RIA Compliance Blog
Highlighting the importance of investment advisers’ proper calculation of assets under management (“AUM”), the SEC recently charged six investment advisers with misrepresenting their AUM.
The six connected firms, Bluesky Eagle Capital Management Ltd., Supreme Power Capital Management Ltd., AI Financial Education Foundation Ltd., AI Investment Education Foundation Ltd., Invesco Alpha Inc., and Adamant Stone Limited, were allegedly deficient in several areas, including claiming incorrect business addresses and falsely claiming to be public companies. AUM reporting, however, was the primary offense, as the cause of action was “making material misrepresentations in their SEC-filed Forms ADV that could not be substantiated.” While the advisers were allegedly engaged in several blatant forms of violative conduct, the SEC’s focus on their AUM misrepresentations underscores the importance of advisers’ proper calculation of AUM.
In order to properly calculate assets under management, advisers must understand AUM’s definition. AUM is defined as, “securities portfolios for which the adviser provides continuous and regular supervisory or management services.” The SEC’s instructions for Form ADV define “securities portfolios” as accounts consisting of at least 50% securities. Beyond stocks, bonds, and derivatives, the Instructions define securities to include any cash or cash equivalents. This broad definition of “security” means most advisory accounts will be “securities portfolios,” as long as the adviser provides “continuous and regular supervisory or management services” with respect to that account.
The Instructions state that regular supervisory or management services are provided if:
(1) the advisor has discretionary authority over and provides ongoing supervisory or management services with respect to the account; or
(2) the advisor does not have discretionary authority over the account, but has ongoing responsibility to make recommendations, based on the needs of the client, as to specific securities or other investments the account may purchase or sell and, if such recommendations are accepted by the client, the adviser is responsible for arranging or effecting the purchase or sale.
Essentially, this means that continuous and regular supervisory or management services are provided in a non-discretionary account if an adviser is continuously recommending and making recommended trades for the account.
Where application of the definition of AUM is not clear, the SEC looks to factors such as (1) advisory contract language, (2) compensation, and (3) management arrangement. The SEC is more likely to find continuous and regular supervisory or management services provided where the contract explicitly describes the services as such, where compensation is continuous (such as by charging a monthly percentage of AUM) and where the adviser is frequently monitoring the account and communicating with its holder. Inversely, the SEC is less likely to find continuous and regular supervisory or management services provided where the contract’s language does not describe its services as such, where compensation is less continuous, such as hourly fees, and where the adviser does not regularly monitor the account and only infrequently communicates with the account holder.
The SEC gives several examples of advisory relationships that don’t constitute continuous and regular supervisory management (and thus should not be counted towards AUM), such as (1) advisers who make initial recommendations without ongoing monitoring or trading, (2) making recommendations without further managing responsibility, (3) providing broad, mass-marketed advice without tailoring it to specific clients, (4) only providing advice on an irregular basis, such as in response to client request, and (5) quarterly or annual meetings to adjust allocations. These examples emphasize the importance of continuous and regular supervisory management.
While different advisers may wish for a larger AUM to present credibility to potential clients, or a smaller AUM to avoid registration requirements, the SEC continues to emphasize the importance of accurate and substantiated AUM calculations. Where advisers wish to report client funds that do not constitute AUM, they may report assets under advisement in their Form ADV Part 2A Brochure and in their marketing material.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.