SEF D.C.: Financial Firm Focus—The SEC’s Enforcement Priorities

Here is a transcript from the financial firm panel at the excellent post-election Securities Enforcement Forum in Washington, D.C. The panelists were:

• Kelly Gibson, Partner, Morgan, Lewis & Bockius

• Adam Aderton, Partner, Willkie Farr & Gallagher

• Gregory Baker, Partner, Patterson Belknap Webb & Tyler

• Joseph Gardemal, Managing Director, Alvarez & Marsal

• Corey Schuster, Co-Chief, Asset Management Unit, SEC

You can find the video here and the full agenda here.

00:00 - 00:36

Bruce Carton: Let's get started with our next panel which is called Financial Firm Focus, the SEC's enforcement priorities for asset managers, broker dealers, private funds and hedge funds. And our moderator is Kelly Gibson. She's a partner at Morgan Lewis based in New York. Is it New York or Philly? Philly and New York. And previously held several key roles at the SEC including acting Deputy Director of the Enforcement Division and Director of the SEC's Philadelphia Regional Office. Kelly, welcome. Next up, Adam Aderson, partner at Wilkie Far in Washington, D.C. And Adam previously served for 14 years at the SDC

00:37 - 01:16

Bruce Carton: including as co-chief of the Asset Management Unit in the Enforcement Division. Welcome Adam. Next up, Greg Baker, a partner at Patterson and Belknap in New York and Greg is a former senior counsel in the enforcement division and former member of the Asset Management Unit. Greg, great to see you. Welcome. To his left, Joe Gardemal, managing director at Alvarez & Marsal. Joe has more than 30 years of forensic accounting experience and he currently serves as a court-appointed independent monitor over GPB Capital Holdings. Joe, welcome. Finally, from the SEC we have Corey Schuster. He's the current co-chief

01:16 - 01:29

Bruce Carton: of the Asset Management Unit in the SEC's Division of Enforcement and he served at the SEC for over 14 years and was previously an assistant director in Enforcement. Corey, thanks so much for joining us and Kelly, let me turn it over to you.

01:30 - 02:03

Kelly Gibson: All right. We're going to try and lighten the mood a little bit and talk about the SEC's focus on financial firms. We have a lot of topics to discuss on the enforcement front, but before we do that, I think we're just gonna touch on exams because as many of you know, I'm sure, the Division of Examinations released its annual priorities a couple of weeks ago. And although enforcement doesn't have its own set of formal priorities, oftentimes exams priorities inform what enforcement is going to focus on. So we thought we'd start there. And Corey, maybe you can

02:03 - 02:08

Kelly Gibson: kick us off and tell us whether there's anything new of interest there, anything we can glean for enforcement.

02:09 - 02:37

Corey Schuster: Yeah, well, first, Bruce, thanks for having me and for the invite. It's always good to come and share the work and perspective of the division and in particular the asset management unit. Kelly, thanks for moderating this. What I'm sure will be hot bench and I'm interested in hearing the perspective and thoughts of my fellow panelists. For those of you who are just joining us, I gotta give my standard disclaimer that any remarks that I give are given in my official capacity as co-chief of the Asset Management Unit, but may not reflect the views of the Commission, any

02:37 - 03:13

Corey Schuster: of the Commissioners or the staff. So exam priorities. Exam priorities came out recently. I'd encourage all to take a look at them. As usual, there's a lot of great information in them that cover a variety of areas, including things like standards of conduct for investment advisors, which is certainly relevant to my unit. I'm talking about fiduciary duties, duties of care. As far as new things, I think, Kelly, you're probably referencing the mention of artificial intelligence and the emerging financial technologies out there. That's certainly included as well as a priority for exams. But more generally, what you

03:13 - 03:47

Corey Schuster: can glean for enforcement, I would say, pay attention to these examination priorities as well as the other documents that are issued by exams. They issue a lot of risk alerts throughout the year. And when you take a look at these documents, you can see issues and risks that are of concern, potential violations or violations that the Division of Examinations is seeing weaknesses in programs. They can also benefit you in the examination process. Just this week the Division of Examinations issued a risk alert that was concerning registered funds in their examination of them, areas that they will

03:47 - 04:20

Corey Schuster: be examining, key document requests that they're going to be seeking, and then other weaknesses that they see. And so definitely take a look at these as far as whether they become enforcement actions later on. You know, it's obviously facts and circumstances, but I would point you back to the February 2023 risk examination priorities that talked about the marketing rule. We saw the marketing rule highlighted there, talk about the various requirements concerning substantiation, third-party ratings, testimonials, and endorsements, and then fast forward a year and a half later to September of 2024, we saw a series of enforcement

04:20 - 04:40

Corey Schuster: actions that concerned substantiation, testimonials and endorsements and third party ratings. So, you know, I think these are good road maps of what the Division of Examinations is thinking about and the concerns there, potential violations that could be out there at various firms and then opportunities for firms to come in compliance before enforcement seeks you out.

