Clearly signaling its intention to support whistleblowers who provide actionable evidence of wrong-doing, the SEC this week settled the first case brought under the authority granted by the Dodd-Frank Act enabling anti-retaliation enforcement actions. The case arose after an employee of a hedge fund advisory firm reported potentially illegal activity related to improper principal transactions.
According to Andrew Ceresney, director of the SEC’s Enforcement Division, “[t]hose who might consider punishing whistleblowers should realize that such retaliation, in any form, is unacceptable.”
According to the SEC’s order, the head trader of a registered investment adviser (RIA) made a whistleblower report to the SEC alleging that the RIA was engaged in prohibited principal transactions with an affiliated broker-dealer. The broker-dealer was majority-owned by the RIA’s Chief Investment Officer (CIO), who was also the controlling shareholder of both the RIA and the broker-dealer.
After investigating the whistleblower tip, the SEC found that the CIO sometimes instructed the traders to sell securities with unrealized losses to a proprietary trading account at the affiliated broker-dealer. Realized losses from the trades were allegedly used to offset the fund’s realized gains in an attempt to reduce the tax liability of investors in the fund. Use of the proprietary trading account facilitated the CIO’s ability to later repurchase attractive securities for the fund, the SEC alleged.
Section 206(3) of the Advisers Act generally makes it unlawful for an RIA, directly or indirectly, “acting as principal for his own account, knowingly to sell any security or to purchase any security from a client . . . without disclosing to such client in writing before the completion of such transaction the capacity in which he is acting and obtaining the consent of the client.” In this case, however, the CIO also controlled the fund’s general partner. As a result, written disclosure of the principal transactions to the fund was ineffective, as was the fund’s consent to those transactions.
The SEC also found that the RIA’s conflicts committee was insufficiently independent because one member of the two-person committee was the Chief Financial Officer of both the RIA and the affiliated broker-dealer.
The head trader made his report to the SEC in March 2012 and informed the CIO of the report in mid-June. One day later, the RIA removed him from his day-to-day activities on the trading desk. He was instructed to work offsite to prepare a report detailing the facts supporting the potential violations that he had reported to the SEC and his access to certain trading and account systems, as well as his company email account, was restricted.
At no time was the trader’s compensation reduced or his benefits affected. He was, however, never reinstated in the head trader role. After approximately one month, he resigned his position.
The SEC found that the RIA violated Section 21F(h) of the Exchange Act, which prohibits an employer from discharging, demoting, suspending, threatening, harassing, directly or indirectly, or in any other manner discriminating against, a whistleblower because of any lawful act done by the whistleblower in providing information to the SEC. The RIA was also found to have violated Section 206(3) of the Advisers Act, as described above, and Section 207 of the Advisers Act, because the RIA’s Form ADV contained materially misleading disclosure regarding its conflicts committee.
The SEC ordered the RIA to pay $1.7 million to certain fund investors and retain the services of an independent compliance consultant to conduct a comprehensive review of the RIA’s compliance policies and procedures.
The action was settled without the RIA admitting or denying the allegations.