Regulatory Update and Recent SEC Enforcement Actions

Funds and Investment Management


Investment Firm VanEck Launches Bitcoin Exchange Traded Fund (“ETF”) One Week after Calling Bitcoin a “Fad”

On August 10, 2017, Joe Foster, portfolio manager and strategist for the money management firm VanEck, expressed his concern regarding the recent surge of Bitcoin. Foster stated “Bitcoin and other digital currencies are a fad that has attracted the attention of programmers, speculators, and early adopters. It is my opinion that governments will not allow digital currencies to reach the critical mass needed to challenge the utility of fiat currencies. At best, digital currencies may eventually occupy some middle ground as a niche product. At worse, they become a failed experiment that ends in tears.” Notwithstanding these comments, the next day VanEck and its fund International Investors Gold Fund (INIVX) filed a Form N-1A with the U.S. Securities and Exchange Commission (“SEC”) for “VanEck Vectors ETF Trust,” a Vectors Bitcoin Strategy exchange traded fund which would invest in Bitcoin futures and trade on the Nasdaq.

SEC’s Office of Investor Education and Advocacy Issues Alert to Investors on Scams Related to Initial Coin Offering (“ICO”)

On September 5, 2017, the SEC’s Office of Investor Education and Advocacy issued a release warning investors about fraud in connection with certain initial coin offerings (“ICOs”), which are digital token launches used to raise capital similar to initial public offerings. In particular, the alert noted that “scam artists” have utilized classic pump-and-dump and market manipulation schemes to garner investment in fraudulent ICOs. Recently, the SEC has suspended trading of the common stock of issuers who issued claims regarding their investments in ICOs or related digital coin or token news. Companies impacted by these suspensions include First Bitcoin Capital Corp., CIAO Group, Strategic Group, and Sunshine Capital. The SEC suspended trading over concerns that the companies had misrepresented their ownership interests (including interests in cryptocurrencies) and their capital structures.

SEC Issues Update on Pay-to-play Rule Regarding Capital Acquisition Brokers (“CABs”)

On August 24, 2017, the SEC issued an update on Rule 206(4)-5 of the Investment Advisers Act of 1940 (the “40 Act”), commonly referred to as the “pay-to-play” rule. Under the pay-to-play rule, certain investment advisers may not provide investment advisory services to government clients (or to an investment vehicle in which a government entity invests) for compensation for at least two years after the adviser (or its executives or employees) makes a campaign contribution to elected officials or candidates who may influence the selection of certain investment advisers. In August 2016, the Financial Industry Regulatory Authority (“FINRA”) adopted its own set of pay-to-play rules. The SEC’s update affects FINRA’s rules and applies only to firms meeting the definition of CABs—registered broker-dealers that are involved in a limited set of activities such as distribution and solicitation activities with government entities on behalf of investment advisers. The SEC’s Division of Investment Management has said that it would not recommend enforcement action for the payment of any CAB to solicit a government entity for investment advisory services under Rule 206(4)-5 until the rules subjecting CABs to the FINRA pay-to-play rules are effective. FINRA filed its proposals to change its pay-to-play rules with the SEC on August 18, 2017.

SEC Office of Compliance Inspections and Examinations (“OCIE”) Identifies Most Common Compliance Issues Relating to the Advertising Rule

On September 14, 2017, OCIE released an alert outlining the most frequent compliance issues relating to the Advertising Rule. An advertisement under the 40 Act encompasses “any notice, circular, letter or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, which offers (1) any analysis, report, or publication concerning securities, or which is to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (2) any graph, chart, formula, or other device to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (3) any other investment advisory service with regard to securities.”1 Under Rule 206(4)-1(a)(5) of the 40 Act, advisers are prohibited, directly or indirectly, from distributing advertising materials containing any false statements of material fact, or that are otherwise false or misleading. Specifically, advertisements referring to the following are prohibited: (1) directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerning any advice, analysis, report or other service rendered by such investment adviser; (2) directly or indirectly, to past specific recommendations of such investment adviser, which were or would have been profitable to any person; (3) directly or indirectly, that any graph, chart, formula or other device being offered can in and of itself be used to determine which securities to buy or sell, or when to buy or sell them; and (4) contains any statement to the effect that any report, analysis, or other service will be furnished free or without charge.To prevent a failure to comply with the Advertising Rule, OCIE suggests that advisers avoid advertisements containing the following:

