Author: Doug Cornelius

You can find out more about Doug on the About Doug page

The One Where You Really Want to Be 94% ESG

Before the current backlash in the political environment, many investors were very focused on making investment that took into account positive environmental, social, and governance factors. Invesco wanted to meet the needs of its investors by saying that it had “over 94% of AUM currently integrating ESG.”

That’s a great goal. If it was true.

It wasn’t.

A third of Invesco’s AUM was management of the QQQ Trust ETF that tracks the 100 largest non-financial companies traded on the Nasdaq exchange. As a passive index, it’s not taking ESG into account. Invesco could have excluded that amount from its calculation and only include actively managed. But it didn’t.

Invesco stated that its ESG-integrated investment strategies had a “minimal but systematic” level of ESG integration. Invesco could have defined what that meant when it did its internal surveys to determine compliance. But it didn’t.

The result is a $17.5 million fine.

Sources:

SEC Compliance Outreach Seminar

On Thursday November 7, the Securities and Exchange Commission produced an online compliance outreach program for registered investment adviser and investment companies. Here are a few notes and points that caught my attention. There were lots of video production issues and sound issues throughout the program.

It kicked off with a welcome from Chair Gensler, broadcasting from his home office. (I assume he is planning to exit the Commission with the change in administration.) He was introduced by Vanessa Horton, National Associate Director, SEC, Division of Examinations.

That was followed by Marshall Gandy, National Associate Director, Division of Examinations introducing Keith Cassidy, Acting Director, SEC, Division of Examinations. He was joined by Natasha Vij Greiner, Director, SEC, Division of Investment Management and Sam Waldon, Acting Deputy Director and Chief Counsel, SEC, Division of Enforcement, for the SEC Directors Panel.

The discussion started off about the three division talking about how they collaborate. Mr. Cassidy stated that the target for examinations is 3,000 a year. They highlighted the training of examiners for compliance with the marketing rule.

The next panel was Information Security & Operational Resiliency  

Speakers:

  • Alexis Hall, Acting National Associate Director, SEC, Division of Examinations, Technology Controls Program (Moderator)
  • David Joire, Senior Special Counsel, SEC, Division of Investment Management, Chief Counsel’s Office
  • Mike Khalil, Senior Counsel, SEC, Division of Investment Management
  • Salvatore Montemarano, Senior Specialized Examiner, SEC, Division of Examinations, Technology Control Program
  • Nikolay Vydashenko,  Assistant Director, SEC, Division of Enforcement, Fort Worth Regional Office
  • Cheryl Zabala, Chief Compliance Officer, Pretium Partners, LLC

Regulation SP amendments were adopted earlier this year. The compliance date is in 2025. It was highlighted in the examination priorities.

Phishing strategies are the biggest threat to firms. An employee doing the wrong thing is more likely than a skilled hacker busting through your firewalls.

Artificial Intelligence is an upcoming risk. There are no clear rules yet.

Companies need to conduct regular cybersecurity threat assessment.

Off channel communications. Would a single rogue employee trigger an enforcement action? It’s a black and white rule. There are no de minimis waiver. There does not need to be an intent of fraud. Nikolay points out that in the enforcement actions it has been pervasive use of off-channel communications and a violation of a firm’s policy. Push back from the panel is that the perception is that there is zero tolerance policy. Separate firm devices and personal devices is expensive.

Panel III: Private Fund Adviser Topics

The private fund panel, after lunch, lacked any sound. You could see the techs on screen trying to pull up the settings. The entire beginning of the panel was lost. Sadly, this was the panel I was most interested in.

  • Jennifer Duggins, Assistant Director and Co-Head of the Private Funds Unit, SEC, Division of Examinations, New York Regional Office (Moderator)
  • Shane Cox, Regulatory Counsel, SEC, Division of Examinations, Private Funds Unit, Philadelphia Regional Office
  • Lee A. Greenwood,  Assistant Regional Director, SEC, Division of Enforcement, Asset Management Unit, New York Regional Office
  • Adele Kittredge Murray, Private Funds Attorney Fellow, SEC, Division of Investment Management, New York Regional Office
  • Michael Neus, Chief Administrative Officer, Brevan Howard US Investment

IRR calculations net and gross both need to address use of a credit line. Hypothetical performance concerns were highlighted. The first prong is have policies and procedures on who gets hypothetical performance. Substantiation. Fund manager needs to retain back up for the performance figures in a PPM or slide deck. Mike, the industry representative, pointed out that the marketing rule often conflicts with what institutional investors want for data.

