (CFTC) by 2021. The down payment includes $1.8 billion for the SEC and $330 million for the CFTC. The target date for Congress to pass the budget resolution is April 15. The increase in funding would enable the SEC to add more examiners and thus bring more enforcement actions, in part assisted by the SEC’s recent creation of the Office of Risk and Strategy within OCIE.
Recent trends in regulatory enforcement are unlikely to diminish this year, and firms should fully prepare for intensifying scrutiny and a rise in enforcement for technical violations.
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Private equity funds must maintain strong operational standards in the face of increased enforcement actions by the SEC. Fees passed on to private equity funds by the fund manager have recently come under increased scrutiny.
The SEC put the private equity world on notice with enforcement actions against some of the industry’s biggest players in the summer of 2015. Blackstone incurred a $10 million fine and was required to reimburse investors an additional $29 million due to failures of disclosure on accelerated monitoring fees. Around the same time, KKR was fined $30 million for failing to disclose, in sufficient detail, information regarding broken deal fees expensed at the fund.
The focus on fees at private equity funds continued into the fourth quarter of 2015. Several fund managers were fined by the SEC in November. In one example, the fund manager ran afoul of the SEC for allocating expenses incurred for the fund manager’s legal and compliance requirements, while not disclosing this fully to investors. In another similar action, the SEC fined a fund manager for improperly passing on compliance consultant fees and expenses for the fund manager’s supplies, computers, and utilities to the fund without proper disclosure.
Considering the zeal with which the SEC is investigating PE funds’ fees and expenses, what are the key takeaways for PE fund managers? First, general disclosures in a fund’s offering documents regarding the allocation of fees and expenses do not give a manager as wide a discretion as the managers may have thought. For example, language that allows a fund to be charged for expenses arising out of the operation of the fund made in a good faith judgment of the manager does not allow the manager to charge the fund for expenses incurred for the manager’s legal and compliance requirements. These general disclosures are very common in fund legal documents, but recent SEC actions show this language is narrower than perhaps expected.
Second, managers need to examine their legal agreements to address the SEC’s approach. The SEC’s actions demonstrate that the fees and expenses of the fund manager cannot be expensed to the fund unless expressly stated in the fund’s legal documents. If a fund’s legal documents are silent or vague in this regard, the managers need to review their compliance procedures to be sure that policies and practices are in place to determine and monitor how expenses are allocated.
PE fund managers should also be aware that the SEC plans to continue down this path of focusing on fees and expenses at private equity funds. At the SEC Speaks conference in Washington, DC in February 2016, Marshall Sprung the Chief of the Asset Management Unit of the SEC’s Division of Enforcement said he expects the SEC to bring cases involving misallocations of fees and expenses in the private equity context in 2016. So expect much of the same in 2016.
In conclusion, the SEC will continue to focus on managers’ allocation of fees and expenses in PE funds. A manager should be clear when writing their legal agreements and be sure they are knowledgeable on the terms of their current agreements. Should you have any questions on your current allocation methodology, Piedmont is prepared to lend our experience.
Cybersecurity was a hot topic in 2015, and will continue to be this year, with the regulatory agencies issuing guidance and notices relating to firms’ cybersecurity practices.
The National Futures Association (NFA) issued a cybersecurity notice in October 2015, which became effective on March 1, 2016. This requires NFA members to put in place supervisory practices “reasonably designed to diligently supervise the risks of unauthorized access to or attack of their information technology systems, and to respond appropriately should unauthorized access or attack occur.” The notice outlines key areas relating to Members’ Information Systems Security Programs (ISSPs), which includes a written program, security and risk analysis, deployment of protective measures against identified threats and vulnerabilities, incident response plan, and employee training.
In addition, firms must regularly monitor and review the effectiveness of their ISSP, agreements with third party service providers, and recordkeeping policies and procedures.
The NFA appears committed to taking a cooperative approach with firms implementing cybersecurity practices, looking to work with Members “to help move them towards compliance.” This stands in stark contrast to the punitive approach of other regulatory agencies.
