SEC Renders Judgment on RIA with Compliance Problems
On February 16, 2024, the SEC obtained a final judgment against a Registered Investment Adviser (RIA) based in Dallas, Texas. The RIA was previously charged with making false and misleading statements in its Form ADV brochures. The SEC also alleged that the RIA failed to adopt policies and procedures designed to ensure fair and equitable trade allocations among the firm’s advisory clients.
The SEC alleged that the RIA made misrepresentations regarding its allocation procedures. The firm misrepresented that those allocation procedures would be fair and equitable. In addition, the SEC contended that the RIA failed to adopt policies and procedures intended to prevent cherry-picking and did not maintain certain required books and records.
The final judgment enjoined the RIA from violating Sections 204(a), 206(2), and 206(4) of the Investment Advisers Act of 1940, as well as Rules 204-2(a)(7), 204-2(a)(14), and 206(4)-7 thereunder. In addition, the SEC ordered the RIA to stop violating Section 17(a)(2) of the Securities Act of 1933. The RIA also agreed to pay a civil penalty of $300,000 and to hire an independent compliance consultant. The SEC’s final judgment can be viewed HERE. SEC.gov | Steven J. Jacobson and Advisor Resource Council.
History of the enforcement action
The RIA’s compliance problems began when an Investment Adviser Representative (IAR) allegedly orchestrated a cherry-picking scheme. A statistical analysis of his trading showed that the IAR disproportionately allocated profitable option trades to favored accounts and disproportionately allocated unprofitable trades to disfavored ones. According to the SEC, the IAR’s scheme was exposed when the custodian for the accounts he managed detected instances of suspected cherry-picking. The custodian then terminated the IAR’s access to the RIA’s block account.
The SEC’s complaint alleged that the IAR disproportionately allocated option trades with positive returns between the time of the trade and the time of allocation to his personal account. He allocated trades with positive returns to his mother’s account, as well as three favored client accounts. The IAR allocated trades with negative first-day returns to other clients.
The IAR’s alleged misconduct led to compliance problems for the RIA. On September 29, 2023, the RIA was charged with disclosure, compliance, and recordkeeping failures. Among other charges, the RIA failed to adopt and implement policies and procedures that were reasonably designed to prevent violations of the Investment Advisers Act by the firm and its supervised persons. In particular, the RIA did not adequately monitor the IAR’s trading activity and failed to implement the policies established in its compliance manual. Those policies and procedures stipulated that block trades had to be pre-allocated in writing and that all of those allocations be reviewed to ensure that no clients were disadvantaged.
The RIA’s Form ADV Part 2A contained statements that were deemed to be false and misleading because of the IAR’s cherry-picking and the firm’s compliance failures. The RIA’s Form ADV Part 2A brochure stated that the firm’s allocation procedure seeks to be fair and equitable to all clients. The brochure assured investors that no particular group or client would be favored or disfavored over any other.
The SEC’s initial complaint against the RIA can be found HERE.
Takeaways
Compliance problems are typically identified during an examination. If they are not corrected expeditiously, compliance problems can mushroom into an enforcement action and then a final judgment.
In addition to the financial consequences arising from compliance mistakes, an enforcement action and final judgment will bring unwanted attention to an RIA. SEC examiners are likely to return more frequently to ensure that the RIA has implemented a robust compliance program and is adhering to it. Examiners will be on the lookout for recidivist violations.
RIAs cannot sweep compliance errors under the rug. Disciplinary information must be disclosed in Item 9 of Form ADV. Although the RIA in this case did not admit or deny the allegations in the SEC’s complaint, it was forced to describe the settlement in detail on Form ADV, including the sanctions imposed upon the firm.
A disciplinary disclosure on Form ADV makes it far more difficult for an RIA to retain and attract clients and can undermine the firm’s marketing efforts.
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
Recent Comments