Author: Doug Cornelius

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

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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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.

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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.

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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.

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