RIAs Required to Disclose Conflicts of Interest & Outside Business Activities
An outside business activity may create an incentive to the registered investment advisor that is not in the best interests of the client. For example, an investment advisor representative that is also an insurance agent may decide to recommend a particular insurance product based on an incentive to sell the product (e.g. higher commission, soft-dollars, trips, marketing allowance) rather than recommending the product solely based on the needs of the client. This is a classic conflict of interest that must be disclosed to investment advisory clients. A registered investment advisor’s failure to disclose outside business activities and the outside business activities of its supervised persons is an all-too-often deficiency during examinations by the U.S. Securities and Exchange Commission ("SEC") and state securities regulators.
A related type of deficiency is the failure to adequately monitor and approve outside business activities considered investment related. Certain financial related activities are considered higher risk for conflicts of interest between an investment advisor representative ("IAR") and his/her clients and even his/her firm. These activities include wholesaling investment products, affiliation with a broker/dealer, acting as a mortgage broker, working for a second registered investment advisor, and serving as a limited partner or managing member of a private investment. Before a registered investment advisor allows its supervised persons (which includes all officers, directors, partners, investment advisor representatives and employees) to engage in these types of activities, it is imperative that the supervised person fully disclose the activity and provide detailed documentation of how the activity will impact their affiliation with the registered investment advisor. If the activity does not comply with the registered investment advisor’s compliance policies and procedures, the registered investment advisor should not approve the activity.
For more information and guidance regarding outside business activities common to many registered investment advisors and to learn some best practices with respect to disclosure and mitigation of conflicts of interest, please consider attending our webinar, “Addressing Outside Business Activities and Conflicts of Interest,” on Tuesday, September 15, 2009 from 12:00 p.m. to 1:00 p.m. CST.
Purchase your webinar seat for $59.95 at www.RIA-Compliance-Consultants.com/webinars.
Labels: Conflict of Interest, Outside Business Activities, Webinar
posted by bhill at 3:30 PM
SEC Takes Disciplinary Action Against Chief Compliance Officer
According to the SEC, beginning in 2002, the investment adviser, Battery Wealth Management, Inc. (“Battery”), recommended to its clients that they participate in investment pools controlled by an individual, who was also a vice president, co-founder and co-owner of Battery (“Associated Person”). In total, the Associated Person and the individual serving as both the president and chief compliance officer of Battery (“President/CCO”) sold $6.5 million of investments in the Associated Person’s investment pools to 25 clients of Battery. The Associated Person’s investment pools had provided quarterly statements to investors reporting positive performance and increasing asset values. The President/CCO had reviewed those quarterly account statements before recommending that Battery’s clients invest in the pools. The President/CCO had also reviewed the Associated Persons website, which was provided as a direct link from Battery’s website and which website was found to have falsely misrepresented that the investment pools held over $134 million in assets.
In its examination of Battery, the SEC staff determined that brokerage account statements reporting account valuations in the various investment pools of the Associated Person were forged and that approximately $90 million of investor funds were unaccounted for or lost. The SEC determined that the Associated Person had misappropriated or lost assets invested in the pools.
The SEC found that the President/CCO had ignored facts that strongly suggested the Associated Person was likely deceiving advisory clients, and that he did not follow up on red flags or inquire whether the investment pools were investing consistent with representations made to investors. For example, the SEC’s order indicates that the President/CCO was aware of information indicating that the Associated Person’s reported income was insufficient to support the Associated Person’s “lavish” lifestyle and that the Associated Person’s loan pool consisted of personal notes issued by the Associated Person -- in many instances to IRA accounts of Battery’s clients. The SEC’s order states that the President/CCO knew of the Associated Person’s personal cash flow problems, that property owned by the Associated Person was facing potential foreclosure and that an investment pool of the Associated Person had failed to comply timely with a redemption request made by a Battery client.
The SEC found Battery to have willfully violated Sections 206(1) and 206(2) of the Investment Advisers Act by advising its clients, through the Associated Person and President/CCO, to invest in the investment pools while the Associated Person knew the pools did not have the claimed assets and that the purported returns were fictitious and the President/CCO took no steps to verify the pools’ assets or returns. Furthermore, the SEC order states that Battery’s compliance manual “did not address the particular risks of Battery’s business, particularly the conflicts of interest resulting from [the Associated Person’s] operation of a side business that offered and managed pooled funds that [the Associated Person and President/CCO] recommended to Battery’s advisory clients” and also that the compliance manual did not address conflicts of interest regarding borrowing monies from advisory clients. The President/CCO was found responsible for the manual and its deficiencies.
The SEC ordered that the President/CCO be barred from association with any investment adviser with the right to reapply for association after one (1) year and pay a civil penalty of $40,000 and disgorgement and prejudgment interest of $6,731.
As a chief compliance officer of an investment adviser, it is critical that you both identify and follow up on red flags alerting of compliance violations. Additionally, it is critical that conflicts of interest are adequately disclosed to advisory clients and that your investment adviser implement supervisory procedures to mitigate such conflicts. If you have questions about your investment adviser’s compliance obligations, RIA Compliance Consultants can help. You can reach us at 877-345-4034.
Labels: Compliance Violations, Conflict of Interest
posted by bhill at 3:29 PM
Identifying and Handling Conflicts of Interest
Recently, FINRA published a webcast on identifying and handling conflicts of interest. Conflicts of interest may arise any time that the interests of a registered representative or investment advisory representative compete with the interests of their customers. This post will summarize the FINRA webcast, as conflicts of interest is an important issue that affects both registered representatives affiliated with a broker-dealer only, as well as investment advisory representatives affiliated with a registered investment adviser.
