SEC Takes Disciplinary Action Against Chief Compliance Officer

November 07, 2008

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The U.S. Securities and Exchange Commission (“SEC”) recently issued an order bringing sanctions against an individual who had served as an investment adviser’s president and chief compliance officer regarding investment pools operated by an associated person of the investment adviser.

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.

Posted by Bryan Hill
Labels: Compliance Violations, Conflict of Interest