Recently, a dually registered investment adviser and broker-dealer, and its former Chief Compliance Officer, were charged and fined by the U.S. Securities and Exchange Commission for violating the Investment Advisers Act of 1940.
The violations began when, during a 2016 examination of the firm by the Financial Industry Regulatory Authority (FINRA), the firm was found to be improperly monitoring cost-to-equity ratios and turnover rates for clients. The lack of review happened, in part, because the firm’s policies and procedures did not require periodic review of these metrics.
In response to FINRA’s findings, the firm revised its policies and procedures to require its CCO to conduct and document a monthly review of client accounts in a turnover report and then to notify the firm’s managing members of any client accounts with high cost-to-equity ratios.
Despite the changes to policies and procedures, the CCO did not assess cost-to-equity ratios or turnover rates of any client accounts. As a result, the FINRA-mandated monthly turnover reports did not contain the required turnover information; and because cost-to-equity ratios were not reviewed, client accounts with high ratios were never referred to the firm’s managing members.
In late 2017, the SEC initiated an exam of the firm where they requested the turnover reports. Because the reports were not properly conducted, the CCO falsified key information and then whited-out the date the reports were printed and hand-notated the documents as if they were produced earlier in the year.
The SEC uncovered the wrongdoing when examiners noticed other reports from the firm included the date they were actually printed, whereas the turnover reports provided by the CCO did not.
The firm was charged with violating provisions of the Advisers Act which require policies and procedures to be adopted and implemented to prevent rule violations. The CCO was charged with aiding and abetting the firm in its violation.
As a result of the CCO’s actions, the firm was ordered to pay a penalty of $1.7 million and the CCO was ordered to personally pay a penalty of $45,000 to the SEC.
WHAT DOES THIS MEAN FOR ME?
The enforcement action against the CCO and the firm, as well as possible damage to clients, could have been prevented with comprehensive policies and procedures regarding review of cost-to-equity ratios and turnover rates. Following FINRA’s findings, the damage could have been further prevented had the CCO followed through with the agency’s directives, including adhering to the updated procedures, and not falsified the firm’s documentation.
If your firm needs more thorough policies and procedures or suspects there are gaps in its documentation and recordkeeping, Fairview can help make your compliance program whole. Our in-house experts have assisted over 150 Chief Compliance Officers with on-going, meaningful back-office support services. Contact Fairview today for more information about what we can do for your compliance program.