04:40 - 04:50

Kelly Gibson: That's great. And Greg, just from your perspective, was there anything there of particular interest to you and do you think, you know, AI is the new ESG in terms of focus areas for enforcement?

04:51 - 05:24

Greg Baker: Yeah, first, I think there's a massive caveat that we have to acknowledge consistent with the theme of the last panel, which is we don't know who's going to be leading the agency six months from now, a year from now. So just because the examination priorities came out a few weeks ago, they may not be the same focus next summer, next fall, when we convene again. So there's a caveat to be had, for sure. But taking what we have with the current exam priorities, AI certainly jumps out as one of the priority areas. We saw several AI

05:24 - 06:00

Greg Baker: washing cases this year, which we'll touch on, and I know the next panel is gonna address this as well. I think it's incumbent on any registered broker dealer, investment advisor, or any other registered entity that uses AI to make sure that their utilization of AI, whether it's generative AI or some other software, is consistent with what they're disclosing. Just a couple of other touch points or areas of interest rather The the examination division wants to focus on investor exposure to assets that are subject to market fluctuations for example commercial real estate that's something new and I

06:00 - 06:27

Greg Baker: think that's something that is going to garner a lot of attention. And then finally outsourcing risk. Historically we thought of outsourcing as sort of a back office outsourcing or compliance outsourcing, but there seems to be a new emphasis on outsourcing of portfolio management or other investment decision-making functions which have come up in the examination priorities that registered entities need to focus on.

06:28 - 07:06

Kelly Gibson: So we're gonna turn now to some specific topics in the enforcement division. And I think this year we saw a very aggressive enforcement program where there was a lot of focus on using sweeps to bring actions, to send messages to market participants. Director Grewal touted the benefits of self-reporting and cooperation through a number of actions. And so before we turn into some specific topics, one of the things I wanted to raise, because it seems so timely, last week we saw a large financial institution. There were five actions filed on the same day against that firm and

07:06 - 07:37

Kelly Gibson: it really, there was really a grab bag of investment advisor broker-dealer issues that were at play in those actions involving misleading disclosures, breaches of fiduciary duty, prohibited joint transactions in principal trades, violations of Reg BI And so these were all, you know, disparate, it was disparate conduct in these five actions yet filed all at the same time. And so, Corey, you know, what can you tell us about how these five cases come together to get resolved at the same time? And what can you tell us about how these five cases come together to get resolved at

07:37 - 07:44

Kelly Gibson: the same time? And what can you tell us about how in some of these actions we saw varying levels of cooperation and what can we glean from that?

07:45 - 08:12

Corey Schuster: Yeah, I mean, I think as you reference, these are some of our bread and butter enforcement actions in the asset management space. You have breaches of fiduciary duty. You have Fundamental Investment Company Act violations, Investment Advisor Act violations in Reg BI. I don't want to talk about necessarily specifically how these enforcement actions came together, but I'll talk more generally because I don't think this is the first instance where, I know it's not the first instance where we packaged cases together and sort of can talk about it more generally. You know, a little over a year ago

08:12 - 08:42

Corey Schuster: we had the DWS matters which involved ESG and AML. We earlier this year packaged some artificial intelligence matters, the Delphia and the Global Predictions. And I think while it's not going to be where casers are always, this is always the case, but if we see certain investigations that are similar points in their life cycle nearing the end of the resolution, is there any sort of benefit or efficiency to bring these cases together for us and then also the potentially settling party. And so that's what we're thinking about. It's not always going to be the case that

08:43 - 09:15

Corey Schuster: a registrant has multiple investigations and we're going to resolve them all at once. But that was the case that took place here. And I think it's incumbent upon the staff and potentially the settling party that we're not going to hold up enforcement actions and resolutions for investigations that are further behind. So if we want to advance investigations and bring them at one time, we need to expedite in an efficient and in a manner that makes sense, an investigation that may be close in time, but lagging. And so that's how we really think about it. If there's

09:15 - 09:31

Corey Schuster: an opportunity to bring these cases together that makes sense for the division and for the Commission. What can we glean from as far as the cooperation, the reporting? I would encourage people to look at the clone ETF matter. I think that's the one that had the clearest example. Reg BI

09:35 - 09:35

Bruce Carton: violation that affected

09:35 - 09:36

Greg Baker: over 10, 000

09:36 - 09:36

Adam Aderton: customers at JP Morgan.

