SEC enforcement to target fund industry

Date: Monday, April 4, 2011
Author: Mark Schoeff Jr., InvestmentNews

'Trouble ahead,' compliance official says

The mutual fund industry will be one of the targets of more-aggressive enforcement by the SEC, according to experts who spoke last week at an Investment Company Institute conference.

As part of its efforts to reorganize and strengthen its Division of Enforcement, the Securities and Exchange Commission has established groups that concentrate on specific parts of the market. The largest of these is the assets-under-management unit.

“There's going to be a lot of trouble ahead, in terms of that unit, for the industry,” said Philip Kirstein, senior officer and independent compliance officer at AllianceBernstein Investments Inc.

The SEC is taking a close look at the approximately $40 trillion asset management industry — mutual funds, private funds and investment advisers — because of the increasingly important role it plays in financial markets.

In an appearance before Congress in March, Robert Khuzami, director of the SEC's Division of Enforcement, hinted at the practices the agency is zeroing in on.

“In the asset management area, we must increase our understanding of issues related to valuation of illiquid portfolios, false performance claims, preferential redemptions and high-risk emerging products,” Mr. Khuzami said in prepared testimony for a March 10 hearing of a House Financial Services subcommittee.

The unit also is working with the SEC examination staff on the Problem Adviser Initiative, which he described as “a risk-based approach to detecting problematic investment advisers through ongoing due diligence reviews of advisers' representations to investors related to their education, experience and past performance.”

Mr. Khuzami was one of several experts on an ICI panel at the conference who said that the SEC is putting more emphasis on patrolling funds.

“You have people who recognize there are significant risks in investment management that have gone unaddressed,” Thomas Biolsi, practice leader in asset management at accounting giant PricewaterhouseCoopers LLP, said after the presentation.

The SEC collected $2.85 billion in disgorgements and penalties in 2010, a 176% increase from 2008. It also returned $2 billion to harmed investors.

Those results are a reflection of a more aggressive posture in which the enforcement division tries to anticipate problems and investigate cases on its own, rather than merely react to problems flagged by the Office of Compliance Inspections and Examinations, according to panelists at the ICI conference.

“They are very much, in enforcement, attempting to be proactive,” said Joan McKown, a partner at Jones Day and a former SEC chief counsel in enforcement.

One example of the new approach is the creation of the Office of Market Intelligence, which is housed within the enforcement division. With a staff of about 35, it is to be a central location for gathering tips, complaints and referrals — and a focal point for following up on those that might lead to big cases.

“Enforcement is where the action is,” said ICI senior associate counsel Tamara Salmon. “We're talking about a revolution, not an evolution.”

The SEC's enforcement demands are set to increase under Dodd-Frank. Although the SEC is transferring investment advisers with less than $100 million assets under management to state jurisdiction, it is taking on oversight of private-equity and hedge fund advisers.

“The firms they're getting are very large and very complex,” Mr. Biolsi said.

The SEC also is exerting influence internationally by being the standard setter on enforcement, according to participants at the ICI conference.

Following the SEC's lead, fines are going up around the world.

“There's a real risk that you get hit with something in the U.S. and everyone says, "Me too,'” said Adam Shapiro, director of Promontory Financial Group LLC, referring to the SEC's global counterparts. “Historically, there are three sets of people you don't want to cross in the world, and they're all in the U.S. — one is the Department of Justice, another is the SEC and another is state attorneys general.”

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