  • Misleading performance results
  • Misleading one-on-one presentations
  • Misleading claims of compliance with voluntary performance standards
  • Cherry-picked profitable stock selections
  • Misleading selection of recommendations
  • Not implementing compliance policies and procedures


Dalia Blass Appointed as Director of the SEC’s Division of Investment Management

On August 31, 2017, the SEC named Dalia Blass as the Director of the Division of Investment Management. This Division is responsible for protecting investors and promoting capital formation and innovation in investment products and services, and, in particular, oversees the regulation of investment companies, variable insurance products, and registered investment advisers. Ms. Blass has recently been in private practice, but had served as the Division’s Assistant Chief Counsel for over a decade during her previous tenure at the SEC.

Thomas J. Butler Appointed as Associate Regional Director for Examinations in SEC’s New York Office

On September 20, 2017, the SEC announced that Thomas J. Butler would become an Associate Regional Director for the Investment Adviser and Investment Company examination program in the SEC’s New York Regional Office. Mr. Butler will leave his current role as Director of the SEC’s Office of Credit Ratings (“OCR”), which he has managed since June 2012. Prior to heading the OCR, Butler was a Managing Director at Morgan Stanley Smith Barney and Citigroup.

Regional Director of the SEC’s New York Office, Andrew Calamari, to Step Down

On September 28, 2017, Andrew Calamari announced that he will be leaving the SEC’s New York Office in October 2017 after a 17-year tenure as its director. Since 2012, Calamari has overseen roughly 400 enforcement attorneys, accountants, investigators, and compliance examiners.

SEC Creates New “Cyber Threat” Combat Unit

On September 26, 2017, the SEC announced the creation of a new enforcement unit designed to protect and combat against cyber-related threats and offenses. Although the SEC stated that the idea to form the new unit has been in development for a few months, the September 20, 2017 hack on the SEC’s EDGAR system likely heightened the desire to form the unit as quickly as possible. The unit will be run by Robert A. Cohen, the co-chief of the Market Abuse Unit for the past two years, and will target various forms of cyber threats such as hacking, market manipulation through the dissemination of false information online, and other related misconduct.


Michael D. Green et al. v. Morningstar Inc. et al. (Case No. 1:17-cv-05652)

On August 4, 2017, Morningstar Inc. (“Morningstar”) and Prudential Financial Inc. retirement subsidiaries Prudential Investment Management Services Inc. and Prudential Retirement Insurance and Annuity Company (together “Prudential”) were sued in a proposed class action in Illinois federal court by Michael D. Green, an investor in a 401(k) program for employees of Rollins Inc. (“Rollins”). In the suit, Green accused Prudential and Morningstar of colluding to develop a robo-adviser software called “GoalMaker,” which allegedly guided investors to make investments that ultimately paid Prudential millions in fees. As administrator of the Rollins 401(k) plan, Prudential offered investors the use of GoalMaker free of charge. GoalMaker determines investment allocation based off of a given investor’s age, income, and savings rates. However, out of the 16 available funds retirement investors of the Rollins plan may invest in, GoalMaker only invests in seven funds, which are the seven most expensive funds according to the suit. Some of these funds share revenue with Prudential as well.

United States v. Coscia (Case No. 16-3017, 7th Cir.)