09:36 - 10:11

Corey Schuster: There was a self-report, there was remediation by JP Morgan, both in terms of process and how they were handling their internal procedures. There was remediation to customers in terms of monetary relief, in terms of conversion to different shares, and also the cooperation that they afforded the staff throughout the investigation. And that's all detailed in the order. And so for this violation, while appropriate to bring an enforcement action, the Commission felt that that level of cooperation for jp morris and that particular case that stand-alone case merited 0 penalty

10:12 - 10:18

Kelly Gibson: and and just throwing out their panels and Adam you'll just start with you anything else jump out at you or that you think is worthwhile noting.

10:18 - 10:43

Adam Aderton: I think they're first things Kelly for moderating thanks for the question and I think Corey hit on a couple things that are interesting about those resolutions and that might be something depending on as the last panel talked about what kind of chair we get next and what kind of enforcement director we get next could be harboring errors of what we're going to see maybe in the future. one good example is the clone order, the clone, the mutual fund ETF clone case that Corey talked about. It's a Reg BI violation that looks a lot like the share

10:43 - 11:13

Adam Aderton: class selection disclosure initiative from the prior administration where there are two products that hold identical portfolios and one is more expensive than the other. Here it's charged under Reg BI because it's a brokerage issue but we have a self report and we have no penalty, very similar to the type of thing that we saw back with the share class selection disclosure initiative. The other case that I think stands out because we may see less of cases like this going forward is there was a case about a preference for JP Morgan's internal portfolio management product versus a

11:13 - 11:37

Adam Aderton: third party product. The order suggests, maybe as explicit, that the internal product was cheaper for investors than the third-party product. Nonetheless, the case got settled and there was a $45 million penalty associated with it. No disgorgement, presumably because there was no client harm. I think a case like that might be less likely in a future administration sort of regardless of who the chair is.

11:38 - 11:57

Kelly Gibson: That's a great point. And I guess just turning back to AI, you know, Greg mentioned AI was announced in the exam priorities again and how that might play out on the enforcement side. You know, Corey, what can you say about the staff's view on AI and what the concerns are from the enforcement staff?

11:57 - 12:27

Corey Schuster: Yeah, I mean, I think, you know, when we talk about AI, AI washing or misrepresentations related to AI, We're thinking about it in a couple of different buckets initially. one is, as a firm misrepresenting, do they in fact have any sort of artificial intelligence or machine learning? That's one bucket. Another maybe. Are they misrepresenting how they're actually using it? Are these lofty expectations? And so the first two cases that the unit brought, not necessarily the Commission brought, were the Delphia and the Global Predictions cases that came out earlier this year. Delphia had represented that it was

12:27 - 13:00

Corey Schuster: incorporating artificial intelligence and machine learning into its process to analyze client data and then make investments when it was not. Delphia had represented it was the first AI regulated financial advisor and that it used AI driven expert forecast when it had. And so I think those are sort of standard cases that we have brought on disclosures about what your strategy is and how you're using it if you don't have those full capabilities. But we also think about them in broad principles that we apply to other situations. In those situations, are you being open and honest about

13:00 - 13:33

Corey Schuster: what your capabilities are and how you're using them. We think about materiality in the asset management context. We think about fiduciary duties. Are you acting with your duty of loyalty? Are there certain conflicts of interest, whether you're using it for certain clients and not others, or how you're using artificial intelligence that require disclosure of conflicts of interest or whether those conflicts need to be mitigated or eliminated altogether. Are you acting with care? Do you understand what the artificial intelligence is doing? Do you understand how it's being employed? What the risks are? What the limits are? These

13:33 - 14:10

Corey Schuster: are just general concepts that we would apply to other situations. And of course you have things like safeguarding client data and information, protecting, making sure that material non-public information that you have in certain parts of your database is not being used to trade. Making sure you are complying with the books and records requirement, and then certainly periodically assessing the artificial intelligence you're using, how it's working, and your policies and procedures that are related to that artificial intelligence. So I think really standard how we apply our thought process to other situations, you know, can apply to artificial

14:10 - 14:11

Corey Schuster: intelligence as well.

14:12 - 14:25

Kelly Gibson: And is there anything that you can say to touch on how enforcement sources those kinds of cases? So, you know, for example, exam referrals, data analytics, anything you can say to, you know, tell people how those cases are typically sourced.

14:25 - 14:54

Corey Schuster: Yeah, I don't want to get too specific on how we do particular types of cases, but I will note that the Delphia case referenced an examination that took place and I would expect that our sources of cases in the artificial intelligence area would be similar to how we have source other cases and those typically for our unit are exam referrals, complaints, you know, the entrepreneurial efforts of the staff, whether that's data analytics or otherwise, news media, and a variety of other sources.

14:55 - 15:06

Kelly Gibson: And Greg, can you just touch on what kinds of questions you're getting from clients about the implementation of AI, what do you recommend as best practices and or risk areas that you see?