Adele highlighted new amendments to Form PF that require additional reporting requirements for Large Hedge Funds. The trigger events are substantial loss like issues at the fund: large margin calls, large redemption requests. You’ve got 72 hours to make the filing. For Private Equity the additional reporting are for secondary offerings and some other events.

Valuation is always a regulatory focus for private funds. Private credit was identified as a new risk.

Enforcement threw bombs at MNPI and highlighted some recent insider trading cases.

Fees and expenses disclosures, are they enough? Is there is enough for a reasonable investor to make an informed decision.

The panel focused on the use of the word “may”. Don’t use “may” if it’s something you do all the time.

Panel IV: Marketing Rule

Speakers

  • Karen Stevenson, SEC, Senior Program Adviser, Division of Examinations, National Exam Program Office (Moderator)
  • Melissa Harke, Senior Special Counsel, SEC, Division of Examinations, Office of Chief Counsel
  • Scott Jameson, Senior Counsel, SEC, Division of Investment Management
  • Brianna Ripa, Assistant Director, SEC, Division of Enforcement, Asset Management Unit
  • Karyn Vincent, Senior Head-Global Industry Standards and GIPS Executive Director, CFA Institute

Always looking for more insight. Dipped the toes into the water as to whether something is an advertisement. Is it an “offer for advisory services” is the standard. Of course, even if it’s not an advertisement, a communication is still subject to the anti-fraud provisions of Section 206.

Material focused on a particular investor is an advertisement if you just pull a stock piece of collateral and slap the investor’s name on the cover.

What is “performance” as opposed to “portfolio attributes”?

DOE ran a sweep on hypothetical performance marketing. The assumption is that is it likely to be deceptive. It can’t be used in broad marketing. So websites are generally bad placed to have hypothetical performance.

Testimonial and endorsements (which one is for clients and which is for non-clients?) require disclosures. There has to be written agreements and oversight.

They spoke about the “Official Wealth Management Partner of”… case. They didn’t provide much justification that this was an endorsement. They pointed out that the firm has other testimonial that weren’t from actual clients.

Panel V: Registered Investment Advisers

  • Ryan Hinson, Regulatory Counsel, SEC, Division of Examinations, Los Angeles Regional Office (Moderator)
  • Aaron DeAngelis, Examination Manager, SEC, Division of Examinations, Philadelphia Regional Office
  • Colin Forbes, Assistant Director, SEC, Division of Enforcement, Boston Regional Office
  • Anna Sandor, Senior Counsel, SEC, Division of Investment Management
  • Jim D’Sidocky, General Counsel & CCO, Sanders Capital, LLC

They pointed out the SEC guidance on the 2019 fiduciary standards of investment advisers: https://www.sec.gov/files/rules/interp/2019/ia-5248.pdf

They also pointed out the guidance on compensation disclosure: https://www.sec.gov/investment/faq-disclosure-conflicts-investment-adviser-compensation

Panel VI:  Hot Topics Lightning Round

  • Steven Levine, Senior Special Counsel, SEC, Division of Examinations, Chicago Regional Office (Moderator)
  • Nadia Brannon, Branch Chief of Crypto Asset Specialized Exams, SEC, Division of Examinations, Technology Controls Program
  • Matt Cook, Senior Counsel, SEC, Division of Investment Management
  • Virginia Rosado Desilets, Assistant Director, SEC, Division of Enforcement
  • Roberto Grasso, Branch Chief, SEC, Division of Examinations, Office of Risk & Strategy, Office of Risk Analysis & Surveillance, Branch of Surveillance and Reporting
  • Maurya Keating, Associate Regional Director, SEC, Division of Examinations, New York Regional Office
  • Sirimal Mukerjee, Senior Special Counsel, SEC, Division of Investment Management
  • Lindsay Topolosky, Regulatory Counsel, SEC, Division of Examinations, National Exam Program Office

AI: If you claim to be using AI in your marketing and disclosure it should be accurate. “Do what you say you do.” No AI washing. There is a rulemaking out there.

The SEC has taken some swings at “internet advisers” and their exemption. There is a revised rule. Basically, the website really needs to work. Vaporware gets you shut down by the SEC.

T+1 Settlement rule as it applies to Investment Advisers.

