On June 7, 2021, the SEC settled an action against a Registered Investment Adviser (RIA) in Scottsdale, Arizona. The SEC’s complaint alleged that the RIA failed to disclose the conflicts of interest related to the firm’s Investment Adviser Representatives (IARs) receipt of forgivable loans from a third-party broker-dealer, its affiliated RIA, and their parent company.
Nineteen IARs, including the RIA’s owner, were registered representatives of the third-party broker-dealer and received approximately $1 million in forgivable loans. The broker-dealer’s affiliated investment adviser provided back office and administrative support services to the RIA in exchange for a portion of the firm’s advisory fees. The broker-dealer’s affiliated investment adviser also offered investment management programs and products to the RIA’s advisory clients.
Loan forgiveness incentives
The forgivable loans were dischargeable over a period of five years or less. The forgiveness of the loans was tied to the satisfaction of annual revenue targets, which included both brokerage commissions and advisory fees, or duration of association targets. The forgiveness of loans incentive was quite strong, because the IARs had to repay their debts.
The forgivable loans gave IARs an incentive to remain registered with the third-party broker-dealer. During the duration of this relationship, IARs would continue to sell the broker-dealer’s brokerage products and its affiliated advisory firm’s services.
The RIA first disclosed the existence of the forgivable loans on or around June 26, 2020, which was when the firm learned of the Division of Enforcement’s investigation. Until then, the RIA did not disclose the conflicts of interest created by having its IARs receive compensation in the form of loan forgiveness.
The SEC found that the RIA willfully violated Section 206(2), which prohibits an investment adviser from engaging in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client. These violations can be based on negligence. There is no requirement that advisers be aware that they are violating the Investment Advisers Act or one of its rules.
Without admitting or denying any of the Commission’s findings, the RIA consented to the entry of the SEC’s order. The order censured the RIA and required the firm to cease and desist from further violations. The SEC also ordered the RIA to pay a civil money penalty of $45,000 and to hire an independent compliance consultant. The compliance consultant was tasked with conducting a comprehensive review of the RIA’s current disclosures, policies, procedures, systems, and internal controls with respect to third-party compensation received by its IARs.
This action demonstrates that the SEC’s Division of Examinations and the Division of Enforcement will continue to focus on undisclosed compensation arrangements between RIAs and broker-dealers. RIAs must fully disclose all material conflicts of interest, including forgivable loans that may keep an adviser from acting in the best interest of clients.
The enforcement action is available 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.