AML Failures at GTS

This year is the year that registered investment advisers need to get fully on the bandwagon with the Bank Secrecy Act. FinCEN promulgated the Investment Adviser Rule to spread the Bank Secrecy Act requirements. While most investment advisers are doing some form of AML-CFT reviews, the process is now subject to explicit regulatory requirements. The compliance date is January 1, 2026.

I’ve been keeping an eye on AML actions brought by the SEC to use those failures to help understand what investment advisers need to do (and should not do.)

GTS expanding rapidly as a market maker for OTC securities. From 50,000 daily trades in August 2019 to 200,000 in August 202o, becoming the second largest broker-dealer for OTC securities. According to the SEC order, GTS failed to adopt and implement reasonably designed AML policies and procedures to surveil OTC transactions within its OTC unit and failed to file Suspicious Activity Reports when required to do so by the SAR Rule.

GTS had an AML surveillance system that flagged high-volume trading activity and submitted a report to an OTC unit supervisor. However that supervisor’s primary responsibilities were unrelated to the AML program and did not report to the AML CCO. So the flags went largely unaddressed.

The policies and procedures gave the supervisor little guidance on what to do or what to look for. According to the SEC order, the polices should have listed these as suspicious transactions:

a. Trading activity that comprised a significant proportion of the daily trading volume in a thinly traded or low-priced security;

b. Trading activity involving sudden spikes in demand for, coupled with sudden price changes in, a thinly traded or low-priced security, including instances of such trading coupled with suspicious stock promotion activity; and

c. Significant trading in a thinly traded or low-priced security previously subject to a Commission trading suspension.

The AML failures cost GTS a $350,000 fine.

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Don’t Share Material Non-Public Information with Your Sister-in-Law

Al Tobia was an insider at two publicly traded companies, obtained material nonpublic information about potential corporate transactions involving three other publicly traded companies. With that information, Tobia tipped his sister-in-law who purchased shares of these three companies in her brokerage account and in an account held by her elderly parents. At least according to the complaint filed against them by the Securities and Exchange Commission.

The source is suspicious trading.

In one of the instances, Lee purchased 102,000 shares in her parents’ account for $765,000. That was half of the account value at the time. Two weeks later the share price rises 26% based on the disclosure of a potential acquisition.

I’m sure the brokerage’s compliance team raised a red flag on the transaction and alerted FINRA and the SEC. Then they dived deeper into the trading of this account and Lee’s own account. That revealed other suspicious transactions.

They get phone records and tie calls to the dates and times that Lee traded. Discovered the calls were with Tobia and that he is her brother-in-law.

They sensibly settle and pay penalties. Tobia gets banned from serving as an officer or director of a public company for five years.

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The SEC versus Musk

If you work in compliance at a shop that does buyouts, you know all about the filing requirements under Rule 13d-1 and the filing thresholds for Schedule 13D and Schedule 13G. Elon Musk doesn’t care. The SEC cares and finally filed the enforcement against Mr. Musk for his shenanigans around the acquisition of Twitter.

The case is very straightforward. Rule 13d requires investors to disclose a stake of 5% or more in a public company within 10 days. The rule came out of the Williams Act of 1968 to help investors make informed investment decisions by providing information about large acquisitions of securities of a company by someone who has the potential to change or influence control of that company.

Musk’s defense seems to basically be that the SEC should focus on other, more important issues.

Given the timing, this will be dumped on the new Chair of the SEC. We’ll get an early indication of how independent the SEC will be from President Trump. I’m sure Musk will ask that the case be shut down.

I’m sure that buyout shops are closely monitoring this to see whether they have to follow the rule of law and comply.

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Investment Advisers Hit with Texting Fines

Twelve firms were hit with fines for off-channel communications. I’ve been waiting for these cases to come out. A couple of these firms have publicly traded securities and there have been notes that they are working through enforcement actions for off-channel communications.

  • Blackstone Alternative Credit Advisors LP, together with Blackstone Management Partners L.L.C. and Blackstone Real Estate Advisors L.P., agreed to pay a combined $12 million penalty;
  • Kohlberg Kravis Roberts & Co. L.P. agreed to pay a $11 million penalty;
  • Apollo Capital Management L.P. agreed to pay a $8.5 million penalty;
  • Carlyle Investment Management L.L.C., together with Carlyle Global Credit Investment Management L.L.C., and AlpInvest Partners B.V., agreed to pay a combined $8.5 million penalty;
  • TPG Capital Advisors LLC agreed to pay an $8.5 million penalty;
  • Charles Schwab & Co., Inc. agreed to pay a $10 million penalty;
  • Santander US Capital Markets LLC agreed to pay a $4 million penalty;
  • PJT Partners LP, which self-reported, agreed to pay a $600,000 penalty.

Santander and PJT are broker-dealers and subject to the strict record-keeping of that regulatory regime. Schwab is duly registered. The rest are pure investment advisers.

My reading of the orders indicates that those firms were subject to a sweep examination by the SEC focused on off-channel communications. The SEC asked for review of mobile devices. They found messages that were required to be retained as business records under Rule 204-2(a)(7).

