Form ADV, Item 18.B. specifically requires investment advisers to “disclose any financial condition that is reasonably likely to impair your ability to meet contractual commitments to clients.” Item 18.C. also requires the disclosure of any bankruptcy petition during the prior 10 years. As investment advisers struggle financially, compli-pros should assess whether the firm needs to enhance its financial condition disclosure.
Once the SEC identifies possible wrongdoing, don’t compound the problem by further misleading clients during the remediation process. It is possible that this firm could have avoided the $400,000 in fines had it not lied to clients about its past practices.
We expect several enforcement actions this year based on the failure to offer the lowest mutual fund share class available. We recommend that advisers conduct an internal reviews of recommendation practices and take action to reimburse clients.
The SEC has proposed allowing a summary prospectus for the sale of variable annuity and variable life insurance products. The summary prospectus would include an overview of the insurance contract, fees, and risks. An issuer could also deliver an updating summary prospectus for existing investors, which summary would disclose any material changes during the prior year. The summary prospectus regime would mirror the summary prospectus adopted in 2009 for open end funds. An issuer would make the full prospectus and information about underlying investments available online. The comment period runs until February 15, 2019.
FINRA has consistently prioritized the regulation and disclosure of variable products and has issued multiple rules and notices to members about sales practices. While we agree that the SEC should allow summary prospectuses, we are not sure whether this will materially improve investor knowledge or reduce sales practice abuses.
An investment adviser platform was fined and censured for receiving fund revenue sharing from a custodian and clearing firms it recommended without proper disclosure. The platform had more than 150 independent investment adviser representatives and 200 registered representatives working out of more than 100 offices. The SEC criticizes weak disclosure that failed to fully describe the conflict of interest when the firm recommended a custodian that kicked back 2 basis points on assets. The SEC also maintains that the firm violated disclosure, fiduciary and best execution obligations when it recommended mutual fund share classes that paid back 12b-1 fees to the firm and its reps when lower fee share classes were available. The firm did not meet its obligations with vague website disclosure that described how the firm “may” receive compensation but failed to fully inform all clients about how fees were paid or calculated.
OUR TAKE: The RIA platform business is extremely competitive, with many firms competing to recruit successful RIA teams. The real cost of an enforcement action like this is the reputational and competitive threat during the recruiting process. Also, as platforms compete for business and margins shrink, the incentives to accept (questionable) revenue sharing increases.
OUR TAKE: Moving assets around among client funds may have been common practice before Dodd-Frank required private fund managers to register. However, Section 206(3) specifically limits such transactions by requiring notice and consent.
OUR TAKE: This case reads like a cautionary tale for large firms trying to quickly roll out a product. It appears that the portfolio management, marketing, legal, operations, and legal functions worked in silos, and, as a result, failed to properly vet or describe the products. We recommend that firms create a cross-functional product assessment team that can ask the hard questions before launching a product.
OUR TAKE: Without proper disclosure and consent, a transaction that benefits the fund sponsor or its principals will violate the Advisers Act’s fiduciary duty whether or not the investors suffered any harm. This case also highlights the perils of the CCO dual-hat model whereby a senior executive with a pecuniary interest also serves as the Chief Compliance Officer, thereby avoiding independent scrutiny.
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.