September 20, 2021
The SEC has recently started cracking down on investment advisers improperly recommending complex financial products.
In a recent case, the SEC found that the adviser had not adopted and implemented any written policies and procedures to prevent these types of recommendations from being made to clients where such an investment would be inappropriate.
The adviser recommended retail clients invest in a feeder fund which provided access to another fund (Fund X). Fund X used complex option strategies and synthetic futures positions to produce returns. This combination carried significant risks with high volatility.
The SEC found that without the proper policies and procedures in place, the adviser failed to reasonably consider whether the feeder fund was suitable for each client that had invested. The SEC found that the adviser not only made unsuitable investment recommendations but also provided misstatements to clients regarding investments in complex financial products by misrepresenting the fund’s risks. The adviser also made misleading statements about the fees clients would pay as investors in the fund.
In 2018, Fund X lost about 35% of its value, resulting in about $16 million in losses to the clients invested in the feeder fund.
Ultimately, the SEC found that the adviser violated the Investment Adviser’s Act of 1940 by failing to supervise its Investment Adviser Representatives (IARs). The adviser neither admitted nor denied the allegations and ultimately paid over $200,000 in fines in addition to the prejudgment interest and a $350,000 civil penalty.
WHAT DOES THIS MEAN FOR ME?
All SEC investment advisers have a fiduciary obligation. They must place their clients’ interest ahead of their own. Since there are no standard polices and procedures provided by the SEC, it is up to the investment firm to make sure they follow and document all the applicable SEC rules.
In this case, these firms could have avoided the charges if they had properly adopted and implemented policies and procedures. Instead of misrepresenting the risks and fees, they should have included disclosures. And they should have also followed the rules by providing documentation of suitability.
If your firm requires assistance with understanding and implementing SEC regulations, Fairview can help. We support registered investment advisers by creating and implementing comprehensive, sustainable compliance programs with the help of our in-house regulatory experts. Contact us today for more information about our services.