Here are the four areas the SEC mentioned in the orders:

(a) any recommendation made or proposed to be made and any advice given or proposed to be given;
(b) any receipt, disbursement or delivery of funds or securities;
(c) the placing or execution of any order to purchase or sell any security; or
(d) predecessor performance and the performance or rate of return of any or all managed accounts, portfolios, or securities recommendations.

Let’s see if the those orders give us any insight into the SEC’s take on off-channel communications for investment advisers.

Blackstone:

For example, a Blackstone Alternative Credit Advisors senior managing director exchanged messages with multiple colleagues on an unapproved platform concerning proposed investment advice for a client. Similarly, a Blackstone Management Partners senior managing director exchanged messages with a colleague on an unapproved platform concerning proposed investment advice for a client. Additionally, a Blackstone Real Estate Advisors senior managing director exchanged messages with multiple colleagues on an unapproved platform concerning investment advice for a client.

TPG:

For example, a TPG Capital Advisors principal exchanged multiple messages with a colleague and with personnel at another investment adviser on an unapproved platform concerning a proposed investment by a client fund in a target company.

For example, a TPG Capital Advisors partner exchanged messages with a colleague on an unapproved platform concerning potential trades on behalf of a client fund.

KKR:

For example, two KKR partners exchanged messages on an unapproved platform concerning the specific pricing, within the range previously approved by the investment committee responsible for a client’s investments, at which KKR should bid for the client to participate in a transaction.

As another example, the two KKR partners exchanged messages on an unapproved platform concerning whether KKR should offer to have one or more of its private fund clients buy into the junior tranche of a transaction.

Apollo:

For example, an Apollo partner exchanged a number of messages on an unapproved platform with Apollo colleagues about a proposed recommendation to increase a position for a client. Another partner exchanged messages with a colleague on an unapproved platform about the terms and execution of a securities transaction for a client.

Carlyle:

For example, a managing director affiliated with Carlyle Credit exchanged several messages with an insurance company regarding the disbursement of funds related to a transaction. In another example, a partner associated with Carlyle exchanged messages with another partner about the performance of a Carlyle investment vehicle.

The big question is whether these off-channel communications investigations are going to continue under the new SEC Chair. These seem like relatively easy wins for the SEC. And they keep compliance officers up at night.

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Don’t Forget to Trim Your Hedge Clauses

An investment adviser has an non-waivable fiduciary duty to its clients. If you try to waive the fiduciary or deceive your clients into thinking its waivable, the Securities and Exchange Commission is going to be unhappy with you. These waivers of fiduciary duty are often called “hedge clauses.”

The SEC settled charges against a registered investment adviser and fund manager, ClearPath Capital Partners, for using hedge clauses in advisory agreements and fund documents in violation of Section 206(2) of the Advisers Act (anti-fraud). The SEC claimed that the private fund documents included “misleading” hedge clauses limiting the scope of its non-waivable fiduciary duty.  The SEC found that the hedge clauses “could lead a client to believe incorrectly that the client had waived a non-waivable cause of action against the adviser provided by state or federal law.” 

If you remember back to the proposed Private Fund Adviser Rules (now defunct), the SEC initially proposed a new regulation that would have explicitly prohibited hedge clauses. That regulation was dropped from the final rule, but in the release commentary the SEC said the regulation was unnecessary because hedge clauses are a clear violation.

In the ClearPath case, the SEC cites back to the Commission Interpretation Regarding Standard of Conduct for Investment Advisers, IA Rel. No. 5248 (June 5, 2019).

“[T]here are few (if any) circumstances in which a hedge clause in an agreement with a retail client would be consistent with [] antifraud provisions, where the hedge clause purports to relieve the adviser from liability for conduct as to which the client has a non-waivable cause of action against the adviser provided by state or federal law. Such a hedge clause generally is likely to mislead those retail clients into not exercising their legal rights, in violation of the antifraud provisions, even where the agreement otherwise specifies that the client may continue to retain its non-waivable rights.” p. 11, fn. 31.

The SEC also pointed out that hedge clauses are generally inconsistent with an adviser’s fiduciary duty regardless of the sophistication of the client.

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Corporate Transparency Act is Back from the Dead (Update: No it’s Not)

On Monday afternoon, the Fifth Circuit issued and order to stay the nationwide injunction against the Corporate Transparency Act. Filings are now due by the end of the year.

UPDATE: And another panel at the Fifth Circuit reversed and let the stay remain in place.

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Firms Dinged for Form D Failures, or Something More(?)

The Securities and Exchange Commission brought charges against three firms for failing to file Form D on time.

Under Rule 503 of Regulation D, an issuer offering or selling securities in reliance on Rule 504 or 506 must file a notice of sales on Form D with the SEC no later than 15 calendar days after the first sale of securities in the offering. You don’t lose the exemption for a failure to file, but failing to file is a violation of the Securities Act.

The SEC targeted GRID 202 LLC, Pipe Technologies Inc., and Underdog Sports Holdings, Inc. for failing to file. Foot-fault. Easy action by the SEC.

What caught my attention was each of the three orders also stated that the firm engaged in general solicitation and contacted more than [285, 140, or several hundred] prospective investors.