15:07 - 15:48

Greg Baker: Yeah, I think the biggest issue that I'm seeing is sometimes there's a disconnect between legal and compliance, the team that's putting the disclosures together, and the engineering team, PMs, and how AI is actually being utilized. It is incumbent on legal compliance to really try to understand what AI is being used, whether it's generative or otherwise, and try to understand the technology behind it to the extent possible before they can make informed disclosures, because I think the risk, what we see in a lot of these cases, and I assume in investigation, is that there's just a disconnect,

15:48 - 16:18

Greg Baker: that there's people who really understand what generative AI is or what it's doing. There's an assumption that we can delegate all of our portfolio management to this, but that's not how it works. It's probably not how it's being utilized by any of the most responsible firms at this point. So I think it's just important to have this dialogue and really, really take whatever steps you can to work with the engineering team, portfolio managers, to really understand how this is being used for our program.

16:20 - 16:51

Kelly Gibson: So another area of interest, I think, to a lot of us involved the cases that the Enforcement Division brought this year involving information barriers. So policy and procedure 204A cases, as well as a case that was decided in the SEC's favor and what we'll call shadow trading. And so, you know, Corey, can you kick us off and tell us some of the highlights of those recent cases that involved violations of 204A and kind of how tailored should a firm's policies be?

16:51 - 17:30

Corey Schuster: Yeah, taking a step back, I mean investment advisors, you know, certain types of investment advisors are entrusted with a tremendous amount of material non-public information to perform their roles and invalid roles. And 204A is designed to prevent the misuse of that material non-public information. It requires registered investment advisors to establish, maintain, and implement policies reasonably designed and that are tailored to their business, the nature of their business, to prevent the misuse of material non-public information by the Registered Investment Advisor and their associated cases. And that really, you know, tailored to sort of firms need

17:30 - 18:08

Corey Schuster: to think about the nature of the business, of their business, where material nonpublic information can come in and how they are addressing it. And the cases that have come out this year really get to that point. Starting with SoundPoint. SoundPoint was a CLO or is a CLO manager. There are also trade CLOs, including CLOs that are managed by third parties. You know, other aspects of SoundPoint's business interact with, you know, creditors' committee where they are hearing about and getting material non-public information into that business. And firms need to adopt policies and procedures that are relevant to

18:08 - 18:52

Corey Schuster: that business. So Soundpoint hadn't adopted a pre-trade review prior to 2-1 and 2-2. Even though it traded CLOs that had third-party loans, it had not included or adopted policies and procedures related to how it would handle material, not public information that came in about loans that were in these third party managed CLOs. Another example would be the Marathon case. Marathon, again, an investor in distressed debt and other types of loans often set on or participated in ad hoc creditors committee where those participants were receiving material non-public information, analyzing material non-public information, and firms such as Marathon

18:52 - 19:26

Corey Schuster: needed to, but did not have reasonably designed policies and procedures to assess potentially when material non-public information could come in at that particular point in time and how it was going to handle it. And so I think firms need to take a step back, think about their business. Where does and how does material non-public information come into its business and what are the pressure points throughout where it could get transmitted. I think it's involving compliance regularly. It's involving legal. And there's a host of lessons that I think can be learned from these cases.

19:28 - 19:47

Kelly Gibson: Great. Thanks. And Adam, just turning to the Panuwat case, I mean, that's a case that certainly garnered a lot of attention from asset managers and wondering how that case applies to them. What are some of the takeaways that you see from that case and, you know, how should managers respond in light of this decision?

19:48 - 20:20

Adam Aderton: It's a good question and it dovetails with what Corey is talking about, about managers looking at their policies and procedures and improving them around MNPI. I will say that you should feel comforted, Corey, that managers have paid attention to all three of these cases and are sort of lighting up everyone in the room's phones about how they should address these sort of issues that converge with the idea under Panuwat that information received in connection with one company could also be material to another company. At the same time, you need to think about co-mingled vehicles of which

20:20 - 20:54

Adam Aderton: a particular company about which you have MNPI is a component, as well as information that you may be getting through participation in a particular creditors committee or some other mechanism where MNPI can be coming in. So people are thinking about it very expansively. I think a real challenge that a lot of asset managers are finding is that the contours of Panuwat are not well defined from mapping on to an asset management business where their entire business exists to think about the relationships between different issuers' securities and to trade those different securities. Now they have to overlay

20:54 - 21:27

Adam Aderton: this concept of the possibility that information that they receive with respect to one of those securities may infect their entire business. So we've seen efforts, I think everyone is making efforts to update policies and procedures. They're updating to broaden if they have a significant CLO component, if they participate in these ad hoc creditors committees, if they have processes, investment processes where they're getting MNPI with respect to potential issuers or particular issuers. The other thing that I think we see is people thinking about the duty. Panuwat, there is a duty to the source of the information. There

