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News June 1, 2015 Issue

State Pension Fund Investments at Heart of SEC Charges Against Adviser

Violate state law and you may find your firm facing SEC fraud charges.

That’s one message to take from the SEC’s May 21 administrative order against Gray Financial Group, an Atlanta-based adviser that specializes in public and private  pension funds nationwide. The firm allegedly made improper recommendations to several public pension fund clients. Specifically, the adviser recommended that the pension funds invest in an alternative investment fund of funds managed by Gray Financial. Between November 2012 and the end of December 2014, approximately $1.7 million in fees were collected by the advisory firm in connection with these investments, the SEC said.

Georgia law allows public pension funds to invest in alternative investments, but only under certain conditions, which the SEC, in an administrative order against Gray Financial and two of its top executives, claims were not met.

"Gray Financial Group breached a fiduciary duty to public pension fund clients by recommending investments it knew did not comply with legal requirements," said SEC Division of Enforcement director Andrew Ceresney. "To make matters worse, the firm profited handsomely from this alleged failure."

"The claims and arguments in the SEC’s filing are without merit," said an attorney representing Gray Financial and its two executives. "The SEC is once again bringing its charges in an unconstitutional and home-cooked  administrative proceeding rather than trying a case  before an impartial U.S. district court and a jury of one’s peers. … Gray Financial will vigorously defend itself and continue to fight the SEC in federal court as well as in these administrative proceedings."

Gray’s pre-emptive strike

In an attempt to head off the SEC’s case, Gray Financial Group and its two executives in February filed a complaint against the agency for what was then the SEC’s plan to bring its charges in an administrative proceeding, which Gray Financial said would rob the three parties of their constitutional protections.

"Without injunctive relief from this Court, plaintiffs will be required to submit to an unconstitutional proceeding," the firm’s complaint before the U.S. District Court for the Northern District of Georgia states. "This violation of a constitutional right, standing alone, constitutes an irreparable injury. The lack of traditional procedural safeguards in SEC administrative proceedings further exacerbates that harm."

The agency’s increased use of administrative proceedings to try cases against advisers and others has come under criticism from a variety of parties, including an SEC commissioner, a federal judge and several defense attorneys (ACA Insight, 5/25/15). It would appear that Gray Financial is employing many of the same arguments against such proceedings in its case against the SEC.

States and enforcement

"The SEC appears to be effectively enforcing state laws by knowing the state-specific investment restrictions in place for public pensions and appears ready to aggressively pursue advisers that fail to adhere to those restrictions," said ACA Compliance Group principal consultant Ted McGrath. "A key takeaway from these charges is the understanding that if the regulatory agencies are aware of these state-specific restrictions, investment advisers better be as well."

McGrath also noted that the charges are the result of the efforts of the SEC’s Atlanta Regional Office working with the Enforcement Division’s nationwide Municipal Securities and Public Pensions Unit. "Advisers should be aware that there is a task force out there specifically looking for this type of thing," he said.

"The novel twist in this case appears to turn in part on an interpretation of state law," said Zaccaro Morgan partner Nicolas Morgan. "As is typical, the SEC’s case draws a contrast between what the adviser told investors versus what the SEC alleges is actually true. However, one of the adviser’s representations dealt with whether an investment complied with Georgia law."

"The adviser reportedly (according to Gray Financial’s complaint against the agency) received legal advice on the issue, and the SEC’s case will turn in part on whether the investments do or do not comply with state law," he said. "While it’s not clear precisely what legal advice the adviser received, the SEC obviously thought that it was insufficient to preclude fraud allegations. As a rule, anytime an adviser relies on legal advice, it is imperative to be able to demonstrate that the adviser fully disclosed all material facts to its attorney before seeking advice, and actually relied on counsel’s advice in the good faith belief that the conduct was legal. In the absence of either factor, the SEC will discount the adviser’s reliance on advice of counsel."