On August 7, 2017, the U.S. Court of Appeals for the Seventh Circuit upheld the first criminal conviction under the anti-spoofing provision of the Commodity Exchange Act, which states “i[t] shall be unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that…is, is of the character of, or is commonly known to trade as, ‘spoofing’ (bidding or offering with the intent to cancel the bid or off before execution).” In other words, spoofing refers to the attempt to influence the price of a stock or commodity through buy or sell orders that the trader never intends to execute. In Coscia, the government alleged that Coscia utilized high-frequency trading algorithms in order to place large buy or sell orders that steered prices in his favor and then cancelled the orders just before execution. In doing so, these orders led to substantial price fluctuations that lasted long enough to fill a smaller order of Coscia’s at the new price. The government alleged that Coscia continued to do this over a 10-week period in 2011 and earned $1.4 million in profits. After a jury convicted Coscia of violating the aforementioned anti-spoofing statute, Coscia appealed. His conviction was upheld by the Seventh Circuit Court of Appeals.

In the Matter of Coachman Energy Partners LLC and Randall D. Kenworthy (Admin. No. 3-18109)

On August 14, 2017, the SEC ordered investment adviser Coachman Energy Partners LLC (“Coachman”) and its managing partner Randall D. Kenworthy to disgorge $2,253,646 for allegedly neglecting to disclose how Coachman determined its management fees and expenses. According to the SEC’s complaint, this led to Coachman’s clients being overcharged by roughly $1.1 million in fees and nearly $500,000 in management-related expenses. Coachman’s offering documents did not state that the firm’s management fees would be based upon year-end capital contributions, but instead the SEC claimed that the firm’s management fees and expenses were calculated based on the average amount of capital contributions under management throughout the course of the year, leading to the aforementioned overpayment by the firm’s clients.

SEC v. DiMaria et al. (Case No. 1:15-cv-07035, S.D.N.Y.)

On August 16, 2017 the SEC settled with two former Bankrate Inc. (“Bankrate”) executives who orchestrated an accounting scheme intended to inflate Bankrate’s net income for the second quarter of 2012. According to the SEC, former CFO Edward DiMaria created the scheme after discovering that Bankrate’s financial results were falling short of analysts’ predictions. Specifically, Bankrate’s EBITDA fell short of projections by nearly $1 million. As such, the SEC accused DiMaria and ex-accounting director Matthew Gamsey of inventing revenue and avoiding tracking certain expenses leading to an overstatement in the company’s revenue. DiMaria was ordered to pay roughly $231,000 in civil penalties, disgorgement and interest while Gamsey agreed to pay $60,000 in penalties. DiMaria was barred by the SEC from serving as an officer or director at an SEC-registered company for five years and both men agreed to refrain from appearing and practicing before the SEC as accountants.

In the Matter of Deerfield Management Co. LP (Case No. 3-18120)

On August 21, 2017, investment management firm Deerfield Management Co. (“Deerfield”) settled claims with the SEC, agreeing to be censured and pay $4.8 million in civil penalties and prejudgment interest for maintaining inadequate disclosure procedures that permitted former analysts to profit from inside information. Analysts who worked with Deerfield and traded on inside information made over $3.9 million in profits for their clients, $714,110 of which was reaped by Deerfield.

SEC v. Jeremy Joseph Drake (Case No. 2:17-cv-06204)

On August 22, 2017, the SEC charged investment adviser Jeremy Drake with defrauding a high profile professional athlete and his wife by deceiving them with respect to the investment advisory fees the couple were paying Drake. According to the SEC’s complaint, while working at HCR Wealth Advisors in Los Angeles, Drake told clients that they paid a special “VIP” rate of 0.15 to 0.20 percent of their assets under management, yet the SEC uncovered that the actual rate clients paid was 1 percent of their assets under management. The SEC determined that Drake’s clients paid $1.2 million more in management fees than Drake advertised, and, in doing so, he earned roughly $900,000 in incentive-based compensation based on these fees. The SEC charged Drake with violating and aiding and abetting violations of the anti-fraud provisions of the 40 Act and is currently seeking a permanent injunction, disgorgement plus interest, and other civil penalties.

