- Out of Sight, Out of Mind – Advisor Continued to Charge Clients Fees for No Services After IARs Departed. Two Investment Advisor Representatives (IARs) left the firm, and although the impacted clients were charged management fees for over five years, they received no services from the firm or notification that their IARs had left during that time. Secondarily, the firm also failed to disclose a financial interest with a third-party portfolio manager who was recommended to the advisor’s clients. The Firm, its founder, and the Chief Compliance Officer were all named in the action, and the latter is barred from serving as a CCO for at least three years. Firms are reminded to establish a robust process to offboard IARs. Clients remaining with the advisor should be reassigned to new IARs to ensure uninterrupted servicing and be notified of the change. Compliance officers should also ensure that their testing program reviews the results of this process. For one, a comparison between accounts billed for a period against trading activity in client accounts could help identify accounts billed with no activity for further research. Finally, advisors and CCO’s are reminded yet again of the importance of identifying and disclosing relationships and financial interests that pose a potential conflict. Contributed by Cari Hopfensperger, Senior Director.
- “Probability of Human Error is Considerably Higher than That of Machine Error” ~Kenneth Appel. MMLIS, a subsidiary of MassMutual Holdings, settled with the Commonwealth of Massachusetts for failing to adequately supervise a registered representative who used social media to promote GameStop stock. The case involved the infamous “Roaring Kitty,” the name adopted by registered representative Keith Gill and used on several social media platforms to discuss his investment strategies. Gill essentially encouraged investors to buy GameStock stock, which Massachusetts asserts “contributed to diminished investor confidence in the securities markets.” Consequently, the securities division found MMLIS failed to adequately supervise its registered representative’s social media activity.
But perhaps the more important lesson learned in this case comes from MMLIS’ failures related to the firm’s trade surveillance system. In addition to Gill’s extensive social media presence, he also engaged in substantial trading activity in GameStop, which the firm’s surveillance system could have flagged if MMLIS had not disabled the system’s excessive trading rule. Advisors should take note: it is not enough to install a personal trading surveillance system. The system should be appropriately programmed and periodically tested to ensure that it’s capturing problematic trading activity. MMLIS ended up paying a $4 million fine and hiring a compliance consultant to help it beef up its supervisory procedures to fix this issue. Contributed by Jaqueline Hummel, Managing Director.
- A Precarious House of Cards and a Royal Flush of Violations. This case, another where the advisor, its principal, and its Chief Compliance Officer are all named, addresses several violations and offers a fascinating list of “what not to do.” For one, the advisor overstated its performance in a sub-advised account, resulting in overcharged performance-based fees. The amounts overstated were not small – reporting and charging the client on gains that, in reality, were only half the amount claimed. And, when the SEC came knocking, the client’s demand to be reimbursed for the overage remained unresolved by the advisor. Additionally, the firm materially overstated assets under management and performance (again) in marketing materials and could not produce records to substantiate why the returns used for marketing differed so significantly from client accounts invested in the strategy. The downward spiral continued with the advisor’s erroneous registration with the SEC in the first place. It reported regulatory assets under management (RAUM) ranging from $100-$300 million for four years when actual RAUM ranged from only $8.6-$22.5 million. A compliance consultant advised the firm to de-register with the SEC, and the firm then filed for state registration in California. However, California abandoned the application after the advisor failed to respond to over 70 different deficiencies identified in their registration materials. Finally, at rock bottom, the SEC called out the firm’s meager 12-page compliance manual, as the CCO herself was named in the action, fined, and barred from the industry for at least one year.
While this conduct may seem so egregious to lack practical take-aways for well-meaning firms, we can still find value in some fundamental reminders: Reasonable controls and oversight were certainly missing here, but those will only get a firm so far – the CCO must be knowledgeable and empowered to design reasonable policies and procedures to prevent, detect and, correct violations. Some rules are technical and nuanced, such as advertising and calculating RAUM. Less experienced CCO’s can fill gaps with an outside compliance expert but should be prepared to justify ignoring their recommendations thoughtfully. Finally, firms that leave issues unresolved do so at their peril – in this case, an unresolved compliant and registration deficiencies contribute to this cautionary tale. Contributed by Cari Hopfensperger, Senior Director.
Worth Reading, Watching, and Hearing
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