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Regulatory Sanctions

Aggressive Business Expansion Plus Limited Compliance Resources Led to This RIA’s Failure

December 20, 2018

by Howard Haykin


This cautionary tale is for firms seeking to significantly expand their business lines without addressing the added regulatory and market risks that accompany such expansions. 


In May 2015, Pennant Management closed down, the victim of an alleged scam involving around $180 million in fake U.S. Agriculture Department-backed loans. This Milwaukee, WI-based registered investment adviser had purchased the loans under a repurchase agreement with First Farmers Financials, a USDA-approved lender. Unfortunately, the repo’s were backed by non-existent loans with forged USDA approvals.


Pennant first began buying loans from First Farmers in 2013 on the belief that the USDA had rigorously vetted First Farmers when it approved the firm as a lender – and apparently failed to conduct its own due diligence reviews of First Farmers. It wasn’t until late 2014 that Pennant began questioning the loans – during “a routine review.” By then, the damage was done. [Journal Sentinel]  



Pennant Management might have survived this ordeal, ... had it addressed its compliance and risk management needs with the same vigor with which it significantly expanded its business lines. We know this because the SEC recently settled its case against Mark Elste, Pennant’s former CEO and CIO, who was charged with failing to provide sufficient resources to the firm’s deficient compliance program.


From January 2012 to June 2014, Mark Elste was aware that Pennant’s compliance program lacked sufficient resources but failed timely to address this deficiency, which contributed substantially to Pennant’s compliance rule violations - Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which require a registered investment adviser to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules, and to review, no less frequently than annually, the adequacy of the policies and procedures and the effectiveness of their implementation.


Elste’s actions – or repeated failures to act - also aided and abetted the firm’s failure to conduct its oversight of, among other things, the USDA repo program, and maintenance of repo trade allocation records.



PENNANT EXPANDED ITS BUSINESS, BUT RETAINED OR SHRANK ITS COMPLIANCE FOOTPRINT.   Here’s a chronological outline of events leading up to the firm’s discovery of the repo scam - apparently based on accounts provided by the firm’s then-Chief Compliance Officer.  [For complete details, click on … SEC Administrative Proceeding.] 


  • In January 2012, Elste asked one of Pennant’s portfolio managers to assume the role of 'interim' CCO for Pennant. The CCO had no compliance experience, but accepted the position contingent upon having access to outside counsel and compliance consultants as needed.


  • In March 2012, the interim CCO expressed concerns about Pennant’s compliance policies and procedures. Pennant opted not to retain additional outside resources.


  • In May 2012, after attending a compliance conference, the interim CCO advised Elste that his “primary objective” would be to review Pennant’s pols and procedures and complete a risk assessment – which he did by September 2012.


  • In August 2012, the individual agreed to become the 'permanent' CCO and drop his portfolio management responsibilities - provided he would have access to outside counsel and that Pennant would engage compliance consultants. No compliance resources were added at this time.


  • In December 2012, the CCO and Pennant’s then-President/COO gave Elste a list of high priority compliance projects that needed to be completed and requested more compliance resources. Elste rejected the request and told the CCO and President A to “re-task” Pennant’s existing staff to help with compliance. Though the CCO later told Elste that re-tasking would be insufficient, Elste refused to add more resources at that time.


  • Soon thereafter, Pennant cut $80,000 from its proposed 2013 budget, which had been earmarked to hire another compliance staff member.


  • In January 2013, the CCO was assigned new compliance obligations – to serve as CCO of a new registered investment company. Later that month, it was decided that Pennant would launch a new mutual fund and a new investment adviser - and responsibilities for the new entities would be assigned to the existing staff, including the CCO.


  • In February 2013, the CCO presented his 2012 annual compliance report to Pennant’s Board of Directors, including Elste, in which he identified several weaknesses in the firm’s compliance program and reiterated the need in 2013 for greater reliance on outside resources and the hiring of a compliance officer. Despite these warnings, Pennant did not hire additional compliance resources in 2013.


  • On multiple occasions during 2013, Elste denied requests from the CCO and the then-President for additional resources. By the end of 2013, the CCO had compliance responsibilities for 4 registered entities: Pennant, 2 investment companies and another adviser.


  • In October 2013, Pennant hired a new President and COO. Soon thereafter, the new President asked Elste for more compliance resources for 2014. Elste and the Holding Company management did not approve additional resources for compliance at that time.


  • In January 2014, the CCO’s 2013 annual compliance report to Pennant’s Board of Directors noted that limited resources and increased demands had increased the risk that compliance issues may go unnoticed. He also detailed planned compliance actions for 2014, which included the hiring of another business person (to allow a current staff member to focus on compliance-related projects) and engagement of an outside compliance consultant. At this time, however, no money was budgeted for additional compliance resources.


  • In February 2014, the CCO raised the need for additional compliance resources with the trustees of the 2 investment companies – who raised the issue with Elste. In June 2014, Pennant hired a compliance analyst, and in July 2014, Pennant engaged an outside compliance consultant to evaluate its compliance program.