Investment Adviser

SEC Continues Increased Focus on RIA Performance Advertising

September 19, 2016 | Patricia Klusmeyer

The F-Squared Investments matter continues to have far-reaching consequences for those investment advisers who used F-Squared’s falsely inflated and improperly labeled backtested performance results in advertisements. As discussed previously, in November of 2015 Virtus Investment Advisers was fined $16.5 million for including the false and misleading performance results in its own advertisements and filings with the Securities Exchange Commission (“SEC”). More recently, the SEC charged Cantella & Co. (“Cantella”), a Boston-based investment adviser that licensed F-Squared’s Alpha Sector strategy, with securities violations for employing F-Squared’s false track record in its marketing materials.

F-Squared is an investment adviser that creates and markets index products using exchange-traded funds (“ETFs”). It sub-licenses these indexes to various unaffiliated investment advisers who manage assets pursuant to those indexes. In 2014 F-Squared admitted in a settled SEC administrative proceeding that it had materially misrepresented the performance results of its largest ETF strategy, AlphaSector, by labeling these results as actual results from a seven-year period when they were in fact hypothetical results derived through backtesting. In addition, F-Squared claimed that the strategy had outperformed the S&P 500 Index from 2001 to 2008 when in fact the hypothetical data contained a calculation error that falsely inflated results by 350 percent. F-Squared agreed to pay disgorgement of $30 million and a penalty of $5 million to settle the claim.

Court Affirms SEC’s Sanction of Investment Adviser Over Fraudulent Performance Advertising

September 7, 2016 | Patricia Klusmeyer

The U.S. Circuit Court of Appeals for the District of Columbia recently denied a petition to review an order of the Securities Exchange Commission (“SEC”) imposing sanctions against Raymond J. Lucia and investment adviser Raymond J. Lucia Companies, Inc. (“Lucia Companies”) for violations of the Investment Advisers Act of 1940 and the advertising rule thereunder, Rule 206(4)-1. In denying the motion, the DC Circuit affirmed the SEC’s broadened views on the use of back-tested performance in marketing and advertising materials.

As discussed previously, this case involves the improper use by an investment adviser of back-tested performance data in retirement-planning seminars. Raymond J. Lucia, and Lucia Companies allegedly used a hypothetical inflation rate that was lower than actual historical rates to make their performance results more favorable. In addition, the performance data allegedly failed to reflect the deduction of advisory fees and was not calculated in a manner fully consistent with the advertised investment strategy. As a result, the SEC barred Raymond J. Lucia from the securities industry and imposed civil penalties of $300,000.

FINRA Proposes Changes to Gifts and Gratuities Rule

August 25, 2016 | Steve Parker

Earlier this month, FINRA issued a regulatory notice advising that it has proposed various changes to the rules relating to gifts, gratuities and non-cash compensation. If adopted, the proposal would amend FINRA Rule 3220 (the “Gifts Rule”) and would create two new rules, Rule 3221 (“Non-Cash Compensation”) and Rule 3222 (“Business Entertainment”).

The current Gifts Rule prohibits any FINRA member or associated person from giving anything of value in excess of $100.00 per year to any person, if such payment is connected with the business of the recipient’s employer. Under the proposed revised Gifts Rule, the $100.00 limit would be increased to $175.00 per recipient per year. The proposed increase is designed to account for the rate of inflation since the adoption of the original Gifts Rule. The current requirements that all associated persons’ gifts must be consolidated with those of the member firm and that records be maintained with respect to all such gifts, will be continued in the new rule. Continue reading ›

SEC Charges Private Fund Administrator with Failure to Satisfy Gatekeeper Responsibilities

June 28, 2016 | Patricia Klusmeyer

The Securities Exchange Commission (“SEC”) recently settled charges against a New Jersey private fund administrator, Apex Fund Services (“Apex”), for failing to notice or correct what it contended were clear indications of fraud by two of its clients, ClearPath Wealth Management (“ClearPath”) and EquityStar Capital Management (“EquityStar”). The SEC’s Division of Enforcement noted that Apex failed to “live up to its gatekeeper responsibility” and thereby enabled the fraudulent activities of these two investment advisers.

Apex provided accounting and administrative services to various private funds, including several managed by ClearPath and EquityStar. Its duties as fund administrator included keeping records, preparing financial statements, and preparing investor account statements. The SEC charged both ClearPath and EquityStar with securities fraud in enforcement actions, finding that ClearPath had allegedly misappropriated fund assets and used fund assets for unauthorized investments, and that EquityStar had allegedly made materially false and misleading statements to investors and prospective investors of its funds regarding undisclosed withdrawals of fund assets.

