Brookside Capital, LLC, a registered investment adviser based in Boston (hereinafter, the Adviser), was the subject of a recent administrative order issued by the SEC (SEC IA Release No. 3226, June 28, 2011) in connection with the violation by the Adviser of Rule 105 of Regulation M of the Securities Exchange Act of 1934 and Section 203(e) of the Investment Advisers Act of 1940.
Rule 105 of Regulation M prohibits short selling of equity securities during a restricted period prior (i.e., five business days before the pricing of the offered securities and ending with such pricing) to a public offering and then repurchasing the subject securities in the offering. The Adviser violated Rule 105 in connection with short sales prior to the public offering and then purchased shares in the public offering of Lincoln National Corporation Co. in June 2009. The Adviser, in conducting the transactions in the hedge fund it advises, made profits of more than $1.6 million in such prohibited transactions. The hedge fund primarily invests in equities of public companies. At the time of the investments, the Adviser had no policies, procedures, or controls in place designed to detect or prevent Rule 105 violations.
The sanctions imposed upon the Adviser by the SEC (as agreed to by the Adviser) are as follows: (i) the Adviser is ordered to cease and desist from committing any further violations of Rule 105 of Regulation M; (ii) the Adviser is censured; and (iii) the Adviser is required to pay disgorgement in the amount of its profits (more than $1.6 million), prejudgment interest (approximately $9,000), and a civil penalty of $375,000. According to the SEC release, the SEC took into consideration the Adviser's remedial acts promptly undertaken by the Adviser and the cooperation afforded the SEC staff.
This enforcement action underscores the need for investment advisers to implement effective written procedures and policies to prevent and detect violations of provisions of the federal securities acts including Rule 105 of Regulation M. Such policies and procedures, if followed, could have prevented the violation and the resulting SEC enforcement.