SEC Charges RIA with Misleading Investors about its Investment Strategy
On September 19, 2024, the SEC charged an Idaho-based Registered Investment Adviser (RIA) with making misleading statements, as well as compliance failures, related to the firm’s execution of its biblically responsible investing (BRI) strategy.
According to Corey Schuster, Co-Chief of the Asset Management Unit in the Division of Enforcement, “Investors must be able to rely on advisers acting consistently with their represented investment process or strategy.” Schuster alleged that the RIA’s investment screening process was inconsistent with what it told investors. As a result, the RIA invested in a manner that was contrary to the firm’s stated investment criteria.
The firm did not adhere to the BRI strategy it touted
The SEC’s action alleged that the RIA made material misstatements regarding how it managed investments for clients. The RIA managed eight exchange-traded funds (ETFs) and separately managed accounts (SMAs), that utilized a BRI strategy. The RIA’s strategy purportedly excluded investments in companies engaging in certain enumerated business practices, which the firm concluded did not align with biblical values.
The RIA claimed that it used a science and data-driven proprietary methodology to provide a positive or negative score for companies, which was derived from their business practices. In the firm’s Form ADV Part 2A brochure (brochure) and ETFs’ prospectuses, the RIA asserted that the ETFs and SMAs it advised would not invest in companies having any degree of participation in certain enumerated activities or products that the firm believed did not align with biblical values.
The SEC’s complaint alleged that the RIA:
- Misrepresented its research process;
- Failed to apply its investment criteria consistently;
- Invested in companies that should have been excluded based on the firm’s stated investment criteria; and
- Utilized a research process that failed to prevent deviations from its stated investment criteria.
The RIA stated in its brochures and ETF prospectuses that the firm only invests in companies that it deems to be aligned with biblical values. For example, certain prospectuses touted the firm’s impact score, which asserted that the RIA would not consider the securities of any company with any degree of participation in certain prohibited activities or products, such as gambling, abortion, cannabis, alcohol and tobacco. The RIA purportedly utilized software that analyzes publicly available data to facilitate the firm’s removal of certain types of investments.
The RIA touted the firm’s methodology and reliability in a white paper published on its website. The website described the firm’s methodology as “objective” and “rules-based” and represented that it gathers the most robust data sets from the world’s leading providers. Nevertheless, the RIA deviated from its BRI strategy and invested in companies that were involved in prohibited activities. Despite representations made to clients, the RIA did not normally conduct research at an individual company level to identify prohibited activities. Furthermore, the SEC found that from at least 2019 to March 2024, the RIA relied on a manual research process, not a data-driven methodology, and did not typically perform research on individual companies to evaluate them for eligibility under its investing criteria.
Policies and procedures must be robust
The SEC alleged that the RIA willfully violated Section 206(4) of the Investment Advisers Act and Rule 206(4)-7 thereunder. Specifically, the RIA failed to adopt and implement reasonably designed policies and procedures related to its investment process. The RIA lacked written policies or procedures establishing a due diligence process to ensure that representations made to investors and clients were accurate. The firm also lacked written policies and procedures for evaluating companies’ activities to determine if they were inconsistent with the RIA’s investment criteria. The RIA also lacked written policies and procedures articulating the firm’s investment process, which occasionally resulted in an inconsistent application of its investment criteria.
These inadequate policies and procedures led to the RIA investing in companies engaged in activities that did not align with the firm’s stated criteria. As a result, clients who came to the firm because of its BRI strategy did not receive the services they expected.
Takeaways
When RIAs communicate their investment strategies to clients and prospects, they must adhere to the representations they made. It is misleading for any investment adviser to misrepresent the strategies they will be using when managing their clients’ money.
Aside from violating Rule 206(4)-7 under the Investment Advisers Act, the SEC alleged that this RIA willfully violated Section 206(4) of the statute and Rule 206(4)-8 thereunder. An adviser may not make any untrue statement of a material fact or omit a material fact necessary to make the statements made not misleading to any investor or prospective investor in a pooled investment. Furthermore, advisers may not engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative in regard to any current or prospective investor in a pooled investment vehicle.
In addition, the SEC contended that the RIA willfully violated Section 34(b) of the Investment Company Act, which makes it unlawful for any person to make an untrue statement of a material fact in any registration statement, application, report, account, record, or other document filed or transmitted pursuant to the statute. The RIA also omitted material facts necessary to prevent the statements made from being materially misleading under the circumstances.
The RIA consented to the entry of the SEC’s order, which found that the firm violated the antifraud provisions of the Investment Company Act of 1940, as well as the Investment Advisers Act of 1940. Without admitting or denying the SEC’s findings, the RIA consented to a censure and cease-and-desist order, to pay a $300,000 penalty, and to hire an independent compliance consultant.
The SEC’s order is available at ia-6710.pdf (sec.gov).
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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