Lessons Learned from Recent SEC and FINRA Cases: May 2018


SEC Nails Three Advisors for Fiduciary Failures when Selecting Mutual Fund Share Classes.  The SEC released three settlement orders where investment advisers failed “to disclose conflicts of interest and violated their duty to seek best execution by investing advisory clients in higher-cost mutual fund shares when lower-cost shares of the same funds were available.”  The firms had to reimburse investors to the tune of $12 million, as well as pay penalties ranging from $250,000 to $900,000.  Check out our blog post discussing these cases:  Why the SEC is Obsessed with Mutual Fund Share Class Selection and Disclosure (and why you should be too).

Adviser Marketed Misleading Hypothetical Back-tested PerformanceWishful thinking is the formation of beliefs and making decisions according to what might be pleasing to imagine instead of by appealing to evidence, rationality, or reality. In the matter of the Securities and Exchange Commission (“SEC”) vs. Arlington Capital Management, Inc. and Joseph F. LoPresti, CCO, the SEC decisively pointed out that wishful thinking is not a basis for advertising hypothetical back-tested performance. In 2010, Arlington and LoPresti started using model portfolios – the Proactive Asset Allocation Strategy (PAAS) — to invest client assets.  From 2012-2015, the firm issued a series of advertisements that contained hypothetical back-tested results. Each time the model was updated, Arlington would restate its performance results as if the new version of the model had been in effect during the entire period. The advertisements either did not disclose that the results were hypothetical and continuously being adjusted as the models were improved or contained disclosures that were not given the appropriate prominence. All advertisements were approved by LoPresti as the CCO.

In addition to being required to revise the firm’s advertising policies and procedures, naming a new CCO, and hiring a compliance consultant, both Arlington and LoPresti were required to pay civil monetary penalties, collectively totaling $200,000. Further, Arlington was required to post the entire SEC order prominently on their website, send a notice of the posting to all existing clients, and update the firm’s ADV.  Lesson learned from this case is that if your firm is going to advertise hypothetical back-tested performance, understand that heightened disclosure is required, including clearly and prominently identifying the nature of the performance on the actual performance page.  Write parameters into the policy and procedures, talk to the portfolio managers and analysts to understand the breadth and scope of the calculations, and train marketing personnel on the disclosure requirements. It takes a village to provide accurate disclosures in this arena. Wishful thinking will not give you a pass with the SEC.  Contributed by Alison R. Palmeri, Esq., Compliance Associate, and Heather Augustine, Senior Compliance Consultant.

Worth Reading:

Brokers May Have to Put Customers FirstMatt Levine provides his entertaining perspective on the SEC’s latest slew of announcements and rule proposals.

SEC National Compliance Outreach boiled down to about 1,000 words.  Check out Lorna Schnase’s Summary of the SEC outreach meeting for RIAs and ICs.  She boils it down to the essentials, so you get the big picture without all the self-congratulation!

Morgan Lewis’ Summary on GDPR’s Requirements: and GDPR: Q & A for Investment Advisers and Private Fund Managers from Foley Hoag:  Good resources on the new regulation.

K&L Gates Alert on BE-12:   Bureau of Economic Analysis is requesting more data to determine and quantify the size and economic significance of foreign direct investment in the United States.  Private funds with material foreign investment should check this out.

Three things define effective compliance training — and here’s what they are:  Ricardo Pellafone provides some great advice for re-tooling your compliance training.

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