On January 14, 2021, the SEC brought an enforcement action against a California-based Registered Investment Adviser (RIA) and its CEO, because they failed to make certain disclosures that led to clients being deceived. The firm also failed to reasonably supervise an Investment Adviser Representative (IAR) associated with the RIA. In addition, the RIA failed to implement certain compliance policies and procedures, including those designed to prevent clients from being misled.
The IAR deceived advisory clients by allowing his father, who was not formally associated with the firm, to advise the RIA’s clients. The RIA and its CEO knew that the IAR had no real experience and no clients of his own. His father, who had previously worked as an IAR for a different firm, wanted to continue advising his clients from an office he shared with his son. Neither the RIA nor the CEO informed clients that the father was not formally associated with the firm.
The RIA and its CEO knew or should have known that the IAR’s father was advising advisory clients under the guise of his son’s association with the RIA. The CEO was also aware that:
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- the father and son shared office space and telephone lines;
- all of the IAR’s clients had worked previously with his father; and
- the son lacked any significant experience and was just learning the business.
In addition, the CEO would often correspond directly with the father, not the IAR, regarding matters such as advisory fees.
The RIA was not willing to associate formally with the IAR’s father, because he was the subject of an ongoing FINRA investigation. Furthermore, the RIA’s clearing broker had barred the father from its platform during an ongoing investigation. The CEO told the IAR’s father that although he could not affiliate formally with the investment adviser, his son was permitted to associate with the firm. Nevertheless, the father called the RIA’s clearing broker and impersonated his son on at least 38 occasions.
Compliance failures
Although the RIA had policies and procedures prohibiting the type of misconduct in which the IAR engaged, the firm failed to implement them. Those policies and procedures stated that supervised persons owe a fiduciary duty to clients to provide full and fair disclosure of all material facts and to avoid misleading them.
The RIA’s policies and procedures also required supervised persons to safeguard material non-public information about clients’ transactions and to adhere to strict confidentiality requirements. The IAR’s ongoing arrangement with his father, which gave him access to clients’ financial information, demonstrated the RIA’s failure implement its policies and procedures. In spite of those policies and procedures, the CEO and the RIA ignored warning signs regarding the IAR’s arrangement with his father. They did not put an ethical screen in place to prevent sharing of confidential client information.
The SEC found that the RIA and the CEO willfully violated Section 206(2) of the Investment Advisers Act. Section 206(2) prohibits any investment adviser from engaging in any transaction, practice, or course of business that operates as a fraud or deceit upon any client or prospect. The RIA and the CEO also willfully aided and abetted and caused the firm’s violations of Section 206(4) of the Act and Rule 206(4)-7 thereunder, which require an adviser to adopt and implement reasonable written policies and procedures. These violations may be based on a finding of simple negligence. In addition, the SEC determined that the RIA and the CEO failed to exercise reasonable efforts to supervise the IAR. As a result of these violations, the SEC imposed serious sanctions on the RIA and the CEO.
Takeaways
Investment advisers will pay a steep price if they look the other way when IARs circumvent their compliance obligations. They will be held responsible if the firm has ignored the warning signs that violations are occurring. Furthermore, investment advisers and their principals should never engage in behavior that causes those violations.
The enforcement action can be found HERE.
About RIA Compliance Group: RIA Compliance Group is an investment adviser compliance consulting firm based in Delray Beach, Florida. The firm’s mission is to provide affordable, timely, practical, and cost-effective compliance advice. We help investment advisers to comply with the myriad of state and SEC regulations and compliance obligations facing their firms. RIA Compliance Group takes pride in giving personal service and real world compliance advice, not theoretical concepts and legalese. The firm interacts on a daily basis with SEC and state securities regulators.
RIA Compliance Group, LLC – 701 SE 6th Ave, Suite 201, Delray Beach, FL 33483 – Tel: 561-600-0564 – sales@ria-compliance.com
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