The Enforcement Division of the Securities and Exchange Commission (SEC) and its Office of Compliance Inspections and Examinations (OCIE) are focusing their examination and disciplinary efforts on the investment adviser community.
On October 23, 2013, the SEC sanctioned three investment advisers for deficiencies in their compliance programs. Rule 206(4)-7 under the Investment Advisers Act of 1940 requires all registered investment advisers (collectively, "RIAs") to adopt, implement and review written policies and procedures that are reasonably designed to prevent violations of securities law, rules and regulations. OCIE inspects and examines RIAs to ensure compliance with this rule, along with the other conduct rules relating to RIAs.
The three cases arose out of inspections and examinations by OCIE. All of them were brought as administrative proceedings by the SEC, and all were settled. In each case, the respondents agreed to pay significant fines and to comply with substantial undertakings.
The violations alleged in the three cases included:
The failure to conduct an annual compliance review
Omitting disclosures required in connection with the marketing of performance information
Discrepancies between the amount of funds under management as disclosed on the adviser's Form ADV and the dollar amount stated in marketing materials
Making false and misleading statements about compensation in Form ADV and marketing materials
Insufficient or misleading disclosure to clients concerning conflicts of interest
Insufficient written supervisory procedures
In one case, In the Matter of Modern Portfolio Management, Inc. (Adm. Proc. No. 3-15583, Release No. IA 3702), the firm and its owners were censured, as well as required to complete 30 hours of compliance training, designate a new Chief Compliance Officer and engage a compliance consultant for a period of three years—in addition to paying $175,000 in fines.
The other cases were brought for similar violations and compliance failures, and they also produced substantial fines and additional undertakings. In addition, certain of the respondents were required to provide notice to their clients of their enforcement actions. [In the Matter of Stephen Derby Gisclair (Release No. 34-70742); In the Matter of Equitas Capital Advisors, LLC, et al. (Release No. 34-70743).]
Five days later on October 28, 2013, the SEC sanctioned three additional RIAs for violations of the SEC's "custody rule" [Rule 206(4)-2)], which requires RIAs that have custody of client funds or securities to implement controls designed to protect those assets from misconduct or other loss. Among its requirements, the rule requires the appointment of an independent public accountant to undertake a process of inspection and audit.
All three of those cases were brought as administrative proceedings, and all three were settled. [In the Matter of Knelman Asset Management Group, LLC and Irving Knelman (Release No. IA-3705); In the Matter of GW & Wade, Inc. (Release No. IA-3706); In the Matter of Further Lane Asset Management, LLC, et al. (Release No. 34-70759).] All of these cases resulted in the imposition of substantial fines, as well as substantive undertakings by the respondents.
Although these six cases were brought as SEC administrative proceedings, the SEC may also bring enforcement cases in the U.S. District Courts and, in cases that it deems flagrant, may refer them to the U.S. Department of Justice for criminal prosecution.
All of these proceedings were announced in the wake of recent public statements by SEC officials indicating that the SEC would focus its examination efforts on the investment adviser community during 2014. In addition to RIAs, the investment adviser community also includes investment advisory and management firms that are exempt from the requirement to register. Following the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, many advisory firms that previously had been exempt from RIA requirements by virtue of the former "private adviser" exemption—former Investment Advisers Act Section 203(b)(3), which provided an exemption for advisors that had 14 or fewer clients—were required to register as RIAs for the first time.
At the same time, new limited exemptions were adopted. They include the private fund adviser, venture capital fund adviser and foreign private adviser. [See Investment Advisers Act Sections 203(m) and 203(b)(3).] A condition of these exemptions is that the exempt adviser "report" to the SEC by preparing and filing portions of Form ADV, which is ordinarily used to apply for registration as an RIA.
In the aftermath of the announcement of these six SEC actions, the OCIE Director announced that, in 2014, the SEC would make it a high priority to inspect and examine RIAs that had not previously been reviewed by OCIE in the past. In addition, OCIE has begun conducting limited "presence" examinations of private fund advisers and indicated that it would commence such examinations of foreign advisers as well. These announcements, coupled with the recent enforcement actions, signal that all advisers, both RIAs and "exempt advisers," may want to pay particular attention to their compliance programs and supervisory procedures. All persons and firms who are either registered as investment advisers or who have reported to the SEC as exempt advisers should consider reviewing their own procedures to ensure that the information contained on Form ADV is consistent with the information contained in internal procedures and marketing materials. Additionally, policies, procedures and disclosures concerning potential conflicts should be reviewed to ensure that they address all potential and actual conflicts related to the relevant advisory business and that they are also sufficiently documented, reported and enforced.
The SEC "wolf" may well be at the door.