Pre-IPO offerings. There has been a lot of boiler room operations pushing that they have pre-IPO offering access. The problem is often blowing through the Investment Company exemptions.

FinCEN AML Rule. (Why I stayed to the end.) New AML requirement. January 1, 2026 is the compliance deadline. But get ahead of it. Banks and mutual funds have been subject to this for years. As part of the final rule, the SEC has examination authority. It will start popping up in SEC exams. It applies to “Exempt Reporting Advisers”.

Five obligations: 1 written AML program. 2. Reporting obligations. 3 record keeping requirements. 4. Special information sharing procedures 5. Special standards of diligence for foreign banking affiliations.

What should be in the written AML program?

  1. Establish internal policies, procedures and controls
  2. Independent testing of the program
  3. Designate an officer in charge
  4. Training of firm employees
  5. Implementation of ongoing diligence

It should be risk-based addressing the client risks.

SAR filings is not a clear concept on when to file.

Greenwashing or Failure to Screen

We’ve seen this before. Funds promote themselves as investing along some standard other than explicit financial performance. But then fail to follow the screening they profess to be using.

We saw that with BNY Mellon in 2002. It represented or implied in various statements that all investments in the funds had undergone an ESG quality review, even though that was not always the case. 

We saw that with the Inspire ETFs. It represented that the ETFs followed biblically responsible investing. The SEC found it wasn’t properly screening investments.

The latest is WisdomTree. It’s a registered investment adviser to three exchange-traded funds (the “ESG Funds”) that it marketed as incorporating environmental, social, and governance (“ESG”) factors. It purported to have the capability to screen out the securities of companies that had any involvement in fossil fuels and tobacco.

WisdomTree contracted with vendors to provide the rating and research to identify companies involved in fossil fuels. The first vendor offered five data sets that addressed different aspects of fossil fuels activities: “Arctic Oil and Gas Exploration,” “Thermal Coal,” “Oil Sands,” “Shale Energy,” and “Oil and Gas.” WisdomTree only subscribed to three of the five. That left a big hole in its screening

WisdomTree contracted with a second vendor to get screening for fossil fuels companies. The second vendor did not have a data set for “fossil fuels.” It’s data set was the “Energy Sector.”

As you might expect, the ETFs ended up owning interests in companies that dealt with fossil fuels: Utility companies that distributed natural gas to residential and industrial customers, a major natural gas distributor that has also had ownership interests in shale gas extraction projects, a specialty chemical company that provides chemicals for use in offshore and onshore drilling, company that owns natural gas distributors, etc.

The problem is poor definition of the screening subject int he fund documents and the failure to implement good screening. As a result of an SEC exam WisdomTree revised the fund documents to more accurately describe the screening.

Do what you say you’re doing to your investors.

Sources:

2025 Examination Priorities

Since 2013, the Securities and Exchange Commission’s Division of Examinations has published its annual examination priorities to inform investors and the industry about key areas where the Division intends to focus resources. You can assume those area areas that the Division believes present the highest risk areas to investors and the markets. Last year marked the first time the Division published the priorities with the start of the SEC’s fiscal year.

2025 marks two years in a row: Fiscal Year 2025 Examination Priorities.

Surprisingly, real estate explicitly popped up a few times. The first was around advice.

[T]he Division will continue to focus on:

Investment advice provided to clients regarding products, investment strategies, and account types, and whether that advice satisfies the fiduciary obligations owed to their clients. In particular, the Division will focus on recommendations related to: (1) high-cost products; (2) unconventional instruments; (3) illiquid and difficult-to-value assets; and (4) assets sensitive to higher interest rates or changing market conditions, including commercial real estate.

The second related to valuation.

The Division’s review of an adviser’s compliance program may focus on or go into greater depth depending on its practices or products. For example, if clients invest in illiquid or difficult to-value assets, such as commercial real estate, examinations may have a heightened focus on valuation.

I’m sure real estate fund managers have valuation as one of their top compliance concerns and properly deal with the issues. Perhaps, non-real estate managers dabbling with real estate may not have a robust method for valuation.

Real estate also pops up in the interest rate volatility item.

Whether disclosures are consistent with actual practices and if an adviser met its fiduciary obligations in times of market volatility and whether a private fund is exposed to interest rate fluctuations. Examples of investment strategies that may be sensitive to market volatility and/or interest rate changes include commercial real estate, illiquid assets, and private credit. The Division may particularly focus on examinations of advisers to private funds that are experiencing poor performance and significant withdrawals and/or hold more leverage or difficult-to-value assets.

