Asset management firms beware: The SEC’s teeth are sharper and it’s biting.

As the U.S. Securities and Exchange Commission steps up its investigation into possible fraud and other investor protection issues under the Investment Advisers Act of 1940, organizations that understand the factors involved in the launch and life cycle of an SEC investigation may be better positioned for healthier outcomes, should they become the focus of such investigations.

Compared to the prior year, the total number of SEC enforcement actions  increased by 12 percent to a record of 755 actions at the end of fiscal year 2014. While broker-dealers, with 166 actions, were the primary focus of these charges, they were followed closely by investment firms with 130 actions.[1]

Additionally, the SEC obtained orders totaling more than $4 billion in penalties and disgorgement, or the repayment of ill-gotten gains imposed by the courts on the wrongdoers. Added to these staggering amounts are the significant administrative and legal costs incurred by asset management firms in response to the investigations that may lead to enforcement actions.

Reasons for the upsurge in SEC investigations and enforcement actions include new whistleblower protections and incentive programs, expanded media coverage of investment firms, evolving rules of compliance for investment firms, and the Commission’s growing use of quantitative data analytics. With regard to the latter, the SEC’s Financial Reporting and Audit Task Force is now using automated investment performance aberration models (nicknamed RoboCop by the industry) to detect possible instances of fraud.

Investment firms in particular can expect even more scrutiny in the future. The asset management industry continues to be a focus of SEC enforcement priorities and SEC Chair Mary Jo White, who spent much of her career as a federal prosecutor, has signaled an interest in exercising additional prudential supervision of investment firms, suggesting greater use of stress tests and calling for more oversight and disclosure obligations. For example, the Commission initiated examinations of the cyber-security controls and related compliance measures in place at broker-dealers and registered investment advisors. It also continues to implement a “broken windows” policy via the Compliance Program Initiative, cracking down on even small compliance infractions. In 2014, 34 such actions were brought against individuals and entities; all but one paid a monetary penalty.

To prepare for this heightened scrutiny, it is important to understand the process by which the SEC launches an investigation, in addition to the nuanced legal defense issues at play. This knowledge can help you assemble an insurance program that ensures optimum coverage terms and conditions. 

Blowing the Whistle

When the SEC is notified by a whisteblower or the Commission’s advanced analytics systems of a possible violation, this triggers a Memorandum Under Inquiry or MUI. The asset management firm under scrutiny is requested to provide preliminary information. In many cases, the MUI is simply a routine checkup and of little concern.

After this information is provided (or not provided) to the SEC, the Commission may undertake a formal order of investigation of the target firm, with broad subpoena power to compel the firm to provide all requested information, documents, and responses by witnesses and other parties to questions under oath.

During the course of its investigation, a Wells Notice may be issued, indicating that the SEC has determined that it may bring a civil action against the company. The notice provides the target with time to explain and, if it so elects, voluntarily provide information as to why it believes the enforcement action is unnecessary.

Once the Wells Notice has been issued and the target company has provided a response, the SEC may decide to take civil or administrative actions against the firm. In cases where it is determined that the violation was willful, the Commission may refer the case to the Department of Justice for criminal prosecution.

For the most part, firms determined to have violated the law are permitted to settle the matter financially without an avowed admittance or denial of the allegations. Consequently, most matters reach settlement.  However, in situations in which a large number of clients were harmed or its conduct was otherwise egregious, the SEC has indicated its intention to pursue individuals and admissions of guilt.

The Role of Insurance in Mitigating the Risks

Insurance plays a vital role in limiting the financial impact of a SEC action brought against asset management firms and its directors and officers.  Asset management liability insurance policies typically include coverage for regulatory investigations, including legal costs and document production fees incurred by the insureds to respond to the investigation.  As the regulatory exposure has increased and evolved, insurance coverage has expanded and evolved to address the risk environment.  Policies have expanded to address cybersecurity related exposures, expenses incurred to comply with regulations governing the recovery of erroneously awarded compensation , costs incurred to hire a crisis management or public relations firm for regulatory events, legal fees and expenses incurred by an employee called to testify as a witness in a hearing in which they are not a plaintiff or defendant and the SEC’s promotion of its Enforcement Cooperation Program.  

The latest evolution of asset management insurance coverage, Regulatory Investigation Cooperation Expense Reimbursement Coverage, effectively rewards insureds for their favorable behavior—cooperation that results in the Commission recommending leniency towards the individuals and the firm in the settlement or disposition agreement.

With asset management firms more squarely in the SEC’s crosshairs, the importance of this insurance protection cannot be understated. Today’s dynamic regulatory environment insists upon dynamic insurance coverage.

This document outlines in general terms the coverages that may be afforded under a policy from The Hartford. All policies must be examined carefully to determine suitability for your needs and to identify any exclusions, limitations or any other terms and conditions that may specifically affect coverage. In the event of a conflict, the terms and conditions of the policy prevail. All coverages described in this document may be offered by one or more of the property and casualty insurance company subsidiaries of The Hartford Financial Services Group, Inc. Coverage may not be available in all states or to all businesses. Possession of these materials by a licensed insurance producer does not mean that such producer is an authorized agent of The Hartford. To ascertain such information, please contact your state Department of Insurance or The Hartford at 1-888-203-3823. All information and representations herein are as of October 2015. 

The Hartford® is The Hartford Financial Services Group, Inc. and its subsidiaries, including Hartford Fire Insurance Company. Its headquarters is in Hartford, CT.

In Texas, the insurance is underwritten by Hartford Accident and Indemnity Company, Hartford Fire Insurance Company, Hartford Casualty Insurance Company, Hartford Lloyd’s Insurance Company, Hartford Insurance Company of the Midwest, Trumbull Insurance Company, Twin City Fire Insurance Company, Hartford Underwriters Insurance Company, Property and Casualty Insurance Company of Hartford and Sentinel Insurance Company, Ltd.


[1] Enforcement actions as of October 2015