Defend Against Allegations of Fraud in Litigation Under Section 206 of the Investment Advisers Act | Oberheiden PC

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Section 206 of the Investment Advisers Act of 1940 is one of several laws that the United States Securities and Exchange Commission (SEC) uses to combat investment fraud. Under section 206, investment advisers can be subject to enforcement actions for engaging in various forms of prohibited conduct, which enforcement actions have the potential to result in administrative, civil or criminal penalties.

Similar to many other laws the SEC uses to combat investment fraud (v. 1940 has an extremely broad scope. As such, this allows the SEC to pursue charges in a wide variety of areas. circumstances, and it will not necessarily be clear precisely why the SEC is conducting a Section 206 investigation.

With this in mind, investment advisers who are the subject of investigations or litigation under Section 206 must take proactive steps to defend themselves. They must promptly engage a securities lawyer to intervene, determine the scope and nature of the allegations in question, and execute a focused defense strategy.

Although a litigation under section 206 can have significant consequences, it will be possible to obtain favorable results before or during the trial in many cases. The potential results depend not only on the facts, but also on the effectiveness and timeliness of an investment adviser’s defenses.

What does section 206 prohibit?

Before we can talk about the potential defenses against allegations under Section 206 of the 1940 Investment Advisers Act, we must first discuss what Section 206 prohibits. Under section 206, it is illegal for any investment adviser, “by using couriers or any means or instrument of interstate commerce, directly or indirectly”, to:

“(1) [E]use any device, scheme or artifice to defraud a client or potential client; “(2) [E]engage in any transaction, practice or business course that functions as a fraud or deception on any customer or potential customer; “(3) [A]acting as principal for his own account, knowingly [] to sell . . . or buying a security from a client, or acting as a broker for a person other than that client, knowingly [] carry out any sale or purchase of any security on behalf of such a client, without disclosing to this client in writing before the performance of this operation the capacity in which he is acting and without obtaining the client’s consent to such operation. . .; or “(4) [E]engage in any act, practice or business course that is fraudulent, deceptive or manipulative.

Section 206 (4) expressly leaves it to the SEC to determine what constitutes “fraudulent, deceptive or manipulative” business activity. In the decades since the enactment of the Investment Advisers Act, the SEC has passed several rules defining conduct prohibited under section 206 (4). This includes the rules regarding:

Business Practices of Investment Advisers (Rule 206 (4) -1) Custody by Investment Advisers of Clients’ Funds and Securities (Rule 206 (4) -2) Provision of Cash Payments by Investment Advisers for Solicitations of clients (Rule 206 (4) – 3) Political contributions of investment advisers (Rule 206 (4) -5) Proxy voting by investment advisers (Rule 206 (4) -6) Compliance procedures and practices of investment advisers investment (Rule 206 (4) -7) Recommendations of investment advisers regarding pooled investment vehicles (Rule 206 (4) -8)

Together, the statutory language of Section 206 and the complex provisions of SEC Rules 206 (4) create a long list of prohibitions and a substantial compliance burden for investment advisers. Even unconscious and unintentional violations of Section 206 can lead to litigation in many cases.

For example, section 206 (2) prohibits investment advisers from “engaging[ing] in “any transaction which” operates as a fraud “- this does not include or imply any element of scienter. Similarly, under the disclosure restrictions of Rule 206 (4) -2, investment advisers may face enforcement litigation from the SEC for violating any of the rule’s prohibitions, whether or not the breach is intentional or intentional. The Rule simply states that an investment advisor’s advertisements “may not not ”(among other prohibitions):

“Include any false statement of a material fact, or omit to state a material fact necessary so that the statement made, in light of the circumstances in which it was made, is not misleading; “Include a material statement of fact that the advisor does not have reasonable grounds to believe will be able to justify at the request of the Commission; [or]
“Include information which would reasonably be likely to cause a false or misleading implication or inference concerning a material fact concerning the investment adviser. . . . ”

How Can Investment Advisers Defend Against Section 206 Litigation?

Given the breadth of Section 206 and Rule 206 (4), defending against claims under these sources of authority can prove difficult for investment advisers on a number of different fronts. . As mentioned above, one of the first challenges in many cases is simply identifying the specific claims at issue.

The SEC pursues business under the four operational provisions of Section 206, and each provision encompasses its own wide array of express and implied prohibitions. Thus, knowing that you are facing allegations under section 206 (1), 206 (2), 206 (3) or 206 (4) is not enough to make informed decisions on the type (s) ( s) defense (s) to pursue.

That said, certain considerations are generally applicable to most, if not all, types of disputes under section 206 of the Investment Advisers Act 1940. These considerations relate to: (i) avoiding litigation under Section 206, (ii) defend against administrative and civil disputes relating to SEC enforcement, and (iii) defend against criminal charges brought by the US Department of Justice (DOJ).

1. Avoid litigation under section 206

The surest way to avoid liability in Section 206 disputes is to avoid Section 206 disputes altogether. Although there is no way to ensure protection from review of SEC, there are ways for investment advisers to mitigate their risk of facing Section 206 litigation.

First, investment advisers can adopt policies and procedures focused specifically on compliance with Section 206 and Rule 206 (4). All investment advisory firms, regardless of size, must have a documented SEC compliance program.

This program should address the legal and regulatory obligations of the firm and its advisers, including their obligations under Section 206 and Rule 206 (4). By understanding their obligations, proactively addressing those obligations, and monitoring their compliance on an ongoing basis, consulting firms and advisors can make informed decisions that will significantly reduce their risk of being subjected to scrutiny by the SEC.

Second, investment advisers can take a proactive approach to responding to an SEC investigation targeting allegations under Section 206 or Rule 206 (4). Even with an effective compliance program in place, consulting firms and advisers can still deal with SEC claims due to client complaints and other issues. When these investigations do arise, intervening and working with the SEC to fully understand the allegations at issue (and to correct any false assumptions or other misconceptions) greatly reduces the chances of the investigation leading to legal action.

2. Defend against administrative and civil litigation relating to SEC enforcement

If the SEC’s Enforcement Division finds evidence of a Section 206 violation during an investigation, the Commission may choose to initiate administrative or civil proceedings. Administrative and civil enforcement proceedings can involve a wide range of issues, and they can present the risk of an equally wide range of potential consequences.

Sanctions in SEC enforcement cases can include temporary or permanent injunctions (i.e. a ban on acting as an investment advisor), as well as monetary penalties ranging from tens of thousands to millions of dollars.

3. Defending against a criminal dispute under article 206

In cases involving apparent and intentional violations of Section 206, the SEC may choose to refer the matter to the DOJ for criminal prosecution. Section 217 of the Investment Advisers Act imposes criminal fines of up to $ 10,000 and up to five years federal imprisonment for each individual violation of the law, including (but not limited to) violations of section 206. Since rule 206 (4) defines certain conduct prohibited under section 206, violations of the rule may also result in criminal prosecution.

In administrative, civil, and criminal section 206 disputes, asserting an effective defense often involves targeting one or more specific elements of the government’s case. Section 206 and Rule 206 (4) are complex, yet they still leave a great deal of room for interpretation. Thus, Article 206 cases are often not clear, and consulting firms and advisers will often be able to avoid their liability by demonstrating that the government is unable to fully construct its case, even if they cannot affirmatively refute the allegations made against them.

Procedural and constitutional defenses will also be available in some cases, and the effective execution of a focused and coherent defense strategy will allow a favorable outcome in a wide range of scenarios.

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