Written by: Jay B. Gould
On October 23, 2013, the Securities and Exchange Commission (“SEC”) brought charges against three different investment advisory firms for recidivist behavior. The enforcement actions came out of the SEC’s Compliance Program Initiative, which targets firms that have been previously warned by SEC examiners about compliance deficiencies, but failed to effectively act upon those warnings. The enforcement actions came out of the SEC’s Compliance Program Initiative, which targets firms that have been previously warned by SEC examiners about compliance deficiencies but failed to effectively act upon those warnings. The SEC takes the view that investment advisory firms that ignore findings in deficiency letters, or represent that corrective action will or has been taken, and then do not take such corrective action, should be provided special treatment. The SEC Enforcement Division’s Asset Management Unit has coordinated with examiners to bring several cases since the initiative began two years ago.
The firms charged, Modern Portfolio Management Inc., Equitas Capital Advisers LLC, and Equitas Partners LLC, agreed to settlements in which they will pay financial penalties and hire compliance consultants. Since the adoption of Rule 206(4)-7 under the Investment Advisers Act (“Compliance Rule”), requiring an investment adviser to hire an outside compliance consultant has been a preferred remedy imposed by the SEC. .
The SEC’s order against Modern Portfolio Management (“MPM”) and its owners found that they failed to correct ongoing compliance violations, such as failing to complete annual compliance reviews in 2006 and 2009, and making misleading statements on their website and investor brochure. According to the SEC findings, one location on MPM’s website represented that the firm had more than $600 million in assets. However, on its Form ADV filing to the SEC during that same time period, MPM reported that the firm’s assets under management were $359 million or less. Asset inflation, as well as education and professional experience “enhancement” are two favorites among Advisers Act violators, and fairly easy to verify by SEC examiners.
MPM and their owners agreed to be censured and pay a total of $175,000 in penalties. The two principals of MPM were required to complete 30 hours of compliance training, a remedy seemingly very close to violating the 8th Amendment. MPM also agreed to designate someone other than the two principals to be its chief compliance officer, and is also required to retain a compliance consultant for three years.
According to the SEC’s orders against New Orleans-based Equitas Capital Advisers and Equitas Partners as well as their owner, current chief compliance officer, and former owner and chief compliance officer, they failed to adopt and implement written compliance policies and procedures and conduct annual compliance reviews to satisfy the Compliance Rule. The SEC charged the Equitas firms with making false and misleading disclosures about historical performance, compensation, and conflicts of interest, and repeatedly overbilled and underbilled their clients. Many of these violations occurred despite warnings by SEC examiners during examinations of the Equitas firms in 2005, 2008, and 2011. Equitas and the named individuals failed to disclose these deficiencies to potential clients in response to questions in certain due diligence questionnaires or requests for proposals.
The former owner of Equitas, who later went on to form Crescent Capital Consulting, an investment advisory firm, was also found to have been responsible for Compliance Rule violations at his new firm (as well as at Equitas) by inflating the amounts of assets under management of both firms their respective Forms ADV by improperly removing and retaining nonpublic personal client information when he left Equitas.
Equitas Capital Advisers and Crescent reimbursed all overcharged clients, and agreed to pay a total of $225,000 in additional penalties, but presumable did not go back after the clients that they undercharged. The Equitas firms agreed to censures, and both the Equitas firms and Crescent were required to hire an independent compliance consultant. Perhaps the most damaging sanction was that the Equitas firms and Crescent are required to provide notice to clients regarding the SEC enforcement actions.