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Category: Securities 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.”

RBC settles SEC enforcement action for false and misleading statements in fairness presentation

The SEC last week settled enforcement action against RBC for false and misleading statements in a fairness presentation regarding the sale of a public company.

RBC was the sell-side financial adviser to a listed company in connection with its sale to Warburg Pincus. RBC’s fairness presentation to the company’s Board incorrectly described company EBITDA figures as analyst “consensus projections.” This lowered the company’s valuation, because in fact analysts would have at least added back $6.3 million of one-time expenses. In related shareholder litigation, the Court of Chancery found that “RBC knew that the Board was uninformed … but failed to disclose the relevant information to further its own opportunity to close a deal, get paid its contingent fee, and receive additional and far greater fees for buy-side financing work.” As the court observed, “On Saturday morning, the ‘consensus’ precedent transaction range was $13.31 to $19.15. On Saturday afternoon, it was $8.19 to $16.71, entirely below the deal price.” The final offer made by Warburg Pincus was $17.25.

RBC’s figures were subsequently used in the company’s proxy statement. Consequently, RBC was found to have caused the company’s violation of Exchange Act rule 14a-9, the general antifraud rule for proxies.

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.

When margin posted on swaps is not excluded from net capital

Assets “not readily convertible into cash” are excluded in calculating net capital for a broker-dealer. SEC Division of Trading and Markets Staff last week took a no-action position that margin collateral posted by a broker-dealer to a DCO for a cleared swap need not be excluded in calculating net capital. Furthermore, even if the swap is not cleared, the initial margin need not be excluded if certain requirements are met. Variation margin on a non-cleared swap, however, must be excluded.

SEC brings enforcement action for whistleblower award waivers in employee agreements

The SEC this week settled an enforcement action for whistleblower award waivers in employee agreements.

Health Net Inc employee agreements waived the employees’ rights to any whistleblower award to which they may be entitled under the Exchange Act. The SEC found that by including such provisions the firm “directly targeted the SEC’s whistleblower program by removing the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.” In so doing, the firm violated Exchange Act Rule 21F-17, which prohibits impeding communication with the SEC about possible securities law violations.

This enforcement action follows last week’s enforcement action for confidentiality provisions without a whistleblower carveout in employee agreements. It is at least the fourth action this year against listed companies for impeding potential whistleblowers through provisions in employee agreements.

SEC brings enforcement action for confidentiality provision without a whistleblower carveout in employment agreements

The Securities and Exchange Commission last week settled an enforcement action against a firm for including in its employee agreements a confidentiality provisions that would impede potential whistleblowers. The firm, BlueLinx Holdings Inc, is a listed company subject to the Exchange Act.

The firm’s agreements with employees contained a number of confidentiality provisions, including one that forbade employees from voluntarily sharing company information. What the provisions did not contain was a carve out “permitting an employee to provide information voluntarily to the Commission or other regulatory or law enforcement agencies.” The SEC found that by including such provisions in agreements with employees, the firm “raised impediments to participation by its employees in the SEC’s whistleblower program.” In so doing, the firm violated Exchange Act Rule 21F-17, which prohibits impeding communication with the SEC about possible securities law violations.

This is at least the third action this year by the SEC against firms for using provisions in employment agreements that impede employees from voluntarily providing information to the SEC’s whistleblower program. SEC staff had also been warning firms over the past few years that the SEC is actively looking for such provisions in employment agreements. Since there is no allegation in these cases that a particular whistleblower was impeded, it is fair to assume that the SEC will not wait for a whistleblower to come along before it brings such a case against any other firm with these provisions in its employment agreements.

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)”).

Introducing brokers may have more time to transmit customer checks according to SEC Division of Trading and Markets Staff

SEC Division of Trading and Markets Staff recently issued a No-Action Letter allowing a group of introducing brokers more time to transmit customer checks.

Introducing brokers enjoy a lighter level of regulation than clearing brokers, but they must meet certain requirements to qualify. One such requirement is that they “promptly” transmit customer funds to their clearing brokers. A group of introducing broker-dealers received a No-Action letter allowing them more time to transmit customer funds, contingent on fulfilling other conditions in the letter.

The brokers represented that they were “engaged in the retail distribution of multiple types of financial instruments” (but also that “none of the Firms maintain proprietary positions for sales to customers.”) Earlier no-action letters in this area were limited to different situations.

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