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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.

 

Hedge Fund Firm Failed to Stop Sharing of Confidential Information

The SEC fined and censured a hedge fund firm for failing to stop its research analyst from sharing confidential information with his wife, who ran another hedge fund.  The research analyst helped his wife start the competing firm and provided internal confidential information including investment models, research and recommendations.  In fact, holdings of the two hedge fund firms significantly overlapped.  After the respondent become aware and warned the research analyst about sharing confidential information, it failed to stop the conduct despite policies and procedures about email review and maintaining confidential information.  The SEC faults the firm for failing to supervise and for failing to implement an adequate compliance program that would effectively monitor and halt unlawful conduct.

OUR TAKE:  You must walk the compliance walk, not just talk the compliance talk.   Registered firms must implement compliance policies and monitoring, not simply adopt broad policies and procedures that sound good.