U.S. Investment Firm Enters $6 Billion Parallel Resolutions With DOJ And SEC Over Allegations Of Fraudulent Conduct By Employees And Related Control Failures
On May 17, 2022, the U.S. Department of Justice (“DOJ”) and the U.S. Securities and Exchange Commission (“SEC”) announced parallel resolutions with a registered investment advisor (the “Advisor”), resolving criminal and civil securities fraud allegations concerning three portfolio managers’ concealment of downside risks associated with the Advisor’s trading strategy, “Structured Alpha,” and the failure to implement an adequate control function in the Advisor’s Structured Products Group. United States v. AllianzGlobal Investors U.S. LLC, No. 1:22-cr-00279 (S.D.N.Y); Securities and Exchange Commission v. Tournant, Taylor, and Bond-Nelson, No. 1:22-cv-04016 (S.D.N.Y.). Three related indictments of former portfolio managers of the Advisor whose conduct contributed to the Advisor’s settlement were also unsealed. United States v. Gregoire Tourant, No. 22-cr-00276 (S.D.N.Y.); United States v. Trevor Taylor, No. 22-cr-00149 (S.D.N.Y.); United States v. Stephen Bond-Nelson, No. 22-cr-00137 (S.D.N.Y.).
As part of its Structured Alpha strategy, the Advisor sold 17 funds that used a portfolio of debt and equity securities as collateral to purchase and sell options to over 100 institutional investors. Following significant market volatility in March 2020 induced by the COVID-19 pandemic, the funds incurred losses of 90%. In the statements of fact accompanying the settlement agreements, the Advisor admitted to making false and misleading statements to current and prospective investors through the conduct of its three former portfolio managers that understated the risks taken by the funds and overstated the level of independent risk oversight. According to the agreed-upon statement of facts, between as early as 2014 through March 2020, the three portfolio managers misrepresented to investors the levels at which the hedging positions for the Structured Alpha Funds were put in place and concealed the magnitude of the Structured Alpha Fund’s downside risk.
The DOJ settlement agreement also noted the Advisor’s alleged failure to implement a control function in its Structured Products group even though the group routinely accounted for 25% of the Advisor’s revenue during the relevant period. Specifically, the DOJ found that the Advisor failed to implement a control function to verify that one of the portfolio managers and his colleagues adhered to the strategies they represented to their investors and did not require legal or compliance review of communications with clients about existing products and investments.
Under the terms of the DOJ settlement agreement, the Advisor pleaded guilty to securities fraud in violation of 15 U.S.C. § 78j(b) and § 78ff; 17 C.F.R. § 240.10b-5; and 18 U.S.C. § 2 and accepted that it is responsible for the acts of its employees and agents described in the DOJ’s Information and the Statement of Facts. The Advisor agreed to pay $463 million in forfeiture, $3.2 billion in restitution, and a penalty of $2.3 billion. The Advisor also agreed to a five-year probation, which includes a requirement to provide continued cooperation with the U.S. Attorney’s Office in the Southern District of New York and to maintain compliance procedures to identify and prevent violations of the securities laws.
The $2.3 billion penalty reflects a discount of 40% off the low end of the applicable Sentencing Guidelines fine range for the conduct at issue. The Advisor was awarded this cooperation credit for having provided “extensive cooperation” in the DOJ’s investigation of the conduct; having agreed to continue to cooperate; its undertaking of certain remedial measures including heightened controls and new policies in connection with its review of client communications; its lack of prior criminal history; and its concurrent resolution with the SEC.
The Advisor also consented to the entry by the SEC of an administrative and cease-and-desist order finding violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Sections 206(1), 206(2), and 206(4) of the Advisers Act and Rules 206(4)-7 and 206(4)-8 promulgated thereunder.
The settlement with the SEC includes a censure and payment of $315.2 million in disgorgement, $34 million in prejudgment interest, and a $675 million civil penalty. In addition to these monetary penalties, the Advisor is disqualified from providing advisory services to U.S.-registered investment funds for the next ten years.
In addition to these two settlements, the DOJ and SEC separately brought charges against the three portfolio managers for securities fraud, investment advisor fraud, and obstruction of justice. Two of the portfolio managers previously pleaded guilty to DOJ charges on March 8 and March 3, respectively, and have each reached settlements with the SEC that are pending approval and will include yet-to-be determined monetary sanctions, injunctive relief, and industry bars. The case of one portfolio manager remains pending.
The implications of the settlement are particularly significant for asset management units and registered investment advisors but have elements of broader application. The DOJ appeared particularly focused on the extent to which the Advisor monitored for compliance with the investment guidelines in its relevant fund disclosures and reviewed investor communications, suggesting that firms, regardless of sector, should evaluate the extent to which their controls are able to fulfill such compliance functions.