Financial advisers filing their annual disclosure forms to the Securities and Exchange Commission should make sure they are paying attention to some recent enforcement cases the agency has brought.
Over the past year, SEC cases have charged firms with perennial favorites like overstating assets under management and making false statements in their ADVs, as well as a few more unusual errors, such as reporting that the firm operates from one state when it really operates from another.
“It's shocking to me that an adviser would lie on their Form ADV, especially with regard to AUM,” said Les Abromovitz, a senior consultant with National Compliance Services. “It seems like a mistake they are going to get caught in.”
Sometimes advisory firms inflate their AUM to court bigger clients, while other times they decrease it so they won't be subject to SEC regulations but those of their state, he said.
SEC-registered advisers, which includes those with AUM of at least $100 million, are required to file annual updates to their ADVs within 90 days of their end of year. For most advisers, they'll be due by the end of March. Smaller advisers register with state securities regulators.
It's important that advisers be consistent with the fees they list and other parameters on all of their documents, Mr. Abromovitz said. The disclosures must match in the ADV, the advisory agreement and any advertising.
SEC examiners often begin reviews by examining a firm's Form ADV and comparing it to actual practices, said Todd Cipperman, principal at Cipperman Compliance Services.
“That's why there has been a significant increase in recent enforcement actions alleging material misrepresentation in Form ADV,” he said. “An incomplete or inaccurate Form ADV makes for easy enforcement cases.”
The SEC went after three advisers last February because their registration documents
falsely reported the state in which they did business.
The agency fined an advisory firm owner $25,000 for reporting on the ADV that it was based in Wyoming when really it operated out of Santa Fe, N.M.
In a separate case, an executive with an advisory firm had to pay $10,000 for saying on the firm's ADV that it was based in Wyoming, when the adviser really worked out of his Colorado home, the SEC alleged.
Both of these firms had the requisite under-$100-million in assets to be regulated by the states. But by choosing Wyoming, which doesn't regulate investment advisers, the firms would have automatically defaulted to SEC oversight. The advisers wanted to have SEC oversight to give the appearance that they were larger than they were, according to the SEC.
In the third case, in addition to falsely saying it was based in Wyoming when it operated from California, the firm also failed to report a complaint filed by Colorado regulators against it and its chief compliance officer for improper use of investments in a private-equity fund, the commission said. That double-shot of deceit led to the CCO being barred from the financial industry.
The SEC also went after RIAs for
overstating the amount of assets they managed.
In one case, the commission required the president, CCO and vice president to complete 30 hours of compliance training. The president was fined $25,000 and the other two executives were each ordered to pay $10,000.
The SEC also targeted those who failed to report conflicts of interests, such as a $50,000 personal loan to an advisory firm exec.
In such a case, a Tennessee investment advisory firm failed to note on its Form ADV
a loan between its CEO and another third-party adviser that the Tennessee adviser had recommended to clients, including at least two public pension funds.
Making matters worse, when the advisory firm did report the conflict, it made false and misleading statements, according to the SEC. It was fined $150,000.
State securities regulators this year also said one of the top five trouble areas they uncovered involved adviser registration documents, namely
inconsistencies between ADV Part 1 and Part 2.
Another problem area was firms that charge fees differently than what's outlined in the ADV, according to the North American Securities Administrators Association analysis.
The SEC also found fault with an investment advisory firm that
failed to report on its ADV fees it was receiving that belonged to collateralized-debt-obligation clients. For this and other indiscretions, the advisory firm agreed to pay $21 million to settle the allegations, the SEC said.
Advisers shouldn't expect regulators will let up on their scrutiny of registration documents. On the contrary, the SEC has said it wants advisers to disclose more information on the forms in an attempt to better reflect how the firms operate in the modern financial world.
The SEC
has proposed rules requiring advisers add details on their use of derivatives in separately managed accounts, additional information about branch office operations and firms' use of social media.
The additional disclosures will give investors more information as well as help the SEC “monitor risks in the asset management industry,” said SEC Chairwoman Mary Jo White in announcing the proposal in May.
For advisers, the impact is greater room for error.
“More information means greater likelihood of mistakes and enforcement,” Mr. Cipperman said.