FINRA has stated that it recognizes conflicts of interest are unavoidable in the securities industry and if not properly managed, conflicts of interest can harm a representative’s business and reputation, as well as lead to regulatory violations. To avoid these harms, it is critical that representatives both identify and address potential conflicts of interest. FINRA pointed out that it has several rules designed to address conflicts, such as its rules addressing the giving of business gifts, working as a research analyst, preventing trading conflicts, preparing fairness opinions, conducting outside business activities, and sales practice rules regarding suitability and communications with the public. While the SEC does not have the same specific rules as to investment advisory representatives, the conflicts of interest principle underlying these FINRA rules equally applies to investment advisory representatives, and the SEC has made its intention clear through various No-Action Letters that it expects registered investment advisor firms to have and investment advisory representatives to follow procedures addressing conflicts of interest.
FINRA commented that many, if not most, FINRA disciplinary actions involve conflicts of interest issues and noted that violations involving conflicts of interest include, for example, violations regarding suitability, false and misleading communications, and trading violations. Also, FINRA stated that conflicts commonly arise regarding recommendations to buy or sell securities and regarding compensation arrangements. FINRA stated that a common conflict is the temptation for a representative to recommend a product based on the representative’s receipt of higher compensation or based on pressure for a representative to recommend proprietary products. Compensation arrangements which pay based on the volume of business a representative directs to a particular product sponsors was another example of a common conflict. FINRA reminded that per the FINRA Suitability Rule representatives are required to make sure that recommendations to a customer are suitable. As investment advisor representatives, fiduciary responsibility requires that interests of customers are put above the investment advisor representative’s own interests. FINRA suggested that representatives can minimize both reputation and regulatory risks resulting from conflicts of interest by always putting their customer’s interest before their own. Additionally, FINRA stated that disclosure can help mitigate conflicts by making sure that customers have the information that is necessary to fairly evaluate recommendations from their representative.
RIA Compliance Consultants, Inc. can help you with questions you may have about identifying, addressing, or disclosing conflicts of interest. Please contact us if you would like more information about our services.
Labels: Conflict of Interest
posted by bhill at 2:19 PM
SEC Issues Cease-and-Desist Order for Failure to Disclose Conflicts of Interest and Misrepresentation of Its Research Process
In the Matter of Banc of America Investment Services, Inc. and Columbia management Advisors, LLC, as successor in interest to Banc of America Capital Management, LLC (Rel. IA-2733/May 1, 2008; File No. 3-13030), the SEC alleges material misrepresentations and omissions by Banc of America Investment Services to its clients for whom it had maintained discretionary mutual fund wrap fee accounts. Specifically, the SEC alleges that in selecting funds for inclusion in its wrap fee accounts that Banc of America Investment Services used a methodology that was contrary to statements of methodology provided to clients and that furthermore, Banc of America Investment Services' affiliate, Banc of America Capital Management earned additional fees as a result of those selections made that were contrary to the stated methodology. As an investment adviser, Banc of America Investment Services had a fiduciary duty to act in the best interests of its clients and was required to disclose all material information concerning potential or actual conflicts of interest.
Section 206(2) and 206(4) of the Investment Advisers Act of 1940 establish a fiduciary duty for investment advisers to act for the benefit of their clients. Section 206 states, in part:
It shall be unlawful for any investment adviser, by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly- … (2) to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client; … (4) to engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative. The Commission shall, for the purposes of this paragraph (4) by rules and regulations define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative.
Misrepresentation to clients that funds in the model portfolios would be chosen according to the approved research process and failure to disclose the conflict of interest in its selection of affiliated funds for inclusion in model portfolios were actions found to be in violation of Section 206(2). Making material misrepresentations and omissions in advertising and promotional materials that were distributed to clients and prospective clients was determined to be a violation of Section 206(4).
This enforcement action by the SEC is a reminder of the importance for every investment adviser to fully disclose conflicts of interest and to accurately state all information that is provided in both the Form ADV and in any advertising. RIA Compliance Consultants, Inc. can help you review the adequacy of your current disclosures or provide assistance in preparing disclosure language related to conflicts of interest or other matters. Please contact RIA Compliance Consultants, Inc. if you would like more information about our services.
Labels: Conflict of Interest, Enforcement
posted by bhill at 10:23 PM
SEC Issues Cease-and-Desist Order for Incomplete Disclosure of a Conflict of Interest
In the Matter of Callen Associates (Rel. IA-2650/Sept. 19, 2007; File No. 3-12808), the SEC alleges that a pension consultant registered as an investment adviser sold its affiliated a broker-dealer, and as part of this sale, the purchaser agreed to pay an annual fee for eight years to the investment adviser for sale of the affiliated broker-dealer contingent upon the investment adviser’s clients continuing to generate a minimum amount of commissions each year with the purchaser’s broker-dealer. The SEC asserts that although the investment adviser disclosed through its Form ADV Part II that the purchaser’s broker-dealer was its preferred/exclusive broker for plan sponsor/investment manager clients, the investment adviser described the ongoing compensation from the sold broker-dealer to the investment adviser as a periodic fixed fee. The SEC found that the characterization of these payments to the investment adviser “… as ‘fixed’ was misleading in that a material portion of each annual payment was contingent upon the [purchased broker-dealer’s] receipt of a minimum threshold of [the investment adviser’s] client brokerage business.”
This enforcement action by the SEC is an excellent example of the need for an investment adviser to describe accurately and thoroughly any potential conflicts of interest to its clients and the SEC. If your investment adviser needs assistance in preparing such disclosures, please contact RIA Compliance Consultants, Inc. for more information about our services.
Labels: Conflict of Interest, Enforcement, Form ADV
posted by bhill at 4:52 PM
