Tag: 206(3)

Related Party Mistakes with Private Funds

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Related party transactions are rife with problems in all areas of the financial services industry. It’s hard to know if someone is looking out for your best interest, if they have interests on the other side of a transaction. Most private equity funds have some structure set up in the organizational documents to deal with affiliate transactions. A recent SEC action highlights the need to have that structure.

According to the Securities and Exchange Commission action, VERO Capital Management cause one of its sponsored funds to purchase notes from an affiliate without providing notice or consent to the fund’s investors.

Section 206(3) of the Investment Advisers Act prohibits an investment adviser from acting as a principal on its own account or acting as a broker for the sale to a client unless the adviser obtains the client’s consent to the transaction before completion. Rule 206(4)-8 applies the anti-fraud provisions to investors in a fund.

On one hand you have the agreements with your fund investors on how to address related party transactions. On the other hand, you must comply with the SEC’s requirements. It’s worth taking a look as the requirements to make sure you are complying with both your investor requirements and the regulatory requirements.

According to the SEC, VERO went further and tried to hide the transactions from investors. But that is just the SEC’s side of things. VERO has not agreed to the charges and has not had a chance to refute the charges.

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Image of Plain Dealing is by Billy Hathorn
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Lessons from Wunderlich

I don’t take pleasure from others’ failings, but I do try to learn lessons. The recent settlement between Wunderlich Securities and the Securities and Exchange Commission is full of lessons to be learned.

  • overcharged advisory clients for commissions and other transactional fees in violation of Section 206(2) of the Advisers Act
  • failed to satisfy the disclosure and consent requirements of Section 206(3) of the Advisers Act when WSI engaged in principal trades with advisory clients;
  • failed to adopt, implement and review written policies and procedures as required by Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder; and
  • failed to establish, maintain, and enforce a written code of ethics as required by Section 204A of the Advisers Act and Rule 204A-1 thereunder.

It seems some of the failings, at least according to the order was that Wunderlich hired a CCO with a background in Broker-dealer compliance, but at the same time, the firm moved from a broker-dealer model to an investment adviser model. That left the CCO in a new regulatory scheme.

Under Section 206(3) of the Advisers Act, an investment adviser must disclose to its clients in writing before the completion of each transaction that it acts as a principal. Wunderlich failed to follow this rule in over 3,00 instances according to the order. The issue is that the investment adviser can both collect a fee and realize a difference between its cost of the security and the price it’s sold to the the client. That difference in price is a conflict that needs to be managed. Wunderlich even hired a consultant to to review their operations who highlighted the principal trading problem. That still did not lead to a correction.

Wunderlich failed to have written compliance policies or a written code of ethics. That leads to the follow up failure of an annual review of the written compliance policies and procedures. Its hard to update something that is not in place. Wunderlich was using its broker-dealer manual and failed to update it to meet the requirements under the Investment Advisers Act. Once again, this failure was highlighted in a consultant’s report and the firm failed to fix the problem.

A long true lesson in compliance is when a problem is highlighted, you need to fix it. The spotlight is on the problem.

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