RIA Compliance Blog

Hedge Fund Manager Settles Charges with SEC for Overcharging on Fees and Overvaluing Assets

January 26, 2016 | Patricia Klusmeyer

A Denver-based alternative fund manager was recently charged by the Securities Exchange Commission (“SEC”) with engaging in fraudulent behavior regarding the handling of its futures fund, The Frontier Fund (“TFF”). The alternative fund manager, Equinox Fund Management LLC (“Equinox”), allegedly overcharged management fees to its investors and overvalued certain assets.

Equinox is registered as an investment adviser with the SEC and thus owes its investors certain fiduciary duties, one of which is to act in the best interests of its investors by being accurate and complete with its registration statements and SEC filings. Equinox, however, allegedly failed to meet those duties by misrepresenting in their TFF registration statements that management fees were based on the net asset value of the assets, when in reality they were based on the notional trading value of the assets. The notional trading value takes into account both the amount invested and the amount of leverage used in the underlying investments, and is significantly higher than net asset value.

Common Mistakes to Avoid in Form ADV Annual Updates

January 22, 2016 | Patricia Klusmeyer

Filing annual updating amendments to Form ADV is an important requirement for all registered investment advisers. All information contained in Parts 1 and 2 of Form ADV must be both accurate and complete. Unfortunately, this is not always the case, and the Securities Exchange Commission (“SEC”) and state regulators have not hesitated in bringing enforcement actions against investment advisers who misrepresent or fail to disclose certain information in their annual filings and amendments.

Based on 1170 routine state-coordinated investment adviser examinations in 2015, as reported by the North American Securities Administrators Association (“NASAA”), the most common errors that are routinely found on Form ADVs include inconsistencies between Form ADV Part 1 and Part 2, inconsistencies between fees charged and fees listed on the ADV, inconsistencies between services provided and services described in ADV, misrepresentations in business description, overstatements or understatements of assets under management, and failure to disclose conflicts of interest.

SEC Clarifies RIA Performance Advertising Obligations: The Virtus & Alpha Fiduciary Matters

January 19, 2016 | Patricia Klusmeyer

Last week we discussed the Lucia matter and the parameters it added for investment advisers to consider prior to utilizing performance advertisements. Today we will discuss two more administrative proceedings involving performance advertisements and the practical implications which can be taken from these cases.

The matter of Virtus Investment Advisers revolved around one of Virtus’ sub-advisers, F-Squared Investments. F-Squared was an investment adviser that had previously been fined by the SEC for allegedly advertising false inflated performance numbers of its most successful investment strategy, AlphaSector. AlphaSector consisted of an algorithm-based sector rotation strategy which traded nine industry exchange-traded funds from the S&P 500 Index. Virtus’ assets under management which utilized this strategy grew from $191 million at the end of 2009 to 11.5 billion by 2013. Unfortunately, F-Squared allegedly falsely stated that the AlphaSector strategy had a history dating back to 2001 and that it had historically outperformed the S&P 500 Index from 2001 to 2008. The SEC found that no assets had tracked the strategy from 2001 to 2008 and its back-tested performance data was miscalculated and substantially overstated results.

SEC Clarifies RIA Performance Advertising Obligations: The Lucia Matter

January 12, 2016 | Patricia Klusmeyer

Pursuant to Section 206 of the Investment Advisers Act of 1940 (“Advisers Act”) and Rule 206(4)-1, it is considered fraud for a registered investment adviser to publish, circulate, or distribute any advertisement which contains any untrue statement of material fact or which is false or misleading. One type of advertising that has been the focus of recent regulatory activity is performance advertising.

Performance advertisements are generally used by investment advisers to portray their past performance results to prospective clients. In order to be avoid misleading the prospective client, all material facts regarding the performance data and how it was calculated must be disclosed. This includes disclosing any material market conditions, the amount of advisory fees or other expenses that were deducted, whether results portrayed include reinvested dividends and other earnings, the investment strategies which were used to obtain the results, and any other material fact which may have impacted the results in any way.
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SEC Targets NY-Based RIA for Failure to Disclose Conflicts of Interest

January 6, 2016 | Patricia Klusmeyer

Investment advisers continue to get into regulatory trouble when it comes to failing to disclose conflicts of interest and related party transactions as required by both federal and state investment adviser law. Recently, the Securities and Exchange Commission (SEC) initiated proceedings against Fenway Partners, a New York-based registered investment adviser which served as adviser to three private equity funds. The conflicts arose around two related entities: Fenway Partners Capital Fund III, L.P., an affiliated fund, and Fenway Consulting Partners, an affiliate largely owned by the executives and owners of Fenway Partners.

Fenway Partners and Fenway Consulting Partners were both owned and managed in large part by respondents Peter Lamm, William Smart, Timothy Mayhew, and Walter Wiacek. The fund in question, Fund III, was operated by an Advisory Board consisting of independent limited partner representatives, pursuant to its organizational documents. According to the SEC allegations, the respondents failed to disclose several conflicts of interest and related party transactions to both the Advisory Board of Fund III and their fund investors.
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Texas Securities Board Approves Advisory Payments to Retiring Advisers

December 28, 2015 | Steve Parker

In a letter dated December 11, 2015, the Texas State Securities Board (“Board”) granted a no-action request by Managed Financial Service Corporation, Inc. (“MFSC”) that paves the way for a retiring investment adviser representative to receive continuing compensation after retirement. The Board confirmed that it would not commence or seek enforcement proceedings against either MFSC or a specified retiring investment adviser representative if certain procedures were followed. MFSC and its retiring representative requested the no-action letter in order to implement a plan under which the retiring representative would continue to receive compensation derived from the residual value of the work as an investment adviser for certain accounts.