Massachusetts Issues Policy Statement Questioning Robo-Advisers

June 27, 2016 | Steve Parker

The Massachusetts Securities Division (the “Division”) recently issued a policy statement in which it stated, “It is the position of the Division that fully automated robo-advisers, as currently structured, may be inherently unable to carry out the fiduciary obligations of a state-registered investment adviser.” According to the Division, robo-advisers are generally incapable of fulfilling their fiduciary obligations, principally because they do not meet with clients, gather sufficient information on which investment advice can be rendered, nor provide highly personalized advice tailored to the information gathered. Continue reading ›

SEC Charges NC Investment Adviser Selling Real Estate-Related Investments with Fraud and Breach of Fiduciary Duty

June 16, 2016 | Patricia Klusmeyer

The Securities Exchange Commission (“SEC”) recently filed suit against a North Carolina investment adviser for allegedly defrauding investors in the sale of certain real estate-related investments in unregistered pooled investment vehicles. The adviser, Richard W. Davis Jr., solicited investors primarily from the Charlotte, North Carolina region and was able to raise approximately $11.5 million from 85 investors, the majority of which were individuals with retirement accounts. However, he allegedly failed to disclose to clients that the money in the funds was being steered towards several other entities beneficially owned by himself.

Davis allegedly told investors in one of his funds that the fund’s capital would be invested in short term fully secured loans to real estate developers. He allegedly failed to mention, however, that many of the real estate developers receiving these loans were companies owned and operated by himself, creating an inherent conflict of interest. Furthermore, the companies never repaid the loans in full and Davis allegedly failed to inform his investors of this or reappraise the value of the fund’s investment. Instead, Davis allegedly misrepresented the value of the pooled fund by repeatedly stating that it had not lost any value.

FINRA Suspends and Fines Adviser for Altering CRM Record

June 15, 2016 | Steve Parker

Last month, the Financial Industry Regulatory Authority (“FINRA”) suspended an Ameriprise registered representative for one year and fined him $50,000 for altering a record in the client relationship management (“CRM”) software that the adviser used in his Ameriprise office. This enforcement case points to the dangers for broker-dealer representatives and registered investment adviser representatives alike, in editing or altering records relating to interactions with clients.

Recent SEC Enforcement Actions Signal Shift Towards Closer Scrutiny on Chief Compliance Officers

June 3, 2016 | Patricia Klusmeyer

Chief Compliance Officers (“CCOs”) play an important role in registered investment adviser firms, as they are responsible for ensuring the firm is developing adequate compliance programs and following its compliance policies and procedures. In the past, the Securities Exchange Commission (“SEC”) has generally avoided second-guessing the professional judgment of CCOs. However, recent SEC enforcement actions show a clear trend towards growing scrutiny over the conduct of CCOs and towards enforcement actions being taken against them.

Two high-profile cases from 2015 illustrate the shift in the SEC’s tone towards CCOs. First, in an April enforcement action against BlackRock Advisors the SEC charged the firm with failing to disclose the outside business interests of one of the firm’s portfolio managers to its board of directors or advisory clients, as well as failing to adopt any policies and procedures addressing outside business activities. In addition, the SEC also charged the then-CCO for causing BlackRock’s compliance-related violations by failing to ensure the firm adopted the required policies and procedures. BlackRock settled the charges with a $12 million penalty, while the then-CCO paid $60,000.

SEC Issues No-Action Letter Lessening Custody Rule Requirements for Sub-Advisers

May 31, 2016 | Patricia Klusmeyer

The Securities Exchange Commission (“SEC”) recently released a no-action letter allowing sub-advisers in certain situations to avoid the annual surprise examination requirement of Rule 206(4)-2 for investment advisers with custody of client funds or securities. Going forward, sub-advisers who do not have actual custody of client assets but are deemed to have custody because they are related to the qualified custodian and primary adviser will no longer have to comply with this burdensome requirement, so long as certain conditions are met.

As a review, custody is defined by Rule 206(4)-2 under the Investment Advisers Act of 1940 as the holding, directly or indirectly, of client funds or securities, or having any authority to obtain possession of them. This includes situations where a “related person,” or a person controlled by you or under common control with you, has custody of client funds. Pursuant to SEC Rule 206(4)-2, investment advisers with custody of client funds must take certain steps to safeguard such client assets. Those steps include: 1) maintaining assets with a qualified custodian; 2) notifying clients about the qualified custodian; 3) ensuring that the qualified custodian sends quarterly account statements to client; and 4) obtaining an annual surprise examination by an independent public accountant.

Investment Adviser Accused of Raising Operating Capital From Clients by False and Misleading Statements

May 26, 2016 | Steve Parker

Earlier this month, the Securities and Exchange Commission (“SEC”) instituted an administrative proceeding against Blue Ocean Portfolios, LLC (“Blue Ocean”), an SEC-registered investment advisor with approximately $106 million in regulatory assets under management, and its Principal, CEO and Chief Compliance Officer, James A. Winkelmann, Sr. According to the allegations, Blue Ocean and Winkelmann began raising capital from clients of Blue Ocean in order to generate business proceeds for Blue Ocean in April, 2011. The adviser raised the funds by issuing a number of what it called “Royalty Units,” which were in fact interests that paid a minimum return to the investors with the prospect of a higher return if Blue Ocean’s advertising investment yielded successful new customers with annually recurring revenue.