21:27 - 21:57

Adam Aderton: was the employer. That doesn't fit neatly with the asset management context in that those asset managers are getting information maybe it's pursuant to an NDA or maybe it's pursuant to something else. And it's one of these contractual agreements where maybe they have the ability to scope the duty that they're undertaking to the source of the information to allow them some insulation for how they use that information in their day-to-day business. I do think at the margins we're getting a lot more calls about trades that we probably wouldn't have gotten a call about before these 3 cases

21:58 - 22:26

Adam Aderton: came out. And I think at the margins we see firms struggling with whether they should undertake a particular trade and that we're losing a little bit of the price discovery function of that trading because people are afraid that a regulator is going to come in and second guess in hindsight whether an MNPI from one company either infected that trade or their policies and procedures just weren't sufficiently tailored a la marathon to address that trade. So

22:26 - 23:07

Kelly Gibson: I want to turn to whistleblower protection rules because This is also another area where we get a lot of questions from clients about this. And we saw a number of sweep cases, in particular sweep cases filed this year by the Enforcement Division. And a number of these cases involved confidentiality provisions outside of the employer-employee context. And also, recent cases noted, explicitly noted that there was no showing that a whistleblower was actually impeded by any of the language in these agreements. So Greg, maybe you can talk about what the SEC's concerns are here and where do we think the SEC is going with extending its reach?

23:07 - 23:51

Greg Baker: Sure. And just as a quick reset, Rule 21F-17 was enacted as part of Dodd-Frank. It broadly precludes companies, individuals from interfering with reports to regulatory agencies, including the SEC. Historically, we've most often, most frequently seen this rule applied in the context of employer-employee relationships. You have the separation agreement and release and the company may ask the departed employee to not report or that they are taking obligation not to report any information they discovered during the course of their employment to the SEC or any other regulatory body. That's a pretty clear violation. And often,

23:51 - 24:36

Greg Baker: historically, we saw these cases, 21F-17 cases, brought as part of a larger package of rules enforcement. More recently we've seen more standalone cases and there were a couple significant ones this year. JP Morgan Securities in January of this year, settlement in action. This was not an employer employee context, but for certain customers who received credits or settlements in their accounts that exceeded $1,000, they were asked to sign certain settlement agreements that basically precluded them from reporting these issues to the SEC. And as a result of these releases that JP Morgan Security has asked of

24:36 - 25:19

Greg Baker: their customers, they settled with the SEC and paid an $18 million civil penalty. Another case was GQG partners in September of this year were potential employees were asked to sign an NDA that essentially would have precluded them from reporting certain violations to the SEC. That case resulted in a $500, 000 penalty and a sentry. So currently this is something that the agency is acutely focused on. Again, just to piggyback on the prior panel, it remains to be seen how aggressively these provisions are enforced going forward. And one of the big issues with these cases that were

25:19 - 25:39

Greg Baker: brought this year is there's no evidence that any of the whistleblowers were actually prevented from bringing information to the SEC. These are all potential barriers to their reporting information. So that's something to keep an eye on. I think that's an aggressive approach. We may not see that going forward under whoever the new leadership is of the Commission.

25:42 - 26:21

Kelly Gibson: Speaking of we might not see going forward, Adam, what do you think about the private funds? We're going to talk about some perennial issues. one of those is fees and expenses. This is something that we've seen discussed in exams, priorities for a number of years. Enforcement's been focused on it. We know that there were the private fund rules that were vacated and struck down by the Fifth Circuit, ruling among other things that regulators hadn't established a record of widespread fraud to justify those rules. But we want to focus on, in particular, the Colony Capital case, and can you talk about the basic proposition there, and what are

26:21 - 26:55

Adam Aderton: the takeaways? Sure. So Colony Capital is kind of the paradigmatic the inexpensive kind of case that the SEC has been bringing for a lot of years now. Just a quick set on the facts. The case involved an advisor who advised several real estate funds. The advisor had the ability to enter into transactions or agreements with affiliates that could create conflicts of interest. The limited partnership agreements for those particular funds required that transactions with affiliates be disclosed and advanced and approved by the LPAC or a majority in interest of limited partners. And according to the order, that

26:55 - 27:28

Adam Aderton: didn't happen and the funds therefore were incurred fees and expenses without those disclosures, without those approvals. That's pretty straightforward. That's the kind of fee and expense case that we've seen in the private fund context for a lot of years. I think what's interesting and sort of where you're going is that these cases didn't completely go away during the previous Trump administration. And so I don't think we should really expect these cases to completely go away today either, but I think the nature of them and which ones get across the line will change. We go all the

27:28 - 28:01

Adam Aderton: way back to the Mary Jo White era, That's when we saw the first of these cases involving private fund advisors and in particular involving private equity funds. A lot of those cases, even if you've been doing this long enough and you remember the accelerated monitoring fee cases, there was just no disclosure about this fee that the advisor was taking on certain services that had never even provided to the funds. It was a pretty straightforward no-disclosure case. Then in the Clayton administration, we continued to see similar cases. We saw cases where there was really lacking disclosure. We

