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May 2, 2019

SEC Scrutinizes Registered Investment Adviser’s Statements to Investors About Due Diligence


On April 23, 2019, the SEC entered a settled Order Instituting Administrative and Cease-and-Desist Proceedings (the OIP) against Charter Capital Management, LLC (CCM), a former Florida-based SEC-registered investment adviser (RIA), and Steven Morris Bruce, CCM's founder and sole managing member.1 The OIP imposed sanctions against CCM and Mr. Bruce for, among other things, negligently violating Section 206(4) of the Investment Advisers Act of 1940 (Advisers Act) and Rule 206(4)-8 by making misleading statements regarding due diligence to investors in two private funds (the Funds) to which CCM served as the investment adviser and manager.2

The Transaction at Issue

According to the OIP, CCM and Mr. Bruce caused the Funds to enter into an agreement by which the Funds loaned $4 million to a Norwegian individual and his company to be used in connection with trading of international notes for large profits. In exchange for this loan, the Norwegian individual and his company promised to pay the Funds $40 million within 90 days of the agreement. The Norwegian company made an initial payment of $1.5 million to the Funds, but it never paid the remaining $38.5 million that was promised under the agreement. This resulted in the Funds incurring a loss of $2.5 million.

Due Diligence as Performed

Prior to executing the transaction, Mr. Bruce performed what the SEC describes as "limited due diligence" on the investment. This due diligence consisted of approximately 30 telephone calls (totaling four to five hours) with the Norwegian individual regarding his trading strategy as well as "some Google searches" about the Norwegian individual. According to the OIP, a Senior Vice President (SVP) of the Funds' administrator participated with Mr. Bruce in one of the telephone calls with the Norwegian individual—and, after the call, the SVP advised Mr. Bruce that he should conduct additional due diligence. Moreover, the OIP states that CCM sent a copy of the loan agreement to its accounting firm, which then questioned the investment. In addition, according to the OIP, CCM did not provide its attorneys with a copy of the loan agreement (or information about the promised return rate) during the due diligence stage.

Due Diligence as Described

After the loan agreement was executed, Mr. Bruce made statements about the transaction in a newsletter and investor letter. In the newsletter, which was issued to Fund investors, Mr. Bruce stated that he had "spent a great deal of time doing my diligence on the investment strategy and [the Norwegian individual's] credentials." Five days later, in an investor letter, Mr. Bruce stated that he had the "buy-in" of the Funds' administrator, CCM's accounting firm, and CCM's attorneys before the loan agreement was executed.

Relevant Provisions Governing Statements Made by RIAs

Section 206(4) of the Advisers Act makes it unlawful for an RIA to engage in an act, practice, or course of business that is fraudulent, deceptive, or manipulative, or to employ a device or scheme to defraud any client or prospective client.3 SEC Rule 206(4)-8 prohibits any investment adviser to a "pooled investment vehicle" from (i) making any "untrue statement of material fact" or "omit[ting] to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading" to any investor or prospective investor in the pool investment vehicle, or (ii) otherwise engaging in "any act, practice, or course of business that is fraudulent, deceptive, or manipulative" with respect to any investor or prospective investor in the pooled investment vehicle.4

The Sanctions

In the OIP, the SEC found that Mr. Bruce's statements to investors were materially misleading and therefore violations of Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. Although the OIP acknowledges that Mr. Bruce voluntarily disgorged approximately $180,000 of his own money to the Funds, the SEC ordered that CCM and Mr. Bruce cease and desist from further violations of the relevant Adviser Act provisions, be censured, and pay a $40,000 civil monetary penalty. The SEC also imposed an undertaking that requires CCM and Mr. Bruce to provide a copy of the OIP to each of CCM's existing clients and to all prospective clients for a one-year period (as well as certify compliance with such undertaking).


The CCM case sends a clear message that the SEC's focus on RIAs is not letting up. In 2018, the SEC conducted risk-based examinations of approximately 17% of all RIAs.5 In its 2019 Priorities Report, the SEC's Office of Compliance Inspections and Examinations confirmed that it is again focused on examining RIAs, especially newly-registered investment advisers and those that have been registered for a number of years but have not previously been examined.6 The SEC also has increased its enforcement efforts in the RIA and investment company space, with the number of enforcement actions in this category growing from 82 in 2017 to 108 in 2018.

In addition, the CCM case demonstrates how in-depth the SEC can be in its review of RIAs, whether during an examination or enforcement investigation. The SEC is not just looking to see whether adequate due diligence was performed. It also is scrutinizing the statements made by RIAs to investors about the duration, scope, and outcome of due diligence. RIAs should be aware that they must not only perform sufficient due diligence, but also ensure that the due diligence process and outcomes are described accurately to investors.

© Arnold & Porter Kaye Scholer LLP 2019 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

  1. In the Matter of Charter Capital Management, LLC & Steven Morris Bruce, Adv. Act Rel. No. 5226 (Apr. 23, 2019).

  2. Additionally, the OIP concludes that CCM and Mr. Bruce negligently breached their fiduciary duties to the Funds in violation of Section 206(2) of the Advisers Act by failing to disclose a conflict of interest involving Mr. Bruce.

  3. 15 U.S.C. § 206.

  4. 17 C.F.R. § 275.206(4)-8(a)(1) and § 275.206(4)-8(a)(2). "Pooled investment vehicles" include investment companies, such as issuers who are, or hold themselves out as being, engaged primarily in the business of investing, reinvesting or trading in securities, or are engaged in the business of issuing face-amount installment-type certificates. 17 C.F.R. § 275.206(4)-8(b); 15 U.S.C. § 80a–3.

  5. Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission, 2019 Examination Priorities.

  6.  Id.