SEC Issues Settled Enforcement Action against Investment Adviser, its President and Senior Officers for Compliance Program Violations

The U.S. Securities and Exchange Commission (SEC or Commission) issued a cease and desist order (Order) on June 23, 2015, against Pekin Singer Strauss Asset Management Inc. (Adviser), an investment adviser registered under the Investment Advisers Act of 1940 (Advisers Act), its former president, Ronald L. Strauss (President), current Chairman William A. Pekin (Pekin), and current co-CEO Joshua D. Strauss (Strauss) (collectively, Officers).¹ Messrs. Pekin and Strauss were, at the time of the investigation, portfolio managers (Portfolio Managers) of the Appleseed Fund (Fund), a series of Unified Series Trust, an SEC-registered open-end management investment company. 

According to the Order, between 2009 and 2011, the Adviser committed a number of compliance violations, including failing to conduct timely annual compliance reviews and failing to implement and enforce significant components of its compliance policies and procedures and code of ethics. The Order also alleges that, from 2011 through 2014, the Adviser kept or placed a number of shareholders in an investor class of shares of the Fund – even though such investors were eligible to hold a share class that charged 25 fewer basis points for administrative expenses. Because of these alleged failures, the SEC charged the Adviser with violating Sections 206(2), 204A, 206(4) and 207 of the Advisers Act, and Rules 204A-1 and 206(4)-7 thereunder. 

Notably, the SEC singled out the former President, alleging that he had failed to allocate sufficient resources to the Adviser’s compliance department, which “substantially contributed to [the] compliance failures.” According to the Order, the President willfully violated Section 207 and caused the Adviser’s violations of Sections 204A and 206(4) and rules thereunder. In addition, the SEC alleged that the Portfolio Managers had willfully caused the Adviser’s violations of Sections 206(2) and 207 and rules thereunder. 

Without admitting or denying the SEC’s findings, the Adviser and the Officers submitted offers of settlement, pursuant to which the SEC: ordered the Adviser and the Officers to cease and desist from violations of the Advisers Act; suspended the President for one year from the securities industry; censured the Adviser and the Portfolio Managers; and fined the Adviser $150,000 and each of the Officers $45,000. According to the Order, in determining to accept these offers of settlement, the SEC took into account the Adviser’s extensive remedial efforts – including the retention of additional personnel, consultants and legal counsel to improve its compliance program – as well as its self-reporting of the share class issue. 

Alleged Violations of Advisers Act Sections 204A, 206(4) and 207 

Statutory Provisions

Section 204A requires registered investment advisers to establish, maintain and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information. Rule 204A‑1 under that section requires registered investment advisers to establish, maintain and enforce a written code of ethics that includes provisions that require access persons to submit, and the adviser to review, reports on personal securities transactions and holdings. 

Section 206(4) and Rule 206(4)-7 thereunder require registered investment advisers to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act, and to review, no less frequently than annually, the adequacy and effectiveness of these policies and procedures. 

Section 207 provides that it is unlawful for any person willfully to make any untrue statement of a material fact in any registration application or report filed with the Commission under Section 203 or 204, or willfully to omit to state in any such application or report any material fact which is required to be stated therein. 

SEC Findings 

According to the Order, the Adviser’s troubles began when the firm transitioned to a new Chief Compliance Officer (CCO) in 2007. The Order states that the President promoted an existing employee to the CCO position, although the President “knew the Chief Compliance Officer had limited prior experience and training in compliance prior to becoming CCO” and the new CCO was expected to retain his existing responsibilities including backup trader, backup trade reconciliation, research analyst, and portfolio manager. The Order alleges that the President “did not provide the Chief Compliance Officer with sufficient guidance regarding his duties and responsibilities,” leaving the transition to the prior CCO. It also alleges that the President “did not provide the Chief Compliance Officer with staff to assist him with compliance” and required the new CCO to seek the President’s pre-approval for all compliance expenditures. According to the Order, the President “did not make the compliance program a priority for the firm.” The Order states that the President “directed the Chief Compliance Officer to prioritize his investment research responsibilities over compliance,” while giving the new CCO even more responsibilities, promoting him to Chief Financial Officer in 2009. The Order states that the CCO “was only able to devote between 10% and 20% of his time on compliance matters.” 

