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Insufficient Compliance Resources Cost Firm and CEO

The SEC fined an investment adviser $400,000 and fined and censured its CEO for failing to devote sufficient resources to compliance, thereby contributing to the firm’s failure to uncover an offering fraud.  The firm appointed a portfolio manager, who did not have regulatory experience, to assume the Chief Compliance Officer role in addition to his other duties.  The PM/CCO highlighted several compliance deficiencies and pleaded for more resources, but the CEO did not address his concerns, and, in fact, cut the compliance budget.  The SEC maintains that the under-resourced compliance program contributed to the firm’s failure to conduct promised due diligence, which may have uncovered the offering fraud that harmed clients.


 Based on our experience and several industry studies, registered investment advisers should spend at least 5% of revenue on compliance infrastructure.  Also, firms should appoint a fully engaged and experienced regulatory professional to serve as Chief Compliance Officer and avoid the cheaper dual-hat model that puts both the firm and the CCO at risk.  Compli-pros should take solace that the SEC did not name the CCO, presumably because he highlighted the compliance deficiencies and advised the firm on how to remediate.

Compliance Failures Lead to Firm’s Demise

 Compliance deficiencies led to the demise of a private fund manager because of failures to enforce a consistent redemption policy, deliver audited financial statements, and file accurate Form ADVs.  According to the SEC, the firm allowed certain clients and insiders the ability to redeem before the stated 90-day redemption policy.  The firm also failed to deliver audited financials as required by the custody rule.  The SEC also cites the firm for filing inaccurate Form ADVs, including claiming SEC registration eligibility even though the firm had less than $100 Million in assets under management.  The SEC attributes the failures to the firm’s deficient compliance program which used a template manual and did not require annual compliance reviews.   

 OUR TAKE: Failure to implement an adequate compliance program can have real-world implications for the viability of your firm.   A tight compliance program will support a more coherent operating environment that will prevent sloppy business practices that will lose clients and attract regulators. 


RIA Failed to Identify or Stop Cherry-Picking

The SEC fined and censured an investment adviser for insufficient supervision and compliance procedures, which allowed one of its investment advisers to cherry-pick trades for the benefit of favored accounts.  The adviser used an omnibus brokerage account to allocate profitable trades to favored accounts to the detriment of other accounts, notwithstanding the firm’s policies and procedures and Form ADV that indicated that it would allocate trades fairly and equitably.  The SEC acknowledges that the firm did conduct daily reviews of the trading but focused on suitability and concentrations, rather than trade allocation.

OUR TAKE: Failure to prevent wrongdoing creates a burden and inference that your compliance policies and procedures do not measure up.  In this case, the SEC did not offer insight into how the firm should conduct allocation testing or whether such testing would have stopped the misconduct.  Instead, the SEC argues that the cherry-picking itself proves that the firm failed to implement reasonable policies and procedures.  This is why firms need to implement testing and monitoring and not just write a nice policy.


Advisers Failing Best Execution Compliance Obligations

The SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert listing the most common deficiencies cited in recent examinations of advisers’ best execution obligations.  Reviewing over 1,500 exams, the OCIE staff highlighted advisers’ failures to (i) conduct any best execution reviews, (ii) consider qualitative factors (e.g. execution capability, responsiveness), and (iii) utilize multiple brokers or to compare execution quality against other brokers.  The OCIE staff also witnessed widespread failures to fully disclose best execution practices such as client preferences and soft dollar arrangements.  The staff reports that many advisers either had inadequate policies and procedures or failed to follow them.  The staff encourages advisers “to reflect upon their own practices, policies, and procedures in these areas and to promote improvements in adviser compliance programs.”

OUR TAKE:  In its recent fiduciary interpretation release, the SEC specifically identified best execution as core to an adviser’s fiduciary obligation.  As a core obligation, it concerns OCIE that they have identified pervasive compliance failures during examinations.  Ensuring a best execution review should be part of every compliance testing program.


Large Wrap Sponsor Pays $18.3 Million for Compliance Problems in Business Sold 8 Years Ago


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.