OCIE will continue its efforts in examining cybersecurity controls, with its 2015 Cybersecurity Examination Initiative serving as a roadmap as to what aspects of cybersecurity they will focus on in 2016. These priorities are focused on the areas of governance and risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response. At the recent SEC Speaks Conference in February, Deputy Director of Enforcement, Stephanie Avakian noted that the SEC is focused on cases where there has been a failure to safeguard customers’ information, cases where material nonpublic information has been stolen for the purpose of illegal trading, and cybersecurity disclosure failures by public companies (although they have yet to bring a case charging this). There appears to be a trend in cybersecurity enforcement actions that mirrors what we have seen in AML enforcement actions; namely, that the SEC will commence actions against firms that have not adopted any written cybersecurity policies and procedures, as was the case in the SEC order against RT Jones Capital Equities Management.
In its 2016 Regulatory and Examination Priorities Letter, FINRA has stated that it will focus on firms’ supervision and risk management related to cybersecurity, technology management, and data quality and governance.
In reviewing firms’ approaches to cybersecurity risk management, they will examine governance, risk assessment, technical controls, incident response, vendor management, data loss prevention and staff training. These reviews will also involve consideration of the ability of firms to protect the confidentiality, integrity, and availability of sensitive customer information. With regard to technology management, FINRA will examine firms’ technology governance and change management practices. In examining data quality and governance, FINRA will assess firms’ data governance, quality control and reporting practices to ensure that firms can adequately monitor and report key information needed for effective risk management.
In its 2016 Regulatory and Examination Priorities Letter released in January, the Financial Industry Regulatory Authority (FINRA) addresses the issues of culture, conflicts of interest and ethics, risk management and controls, and liquidity. FINRA’s emphasis on scrutinizing firm culture is a top priority, despite concerns that it amounts to micromanagement of a subjective concept. FINRA noted that it would assess five indicators of firm culture: “whether control functions are valued within the organization; whether policy or control breaches are tolerated; whether the organization proactively seeks to identify risk and compliance events; whether supervisors are effective role models of firm culture; and whether sub-cultures that may not conform to overall corporate culture are identified and addressed.”
FINRA subsequently issued a sweep letter to Members, noting its intent to review “how firms establish, communicate and implement cultural values, and whether cultural values are guiding business conduct.” As part of this review, FINRA plans to meet with executive business, compliance, legal, and risk management staff of Member firms in order to discuss their cultural values. In preparation for these meetings, FINRA has requested information concerning the following by March 21, 2016:
The issues surrounding FINRA’s prioritization of assessing firm culture is rooted in concerns of fraud and breach of the fiduciary duties owed to investors, however difficult an assessment of firm culture may be.
Interestingly, a recent paper by business school professors at the University of Chicago and University of Minnesota highlights the relevance of firm culture in the first large-scale study to document the economy-wide context of misconduct among financial advisers and advisory firms. It found that about 7% of financial advisers have misconduct records, and at some of the leading financial firms in the country, more than 15% of financial advisers have misconduct records. Out of those financial advisers who had been fired for misconduct, 44% were reemployed in the financial services industry within a year. “The substantial presence of repeat offenders implies that the industry does not immediately purge advisers who have engaged in misconduct”. The paper posits that there is a “match on misconduct”, whereby those advisers who lose their jobs following misconduct simply move on to firms that are more tolerant of, and engage in more misconduct. Although individual firms may be strict in terminating the employment of advisers found to have engaged in misconduct, the financial industry was found to be “substantially less strict than firms individually,” and that “The reallocation of financial advisers to new firms partially blunts the firm-level response to misconduct,” an occurrence which frustrates the financial industry’s disciplining mechanism, decreasing the punishment for misconduct.
The study found that misconduct is more common among firms that advise retail investors, and in wealthy, elderly, and less educated counties, suggesting that misconduct is targeted at customers with potentially less financial sophistication.
The authors suggest that an increase in market transparency and policies helping unsophisticated consumers access more information is a natural policy response to decreasing instances of misconduct. Will FINRA’s scrutiny on firm culture assist in this goal, or does it go too far in its micromanagement?
 Ibid, 14
 Ibid, 21
 Ibid, 18
 Ibid, 26
 Ibid, 26-27
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