Clearly, interest rates have affected commercial real estate. I suspect examiners may be diving deeper into debt practices.

Other items that caught my attention:

  • A focus on post-commitment period management fee calculations
  • Disclosure around fund credit facilities
  • Alternative sources of revenue from selling non-security services to clients

Before and After Reg BI

The case against PHX Financial caught my attention because it involves actions of the firm before and after the compliance date of Regulation BI.

During the Pre-Reg BI Period, PHX failed reasonably to supervise Representative 1, within the meaning of Section 15(b)(4)(E) of the Exchange Act, with the view to preventing and detecting Representative 1’s violations of Section 17(a) of the Securities Act of 1933 (“Securities Act”) and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

Further, during the Reg BI Period, PHX violated the Reg BI Care Obligation, Exchange Act Rule 15l-1(a)(2)(ii), when Representative 1 recommended a series of transactions to retail customers without a reasonable basis to believe that the recommended transactions, even if in the customers’ best interests when viewed in isolation, were not excessive and in the customers’ best interests when taken together in light of the customers’ investment profiles.

The actions were the same. A PHX registered representative recommended a short-term, high-volume investment strategy to at least eight of PHX’s retail customers . The customers each lost money in their PHX brokerage accounts while PHX and the Representative made over $400,000 in commissions and fees.

PHX had a a process for identifying accounts with what appeared to be excessive trading. The procedures fell apart when trying to address and manage the issue.

The SEC order characterized the problem in the Pre-BI period as fraud and supervisory failure. While after BI it’s a violation of the Care Obligation under Reg BI.

Post Reg BI, the SEC appears to hang its hat on the accounts having cost-to-equity ratios in excessive of 40% and turnover rates from 7 to 53 in the affected accounts.

Sources:

The One Without the Magic in the Mushrooms

Was Robert Shumake a shaman or a securities fraudster? Or Both?

On one hand he was the shaman of Soul Tribes in Detroit that was trying to “safe and sacred space for individuals to explore the healing benefits of sacred plants.” That apparently included storing over 99 pounds of mushrooms believed to be psilocybin and over 120 pounds of “material believed to be marijuana” from the church. Shumake claimed he was protected under the Religious Freedom Restoration Act. Detroit claimed it was a distribution center for unlawful controlled substances, poorly masquerading as a church. (Soul Tribes was apparently not a licensed marijuana dispensary.)

On the federal side, the Securities and Exchange Commission and the Department of Justice claim that Shumake was running a securities fraud on Minerco. The company claimed to be “first publicly traded company focused on the research, production and distribution of psilocybin mushrooms.”

Minerco was largely defunct company in 2019. According to the SEC complaint, Mineco got his hands on old debt owed by the company that was convertible into Minerco stock. That conversion of stock gave Shumake and his co-conspirator control of the company, gave control of the company to them and the power to issue more shares.

Then they had Minerco issue a bunch of press releases and advertising to pump up the value of the company. The company claimed that it had been reviewed by a third-party and was worth $1 billion.

At the start of the scheme, Minerco’s stock closed at $ 0.000001. Four months later Minerco’s stock closed at $0.0127, a 1,269,900% increase. Trading volume likewise skyrocketed from approximately 22 million shares to nearly 3 billion shares.

During the Relevant Period, Defendants’ pump-and-dump scheme inflicted pecuniary harm on investors who traded Minerco shares. Investors who bought Minerco stock in reliance on the public announcements that were either misleading or false, or that created a false appearance of fact, were duped. They paid a higher price than the shares were worth, and they suffered losses when they tried to sell their shares. Moreover, Minerco’s issuance of one billion additional shares diluted existing stockholders’ equity.

During this time, Shumake and his co-conspirator sold the stock they had acquired for at least $7 million.

Sources:

The One Without its Biblical Strategy

Inspire Investing advertises its ETF as “biblically responsible investing.” The obvious problem is how you define what is biblical. If it were so easy to define would we would not have so many sects and theologies of Christianity and Judaism.

Inspire came up with its own methodology for excluding companies. A company is automatically given a negative score for having any “exposure” to fourteen categories. Alcohol is on the list, but weapons are not. Other factors are used to develop a positive score.

Inspire touts a scientific approach in its marketing. It looks like Inspire was not able to prove that it was actually using this approach.

