Recently, the U.S. Securities and Exchange Commission (the “SEC”) charged a dually registered firm and its Chief Compliance Officer (“CCO”) with multiple violations of the Investment Advisers Act of 1940 (“Advisers Act”). The charges included allegations against the CCO that she altered documents in an attempt to mislead SEC examination staff and failures to comply with enhanced policies and procedures adopted as a result of a prior examination by FINRA. The SEC charged the firm with willfully violating Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which require, in part, that registered investment advisors “[a]dopt and implement written policies and procedures reasonably designed to prevent violation” of the Advisers Act and its rules. The CCO was charged with willfully aiding and abetting the firm’s violations. The firm and the CCO were fined $1.7 million and $45,000, respectively, and the CCO was barred from the industry.
Four years prior during its examination, FINRA found the firm failed to actively monitor its cost-to-equity ratios and turnover rates in its clients’ accounts. In response, the firm amended its policies and procedures to require that the CCO or her team review the cost-to-equity ratio and turnover reports on a monthly basis, document these reviews, and escalate all client accounts with a cost-to-equity ratio above 6%. Despite the firm’s amended policies, the SEC stated that the respondents did not implement them by conducting any monthly reviews of cost-to-equity ratios of its client accounts in 2017. According to the SEC’s order, these reviews were “especially important” because the firm charged commissions instead of an asset-based percentage management fee for over 4,500 nonretirement advisory accounts. Because the respondents did not review the cost-to-equity ratios in 2017, the SEC stated that the CCO did not escalate any client accounts with cost-to-equity ratios above 6%, as required by firm policy.
While it is somewhat unusual for CCOs to face regulatory liability, the order noted that the CCO attempted to cover up her failures by providing altered reports to the SEC’s examination and enforcement staffs. Specifically, the order noted that the CCO had altered the firm’s cost-to-equity and turnover reports by “manually whit[ing] out the printed ‘as of’ date at the bottom of each of the[ ] turnover reports, covering up that they had been printed in December 2017.” The CCO also made handwritten notations on the report to give the appearance she reviewed them earlier in the year. The SEC stated this effort was to give “the misleading appearance that she had contemporaneously reviewed them.” According to the order, the CCO did admit under oath that she altered the reports. While SEC cases charging CCOs individually are rare, the facts of this case align with the guidance provided by a prior director of the Division of Enforcement regarding when CCOs will be investigated and charged. Short of the unique and egregious conduct here, CCOs do find themselves periodically confronted with red flags regarding potential violations of the federal securities laws and/or firm policies and procedures. For guidance on how to reasonably manage those difficult situations, please refer to this article. Another important takeaway from this SEC enforcement action is that firms need to take examination findings by FINRA and the SEC examination staff seriously and follow through on efforts related to responses to examination findings.