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Adviser Failed to Disclose Personal Financial Problems

A state registered adviser was barred from the industry for failing to disclose a personal bankruptcy on Form ADV in addition to other charges. The Colorado Securities Commissioner cited a Form ADV that contained material omissions about the respondent’s 2017 personal bankruptcy and otherwise misrepresented his qualifications. The CSC also charged the respondent with overcharging clients and intentionally concealing the misconduct. The SEC also barred the adviser from the industry.

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.

Adviser Withheld Prepaid Fees and Concealed Deteriorating Financial Condition

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.

 

Adviser Borrowed From Clients without Full Disclosure of Financial Condition

The SEC censured and fined an investment adviser and its two principals for failing to disclose the firm’s weak financial condition to retail investors, including advisory clients, to whom it sold promissory notes.  As far back as 2012, the advisory firm struggled financially as its inability to raise assets and earn fees failed to offset rising operating costs. To keep afloat, the firm issued short-term promissory notes to retail investors including its advisory clients.  The SEC faults the firm for failing to disclose its weak financial position and the significant risk that it would not repay the notes (even though it did not default on any interest payment).  The SEC cites violations of the Exchange Act’s and Advisers Act’s antifraud rules.

OUR TAKE: The SEC can assert regulatory violations even where there is no client or investor harm.  Here, the SEC filed a settled enforcement action related to concerns about the notes even though the adviser never actually defaulted.  Adviser should also note that Item 18.B. of Form ADV requires disclosure of any “financial condition that is reasonably likely to impair your ability to meet contractual commitments to clients.”

https://www.sec.gov/litigation/admin/2018/33-10454.pdf