The SEC censured and fined an investment adviser and its two principals for failing to disclose the firm’s weak financial condition to retail investors, including advisory clients, to whom it sold promissory notes. As far back as 2012, the advisory firm struggled financially as its inability to raise assets and earn fees failed to offset rising operating costs. To keep afloat, the firm issued short-term promissory notes to retail investors including its advisory clients. The SEC faults the firm for failing to disclose its weak financial position and the significant risk that it would not repay the notes (even though it did not default on any interest payment). The SEC cites violations of the Exchange Act’s and Advisers Act’s antifraud rules.
OUR TAKE: The SEC can assert regulatory violations even where there is no client or investor harm. Here, the SEC filed a settled enforcement action related to concerns about the notes even though the adviser never actually defaulted. Adviser should also note that Item 18.B. of Form ADV requires disclosure of any “financial condition that is reasonably likely to impair your ability to meet contractual commitments to clients.”