Closing the Door on “Broken Windows” – What Does It Mean for Private Fund Sponsors?

Print Print

Recent speeches by SEC Commissioner Michael Piwowar and SEC Division of Enforcement Co-Directors Stephanie Avakian and Steven Peikin indicate that the era of the “broken windows” approach, where relatively minor compliance infractions were broadly and aggressively policed and often punished in order to deter potentially larger violations, may be coming to an end. Commissioner Piwowar’s views on broken windows, a policy championed by former SEC Chair Mary Jo White, can be summed up by the following:

For 78 months – from July 2010 through December 2016 – the Commission’s policy agenda was dominated by what I affectionately call the “Dodd-Frank Death March.” … At the same time the Dodd-Frank Act took over the Commission’s policy agenda, the agency also sunk a large portion of its scarce enforcement resources into a so-called “broken windows” approach. While this misguided effort proved successful at boosting our enforcement statistics, it did not meaningfully improve investor protection.

Ms. Avakian and Mr. Peikin have stated that under their watch the protection of retail investors and the policing of cyber-related misconduct will receive heightened attention, as evidenced by the Enforcement Division’s new Retail Strategy Task Force and Cyber Unit. Additionally, Mr. Peikin has suggested that the number and scope of industry-wide “sweep” exams focused on technical violations may decline, with resources instead concentrated on more substantial (and intentional) wrongdoing.

So do these new priorities, combined with the announced reduction of SEC enforcement staff by as much as 7%, herald a more “hands off” approach to private fund regulation by the SEC? The answer is almost certainly no. The issues raised in the past few years relating to private fund sponsors (such as undisclosed conflicts of interest, misallocation of fees and expenses and insufficient compliance policies and procedures) will continue to be the subject of routine examinations by the Private Funds Unit of the SEC’s Office of Compliance Inspections and Examinations (OCIE), and the Enforcement Division’s Asset Management Unit is still tasked with prosecuting misconduct by investment advisers and private funds. This institutional focus on the private fund industry by the SEC pre-dates broken windows and for the time being appears set to outlive it.

While the recent pronouncements indicate that the Enforcement Division may bring fewer cases for “foot faults,” those private fund managers who have not heeded the lessons of the recent past and tightened up their disclosure and compliance practices are surely leaving themselves exposed. Furthermore, new enforcement initiatives, such as investigating cyber-related compliance shortcomings, are generally as relevant to private fund sponsors as to other SEC-regulated persons. Finally, many investors are now hyper-focused on these issues and expect managers to be as well. Therefore, while the broken windows policy may be ending, now is not the time for the private fund industry to take its collective eye off the compliance ball. As Ms. Avakian said recently, “…we are always going to be focused on issues raised by the conduct of investment advisers, broker-dealers, and other registrants….”