28:01 - 28:31

Adam Aderton: would see an enforcement action. In the current administration, it feels like tie or even maybe a little bit past tie is not going to the advisor. And these things are being, the language is being really parsed and construed against the advisor such that we see a lot of enforcement actions now in the fee and expense space where there's a lot of disclosure there for investors about how the advisor is going to take fees, and then you see an enforcement order that says, aha, but there's, you know, these couple of lines that we would have liked to

28:31 - 28:59

Adam Aderton: have seen that are not there and therefore, you know, there's going to be an enforcement action and you need to provide disgorgement. I think those marginal cases are going to be more difficult to bring, no matter who the next chair is. And that's just assumed, that's all assuming that whomever the next chair is continues to have at least some interest in bringing private fund cases, which I think is a little bit of an open question as to whether it's going to have to be cases where there's no disclosure at all before they get out of the gate.

29:01 - 29:16

Kelly Gibson: And, Corey, just curious in your views, you know, given that we have almost a decade worth of these kinds of cases where they're reinforcing the importance of strong disclosure and expense allocation, you know, is it surprising we still have these kinds of cases? What are the concerns?

29:17 - 29:47

Corey Schuster: Yeah, I don't know if it's surprising necessarily, but you're right, we do continue to see them. I mean, I think it's been 10 years since one of my predecessors gave a speech entitled Conflicts, Conflicts Everywhere, which Adam may have written. But we do continue to see these these conflicts of interest cases these fee and expense cases whether it's on retail or whether it's in the private fund space You know I think we're going to continue to see them if we don't see full and fair disclosure and the standard really is not Just as Capital Gains said

29:47 - 30:17

Corey Schuster: showing the store window. It's really showing what the full store looks like, really showing what the full nature of those conflicts of interests are. So for example, if you are, in the fee and expense case, interpreting a provision in a certain manner that's subjective and is to your benefit and may not be the way that others are interpreting it or a reasonable person would interpret it. You know, that may be a scenario and has been a scenario where we've brought cases. If your – one area that even – not just on the failure to disclose, but

30:17 - 30:56

Corey Schuster: the interpretation of them. Or seemingly not knowing what the documents that you provided to your, for example, the private funds, your limited partners state. That's an area where we see certain advisors get tripped up. You know, calculating management fees based upon committed capital as opposed to invested capital, and there's a difference in how those are calculated. You know, assessing impairment, which flows down to fees and expenses at the portfolio company level as opposed to the portfolio investment level. So a fund may have a variety of investments in a portfolio company, but are structured differently and certain

30:56 - 31:29

Corey Schuster: ones may be impaired and others not. And so the LPA may spell out how you are supposed to calculate fees and we see firms getting tripped up in that area. You also may see firms, and you know that that's a reference to the inside case. You also may see firms that are you know using certain funds to pay the expenses of others, whether intentionally or just through negligence or because of the way the deal worked out. And that becomes an interest-free loan, even if it's later paid back. And so those are some of the conflicts of

31:29 - 31:55

Corey Schuster: interest that we've seen over the years that we have concerned about in the private fund context. Obviously, we continue to have retail cases. We talked a little bit earlier about the JP Morgan, but we also had the Caterig case and the Fusion cases earlier this year that relate to fees and expenses and conflicts of interest that are present at retail investment advisors. So something that we continue to see and wouldn't be surprised, you know, to see more of these in the future.

31:56 - 32:20

Adam Aderton: Kelly, can I? Sure. You brought up the private fund advisor case and or the private fund advisor rule case in the Fifth Circuit. And there's just one more point that I think is an interesting one there that, you know, Corey rightly points out that LPs need disclosure so they understand the deal that they are signing on to. one of the things that's very interesting about that Fifth Circuit opinion to me is that it can be read, you know, if you look at it the right way, to suggest that maybe the Commission shouldn't be spending time protecting

32:20 - 32:26

Adam Aderton: limited partners at all, and it sort of treats any limited partner, anyone who could qualify as a limited partner for

32:26 - 32:27

Joe Gardemal: a private fund, monolithically.

32:29 - 32:50

Adam Aderton: I'm not sure that's exactly the right standard, because some of them are just accredited investors, but it does raise a question of if we're talking about a qualified purchaser's fund or something like that, whether that is the right, what the scope of the SEC's authority is to require disclosure in those contexts. And it would be interesting, these cases are almost never litigated, but it would be interesting to see someone consider litigating that issue.

