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News January 8, 2018 Issue

PF Manager Settles Charges Involving Conflicts, Disclosure and Exam Findings

A private fund manager that the SEC accused of not acting in a timely fashion on multiple examination findings was taken to federal court by the agency, which charged him with, among other things, engaging in conflicted transactions and misleading investors. The manager, Louis Mohlman, Jr. and his two advisory firms reached a settlement with the SEC the same day.

Mohlman, according to the complaint filed by the SEC on December 8 in the U.S. District Court for the Northern District of Indiana, was the owner and chief compliance officer of the advisory firms, Mohlman Asset Management (MAM) and Mohlman Asset Management Fund (MAMF). As of press time, the settlement was still awaiting approval by the court.

"The SEC is continuing its quest to root out conflicted transactions and inadequate disclosures by private fund managers," said Bell Nunnally partner Robert Long. While the disgorgement amount was relatively small, he described the $100,000 fine as "hefty" and noted that the SEC staff was seeking permanent injunctions as well.

"The SEC Enforcement Division and exam staff have long focused on inadequate disclosures of expenses charged to fund clients," said Mayer Brown partner Matthew Rossi. "This is exactly the type of activity that will attract the attention of agency exam staff and is likely to result in an enforcement action. The SEC expects investment advisers to clearly disclose which expenses will be paid by fund clients and how those expenses will be allocated among funds."

The allegations

In filing its 22-page complaint, the agency alleged that Mohlman:

  • Used fund assets to satisfy obligations to third parties between 2012 and 2015. "Certain of these payments [the fund, identified in the complaint as ‘fund II’) was not legally obligated to make, and did not benefit fund II," the agency said. "Mohlman also used fund II proceeds to enter into transactions that paid undisclosed advisory fees that indirectly inured to his personal benefit. The investors in fund II never consented to these transactions. Indeed, in most cases Mohlman never told the investors about them. And when he made disclosures, he omitted key details – details that reasonable investors would have wanted to know."
  • Used fund assets to make a $150,000 unsecured loan that constituted approximately 16 percent of that fund’s portfolio. Mohlman misled investors in 2014 about the nature of the loan, the SEC said, "despite being told by SEC examiners that the loan should be fully disclosed to fund investors." It was "only after Mohlman learned of the underlying SEC investigation in this matter [that] he finally [made] full and accurate disclosures to Fund II investors about the loan and cause[d] MAM to repurchase from Fund II the loan’s remaining balance (approximately $61,000)," the agency said.
  • Encouraged clients to invest in a particular strategy he devised and which he said was endorsed by tax and legal experts when this was not the case. In 2013, the agency said, Mohlman advised clients to invest money in what he called his "Roth IRA strategy," which he described as a process that allowed for unlimited, tax-free transfers from traditional IRAs and retirement plans into a Roth IRA account under his and MAM’s management. "He told current and prospective investors that his strategy was endorsed by tax and legal opinions he had procured from accounting firms and law firms," the SEC said. "That was not true. Indeed, one accounting firm admonished Mohlman to stop telling investors that it was backing Mohlman’s strategy."
  • Failed to correct deficiencies found by examiners in 2010 and 2014 in both of his firms’ compliance programs. From approximately 2011 to October 2015, the agency said, "MAM and MAMF failed to adopt and implement written compliance policies and procedures reasonably designed to prevent violations of the Advisers Act and SEC rules promulgated under the Act." Despite the examiners’ findings, both compliance programs continued to be deficient, according to the complaint. It noted, as an example, that while MAMF had a compliance manual in 2011, that Mohlman, in his capacity as the firm’s CCO, "did not perform any work on MAMF’s compliance program between 2011 and the present." While MAMF’s 2011 compliance manual was in effect, it did not contain procedures that adequately addressed MAMF’s role as the adviser to the funds in question, the agency said, adding that a similar situation existed in regard to MAM’s compliance manual.
  • Failed to comply with the SEC Custody Rule. After an existing custodian terminated its relationship with MAM in 2014 "following its investigation into Mohlman’s and MAM’s Roth IRA investment strategy," the SEC said, Mohlman found a new custodian (referred to in the complaint as "Custodian A") who, "in exchange for MAM’s business, provided him with what they characterized as a ‘loan’ for $91,770. The transaction incentivized Mohlman and MAM to maintain MAM’s relationship with Custodian A for at least three years." It did this by forgiving one-third of the loan principal and interest for each year that MAM stayed with Custodian A. "Mohlman did not disclose this side deal to advisory clients," the SEC said. Further, the agency alleged, that Mohlman, would "pressure" clients to switch to Custodian A by telling them that their accounts with the previous custodian would be frozen unless a new manager was chosen.

The complaint also alleged that Mohlman and his firms filed inadequate offering documents and inadequate disclosures in their Forms ADV.

Ropes & Gray partner Jeremiah Williams noted the amount and variety of allegations in the case, but pointed to the allegation regarding the fund’s relatively large loan (16 percent of the portfolio) to two individuals as perhaps the most interesting. "The SEC’s allegation is based on a failure to adequately disclose loan details, but what is interesting is that there is no allegation that the loan recipients were affiliated with the adviser or that the adviser benefitted in any way from the loan."

The firms, the settlement and the violations

MAM, registered as an SEC advisory firm since September 2009, had approximately $178 million in assets under management as of March 2017, according to the agency’s complaint to the court. Most of its clients were individuals. The firm advised two funds, identified in the complaint as "Fund I" and "Fund II." MAMF was registered as an advisory firm with the SEC in March 2010, but terminated its registration in September 2017, for reasons not identified in the complaint.

Under the settlement, Mohlman, MAM and MAMF agreed to collectively pay a $100,000 civil money penalty, and disgorgement and interest of approximately $937. An attorney representing Mohlman, MAM and MAMF, when contacted, chose not to comment on the pending settlement.

Mohlman, MAM and MAMF were charged with violating Sections 206(1) and (2) of the Advisers Act, both of which prohibit fraud; as well as violating Section 206(4) and its Rule 206(4)-7, the Compliance Program Rule, for failing to adopt and implement reasonable written compliance policies and procedures. Mohlman and MAMF were charged with violating Section 206(8) and its Rule 206(4)-8, which prohibit making untrue statements of material fact or omitting to state material facts; and Rule 206(4)-2, for violating the Custody Rule.

In addition, Mohlman and MAM were charged with violating Section 207 of the Advisers Act, which requires full and complete disclose of certain facts on Form ADV; and Mohlman alone was charged with aiding and abetting MAM’s and MAMF’s primary violations.