SEC v. Navellier & Associates Inc. et al. (Case No. 1:17-cv-11633, D. Mass.)

On August 31, 2017, the SEC brought a suit in the U.S. District Court for the District of Massachusetts against investment advisory firm Navellier & Associates Inc. (“Navellier”) and its founder Louis Navellier for allegedly defrauding clients by pitching false and misleading investment strategies based upon materials provided by bankrupt adviser F-Squared Investments Inc.’s (“F-Squared”) AlphaSector strategies. In 2015, F-Squared filed for bankruptcy and settled with the SEC for $35 million after admitting that it had made false and misleading statements to investors about the historical returns of AlphaSector, a portfolio comprised of exchange-traded funds that trade based on an algorithm developed by a college intern. According to the SEC’s Complaint, when contemplating entering into a business agreement with F-Squared in 2009, Navellier disregarded red flags found through due diligence of AlphaSector’s performance and continued to pitch F-Squared’s strategies to investors. Navellier further rebranded F-Squared’s strategies as “Vireo AlphaSector” and marketed investment materials to clients hyping F-Squared’s false performance record. The SEC alleged that Navellier realized that F-Squared’s claims were fraudulent, but never informed clients that its past statements regarding AlphaSector contained poor information. Navellier sold Vireo AlphaSector to F-Squared in August 2013 for $14 million, and according to the suit, “[Navellier] profited from the company’s successful marketing of a fraudulent performance record, without correcting Navellier’s misrepresentations to its fiduciary clients or disclosing the conflicts-of-interest he and Navellier had in selling Vireo AlphaSector.” The SEC asked the District Court to order disgorgement and the imposition of both civil penalties and permanent injunctions.

In the Matter of Potomac Asset Management Company (Admin. No. 3-18168)

On September 11, 2017, registered investment adviser Potomac Asset Management Company (“Potomac”) and its founder Goodloe Byron, Jr. consented to entries of a cease and desist order and censure as well as agreed to pay $300,000 for violating Sections 206(2), 206(4), and 207 of the 40 Act for failing to make required disclosures of certain fee charges among various other wrongdoings. Additionally, Potomac improperly charged both operating and investigative expenses relating to an OCIE inspection to the funds; none of these expenses were disclosed on Forms ADV as required by SEC regulations. As a result of these improper expenses, Potomac violated the custody rule, which requires charges among related parties to be disclosed in audited financial statements as related party transactions.

SEC v. Scott Newsholme (Case No. 17-cv-06813, D.N.J.)

On September 6, 2017, the SEC charged New Jersey tax preparer and investment adviser Scott Newsholme with stealing over $1 million from clients for personal expenses. According to the SEC’s Complaint, Newsholme falsified account statements, altered stock certificates, and forged promissory notes in order to convince clients to invest with him. However, instead of investing his clients’ money, Newsholme allegedly cashed investor money for personal use, gambling debts, and other Ponzi scheme-like payments to clients seeking a return on their investment. The SEC is seeking disgorgement plus interest, civil penalties, and permanent injunctions. The U.S. Attorney’s Office for the District of New Jersey is also pursuing criminal charges in a parallel action.

U.S. v. Ourand (Case No. 1:15-cr-00182, D.D.C.)

On September 6, 2017, Brian J. Ourand, former president of investment firm SFX Financial Advisory Management Enterprises (“SFX”) was sentenced to 33 months in prison and $1 million in forfeiture and restitution for stealing over $1 million from high profile clients including former boxer Mike Tyson and former NBA star Glenn Rice. Ourand managed his clients’ personal and business accounts and credit cards, and according to his plea, deposited roughly 100 unauthorized checks drawn from his clients’ accounts into his personal accounts for personal expenses, resulting in substantial losses. He then relied on falsified documentation to hide his actions from his clients. In June 2015, Ourand was also at the heart of an SEC complaint accusing him of stealing $670,000 over a five-year period as head of SFX. The SEC ordered him to pay $671,367 in disgorgement and a $300,000 civil penalty, and he agreed to be barred from the securities industry.