The no-action was requested based on a concern, predominant in the investment adviser industry, that receipt by a retired adviser representative of ongoing advisory fees or a portion of advisory fees received by a successor adviser or firm would subject the retired representative to discipline for conducting business without registration.

The no-action relief granted by the Board is similar to the practice in the brokerage industry that has been codified in FINRA Rule 2040 (b) in which, prior to that date, was sanctioned by a FINRA no-action letter issued to Merrill Lynch in March 2012.
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FinCEN Proposes AML Requirements for RIAs

December 22, 2015 | Steve Parker

Although there is currently no requirement that registered investment advisers maintain anti-money laundering programs pursuant to the USA PATRIOT Act, the Bank Secrecy Act (“BSA”) or any of the other acts that apply to certain financial institutions, that may change if the Treasury Department’s Financial Crimes and Enforcement Network (“FinCEN”) adopts a rule proposed earlier this year. Specifically, the proposed rule would subject investment advisers registered with the Securities and Exchange Commission (“SEC”) to formal AML compliance program adoption and reporting requirements. The rule, if adopted, would expand the current definitions of “financial institutions” to cover SEC-registered advisers. The rule would require compliance with the Bank Secrecy Act (“BSA”) and the USA PATRIOT Act, resulting in an adviser being required to establish AML compliance programs, file suspicious activity reports, and keep records relating to AML activity, among other things.

Currently, most registered investment advisers do adopt policies relating to AML and suspicious activity reporting procedures, even though they are not so required by law or regulation. In a sense, it has become a “best practice” to do so. Practically speaking, because all investment advisers conduct activity on behalf of their clients through qualified custodians, broker-dealers, and other financial intermediaries that are expressly covered by the PATRIOT Act, the BSA and other laws, AML, the intermediaries who partner with investment advisers usually require such advisers to have AML and suspicious activity reporting programs or procedures in place as a means of aiding the broker or other primarily responsible firm fulfilling its obligations.
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NASAA adopts model rule concerning business continuity and disaster planning for Investment Advisers

November 24, 2015 | Bryan Gort

On April 13, 2015, the North American Securities Administrators Association (“NASAA”) adopted a model rule concerning business continuity and succession planning for investment advisers. The model rule is intended as guidance for state-registered investment advisers to determine how to develop succession planning policies and procedures. Investment advisers without business continuity and succession plans face serious risks if the adviser is temporarily or permanently unable to service its clients. Included with the model rule are scenarios to help illustrate when business continuity plans are important for an investment advisory firm and many questions to help determine how to craft the plan properly.

Many different types of disasters can strike an investment advisers’ business. From naturally occurring disasters such as hurricanes and snow storms to unnatural disasters like terrorist attacks or a sudden death, it is important to have thought about and created a succession plan to ensure that your clients’ interests are not harmed. A business continuity and succession plan allows the adviser to safeguard critical business functions so that your firm can continue as long as needed when a disaster strikes.
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Investment Adviser Charged with Misleading SEC Regarding Examination

November 12, 2015 | Steve Parker

In August of this year the Securities and Exchange Commission (“SEC”) settled an administrative proceeding that related to statements an investment adviser made during the SEC’s on-site examination. The adviser at issue, Parallax Capital Partners, LLC, is a registered investment adviser that focuses primarily on mortgage-backed bonds and other similar fixed income securities. Parallax also advises a private fund in addition to providing advisory services to individuals and other entities. During an examination of Parallax that the SEC conducted in April 2011, the firm’s Chief Compliance Officer represented to the examination staff that he had performed and documented the annual compliance review required by Adviser’s Act Rule 206(4)-7 for the year 2010. The CCO further represented that the review and documentation had been conducted in February 2011, and provided the examination staff with a memorandum purportedly documenting the compliance review for 2010 that stated: “This memo documents that I have performed the review and reported significant compliance events and material compliance matters.”

The SEC examination staff was able to determine, by a review of the metadata attached to the compliance memorandum, that it had not been drafted in February 2011 as the CCO had represented, but instead that it had been created and completed in April 2011, just three days prior to the onsite examination and after Parallax received notice of the impending examination.
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SEC Announces Cybersecurity Enforcement Action Against RIA

October 27, 2015 | Alison Burns

On September 22, the Securities and Exchange Commission (“SEC”) announced an important cybersecurity enforcement action that has broad implications to registered investment advisers. In a Settlement Order, the SEC found R.T. Jones Capital Equities Management, a St. Louis-based investment adviser, “willfully violated” the Safeguards Rule. From September 2009 through July 2013, the firm stored unencrypted, sensitive personally identifiable information (“PII”) of clients and others on its unencrypted, third party-hosted, web server.

In requiring that brokers-dealers, investment companies, and registered investment advisers guard against cybersecurity breaches, the SEC has relied on its authority under Sections 501, 504, and 505 of the Gramm-Leach-Bliley Act of 1999, to create the new regulations. The “Safeguard Rule” is Rule 30(a) of Regulation S-P (17 C.F.R. § 248.30(a)). Enforcement actions initiated by the SEC relating to computer security are often grounded in violations of the Safeguard Rule.
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