investigations of pension fraud, money management abuse, wrongdoing, securities brokerages, pension investment consultants, unethical business practices, benchmark alert, institutional investors, plan sponsors
investigations of pension fraud, money management abuse, wrongdoing, securities brokerages, pension investment consultants, unethical business practices, benchmark alert, institutional investors, plan sponsors
investigations of pension fraud, money management abuse, wrongdoing, securities brokerages, pension investment consultants, unethical business practices, benchmark alert, institutional investors, plan sponsors
(January 1, 2001) When Money Managers Are "Sanctioned" By The SEC: 3 Tips To Protect Funds

Money Matters Managing dozens of money managers is not easy under the best of circumstances, a large fund executive recently confided to me. It's not just a question of monitoring performance and enforcing compliance with investment policies of the fund, but sometimes it involves playing the sleuth. "What does it mean when a manager has been "sanctioned" by the SEC and how do I find out if it is true that the manager has been sanctioned," he asked. He had heard through the grapevine, probably from a competitor of the manager or a broker, that one of his managers had been sanctioned by the SEC. He was annoyed that he hadn't heard the news from the manager first. Fiduciaries don't like these kind of surprises.

Sanctioning by the SEC means that a manager has been found by the Commission to have engaged in a form of wrongdoing that is serious enough to merit some form of punishment. The SEC inspects larger money managers at least every five years; smaller managers are reviewed by state securities regulators. In a typical year, the SEC conducts somewhere between 1200 to 1400 inspections of money managers. According to SEC officials, virtually all money managers are found to have some compliance problems and are issued a "deficiency letter" upon completion of the SEC inspection. The deficiency letter summarizes the compliance problems found and may stipulate a resolution, as agreed upon by the SEC staff and the manager. Obviously many deficiency letters concern minor compliance oversights; these letters need to be carefully scrutinized to assess whether or not there is reason for concern.

As we discussed in a recent Alert entitled "No Freedom Of Information When It Comes To Money Managers," deficiency letters are not available to the public under the Freedom of Information Act. (We believe all information about money managers gathered by government agencies, including the SEC and law enforcement, should be publicly available. In our opinion, the public does not benefit from a misleading portrayal of the money management business.)

When deficiency letters are issued, there is no fine or penalty levied against the manager and the matters addressed in the deficiency letter are not referred to the Commission's Enforcement Division for further legal action. According to the SEC, about 4-5% of all SEC inspections result in a referral to Enforcement. Generally, for a matter to be referred to Enforcement, there must be intentional wrongdoing, designed to enrich the advisor and which results in harm to clients. Furthermore, not all matters referred to Enforcement are pursued. For example, the Enforcement Division may feel that the case against the adviser may be too difficult to prove or jurisdiction may be lacking.

SEC Enforcement actions involving managers, once a legal action has been filed in federal court, are publicly accessible generally. Today investors can even go the SEC's website,, and look under "litigation releases." Unfortunately, all-too-often when it comes to money managers, the SEC waits to institute a proceeding in federal court until it has already reached a settlement with the adviser. The suit is instituted and settled in one swift announcement. A "sanction" may be imposed and announced in connection with the settlement.

For example, in two 1998 cases involving Rhumbline Advisers and Nicholas-Applegate Capital Management, remedial sanctions were imposed in connection with settlements. The cases concerned violations that had taken place since 1995 at Rhumbline and 1991 in the case of Nicholas-Applegate. Information about these managers was not available to investors until years after the wrongdoing occurred.

Getting back to our story. I informed the executive at the large fund who had called me that my check of the SEC's website revealed no public case involving his money manager. I informed him that the only way he could learn about any SEC sanctioning of his manager, prior to the SEC issuing a litigation release, was to call the manager and ask. Otherwise he might have to wait three or more years for an answer. Later the fund executive called back dissatisfied. Once confronted, the money manager had confirmed that he was going to be sanctioned and fined by the SEC. The manager claimed to have verbally advised the fund executive of this upcoming action; the executive had no recollection of any such conversation. Finally, the manager explained that the SEC sanction and fine was related to an innocent overstating of certain facts about the investment advisor's operations. Since the advisor's account of the SEC upcoming action seemed unlikely, I suggested a conference call with the SEC.

A senior SEC official welcomed the call. It seems the SEC seldom hears from large pension funds and other institutional investors regarding problems with managers. These investors typically walk away from bad situations involving their managers without thinking to notify the SEC. In fact, these investors are often suspicious of the SEC and question its methods and motives. The SEC official confirmed that until the matter was made public, he could not comment; however, he agreed that if the manager was going to be sanctioned and fined by the SEC, an unintentional, harmless compliance oversight was unlikely to be the extent of the wrongdoing.

"So," said the fund executive, "what am I suppose to do if you (the SEC) won't tell me what's going on and the manager is apparently lying to me?" "Well," said the SEC official, "I can see your dilemma. If you leave your money with the manager, you may be at risk. But if you take the money away, you are incurring transaction costs and drawing attention to the situation, perhaps unnecessarily. That's a tough one."

This scenario could only occur where institutional investors are involved. Individual investors do not have access to non-public information about their money managers, while institutional investors may. Managers working together with regulators keep violations from the public until such time as disclosure could do little damage. No one wants a "run on the bank," even when investors should be running.

Institutional investors, through their Requests for Proposals, have access to greater information about the managers they hire than the general public, as well as greater leverage in negotiating contracts with their money managers. Institutional investors have their own "grapevine." Once one institution learns of problems and terminates a manager, everyone, including even the broker executing the liquidation trades, may become suspicious. Institutional investors can have covenants in their contracts with money managers that require immediate disclosure of any adverse regulatory developments, well in advance of any public disclosure.

Individual investors have to go it alone and only learn of violations after managers and the SEC, having completed their settlement negotiations, see fit to tell them. Thanks to the generous provisions of the Investment Company Act of 1940, managers to mutual funds and 401(k) plans write their own advisory contracts. Investors have no input whatsoever. Compliance with the law is monitored by the manager and compliance records can be kept from investors by the manager under the attorney-client privilege. Investors cannot complain about what they do not know. The system works until you introduce a fiduciary with a duty and power to investigate.

So what's the answer to the puzzle described above? What can you do when you hear one of your managers may be in trouble with the SEC?

1. First, use technology to search for answers. Check the SEC's website and have your counsel check LEXIS/NEXIS. Second, while the SEC wouldn't give the fund executive any non-public information about the manager, the fund could demand all correspondence between the manager and the SEC from the manager.

2. Second, pensions can include in their contracts with managers the requirement of immediate written notice of any adverse regulatory developments. Be sure to broadly define "adverse regulatory developments" to include even deficiency letters. Otherwise the manager may interpret the requirement to apply to only final, non-appealable legal decisions. It is advisable that written notification be required, so as to avoid any question as to whether notice was given by the manager.

3. Finally, get your pension consultant involved. While pension consultants are generally not well versed in SEC matters, their contacts with multiple funds and managers, can be useful in ferreting out the truth.

The one thing you shouldn't do is refuse to get involved. Remember individual investors have none of the power that institutions enjoy. By investigating, not only are you protecting your fund's participants, you are also performing a service for all investors who may be at risk.

Most read story about Money Matters:
(November 2009) A ''Tipping Point'' for Public Pensions?

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