According to the Order, the firm’s principal allegedly grossly misstated Calhoun’s assets under management on the firm’s Form ADV in order to attract investors for two funds of funds.  According to Calhoun’s February 2009 Form ADV, the firm had $79.8 million in assets under management; the SEC’s Order alleges that the firm actually had $7 million in assets under management.  In addition, the SEC’s Order alleges that the principal misstated the assets under management for another investment adviser controlled by the principal.  For that firm, the principal regularly filed the Form ADV and stated the firm’s assets under management ranged from $24 million to $335 million, when in reality, according to the SEC, the firm had no assets under management.

On Thursday, January 12, 2012, RIA Compliance Consultants will be hosting a webinar, “Preparing your Form ADV Annual Amendment.”  During this webinar, we will review the Form ADV items that are required to be updated on an annual basis. The webinar will include a review of the ADV Part 1 instructions for calculating regulatory assets under management.  Our consultants will also discuss some of the common mistakes we see when investment advisors are filing their annual amendment. Additionally, our consultants will also address some of the other amendments and filings that may need to be made with your annual amendment, including those resulting from the recent SEC revisions to the Form ADV.  To register for this webinar, click here.

The SEC attributed this increase to a “significant reorganization” to the SEC’s Enforcement Division.  According to the SEC, in the 2009 and 2010 fiscal years, the Enforcement Division “flattened its management structure, revamped the way it handles tips and complaints, facilitated the swift prosecution of wrongdoers through a formal program that encourages cooperation from individuals and companies in the SEC investigations, and created national specialized units in five priority areas involving complex and higher risk areas of potential securities laws violations.”  These changes appear to be effective because the Enforcement Division filed more enforcement actions in 2011 than it ever had before.

A recent example where the SEC has initiated a disciplinary action as a result of a periodic record inspection is In the Matter of Diane M. Keefe.  In this regulatory enforcement action, the SEC brought an action against Diane Keefe, an employee of a registered investment adviser, when the SEC, while conducting a period examination, discovered that Keefe did not maintain accurate records.

Diane Keefe, a former employee of Pax World Management Corp., a registered investment adviser, was found to have willfully violated Section 34(b) of the Investment Company Act for failure to maintain accurate books and records.  Section 34(b) of the Investment Company Act prohibits investment advisors from making any untrue statement of material fact in a document that is required for record keeping pursuant to Section 31(a) of the Investment Company Act.

Keefe served as the portfolio manager of the Pax World High Yield Fund (“Fund”).  The Fund’s filed registration statements state that an Investment Committee was responsible for overseeing the Fund’s investments.  Keefe created handwritten notes that falsely represented that the Investment Committee was overseeing the investments of the Fund.  However, the Fund’s board had never even assembled the Investment Committee.

The administrative law judge suspended Keefe for twelve months from association with a registered investment adviser or broker-dealer.  Keefe has appealed her suspension and the case has been remanded for further fact-finding determinations.

On July 28, 2010 RIA Compliance Consultants will be conducting a webinar on the topic of  maintaining investment adviser required books and records pursuant to SEC Rule 204-2 issued under the Investment Advisers Act.   Individuals can register for this webinar, or any of our other upcoming webinars, by clicking here.

According to the SEC’s complaint, the defendants caused the CDOs to enter into several prohibited transactions at inflated prices so the firm could collect larger advisory fees.  In some instances, the defendants caused the CDOs to purchase assets from other firm clients at prices well above the market price.  The SEC further alleges that the defendants made misrepresentations about these transactions to both investors and the trustees of the CDOs. 

The defendants are charged with violating their fiduciary duty as investment adviser, which requires all investment advisers to conduct their business in a manner that is in their clients’ best interest.  Robert Khuzami, the Director of the SEC’s Enforcement Division, characterized the firm’s actions as violating their fiduciary duty by putting their own interests ahead of their clients and taking “advantage of a distressed market to line their own pockets.” 

Seeking a permanent injunction, disgorgement of profits, and other monetary penalties, the SEC’s complaint also charges the defendants with participation in prohibited transactions, failure to maintain required books and records, and other charges in violation of Sections 204 and 206(1)-(4) of the Investment Advisers Act of 1940; SEC Rules 204-2, 206(4)-7, and 206(4)-8; the Securities Act of 1933; and the Securities Exchange Act of 1934.

In the complaint, the SEC alleges breach of fiduciary duty and fraud for misrepresenting the safety and stability of the two largest private funds managed by Wealth Management while placing their clients into these investments even though they were unsuitable for some of their clients. The SEC’s complaint also alleged, among other things, that Mr. Putman and Mr. Fevola each accepted at least $1.24 million in undisclosed payments derived from certain investments made within the private funds that were managed by Wealth Management, while continuing to cause clients to invest in these private funds.

The offering documents for the private investment funds disclose that Wealth Management would be compensated for managing the funds through a management fee based on a percentage of assets under management. Additionally, on four of the six funds that were managed by Wealth Management an annual “Incentive Allocation” of up to 10% (depending on the fund) of the annual profits could be paid to Wealth Management. No other forms of compensation were disclosed, and Wealth Management’s Form ADV indicated that the adviser and its associated persons did not receive any economic benefits from non-clients in connection with giving investment advice to clients. No references were made regarding the payments received from the investments made within the funds.