The Order alleges that the CCO made several attempts to voice compliance-related concerns to the President – the CCO told the President on multiple occasions that more help was needed to meet compliance-related responsibilities, including finishing the annual compliance review, and the CCO warned the President that the firm would not be ready for a SEC examination, if one took place. According to the Order, the President informed the CCO that advising clients was the higher priority and that compliance matters could be addressed later, if and when an examination occurred. The Order alleges that the CCO identified two potential consultants to assist him with completing compliance matters, but the President did not hire the first consultant because of cost concerns and delayed action on the second consultant for more than a year, which contributed to the failure to timely complete both the 2009 and 2010 annual compliance reviews. 

According to the Order, a compliance consultant was ultimately hired to help with compliance matters, but the President “narrowed the scope of the engagement – and thus the amount of assistance for the Chief Compliance Officer – from a more comprehensive compliance review to limited trade testing for a six-month period in 2010, in part to reduce the cost of the engagement.” According to the Order, the SEC’s Office of Compliance Inspections and Examinations (OCIE) examined the Adviser in 2011 and cited the firm for several compliance deficiencies, including: failing to pre-clear personal trading transactions; failing to conduct annual compliance reviews for two years; violating the code of ethics with respect to trainings and certifications; and failing to obtain securities holdings reports and other documentation. According to the Order, the Adviser also failed to disclose aspects of the foregoing issues in its Form ADV.

Alleged Violation of Advisers Act Section 206(2) 

Statutory Provisions 

Section 206(2) of the Advisers Act prohibits investment advisers from directly or indirectly engaging in “any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” 

SEC Findings 

According to the Order, the Adviser defrauded certain Fund investors by selectively converting the investments of certain shareholders into share classes that paid lower administrative expenses, while not converting others. The Fund offered two different share classes: Investor Class shares and Institutional Class shares. The Order states that the expense ratio for Investor Class shares was 25 basis points higher than the expense ratio for Institutional Class shares, to compensate the Adviser for its payment of platform fees to broker-dealers that provide administrative services to Investor Class shareholders. The Order alleges that the Adviser converted Investor Class shares into the less-expensive Institutional Class shares when such conversions would result in the Adviser collecting higher administrative service fees. According to the Order, the Adviser viewed the administrative fees “as comparable to a negotiable investment advisory fee.” According to the Order, the Adviser converted shareholders that held their shares on one broker-dealer’s platform because the conversion resulted in a net gain to the Adviser of five basis points. At the same time, the Adviser declined to convert shareholders that held their shares on another broker-dealer’s platform because the conversion would have reduced the Adviser’s overall fees. In addition, according to the Order, the Adviser and the Portfolio Managers failed to disclose this conflict of interest and the failure to seek best execution in the Fund’s share classes, either to clients or in the Adviser’s Form ADV. 

Observations for Advisers 

The Order highlights the SEC’s view that the “tone at the top” set by leaders of investment advisers on matters of compliance is critically important, and that compliance violations may result in serious individual sanctions. Officers of registered advisers are expected to maintain fully-operational, effective compliance programs, even if a technical violation does not directly cause harm to the adviser’s clients. Among other things, senior officers of a registered adviser should ensure that their CCO is provided with the time and resources necessary to carry out critical compliance functions. When competing demands are made on a CCO who performs other non-compliance functions, the Order illustrates the SEC’s view that the CCO must prioritize essential compliance functions, even at the expense of performing client-related functions. 

In addition, for advisers that become first-time managers or administrators of registered investment companies, the Order calls attention to important differences – including with respect to administrative and distribution-related costs and expenses – between advising individual high net worth clients pursuant to a negotiated advisory fee and managing a registered fund. An investment adviser managing a registered fund must, among other things, seek best execution in sales of fund shares and consider distribution-related conflicts of interest, disclosure requirements, and compliance controls. 

Footnotes 

_{1) In the Matter of Pekin Singer Strauss Asset Management Inc., Ronald L. Strauss, William A. Pekin and Joshua D. Strauss, Investment Advisers Act Release No. 4126 (June 23, 2015).}