If this rule were the only legacy of the Clayton/Blass SEC, we would consider it a success. This rule is long overdue and should level the playing field for smaller ETF sponsors burdened with the expense of obtaining exemptive relief.
Don’t make promises based on a promise. It appears that the respondent genuinely believed the money was coming, but, unfortunately, the third party never legally committed. As the old saying goes, “If wishes were fishes, we’d all have a fry.”
An exempt reporting adviser is still subject to several provisions of the Advisers Act, including its fiduciary and anti-fraud rules. We recommend that ERAs implement a legitimate compliance program to avoid a firm-ending regulatory action like this one.
The SEC fined a now-defunct fund manager for ignoring its compliance obligations. The SEC charges that the firm never delivered audited fund financials within 120 days as required by the custody rule (206(4)-2). Although the firm did hire an auditor, the firm never received an opinion that the financials were prepared in accordance with GAAP. Instead, the audit firm issued reports stating that it was unable to express such an opinion. In addition, the SEC charges the firm with violating the compliance rule (206(4)-7) because the principal, who also served as the Chief Compliance Officer, failed to adopt and implement policies and procedures and disregarded his obligation to conduct annual compliance reviews.
When you register as an investment adviser, you subject yourself to the full panoply of substantive regulation imposed by the Investment Advisers Act. To comply and continue as a going concern, you need to hire a competent Chief Compliance Officer to help you meet the regulatory requirements. Otherwise, you may end up either in your next career or in jail.
A large dual registrant agreed to pay over $15 Million in fines, disgorgement and penalties for failing to convert inactive fee-based advisory accounts into traditional brokerage accounts. The firm had policies requiring its financial advisers to conduct ongoing suitability reviews and flag those accounts without significant trading activity during the prior 12 months. According to the SEC, the FAs, without an imposed deadline, failed to respond to requests from the Compliance Department to complete the reviews. As a result, over a 5-year period, the firm failed to properly review nearly 8,000 accounts. Once the SEC began an investigation, the firm converted 1700 accounts to brokerage and closed an additional 2000 accounts. The SEC faults the firm for failing to have specific escalation procedures when they failed to respond to compliance inquiries and for neglecting to impose deadlines. The SEC also charged the firm with unsuitable UIT recommendations.
Dual registrants (and parent companies of dual registrants) have this unique suitability compliance obligation that overrides the specific compliance programs for the investment adviser and its broker-dealer affiliate. The firm must determine which product line – fee-based account or traditional brokerage – is suitable and then continuously monitor the accounts to avoid either churning or, as in this case, reverse churning (i.e. inactive fee-based accounts). Many industry observers used to think that fee-based accounts would displace bad brokers who churned accounts. We have now come full circle as the regulator targets reverse churning.
A fund sponsor agreed to pay over $32.5 Million in disgorgement and penalties because its tax planning strategy harmed the funds it managed. In 2005, the fund manager caused the underlying funds to convert to partnerships in order to benefit from certain deductions. However, the deductions required the unwinding of securities lending transactions that benefited the funds. The SEC asserts that the fund sponsor did not disclose this conflict of interest to the Board or the shareholders. The firm failed to resolve the internal dispute between the tax department and the securities lending group, until (10 years later) the securities lending group informed the Chief Compliance Officer, who prompted an internal investigation. The SEC also faults the firm for not reimbursing the funds for certain foreign taxes paid as a result of the conversion to a partnership. The SEC gave credit, which resulted in a lower fine, to the CCO and the firm for initiating the internal investigation and the self-reporting.
It’s never a good idea to keep Compliance in the dark about internal conflicts of interest. The Chief Compliance Officer is in the best position to protect the long-term interests of the firm and clients.
The regulators can impose significant fines and penalties for failures to implement required policies and procedures without alleging any underlying loss or harm to investors. The failure to implement required risk management and compliance policies can itself serve as the predicate for an enforcement action.