32:50 - 33:14

Kelly Gibson: That's a great point. Okay, turning back to broker-dealers for a minute, we mentioned Reg BI at the outset, and it's been several years now since the rule went into effect and we've certainly seen that play out on the enforcement side. So Greg, can you talk a little bit about what enforcement's focus was particularly with regard to some of the cases over this past year and what are best practices here?

33:15 - 33:55

Greg Baker: Yeah, sure. So again, just as a quick reset, Reg BI establishes the standard of care for broker-dealers. It's been in place for a few years now. There are essentially four components of it. The duty to disclose material facts about the investment products, the duty of care where the broker-dealer has to exercise reasonable care and skill in making the recommendations, conflict of interest, they have to maintain and enforce written policies and procedures to prevent conflicts of interest and address them when they arise. And finally, the compliance component, which is a permit to establish policies that ensure compliance

33:55 - 34:40

Greg Baker: with Reg BI. This was clearly, Reg BI is a focus of the exam priorities. We saw several Reg BI cases this year. Thrivement was charged early this year for where the broker recommended a class of mutual fund shares where a less expensive alternative was available. Another firm was charged with a Reg BI violation for recommending certain risky bond investments to retail investors. And there were a couple other matters where the SEC was keenly focused in on the Reg BI policies and procedures, the entities really didn't have them in place or didn't update them accordingly. So this

34:40 - 34:54

Greg Baker: is a hot button issue for the agency. Again, it remains to be seen what happens next year, but the current administration has telegraphed this is an area of focus and we can expect it to continue to remain so for the foreseeable future.

34:56 - 35:28

Kelly Gibson: Great, so one thing we wanted to try to do is tie some of these things together. And so we talked a lot about these different priority areas, so conflict, adequacy of disclosure, whistleblower retaliation. And we know these priorities can be informed by actual events. And Joe, I know that you have been involved and have a lot of experience on the operational side of dealing with the consequences of SEC enforcement actions. And so we're hoping you could highlight that for us today and talk about a case you've been involved with so that we can see how those

35:28 - 35:33

Kelly Gibson: priorities play out and talk to us about what your role is and what you think is important to take away.

35:33 - 36:06

Joe Gardemal: Certainly. Thank you, Kelly. So you've heard my fellow panelists talking about examination priorities and cases that have occurred recently. I'm going to tell you about one case where almost all of those issues have been covered in one project. This is GPB Capital. It's the largest fraud involving a private equity firm since a rise group collapsed in 2018. Because the litigation is ongoing, I'm going to limit my remarks to information that's been released either by the government agencies reported in the media or contained in my monitor reports to the court. As I mentioned, I was appointed as

36:06 - 36:41

Joe Gardemal: the monitor 3½ years ago now. An order appointing me as the receiver was entered in December of 2023. It was appealed. It's actually being argued today in the Second Circuit, so hopefully we'll have some clarity on that issue in the near future. By way of background, GPB was a registered investment advisor formed in New York in 2013. Mr. Gentile was the founder of it. He marketed his securities through a company called Descendant Capital. Mr. Schneider was the man who owned Descendant Capital. And the third relevant person, Mr. Lash, ran the automotive business of

36:41 - 37:22

Joe Gardemal: GPB Capital, which was by far the largest investment component of the enterprise. GPB raised over 1.7 billion dollars from over 17,000 retail investors and you'll see from the pleadings many retirees, folks who were sort of marginally qualified to invest in these securities. And it promised, you've heard this before, an 8% annual return on the invested capital. Now the question is, what invested capital? Was it gross or net? And that's a different issue. It also promised special returns ranging from a half percent to 3 percent. And it actually made some of those initially. It took this

37:22 - 38:03

Joe Gardemal: $1.7 billion and invested in a number of different funds, by far the largest of which were two funds that held automotive assets. By the time GPB reached its peak, it owned the tenth largest privately held group of auto dealers in the country, about 55 auto dealers. And so it was a fairly significant enterprise and It was operating reasonably successfully. It also invested in physical therapy businesses, waste management in New York. I don't know if anybody knows about waste management in New York, but that was one of its investments, and waste, real estate investments and some other

38:03 - 38:35

Joe Gardemal: things. And that's where all the problems began. So when you buy a car dealership, if you know anything about the car industry, it's not like buying a car. You can't just walk in, give them a check and walk out with a car dealership. It takes time for the manufacturer to approve the investment and that's time during which the enterprise GPB is holding cash and is not able to generate a return from it. And so that started to create some problems. one of the counter parties to a car deal sued GPB and alleged that it was running

38:35 - 39:19

Joe Gardemal: a Ponzi scheme, that in fact some of these distributions that it was making were returns of capital and not from the operating funds of the companies, as GPB had disclosed to its investors. Through 2018, a number of bad things happened. It's late filing its financial statements, its auditors resign, the SEC, the state of Massachusetts and FINRA announced that they're investigating irregularities at GPB. In early 2019, the FBI conducts what GPB later describes as an unannounced visit. The unannounced visit results in the seizure of lots of files and lots of other information. Later in 2019, the former

