Non-Enforcement Matters

SEC Advocating for Point of Sale Disclosures Over a Broad Array of Retail Products

The SEC has supported legislative proposals to broaden its authority in requiring point of sale disclosures for mutual fund transactions prior to the time the investor received a confirmation for the transaction. The SEC believes that the investor needs disclosures prior to the confirmation receipt about the costs, risks, and conflicts of interests, among other things, in connection with the distribution of the mutual fund shares.

SEC Chairman Mary Shapiro recently stated that if this legislation does not pass, the SEC will attempt to utilize existing authority to require more disclosure at the time of sale (i.e., when the investor makes his/her decision to purchase) rather than at the time of confirmation, which is after the investment decision has been made.

In addition, the SEC is setting its sights on additional securities products geared to individual investors. Products such as equity-indexed annuities, according to Chairman Shapiro, are difficult enough to understand and investors need the essential information upfront to make an informed investment decision.

In a related area, Chairman Shapiro reported that the SEC would devote a significant amount of time in 2010 reviewing 12b-1 fees. These fees were originally intended to provide funding for mutual fund marketing expenses. However such fees have grown ($13 billion in 2008) to cover other expenses, including distribution expenses. Added to the significant amount of fees being paid out, investors, according to Chairman Shapiro, are generally confused over what the fees are for and how they affect their investments.

More Comments on Proposed Ban on Placement Agents

In July 2009, the SEC proposed a new rule to curb pay-to-play practices by investment advisers while soliciting business from public pension and government plans that includes a bar on paying a third party to solicit such prospective clients. Placement agents have particularly opposed this part of the proposed rule, and officials for government plans have voiced concerns that the bar would make it more difficult for such investors to find additional investment opportunities.

Senator Chris Dodd (D-Conn.), current Chairman of the Senate Banking Committee, has heard the concerns by the critics of the ban and suggested that a better alternative to the outright ban would be to require registration of such solicitors as broker-dealers under the Securities and Exchange Act of 1934. According to Sen. Dodd, the solicitation of public pension and government plans by the registered placement agents would, therefore, be reviewed by the Financial Industry Regulatory Authority (FINRA). Also, hearing the criticism, the SEC may be changing its view of the outright ban proposal. Andrew Donohue, Director of the SEC's Division of Investment Management, indicated in a letter to FINRA that an exception to the outright ban for registered broker-dealers may be appropriate if the SEC was convinced that FINRA had adopted rules prohibiting pay-to-play activities by such FINRA members.

Finally, the State of California Legislature, no stranger to forging ahead in addressing regulatory issues that are both local and national in scope, has received legislative proposals that would require placement agents to register as lobbyists with the state if they are going to introduce investment opportunities to public employee funds in California. As registered lobbyists under the proposed legislation, the placement agents would have to report their fees and compensation to the state on a quarterly basis and would be barred from making campaign contributions to government plan officials.

Late in 2009, the California Public Employees' Retirement System (CalPERS) enhanced its rules for disclosure of relationships between investment firms and placement agents and supports the legislation described above.

Enforcement Matters

Registered Investment Adviser Charged With Fraud in Connection With Money Market Fund

A Maryland registered investment adviser was recently charged by the SEC in federal court (SEC v. Wehrs, D. Md., Case No. 10-CV-0242-BEL, 2/1/10) for misappropriating almost $2 million of investor funds designated for investment in a so-called FDIC-insured money market fund.

David W. Wehrs, the investment adviser, settled the SEC's civil proceeding against him by agreeing to be barred from future violations and the investment advisory industry, but without agreeing to any disgorgement or civil money penalties. However, if the SEC prevails in the federal court proceeding, it could result in a felony conviction with up to 20 years of prison time for Mr. Wehrs.

According to the SEC complaint, Mr. Wehrs, as owner and operator of Maryland Title and Escrow Co., fraudulently led investors to invest in a money market fund that was supposedly FDIC-insured with a guaranteed 10.85 percent annual interest payment. Also, according to the SEC, Mr. Wehrs told investors that the money market fund was affiliated with American Funds, a registered mutual fund.

The SEC alleges in its complaint that Mr. Wehrs instead used the investors' funds for his own personal and business use, that the money market fund was not FDIC-insured, and there was no connection to any registered mutual fund. In addition, the SEC alleges that Mr. Wehrs fabricated account statements he sent to investors that reported balances in their accounts when the investors' funds were substantially depleted.

Hedge Fund Manager Pleads Guilty to Insider Trading Charges

David Slaine, a hedge fund manager, recently pleaded guilty to charges that he obtained more than $3 million for a hedge fund he managed by trading ahead of the market based on non-public information (U.S. v. Slaine, S.D.N.Y. 09 cr 2/2/10). In addition, the SEC alleges that Mr. Slaine personally benefited by more than $500,000 from the scheme.

The SEC's complaint against Mr. Slaine represents its related actions against several other persons involved in trading with non-public information about UBS' recommendations in certain equity securities. Information was shared by the then executive director in UBS' equity research department with Mr. Slaine and others, and Mr. Slaine allegedly used the information for his funds' advantage even though he knew that the information could not be legally acted upon.

Mr. Slaine faces up to 25 years in prison and is scheduled to be sentenced in June. In addition, he faces administrative action by the SEC.

Improper Short-Selling Practices Result in an SEC Sanction

A state-registered investment adviser and its two principals were recently sanctioned by the SEC for violating Rule 105 of Regulation M (Rule) by the use of improper short-selling practices. (In the Matter of AGB Partners LLC, Gregory A. Bied, and Andrew J. Goldberger, SEC Release No. 34-61422).

Under the Securities Exchange Act of 1934, the Rule states, in part, that in connection with a public offering of equity securities for cash pursuant to a registration statement filed under the Securities Act of 1933, it is unlawful for a person to sell short a security that is the subject of such offering and purchase the offered securities from an underwriter or broker or dealer participating in the offering if the short sale was effected during the period (the Rule 105 restricted period), the shorter of which is (i) beginning five business days before the pricing of the offered securities and ending with such pricing; or (ii) beginning with the initial filing of the registration statement with the SEC and ending with the pricing.

The Rule is intended to take away the advantage of persons who are allocated shares in the offering, which are generally priced at a discount to a stock's closing price prior to closing, to capture the discount by short selling just prior to pricing and covering the short sales at the discounted offering price with the shares received through the allocation. Covering the short sale with a specified amount of the registered offering securities at a fixed price usually allows the short seller to avoid market risk and guarantee a profit.

AGB Partners LLC (AGB) provides investment advice to two private investment funds. The two individual respondents co-own AGB and each traded the securities for one of the investment funds. According to the SEC, the respondents violated the Rule by short selling securities during the Rule restricted period and then purchasing offered securities of the same issuer in the accounts of the private investment funds they managed.

The SEC charged the respondents with violations of the anti-fraud provisions under Sections 203(e) and 203(f) under the Investment Advisers Act of 1940 in connection with the underlying violations of the Rule. The respondents agreed to the SEC's administrative sanctions that included a censure, an order to cease and desist from committing or causing any violation of the Rule, disgorgement of $38,444 with interest of $2,921, and a civil penalty of $20,000.