In the Matter of State Street Bank and Trust Co. (Case No. 3-18158) and In the Matter of State Street Global Markets LLC et al. (Case No. 3-18159)

On September 7, 2017, Boston custody bank State Street Corp. (“State Street”) settled with the SEC for two separate claims and agreed to pay a total of $35 million in penalties. The first claim involved overcharging government and pension fund managers for transition management services. In this case, the SEC alleged that certain current and former employees in the U.K. charged hidden markups and commissions greater than the amount clients had originally agreed to pay. As a result, these unauthorized markups generated about $20 million in improper revenue for State Street. In the second case, the SEC alleged that State Street neglected to inform subscribers about its government securities trading platform known as “GovEx,” which was allowing one subscriber to reject matches to submitted quotas. In particular, between July and October 2010, State Street was permitting one of its subscribers to use a “Last Look” feature that gave this subscriber the opportunity to reject a match to quotes it had submitted on GovEx. However, no other subscribers had the ability to use this function at the time, and State Street even told another subscriber on three separate occasions that no such feature existed. State Street settled without admitting or denying the allegations.

In The Matter of SunTrust Investment Services Inc. (Case No. 3-18178)

On September 14, 2017, the SEC charged SunTrust Investment Services Inc. (“SunTrust”), a subsidiary of SunTrust Banks, with collecting over $1.1 million in improper fees stemming from investment recommendations made to clients in more expensive share classes of multiple mutual funds when cheaper shares of the same funds were available. SunTrust settled with the SEC and agreed to pay $1,148,071.77 in penalties as well as disgorgement plus interest.

SEC v. Moses Investment Company, LLC and Michael S. Moses (Case No. 17-cv-02296, D. Colo.)

On September 22, 2017, the SEC charged investment advisory firm Moses Investment Company, LLC and its sole owner and manager Michael S. Moses with fraud. According to the SEC’s complaint, Moses raised about $1 million for a private fund called WAKE Fund I, LP through improper means such as lying to investors about Moses’ past experience and performance as a trader as well as the performance of his own personal investment in the fund. In one instance, Moses allegedly claimed to be a “Portfolio Manager” in 2007 for a $750 million global macro fund and emphasized his 24 percent trading return during the financial crises of 2008. However, Moses actually had very little experience managing portfolios, fabricated his tax returns, and utilized significantly risky investment strategies. The SEC is seeking permanent injunctions, disgorgement plus interest, and civil penalties.

In the Matter of Lynn Tilton et al. (Admin. No. 3-16462)

On September 27, 2017, administrative law Judge Carol Fox Foelak dismissed the SEC’s case against investment manager Lynn Tilton and her firm Patriarch Partners for allegedly misleading investors regarding the value of loan pools, which led to the collection of $200 million in additional management fees. Specifically, in 2015, the SEC accused Tilton and her companies of violating the 40 Act by hiding the poor performance of three funds she managed, known as the Zohar funds, in order to generate higher management fees. In particular, the SEC claimed that Tilton neglected to disclose conflicts of interest and issued misleading financial statements to her investors. Tilton’s defense was that the agreements made between her and her investors granted her broad authority to alter the terms of the loans. However, Judge Foelak found that the true performance of the loans in question were available in reports circulated to Zohar investors, and as such, the SEC’s alleged violations were unproven.

1. See Advisers Act Rule 206(4)-1(b).

2. See Advisers Act Rule 206(4)-(a)(1)-(4).

© 2017 Blank Rome LLP. All rights reserved. Please contact Blank Rome for permission to reprint. Notice: The purpose of this update is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy and completeness of which cannot be assured. This update should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.