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Category: Dual Hatting

IA/BD Failed to Supervise Its CEO/CCO

The SEC fined and censured an IA/BD for failing to supervise its CEO/CCO who was ultimately criminally convicted of stealing from clients.  The CEO/CCO used the firm’s consolidated reporting system, which allowed manual inputs of outside investments, as a way to mislead clients about false investments that he siphoned off into his own account.  The SEC faults the firm for failing to implement reasonable policies and procedures to review the consolidated reports, which, according to the SEC, would have quickly uncovered the obvious scheme.  The SEC charges violations of the antifraud rules and the compliance rule (206(4)-7), which requires firms to adopt and implement reasonable compliance policies procedures to prevent violations of the securities laws.

OUR TAKE: It’s never good when the CEO (or any other revenue-producing individual) also serves as the CCO.  Such a structure virtually ensures a lack of proper supervision.  Firms must ensure that the CCO, whether inside or outsourced, has significant independence from management and the revenue-producing function.  The SEC has brought several enforcement actions against dual-hatted CCOs, who also serve in a management capacity.


Dual-Hatted CCO and Under-Resourced Compliance Function Result in Fine/Censure for BD

The SEC fined and censured a broker-dealer because its under-resourced compliance function failed to implement adequate employee and information monitoring procedures.  The firm’s Chief Compliance Office, who also served as a relationship manager, was initially appointed despite a lack of compliance experience.  He pleaded for more compliance resources, including the use of a third party compliance consultant, to monitor the firm’s 45+ registered representatives, but the CEO refused because the firm “needed to generate more revenue before it could spend more money on compliance.”  As a result, the broker-dealer failed to review employee securities trading, review a sufficient number of emails, and monitor information barriers.

OUR TAKE: Registered advisers and broker-dealers should retain a fully-committed CCO – either through hiring or by retaining a third party compliance firm – that has significant compliance experience.  Dual-hatting an unqualified internal employee will not satisfy the regulators.  Also, firms must adequately resource the compliance function.  Based on previous benchmarking studies, most SEC-regulated entities spend between 7%-20% of total operating costs on compliance, with a minimum of 5% of revenues.


SEC Bars Dual-Hatted Executive for Inadequate Form ADV Disclosures

CCO Wearing too Many Hats 

The SEC barred the principal/chief compliance officer of an investment adviser for inadequate ADV disclosure about revenue sharing and the firm’s financial condition.  The SEC also revoked the firm’s registration.  The SEC alleges that the firm’s ADV failed to disclose that the principal received revenue sharing out of 12b-1 fees paid on client assets even though lower-expense share classes of the same funds were available.  The SEC also faults the principal and the firm for failing to disclose its deteriorating financial condition including its difficulties meeting payroll and rent obligations.  The SEC explained, “As the sole owner and chief compliance officer, it was [the respondent’s] responsibility to review and ensure the accuracy” of Form ADV.  The executive “should have known that the Forms ADV contained materially misleading statements and omitted material facts” but he “failed to exercise reasonable care in reviewing and signing” the ADV.

OUR TAKE: Advisers should have a dedicated chief compliance officer that knows the rules and can act as a check against conflicts of interest.  The SEC has brought several enforcement cases against dual-hatted executives that short-change compliance.


Adviser Agrees to Hire Experienced CCO to Settle Compliance Charges


The SEC fined and censured an investment adviser and its president/CIO for failing to implement compliance policies and procedures after the SEC noted principal transaction and best execution deficiencies during 2 separate exams.  As part of the settlement, the respondent agreed to hire an experienced chief compliance officer and retain an independent compliance consultant.  The SEC alleged that the respondent promised, but failed, to implement required principal transaction and best execution policies following SEC exams in 2006 and 2009.  Even though the firm adopted policies and procedures, the SEC maintains that the firm violated those policies by continuing to engage in unlawful principal transactions and failing to monitor best execution.

OUR TAKE: Investment firms must hire a competent, experienced, and fully-engaged chief compliance officer to maintain and implement the compliance policies and procedures.  The SEC will not accept mere lip service when it comes to regulatory compliance, especially when a firm does not follow through on specific undertakings made in response to deficiency letters.