A recent opinion in an SEC administrative proceeding (SEC v. J.S. Oliver Capital Management, LP & Mausner, June 2016) highlights how an investment adviser can get in trouble through acts of its own. The commission held, among other holdings, that the registered investment adviser and its principal in question violated antifraud provisions by “cherry picking,” profitable transactions for favored accounts, by failing to disclose uses of soft dollars to their client, and by engaging in compliance and record keeping violations.

Cherry picking is a practice in which securities professionals allocate profitable trades to a preferred account (like there own) and less profitable or unprofitable trades to a non-preferred account (like a customer’s). In that way, an investment adviser can increase the performance of favored accounts, or at least make it more likely that they will out perform other accounts.

One form of cherry picking involves an adviser’s allocation of block trades. When an adviser executives a block trade at multiple prices, it may allocate the highest-price sales to favored accounts and the lowest-price sales to disfavored accounts. An Adviser can also cherry pick by allocating profitable trades entirely to favored accounts.

This is what happened in this case even after the brokerage firm where trades occurred informed and warned that investment adviser that the record of trades show bias trade allocation. Moreover, in the hearing, an expert witness confirmed this statistically undeniable fact. Even though there was in place an order management system, the principal went into the accounts and made manual allocations, despite written policy to allocate trades fair and equitable.

The commission found that the investment adviser had scientor when allocating trades. Scientor is a mental state embracing intent to deceive, manipulate or defraud, and includes recklessness defined as conduct that is an extreme departure from the standards of ordinary care.

The investment adviser and the principal were also liable for using soft dollars to pay expenses to benefit them without disclosing these uses to clients. Soft dollar practices are arrangements under which products or services other than execution of securities transactions are obtained by an adviser from or through a broker in exchange for the direction by the adviser of client brokerage transactions to the broker. The Exchange Act creates a limited safe harbor that applies to certain payments of research and brokerage expenses.

The liable use of soft dollars in this case included making payments to a former spouse and to a residence club for a timeshare. Even without these egregious acts, the commission held that the investment adviser did not abide by its duty to disclose soft dollar arrangements to its clients, or to disclose potential conflicts of interests accurately and completely.

The commission also held that the investment adviser violated compliance and record keeping requirements and the principal aided, abetted and caused these violations. For one, the investment adviser did not adhere to its own written policy. Also, the commission found that there was a failure to maintain trade blotters and a failure to comply with document retention obligations.

The moral of the story

No matter how hard your personal life gets complicated and how you want to live at a high standard of living, or how hard you want to please certain clients over other clients, violating anti-fraud provisions or even poor record keeping can lead to a finding of liability (and to large damages and to the removal from the industry).

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Congress authorized the Securities and Exchange Commission (“SEC” or “Commission”) to bring civil actions to enforce violations of the Securities Exchange Act of 1934 (the “Exchange Act”), and the regulations promulgated thereunder. The Commission is empowered to bring such actions in either federal district court or in an administrative proceeding before the Commission. An SEC administrative enforcement action culminates in a final order of the Commission, which in turn is reviewable exclusively by the appropriate federal court of appeals.
In one recent court case, a respondent in a SEC proceeding attempted to bring a “sister action,” in federal court at the same time. The respondent was actually attempting to challenge the constitutionality of the administrative proceeding. (Hill v. SEC, et al, Eleventh Circuit, 2016). The issue was whether the respondent in an SEC administrative enforcement action could bypass the Securities Exchange Act of 1934 by filing a collateral lawsuit in federal district court challenging the administrative proceeding on constitutional grounds.
The appeals court held that the district court lacked jurisdiction over the respondents’ collateral attacks. The court found that it was fairly discernible from the review scheme provided in the statute that Congress intend the respondent’s claims to be resolved first in the administrative forum, not the district court, and the if necessary, on appeal to the appropriate federal court of appeals. The court reasoned that the Commission could rule that the appellant/respondent did not violate securities laws, in which case the constitutional question would become moot.
The court discerned that the general intent of Congress was to channel all objections to a final Commission order, inducing challenges to the constitutionality of the SEC’s administrative law judge or the administrative proceeding itself, into the administrative forum and to preclude parallel federal district court litigation. The court found that the respondents’ constitutional challenges were not outside the type of claims that Congress intended to be reviewed within the statutory scheme.
Interestedly, the court never addressed the challenge of whether an SEC administrative proceeding is constitutional, by only that any objections to the proceeding itself, including constitutional objections, are to be brought within the proceeding. Whether the SEC proceedings are constitutional appears to be a decision for another day.
SEC proceedings do differ from proceedings in Federal Court, mostly involving discovery issues as more fully described below.
How SEC Administrative Proceeding differ from proceedings in federal court