10. For example, certain companies were excluded from Inspire’s investment universe for donating to certain advocacy organizations or sponsoring certain events that Inspire considered to be Prohibited Activities. At the same time, multiple companies held within the Inspire ETF portfolios donated to organizations or sponsored events that were the same or similar.

I suppose these Inspire ETFs would be prohibited investments by some of the 35 states that prohibit ESG investing. The Inspire ETFs take into account factors other than pecuniary factors, which is prohibited by many of those anti-ESG laws. Its “positive score” factors are typical of ESG funds.

The Inspire BIBL ETF also consistently underperforms the market.

Sources:

The One With Pig Butchering

What’s with the fake profiles on Facebook, Instagram, or your social networking platform of choice reaching out to you? It’s likely the first step in a “relationship investment scam” or “pig butchering.” The scammer starts with casual conversations, try to build trust, maybe even a little romance. After building some trust/relationship over an extended period of time, they introduce an investment tip. Usually a crypto. Money doesn’t go your new friend, its just a tip. You move the money and then its gone.

The SEC charged two outfits NanoBit and CoinW6 with fraud involved pig butchering.

The Scheme Participants contacted prospective investors through social media platforms, such as LinkedIn and Instagram, and then pursued romantic relationships with them over the messaging platform, WhatsApp. After developing online romantic relationships with prospective investors, the Scheme Participants introduced the investors to so-called “cryptocurrency,” claiming that they had earned hundreds of thousands of dollars through crypto asset products that CoinW6 offered and sold on its websites through an online crypto trading platform (“CoinW6 Platform”). The CoinW6 Platform promised two to three percent passive returns per day from crypto asset staking, mining, or yield farming products that the Defendant purportedly operated.

Of course, it was all fictious and the money disappeared.

The scams slap financial fraud onto a catfishing scam.

Sources:

The One with the “Official Wealth Management Partner of”…

Of the nine marketing cases released by the SEC recently, one caught me off-guard and has left me concerned.

Say you’re a proud alumni of Notre Dame. You want to be associated with the athletic program and give some money back to the school. All you ask is that you get to be the official ____ of program. That works for most industries. But if you’re a registered investment adviser…

Is this a problem? The SEC said this was an endorsement that lacked proper disclosure.

The first step is whether this affiliation is advertising for purposes of the Marketing Rule. That is obviously “yes.”

What’s less obvious to me is whether this is an “endorsement” under the Marketing Rule. (Section 206(4)-1(e)(5))

(5) Endorsement means any statement by a person other than a current client or investor in a private fund advised by the investment adviser that:
(i) Indicates approval, support, or recommendation of the investment adviser or its supervised persons or describes that person’s experience with the investment adviser or its supervised persons;
(ii) Directly or indirectly solicits any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser; or
(iii) Refers any current or prospective client or investor to be a client of, or an investor in a private fund advised by, the investment adviser.

Does being the “official wealth management partner” indicate support by Notre Dame Athletics? I suppose “partner” does indicate some level of endorsement.

What if you replaced “partner” with “firm”?

Howard Bailey agreed to the SEC’s position and agreed to remove advertisements or add disclosure to advertisements. So now there is this footnote at the bottom of the website:

University of Notre Dame and University of Notre Dame Athletics (“Notre Dame”) are not current clients of Howard Bailey Securities, LLC nor Howard Bailey Financial, Inc. Legends / JMI Rights Holders, on behalf of Notre Dame, was compensated for this Endorsement, as such term is defined under SEC Rule 206(4)-1. More Information

Yes, that “more information” exposes all of the monetary details.

Let’s move down to the local level. How does this work for an investment advisory firm that sponsors the local little league team?

Notre Dame Athletics is a non-profit. Does this carry over to other non-profit sponsorships?

I was looking at the back of my Pan-Mass Challenge jersey with all of the corporate logos. If any of them are RIAs, should they be concerned that the logo placement has created an “endorsement” under the Marketing Rule?

I didn’t sleep well last night thinking about all of the possible implications of this case.

Sources:

Cut Those Pennies in Half

I’m old enough to remember when stock prices were quoted in eights. They had been marked that way for 200 years on the New York stock exchange. Then they were shifted to decimals. That pushed the bid-ask spread for many stocks to $.01. Now that penny limit is being cut in half.

The Securities and Exchange Commission just enacted changes to Rule 612 which will reduce the tick size to $.005.

Now we have to figure out what systems and spreadsheets will break because trading is happening in half-pennies.

Sources: