The SEC fined an adviser and its principal for failing to timely refund prepared advisory fees to terminating clients and for neglecting to disclose its failing financial condition. When two of the firm’s financial advisers left the firm and forwarded 63 client termination letters, the respondent declined to refund fees paid at the beginning of the quarter, claiming that it would not accept electronic signatures, notwithstanding the firm’s written policies. The SEC also asserts that the firm suffered from chronic cash shortages late in every quarter because it received its fees at the start of the quarter. The SEC faults the firm for failing to disclose its deteriorating financial condition including its default on several loans and its negative net worth and insolvency. Item 18.B. of Form ADV requires discretionary advisers to “disclose any financial condition that is reasonably likely to impair your ability to meet contractual commitments to clients.”
OUR TAKE: As economic circumstances change, advisers should consider whether they need to make Item 18 disclosure, especially if creditors declare a default on outstanding loans. Unlawfully withholding client funds turns financial problems into regulatory actions.