This case should serve as a reminder to a registered investment adviser that it has a fiduciary duty to its clients. As a fiduciary, a registered investment adviser has an affirmative duty of utmost good faith to act solely in the best interests of the client and to make full and fair disclosure of all material facts, especially when the registered investment adviser’s interest may conflict with the client’s interest. Not providing proper disclosure to advisory clients can result in violations to the anti-fraud provisions of the Investment Advisers Act of 1940. The receipt of any form of additional compensation received from any source other than the client when the adviser is recommending a security to a client is just one example of a conflict of interest that must be fully disclosed to the client.

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.

It is important for investment advisor firms to not only collect these reports, but to also establish a system of reviewing and documenting the reviews of all reports. In particular, the review of personal securities transactions should attempt to detect instances or patterns when the interests of the firm or its access persons are placed ahead of the interests of clients. Depending on your firm’s specific procedures, reviews may focus on restricted lists, black-out periods, and other conditions placed on access persons trading activities.

If your firm has questions or concerns about your firm’s requirements to monitor and review personal securities transactions, please give us a call to find out how we can develop a customized suite of compliance services designed specifically for your firm.

While this firm’s actions were found to be willful and were intentionally done to mislead potential clients and the public in general, the lessons learned can be applied to every registered investment advisor. This case illustrates the importance of disclosing accurate AUM on the Form ADV Part 1. If your firm does not meet an eligibility requirement for SEC registration, it must deregister with the SEC and register with the state regulators. Do not take the risk of over reporting or misreporting AUM simply to maintain SEC registration. This case also illustrates action the SEC is willing to take when a registered investment advisor presents misleading AUM and performance information to the public through advertising and other marketing channels. All performance numbers need to be substantiated, documented and maintained with the firm’s books and records. Finally, a registered investment advisor is required to maintain books and records under Rule 204-2 and other applicable regulations, even after the firm terminates its registration. Once termination is effective, a registered investment advisor must maintain all books and records for the time period required under Rule 204-2, typically not less than five years from the end of the fiscal year during which the last entry was made on such record.

According to the SEC, the investment adviser described itself as a “fee-only” investment adviser that is “…only compensated by clients and receive nothing for the investments we recommend….” Additionally, the SEC asserted that the investment adviser filed annually the Form ADV Part I with the Commission for over six years that falsely stated that the investment adviser and its related persons were not paid commissions and didn’t recommend securities in which it had a sales interest. However, the president of the investment adviser allegedly entered into an agreement with a security issuer whereby the issuer would pay a referral fee for each client investing in issuer’s security based upon size of the investment. The SEC found that this arrangement resulted in the investment adviser receiving $361,307 in undisclosed referral fees from the security issuer.

Based on the receipt of the referral fees by the investment adviser’s president and the investment adviser’s failure to disclose such referral fees and misstatement that no such referral agreement existed, the SEC found that the investment adviser violated Section 206(1), Section 206(2) and Section 207 of the Investment Advisers Act of 1940. Accordingly, the SEC ordered a civil penalty of $40,000 and disgorgement of $361,307 for undisclosed referral fees from the investment adviser’s president.

This enforcement action clearly demonstrates the importance of accurately disclosing all forms of direct and indirect compensation received by an investment adviser and its related persons. If your registered investment adviser needs to update the compensation disclosures on its Form ADV, RIA Compliance Consultants offers Form ADV Review and Drafting services for existing investment advisers. For more information about our investment adviser compliance services, please call us at 877-345-4034.

In the Matter of Amaroq Asset Management, LLC and Dwight Andree Sean Oneal Jones (Investment Advisers Act of 1940 Release No. 2651 / September 24, 2007; Administrative Proceeding File No. 3-12822), the SEC alleges Amaroq Asset Management (Amaroq) repeatedly failed to cooperate with the SEC during the SEC’s attempt to conduct routine registered investment adviser examinations. Initially, Amaroq’s owner, Dwight “Sean” Jones, initially failed to even respond to the SEC and then later claimed his books and records were, first, destroyed in a fire, and then second, inadvertently sold by a storage company. Mr. Jones then claimed the firm ceased conducting business operations in 2004.

However, the SEC order claims that Amaroq continued to hold itself out to the public, through its website, as an investment adviser subject to SEC examinations. The order states Amaroq failed to file a Form ADV – W and that as of the date of the order, the firm was still registered with the SEC. The SEC further alleges Amaroq failed to update its Form ADV Part 1A through the Investment Advisor Registration Depository. Amaroq did not file an annual amendment to Form ADV Part 1A for fiscal years 2004, 2005, and 2006, nor did it file amendments to notify the SEC of changes in address and contact information.

This SEC order is another example of the importance of filing timely Form ADV amendments and cooperating with the SEC during routine examinations. More importantly, it is a reminder that a registered investment adviser must file a Form ADV-W in order to officially notify regulators of the firm’s intent to cease offering investment advisory services and to terminate its investment adviser registration. If your registered investment adviser needs help filing its Form ADV amendments or help preparing for an SEC examination, please contact RIA Compliance Consultants, Inc., for more information about our services.