SEC Scrutinizing ETFs, Short Sales and Private Equity Real Estate Hiring

The SEC has raised concerns over ETFs and private equity hiring in the past week while continuing to pursue enforcement actions for short sale violations of Rule 105.

ETFs Raise Concern

The Wall Street Journal reported last week that exchange traded funds (ETFs) are causing concerns at the Securities and Exchange Commission. The August 24th morning market crash which was ostensibly caused by investor concerns about the Chinese stock market exposed some fundamental problems with ETFs. The SEC is now examining what changes, if any, need to be made in order to address concerns about these products in the market.

Although the issues raised by the SEC commentary have gone more to the question of whether additional rules should be put in place rather than identify misconduct by those operating these funds, the rapid growth of the industry raises the possibility that beneath these products are corporate wrongdoing that could be the subjects of reports by SEC whistleblowers.

The effects of the growth of ETFs have led both to hedge funds trying to exploit inefficiencies in this market as well as concerns that leveraged ETFs such as the Next Funds Nikkei 225 Leveraged Index ETF have grown so large that they are moving the market. Although the Nomura Asset Management Co. has denied that its ETF has been moving the Tokyo stock market, it recently closed to new subscription orders out of liquidity concerns.

This discussion is one piece of the SEC’s examination into liquidity concerns in mutual funds, but it has definitely risen to the forefront after what happened in August.

More Rule 105 Enforcement Actions

The SEC has also completed another round of settlements for short sales by investment firms prior to their participation in new stock offerings. Rule 105 prohibits the purchasing of securities in a secondary offering from an underwriter or broker-dealer after the purchaser has sold short securities The rule is concerned with short selling that could artificially depress market prices prior to the offering. In 2013, the SEC announced a zero tolerance policy for violations of this rule.

In total, the six firms settling this week, one of which was JPMorgan Chase, paid $2.5 million to resolve the SEC allegations. The two previous enforcement sweeps led the SEC to receive penalties of more than $20 million from 42 firms.

In-House Real Estate Advisers Examined

SEC Chair Mary Jo White also commented on private fund advisers this week to the Managed Funds Association. Five years ago, the Dodd-Frank Act required new registration and reporting requirements for private fund advisers. During a speech indicating some of the problems within this industry that we have discussed here previously (conflicts of interest, inadequate disclosures, etc.), White also indicated that the Private Funds Unit of the OCIE was looking at the hiring of real estate advisers by private funds.

The SEC staff have concerns that funds are hiring real estate advisers employed by related parties and charging above market rates. The SEC believes disclosures of these relationships and/or fees may be inadequate or misleading. A Bloomberg article picked up this aspect and ran an article on the agency’s scrutiny of private equity real estate hiring.

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