39:19 - 39:59

Joe Gardemal: chief compliance officer of GPB, who by the way is a former SEC employee of the asset management unit, is indicted and ultimately pleads guilty to a misdemeanor charge of the theft of government property. And the plea agreement states, especially what he stole, were files related to an SEC investigation. This is a fairly unique circumstance as far as I understand it, because I've not seen a case like this before. By February 2021, the SEC files an enforcement action against the individuals and the entities, and the DOJ indicts the three individuals I mentioned earlier on securities, wire fraud,

39:59 - 40:33

Joe Gardemal: and conspiracy charges. In June 2023, Mr. Lash, the former head of the automotive business who had a falling out with the owners, pleads guilty to a single count of securities fraud. In August of this year, after an eight-week jury trial in the Eastern District of New York, Gentile and Schneider were both convicted on all charges. The jury deliberated for only 5 hours, which I think is an indication of the strength of the DOJ's case here. Their sentencing is set for the spring of 2025. So what my team is doing, I'll talk about that and then talk

40:33 - 41:08

Joe Gardemal: about how some of the individual issues here relate back to the enforcement priorities. We've been working with management to liquidate the portfolio of GPB assets. We've raised about $1.3 billion from asset sales so far. We have more asset sales to conduct. We've generated over $100 million in interest income. That has been more than offset by advancements of legal fees, which in my last report dated last week, totaled about $140 million, which is – I'll divert from the script for one minute and say that it's outrageous and it's not over yet, but that will be litigated as

41:08 - 41:49

Joe Gardemal: we go forward. So how do these facts inform the risk priorities and the examination priorities? So first, the focus on economic incentives and conflicts of interest that you heard Corey and Adam talk about earlier. Here there were significant fees, some of which were disclosed and some of which the government alleges were not disclosed. 11 percent selling fees. So if I put $100 in, $89 net gets invested. Additional fees, 2% management fees, 1.25% organizational expenses, acquisition fees that were paid in many cases to the principals, and also control over the amount of the acquisition fee by the

41:49 - 42:28

Joe Gardemal: principals because they were deciding what price assets were acquired. Whether these disclosures included relevant facts and conflicts of interest, they did not. At least the government alleges they did not and that's where we stand today. There was a failure to disclose the source of the distributions, many of which were coming from capital and not from earnings of the businesses. And then there were also undisclosed performance guarantees which artificially inflated the performance, particularly of the automotive assets. There was a compliance program put in place by the company. They created an independent board in 2020, about a year

42:28 - 43:05

Joe Gardemal: too late, maybe a couple years too late, And the indictment of the chief compliance officer obviously plays into that compliance issue as well. Then reporting to the SEC, auditor resignations, late financials, withdrawal of auditor opinions. There were two funds that should have been registered but could not be registered because they could not get audited financial statements. Those were ultimately registered during the pendency of the monitorship. And then whistleblower retaliation, my last point. The former head of the automotive business who sued the company and was a whistleblower had a term in his separation agreement that prohibited him

43:05 - 43:40

Joe Gardemal: from communicating with the SEC. And we've heard a lot about that already today. So, this case is a long way from being done, but it's a critical cautionary tale for those of us involved in supervising and advising companies in this industry. It's an example of the real risk that investors face when compliance takes a backseat to economic considerations. And here we have 17,000 investors who haven't gotten a dollar from GPB since 2018 were prepared to start moving that money out as soon as I'm appointed as the receiver, which we hope will occur fairly soon. But

43:40 - 43:49

Joe Gardemal: it illustrates the real risk. These are real people who have lost real money as a result of these violations. So with that, Kelly, I'll turn it back over to you.

43:49 - 44:04

Kelly Gibson: That's great, thanks Joe. We have a little less than a minute left, so we'll just do a quick lightning round and Corey can abstain. But where do we see asset management enforcement in a year from now, two years from now. What are your crystal ball predictions, Adam?

44:05 - 44:10

Adam Aderton: Fewer private fund cases, more retail conflict cases, more cases where money goes back to investors.

44:11 - 44:12

Kelly Gibson: Great, how about you, Greg, anything else?

44:14 - 44:23

Greg Baker: To the extent that there are off-channel communications filed, I think the penalties will not be anywhere near what we've seen, but I also expect there will be fewer of those cases brought going forward.

44:24 - 44:25

Kelly Gibson: Joe, any last thoughts?

44:25 - 44:36

Joe Gardemal: Yeah, this is not an SEC issue, but you heard me say advancement and indemnification, and I think that's something we need to think about reforming. It's not at the SEC, it's in the states, but something to think about going forward.

44:37 - 44:38

Kelly Gibson: All right, thank you.