Because Respondent engaged in general solicitation, the offerings could not have been conducted as exempt offerings under Section 4(a)(2) of the Securities Act and therefore could not have been conducted without reliance on Rule 504 or Rule 506(c) of Regulation D. Accordingly, Respondent needed to file a Form D for each offering, but Respondent failed to timely file Forms D for all of these offerings.

It would have been great if the SEC had said what action made those contact “general solicitation” instead of mere “solicitation.” But the orders provide no insight and just state the conclusion that it was general solicitation.

We are just left with reminder to file Form D within 15 calendars of your first sale of interests in a private offering.

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The Death of the Corporate Transparency Act? (or not)

If you’re reading this, you’ve probably put a bunch of time into getting ready for compliance with the Beneficial Ownership Information reporting under the Corporate Transparency Act. You already know that there has been a nationwide injunction put in place to temporarily stop implementation of the requirements.

Texas Top Cop Shop, Inc. v. Garland (E.D. Tex. Dec. 3, 2024) is one of four cases floating through the judicial system attacking the Corporate Transparency Act. It is only one that has caused much of a ripple. The judge didn’t overturn the CTA. He merely issued the injunction based on the likelihood that the the CTA would be found to be unconstitutional.

Back in March in Alabama, the judge in National Small Business United v. Yellen merely applied his ruling to the parties to the case. If you were a member of the National Small Business United group, you’ve been celebrating for a while. That judge found the CTA to be unconstitutional.

On the other side, Courts in the District of Oregon and the Eastern District of Virginia have come down the other way. The judges in Firestone v. Yellen (D. Or. Sept. 20, 2024) and Community Associations Institute v. Yellen (E.D. Va. Oct. 24, 2024) found that the CTA was likely to be found constitutional and denied the request for an injunction.

All four decisions are under appeal. Do we think all four appellate courts are going to deny injunctions? Maybe. If we get splits, that would make it very likely that the US Supreme Court will take up the case to reconcile the dramatically different results.

Then we have to add in whether the Trump administration will continue to support the appellate process. Who knows what will happen after January 20.

I wish FinCEN was offering a better on-ramp. The current position has a hair-trigger.

[R]eporting companies are not currently required to file their beneficial ownership information with FinCEN and will not be subject to liability if they fail to do so while the preliminary injunction remains in effect. 

The way I read this if the injunction is lifted on January 2, then Reporting Companies have to immediately file to be in compliance.

You can currently file voluntarily. My provider has told me that the automated filing process has been disabled while the injunction is in place.

Hopefully, FinCEN will quickly get a better idea of timing and extend the compliance deadline out for several months while the litigation is ongoing.

The latest short term funding bill has a provision moving the compliance date from January 1, 2025 to January 1, 2026. Of course that could change.

The US filed a motion to stay the injunction pending the appeal. That was (no surprise) denied on December 17.

On the appeal, motions had to be filed this week with the Fifth Circuit Court of Appeals. FinCEN is asking for an emergency motion for stay pending appeal. Maybe the Court is looking to make a ruling by the end of the year. If it stays the injunction, that will cause havoc on many people’s year-end as they ramp back up for the filing process.

Based on filing on December 17 and December 18, the Fifth Circuit is allowing amicus filings on the appeal. That makes it seem less likely that a ruling will come out by year end.

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(update this morning from the original post)

A Step Up in Fraud From the Nigerian Prince

In this case, the “prince” was a well established financial adviser. Chibuzo Augustine Onyeachonam, Stanley Chidubem Asiegbu, and Chukwuebuka Martin Nweke-Eze created websites using the the names of real US-based financial professional.

For example assuming I was known financial professional and wanted to impersonate me they would create dougcornelius.com and send an email from doug @ dougcornelius.com. Then lure them in with chats and linkedin comments and Youtube videos. Finally convince the victims to send money, purported to be invested.

Of course, the money was stolen instead. Often using bitcoin.

Protect yourself. Do you own your name domain? That’s a cheap and easy way to control and prevent. Do you have a Google Alert on your name? https://www.google.com/alerts

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Nabbing RIAs to Private Funds Who Do Not File Form PF

Private fund advisers managing $150 million or more of assets have been required to make annual filings on Form PF since 2012. (More often in some cases.) It’s really easy for the Securities and Exchange Commission to match the Form ADV data listing private funds to the Form PF filings for those funds. And it should be just as easy to find those firms who list private funds on Form ADV but didn’t file Form PF for those funds.

The SEC nabbed seven firms that failed to file Form PF for several years. The firms had to pay fines ranging from $90,000 to $150,000. It wasn’t clear why there was a relatively broad range of fines. Size of the firm? Size of the fund? There was no reason to find fraud or malice.

“The SEC uses information collected on Form PF in its regulatory programs, including examinations, investigations and investor protection efforts relating to private fund advisers.  The SEC publishes quarterly reports with aggregated information and statistics derived from Form PF data to inform the public about the private fund industry.  It also provides Form PF data to the Financial Stability Oversight Council to help it evaluate systemic risks posed by hedge funds and other private funds.”

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