Georgia allowances and restrictions

The state of Georgia has, since 2012, allowed eligible large public pension funds to invest in alternative investments – but those investments are subject to restrictions. According to the SEC, these criteria include:

  • No single Georgia-based public pension fund’s investment in an alternative instrument may exceed 20 percent of the aggregate amount to be invested in the applicable private pool;
  • Each alternative investment must be either concurrently made or committed to be made by at least four other investors not affiliated with the issuer; and
  • Any alternative investment pools and issuers must have at least $100 million in assets, including committed capital, at the time the investment is either made or committed to be made.

The pension funds and the investments

Among the pension funds that Gray Financial advised were the City of Atlanta Firefighters’ Pension Fund, the City of Atlanta General Employees’ Pension Fund, the City of Atlanta Police Officers’ Pension Fund, and the MARTA/ATU Local 732 Employees Retirement Plan.

In 2012, Gray Financial owner and president Laurence Gray and chief operating officer Robert Hubbard IV created the alternative-based fund of funds that it would market to public pension funds. According to the SEC’s administrative order, marketing of the fund fell to Gray, while Hubbard was largely responsible for arranging the drafting of the offering and subscription documents, providing investors’ names to Gray, and tracking the date and amount of the investments.

Here’s how the SEC delineates the investments of the public pension funds that invested in Gray Financial’s alternative funds of funds:

  • Atlanta Firefighters Pension. Invested $15 million on October 20, 2012, thereby comprising 19.2 percent of total fund assets.
  • Atlanta Police Pension. Invested $21 million on October 22, 2012, comprising 26.9 percent of total fund assets.
  • Atlanta General Pension. Invested $28 million as of November 7, 2012, making up 35.9 percent of total fund assets.
  • MARTA/ATU Retirement. Invested $13 million as of November 30, 2012, comprising 16.7 percent of total fund assets.

These fund investments, combined with $1 million from a Gray Financial affiliate that serves as the fund’s general partner, totaled $78 million, the SEC said, but did not meet any of the three restrictions the agency listed in its action. Specifically, the agency charged that:

  • The fund never met the $100 million threshold required for investment.
  • Two of the pension funds – Atlanta Police Pension and Atlanta General Pension – made investments that exceeded the 20 percent statutory ceiling.
  • Each of the investments from the four public pension funds fell outside the statutory requirement that four non-issuer affiliated investors exist prior to the
    investment by a Georgia public pension fund.


Gray Financial and Gray made "two specific material misrepresentations" to the Atlanta General Pension relating to investments in the alternative fund of funds, the SEC said.

The first alleged misrepresentation was that Gray told the board that Atlanta General Pension’s proposed investment in the Gray Financial fund was legal, the agency said. When asked by a pension fund trustee prior to voting if the investment was consistent with the law, Gray responded that it ‘absolutely’ was and that "‘the only reason you can do this now is because of the change in the law,’" the SEC said. "Gray knew, was reckless in knowing, or should have known his claim was false, as the three relevant limitations of the [applicable law] were not met at that time," the agency said.

The second alleged misrepresentation was that Gray "falsely stated that certain other public pension clients had already invested in [the fund]." In fact, the SEC said, they had not yet done so.


Gray Financial and Gray were charged with willfully violating Section 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and its Rule 10b-5, which prohibit fraud in the offer and sale of securities. In addition, the agency charged that Hubbard willfully violated Sections 17(a)(1) and (3) of the Securities Act and Section 10(b) of the Exchange Act, as well as its Rule 10b-5(a) and (c).

But that’s not all. Charges of violating the Advisers Act were also leveled. Gray Financial and Gray were accused of willfully violating Sections 206(1), 206(2) and 206(4) of the Advisers Act, which prohibit fraudulent conduct by an investment adviser, as well as Rule 206(4)-8. Hubbard also allegedly "willfully aided, abetted, and caused Gray Financial and Gray’s violations of Section 206(1), 206(2), and 206(4)," as well as Rule 206(4)-8(a)(2).