The Chief Compliance Officer of a registered investment adviser was barred from the industry and faces criminal sentencing for wire fraud for his role in overbilling clients over $11 Million over a 10-year period. The CCO, a 5% owner of the firm and a protégé of the firm’s CEO/principal, implemented several of the billing practices directed by the firm’s principal and 90% owner. Overbilling practices included double billing clients, charging the wrong fee, charging a management fee instead of a performance fee, failing to prorate fees, and billing for services not performed. The CCO admitted that he knew there was a high probability that the CEO was defrauding clients, but the CCO deliberately avoided learning the truth.
There is no “just following orders” defense for employees of registered investment advisers. We can appreciate the conundrum when your boss and mentor engages in wrongdoing; but, failing to resign and call out the wrongdoing can lead to significant civil and criminal penalties.
A registered investment adviser agreed to pay $354,000 in client reimbursements and penalties for failing to give clients the benefit of promised fee breakpoints over an 8-year period. The adviser marketed a fee schedule that offered lower fees as assets increased and offered clients lower fees for aggregated household accounts. According to the SEC, the respondent failed to apply the lower fees as clients reached the breakpoints or to aggregate household accounts for certain clients. The SEC maintains that the firm overcharged 293 clients an aggregate of $304,000, which the firm voluntarily refunded following the commencement of the enforcement investigation. In addition to alleging violations of the Advisers Act’s antifraud provisions, the SEC also faults the firm for failing to implement reasonable compliance policies and procedures.
Some very elementary supervision, operations and compliance infrastructure could have avoided the overcharging and the resulting enforcement action. Emerging firms looking to squeeze out some profits should not skimp on the basic must-haves of running a proper firm.
The SEC’s Office of Compliance Inspections and Examinations has issued a Risk Alert detailing investment adviser failures to properly calculate and disclose fees and expenses. OCIE cites failures to properly value assets, thereby leading to overbilling, using the incorrect fee rate, and billing based on the wrong time period. OCIE also details faulty disclosure practices including Form ADVs that do not reflect actual billing practices and failures to fully disclose compensation arrangements. OCIE also highlights fund sponsors that misallocate expenses. The OCIE findings result from issues identified in deficiency letters issued in recent SEC exams. The Risk Alert advises that firms take action by reimbursing clients and enhancing policies and procedures.
OUR TAKE: These Risk Alerts often precede enforcement actions. Compli-pros should review their fee billing and disclosure practices in anticipation of an OCIE sweep.
A large dually registered adviser/broker-dealer agreed to pay over $18 Million to settle charges that it overbilled clients in a wrap program that it sold off in 2009, although it maintained an interest through 2013. The SEC charges that the respondent overbilled clients by failing to (i) input lower negotiated fees into its system, (ii) track transferred accounts, (iii) rebate prepaid fees after termination; (iv) benefit investors when rounding, and (v) track lower rates when switching platforms. The SEC faults the firm for failing to implement adequate compliance policies and procedures (Rule 206(4)-7) that would have required sample testing to discover the over-billing. The SEC also charges violations of the books and records rule (204-2) because the respondent could not locate over 83,000 advisory contracts.
OUR TAKE: Selling or terminating a business line does not cut off regulatory liability for prior events. Also, this case is a good example of how overbilling could occur and how to test for irregularities.
A large investment adviser agreed to reimburse clients and pay a $13 Million penalty for compliance breakdowns related to fee billing, custody, and books and records. According to the SEC, over a 15-year-period, the respondent overbilled clients because of coding and administrative errors included in predecessor firms’ billing systems. The SEC faults the firm for failing to test and uncover the over-billing when it integrated the systems. The SEC also accuses the respondent of violating the custody rule’s surprise audit requirement by failing to properly identify the accounts subject to audit. Also, the SEC faults the firm’s books and records practices for failing to retain client agreements. The SEC cites violations of the Advisers Act’s custody rule (206(4)-2), compliance rule (206(4)-7), and books and records rule (204-2).
OUR TAKE: Integrating operations following a combination should trigger compliance due diligence into the prior firm’s policies and procedures. Also, firms should include compliance due diligence as part of the acquisition process.