SEC administrative actions differ from cases brought in federal district court in several respects. The administrative action begins when the Commission serves the respondent with an Order Instituting Proceedings (“OIP”). The Commission then presides over the action, but it typically delegates review to an Administrative Law Judge (“ALJ”). Unlike an action brought in federal court, in a proceeding before the Commission the Federal Rules of Civil Procedure and Evidence do not apply, and the respondent does not enjoy the right to a jury trial. Instead, the SEC’s Rules of Practice govern administrative proceedings. Among other differences, the Rules of Practice provide for more limited discovery. For example, the Rules of Practice allow the taking of depositions at the Commission’s discretion, only upon a finding that the prospective witnesses will be unavailable to testify at the hearing. The Rules of Practice also do not provide for routine document production, instead requiring parties to request that the ALJ issue subpoenas. Administrative actions proceed relatively quickly along fixed timelines set by the rules.
When the Commission delegates review to an ALJ, the ALJ holds an evidentiary hearing and then renders an initial decision with factual findings and conclusions of law. Either party may appeal the initial decision to the Commission. The Commission’s review authority is broad. It may affirm, reverse, modify, set aside or remand for further proceedings, in whole or in part, an initial decision by a hearing officer and may make any findings or conclusions that in its judgment are proper and on the basis of the record. Conversely, if there is no appeal to the Commission, and the Commission declines to exercise its right to review on its own, the ALJ’s initial decision becomes the final decision of the Commission for all purposes.
Regardless of whether the initial decision is appealed, the administrative process culminates in a final order of the Commission. The process of obtaining judicial review begins with the filing of a petition in the court of appeals that triggers the court’s jurisdiction. Upon the filing of the record in the court of appeals, the court’s jurisdiction becomes exclusive. Although other provisions of the Exchange Act provide limited district court jurisdiction over some types of securities related claims, the Act contains no express authorization for district court review of a final Commission order.
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In many ventures, from real estate to filmmaking finance, there may be the need for the services of an escrow agent (e.g., a bank, an attorney, title insurance company, or an escrow company) who acts as the holder of funds for eventual payment from one party to another party. In some cases, disputes arise among the parties and escrow agent. This article reviews some of the situations when disputes occurs.

The risk of being caught up in a dispute can cause some potential escrow agents to decline the offer to act as an escrow agent because of the risk of being involved in a dispute or accused of wrongdoing. Other entities make a business of being an escrow agent, earning fees and living with the risks involved.

Sometimes the escrow agent is caught in the middle of a dispute between the contracting parties, who join the escrow agent in litigation or accuse the escrow agent of wrongdoing even if there is no wrongdoing on the part of the escrow agent.

An escrow agent has a fiduciary duty to transfer property (usually cash) from one party to another. Part of this duty is to examine documents to make sure that the seller and buyer ( or the investor and startup, or investor and filmmaker, etc.) follow the terms of the sale or investment, and to serve both the buyer and seller in the transaction.

The scope of the fiduciary duty is defined by the scope of its contractual duties under an escrow agreement. If the escrow agent acts in accordance with its obligations under the escrow agreement, it has not breached its fiduciary duty.

Disputes may occur when parties to an escrow agreement attempt to impose upon the escrow agent an obligation in addition to its limited duties under the express terms of its contract. Also, dispute occurs when a contractual provision is incomplete, unclear or ambiguous. If it is complete, clear and unambiguous, courts must enforce it according to the plain meaning of its terms.

Sometimes an escrow agreement may require the agent to ratify a condition precedent, i.e., to make sure the one party or another did what they said they were going to do before releasing the monies. Disputes occur because one party may accuse the agent of not making sure that pre-conditions are met before releasing money or refusing to release monies when met. Additionally, disputes occur when there is the issue of whether the escrow agent has a duty to validate the actions of parties (i.e., make sure the parties really did what they said they did). All this must be set forth in the agreement.

Another potential roadblock is when the escrow agreement requires the approval of one of the parties to release funds but never receive the approval even after all conditions are met. Or possibly the parties will not provide a release of liability to the escrow agent. If the party does not give approval or the escrow agent doe not get releases, then the funds could be in “limbo.” The escrow agent may be caught in the middle, or may even have to file a lawsuit to resolve the issue.

Parties sometimes act in extremes to get their way, and the escrow agent in caught in the middle of it all. Looking at the big picture, one can only hope that in business dealings (including those involving escrow agreements) the actions of the parties involved are not so extreme as to exceed the bounds of a civilized community, which some deal makers seem to forget.


Registered investment advisers, either registered with the Securities and Exchange Commission or with a State, are “fiduciaries” to their advisory clients. With the recent talk about fiduciary requirements being extended to agents or financial professionals offering advise on retirement plans, what exactly does being a fiduciary mean in the context of a registered investment adviser? It means that there is a fundamental obligation to act in the best interests of clients and to provide investment advice in a client’s best interests. Registered investment advisers owe their clients a duty of undivided loyalty and utmost good faith.

Having a fiduciary duty is a higher burden than requiring only suitability of an investment where the investment professional offering services would only have to determine whether the investment is suitable for a client, not whether the product being offered to the client is in the client’s best interest.

Registered investment advisers are not to engage in any activity in conflict with the interest of any client, and are to take steps reasonably necessary to fulfill their obligations. They must employ reasonable care to avoid misleading clients and must provide full and fair disclosure of all material facts to their clients and prospective clients.

Generally, facts are “material” if a reasonable investor would consider them to be important. Investment advisers must eliminate, or at least disclose, all conflicts of interest that might incline them — consciously or unconsciously — to render advice that is not disinterested. If they do not avoid a conflict of interest that could impact the impartiality of their advice, they must make full and frank disclosure of the conflict. Additionally, an adviser cannot use a client’s assets for their own benefit or for the benefit of other clients, without the client’s consent.

Departing from this fiduciary standard may constitute “fraud” upon the clients under Section 206 of the Advisers Act, which says in part that fraud is,

(1) to employ any device, scheme, or artifice to defraud any client or prospective client;
(2) to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client;
(3) acting as principal for his own account, knowingly to sell any security to or purchase any security from a client, or acting as broker for a person other than such client, knowingly to effect any sale or purchase of any security for the account of such client, without disclosing to such client in writing before the completion of such transaction the capacity in which he is acting and obtaining the consent of the client to such transaction. The prohibitions of this paragraph shall not apply to any transaction with a customer of a broker or dealer if such broker or dealer is not acting as an investment adviser in relation to such transaction; or
(4) to engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative. The Commission shall, for the purposes of this paragraph (4) by rules and regulations define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative.

Although the role of being a fiduciary may be a burden, there is the flip side that a client knows that the adviser is acting in the client’s best interest, causing less doubt of the motive of the registered investment adviser in offering advise to the client.