Financial Law Blog

Updates on Banking Law, Investment Management Law, Securities Law, Commodities/Derivatives Law

Category: Investment Management Law

PIMCO settles SEC enforcement action for misleading disclosures about sources of fund performance

PIMCO agreed yesterday to pay $19.8 million to settle enforcement action by the SEC for misleading disclosures about sources of fund performance and defects in PIMCO’s fair value process.

PIMCO was able to outperform benchmarks for a new ETF by buying “odd lot” private label MBS bonds for the fund and marking them using “round lot” prices. Odd lots in that market, as opposed to round lots, are those bonds with lower face value. During the relevant period odd lots in that market traded at a “significant discount” to round lots. PIMCO bought odd lots for the fund but used values for round lots from its pricing vendor to mark these purchases. This increased the fund’s stated performance and NAV.

PIMCO’s investor-facing “Monthly Commentaries,” however, did not explain that this strategy was the reason for the fund’s performance and instead seemed to attribute performance to the private label MBS sector. The fund’s annual report, which was prepared by PIMCO, suffered from the same defect. These disclosures triggered investor-facing antifraud Rule 206(4)-8. PIMCO was also found to have violated ’40 Act, Section 34(b) because it was “responsible for the inclusion of” misleading statements in the fund’s annual report. The incorrect valuation of fund assets triggered another ’40 Act violation — SEC found PIMCO to have caused the fund’s violations of Rule 22c-1 since the fund executed transactions in its redeemable securities at prices based on an overstated NAV.

PIMCO’s pricing process was also found to violate Rule 206(4)-7: “By vesting the responsibility with its traders for determining when to report to PIMCO’s Pricing Committee any price that did not reasonably reflect market value without sufficient objective checks or guidance for elevating pricing issues to the Pricing Committee or Valuation Committee, PIMCO’s pricing policy was not reasonably designed to prevent valuation-related violations.”

Apollo to pay $52.7 million for failure to adequately disclose right to accelerate monitoring fees (and other violations)

Apollo agreed to pay $52.7 million on Tuesday to settle enforcement action by the SEC for failure to disclose to investors that it may accelerate monitoring fees paid by portfolio companies, along with other violations. While Apollo did disclose that it “may receive monitoring fees,” the SEC found that Apollo failed to adequately disclose that it “may accelerate future monitoring fees upon termination of the monitoring agreements.” When monitoring fees were accelerated with respect to a portfolio company (following an IPO or sale), Apollo did disclose the amount accelerated after the fact. However, the right to accelerate was not disclosed to LPs prior to commitments of capital (i.e., in fund documents). This type of nondisclosure is viewed as a breach of fiduciary duty for an investment adviser, which in turn is viewed as a violation of the antifraud provisions of the Advisers Act.

Apollo joins private equity advisers Blackstone ($39 million) and KKR ($30 million) which had settled SEC enforcement actions for fiduciary duty breaches in 2015. Apollo is at least the ninth private equity adviser to be subject to SEC enforcement action since statutory exclusions relied upon by private fund advisers were narrowed by Dodd-Frank. SEC Staff noted that the enforcement program with respect to private equity fund advisers has so far focused on three broad areas: (1) advisers that receive undisclosed fees and expenses; (2) advisers that impermissibly shift and misallocate expenses; and (3) advisers that fail to adequately disclose conflicts of interests, including conflicts arising from fee and expense issues.

CFTC proposes allowing Luxembourg, UK, Irish, and Canadian GAAP in annual reports by CPOs

CPOs are required to provide an annual report to pool participants and the NFA. The report can be either in accordance with GAAP or, subject to certain conditions, IFRS. CFTC Staff, however, have been providing one-off relief to CPOs following accounting conventions of other jurisdictions. The CFTC recently proposed amending its regulations to allow CPOs to report in accordance with U.K. GAAP, New Irish GAAP, Luxembourg GAAP, and Canadian GAAP, subject to certain conditions. If the changes are adopted, CPOs with pools in foreign jurisdictions would not need to request individualized no-action relief should they wish to prepare pool financial statements in accordance with these accounting conventions.

CFTC proposes removing clearing requirement from registration exemption for foreign entities

The CFTC proposed revisions to Regulation 3.10 yesterday which would remove the clearing requirement from the registration exemption for foreign entities.

Regulation 3.10(c) allows foreign entities touching “commodity interest” transactions to not register with the CFTC as CPOs, CTAs, FCMs and IBs so long as they meet certain conditions. For example, with respect to such transactions, the foreign entity must act only on behalf of persons located outside the U.S. The foreign entity would still be subject to all the substantive rules relating to the transactions, but not those rules which relate only to CFTC registrants.

The CFTC proposed doing away with the requirement that foreign entities clear their commodity interest transactions through a registered FCM. Although prior no-action relief from CFTC Staff allowed foreign entities to rely on the exemption without clearing through FCMs, a change by the Commission in the regulation itself would provide more certainty and permanence to foreign entities intending to rely on the exemption.

State Street settles SEC enforcement of ICA 34(b) violation for $167.4 million

State Street agreed yesterday to settle enforcement action by the SEC alleging that it applied undisclosed markups to foreign currency exchange trades by its custody clients, which include mutual funds.

The agreement is part of a global settlement with SEC, DOJ and DOL totaling $382.4 million, $167.4 million of which is disgorgement and penalties with respect to the SEC enforcement action. The SEC will issue its order only after a court approves State Street’s settlement of related securities class actions.

The SEC’s order “will find” that State Street willfully violated Section 34(b) of the ’40 Act and caused violations of Section 31(a) and Rule 31a-1(b) by giving mutual fund custody clients “trade confirmations and monthly transaction reports that were materially misleading in light of the representations it made about how it priced foreign currency exchange transactions.”

The SEC used similar reasoning in its 2011 enforcement action against Morgan Asset Management. Release No. 34-64720 (“Any person who makes a material misrepresentation … in the records required to be maintained by the Fund, or submits inflated prices to be included in the Fund’s NAV calculations and the records forming the basis for the Fund’s financial statements, violates Section 34(b)”).

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