Recent SEC Enforcement Actions Indicate Strict Regulatory Interpretations
Two recent enforcement “sweeps” by the U.S. Securities and Exchange Commission (“SEC”) serve as a reminder that the SEC at times takes a strict and technical view of regulatory requirements, even when failure to comply has no apparent economic or client impact.
First, in early September, the SEC announced that it had settled enforcement proceedings (available here: Press Release) with nine private fund advisers for violations relating to the requirement under the Custody Rule that private funds generally must distribute audited financial statement to the funds’ investors within 120 days of the end of each fiscal year. Form ADV requires a private fund adviser to name the auditor of its private funds, and answer certain questions about the funds’ financial statements. One of the questions asks whether the fund has received a unqualified audit report, and if the fund hasn’t yet received its audit report (such as during the first year after the fund’s launch) the adviser will check a box saying that the fund’s audit has not yet been received. The instruction for that item states that if that box is checked the adviser must “promptly” update its Form ADV after the audit is received to show whether the audit is unqualified. In one of the settled enforcement proceedings, the SEC fined an adviser $50,000 for failing to promptly update its Form ADV to show that the funds it managed had received their audit reports for that year. In the other cases, the violations included both failures to timely deliver audited financial reports and failures to update the Form ADV question about whether the report was unqualified.
Second, in mid-September the SEC announced settled enforcement proceedings (available here: Summary) against four investment advisers (three exempt reporting advisers and one adviser registered with the SEC) relating to violations of the political campaign contribution “pay-to-play” rule. In each of the cases, the donation amounts were relatively small, but exceeded the de minimis amount permitted by the pay-to-play rule, and in most of the cases the donations were made to the candidate for a state or local office after the governmental entity had already invested with the adviser. In one of the cases, an individual who had previously made a contribution was promoted to a position in which he supervised employees who marketed advisory services. The enforcement actions triggered a lengthy dissent (available here: Statement) from SEC Commissioner Hester Pierce, who stated in part: “Today’s enforcement actions illustrate that the Rule is a poorly conceived means to pursue laudable ends. Accordingly, I dissent and urge the Commission to revisit the Pay-to-Play Rule to ensure that it does not hinder political engagement that is unconnected to an adviser’s quest for government clients.”
These recent enforcement sweeps are a reminder that the SEC takes a strict view of technical rules and Form ADV instructions, and at times is willing to bring an enforcement action for technical violations regardless of whether the failures result in any breach of fiduciary duty or other harm to investors.