Chief Compliance Officers (“CCOs”) should take note of the SEC’s aggressive enforcement posture. Compliance officers and Registered Investment Advisers (“RIAs”) may find themselves in the agency’s crosshairs if they fail to fulfill their obligations or engage in misconduct.
Andrew Ceresney has warned that the SEC will continue to bring actions against legal and compliance officers in appropriate situations. According to Ceresney, Director of the Division of Enforcement, these actions would typically be commenced when the:
- Division believes legal or compliance officers have affirmatively participated in the misconduct;
- Legal or compliance officers were involved in misleading securities regulators; or
- Officers who are responsible for implementing compliance programs, procedures, or policies failed completely to fulfill their responsibilities.
Ceresney observed that the SEC’s Compliance Program Initiative identified and brought actions against RIAs that failed to adopt or implement compliance programs after receiving repeated notifications of deficiencies by examination staff.
Action Taken Against Compliance Officer for Altering Records
Lying to examiners or altering documents will almost always lead to an enforcement action. On October 15, 2014, the SEC announced an enforcement action brought against a compliance officer for a dually registered broker-dealer/investment adviser. The compliance officer allegedly altered a document that was turned over to the SEC during an examination. The enforcement proceeding alleged that the compliance officer willfully aided and abetted and caused the firm to violate Rule 204(a) under the Investment Advisers Act of 1940, as well as Section 17(a) of the Securities Exchange Act of 1934 and Rule 17a-4(j). The SEC’s order instituting the administrative proceeding can be found at http://www.sec.gov/litigation/admin/2014/34-73350.pdf.
The SEC alleged that the compliance officer was responsible for identifying suspicious trading activity by the firm’s personnel or its clients. She was then required to analyze whether the trades benefitted from material nonpublic information. In 2010, the compliance officer summarized the results of her review of a registered representative’s trading. Her review was closed with no findings of misconduct by the representative. Over two years later, the compliance officer learned that the SEC was investigating the representative for insider trading. The SEC’s enforcement action claimed that the compliance officer altered the document to give the impression that she had performed a more thorough review than was actually the case. The SEC enforcement team discovered the alteration of the summary and questioned the compliance officer regarding the document. At first, the compliance officer unequivocally denied altering the document. The compliance officer subsequently admitted to the alteration after being confronted with additional documents and metadata produced by the firm to the SEC.
CCO Responsibility for False Advertising and Other Compliance Failures
While altering documents will clearly expose a CCO to liability, misleading clients and prospects might also lead to enforcement proceedings. The SEC recently settled an action against an RIA and its CCO because of their compliance failures. The CCO was Chief Executive Officer of the firm, as well as a 50 percent owner. Along with other sanctions, the CCO was ordered to pay a civil money penalty of $50,000. The enforcement action can be found at http://www.sec.gov/litigation/admin/2014/ia-3924.pdf.
In addition to other compliance violations, the SEC alleged that the firm’s advertisements materially overstated investment performance, because the RIA failed to disclose that the advertised returns did not reflect the impact of advisory fees. The SEC claimed that the advertisement violated Section 206(4) of the Investment Advisers Act and the advertising rule, which is found in Rule 206(4)-1.
Aside from false advertising, the RIA engaged in hundreds of securities transactions with advisory clients on a principal basis through its affiliated broker-dealer without providing written disclosure to, or obtaining consent from, the clients. Furthermore, the RIA stated in its Forms ADV that neither the firm nor any related person engaged in principal transactions. The RIA also failed to seek best execution of clients’ trades.
The SEC took note that the CCO possessed the overall responsibility and authority to develop and implement the RIA’s policies and procedures. Moreover, the CCO was required to conduct an annual review of those policies and procedures to ensure that they were thorough and effective. The RIA’s compliance manual also contained detailed policies and procedures for approving advertisements. Because the CCO failed to implement those policies and procedures, he caused the RIA’s compliance failures and was held accountable.
The lesson to be learned from these enforcement actions is that CCOs will not be insulated from liability by merely having copious policies and procedures. Policies and procedures must be reasonably designed to prevent violations of the SEC’s rules, and firms must enforce them vigorously.
It is not enough for an RIA’s policies and procedures to parrot the Commission’s rules without tailoring them to the firm’s activities. As Norm Champ, the SEC’s former Director of the Division of Investment Management, said in his remarks to the 2014 IAA Investment Adviser Compliance Conference on March 7, 2014, “It is crucial that policies and procedures be reviewed and updated as your business changes, as regulations change, as new guidance is issued.” According to Champ, “Compliance policies and procedures should evolve and grow with your business.”
When policies and procedures are inadequate or disregarded, compliance mistakes are likely to occur. Egregious compliance lapses can lead to sanctions of a CCO who is responsible for the RIA’s policies and procedures.
As the person in charge of a RIA’s compliance program, a CCO might face serious consequences if examiners uncover deficiencies. To avoid being the target of an enforcement action, RIAs and CCOs should fully understand their compliance obligations.
Les Abromovitz is a senior consultant with National Compliance Services (NCS), and the author of two books on compliance for investment advisers, including The Investment Advisor’s Compliance Guide, published in 2012 by the National Underwriter Company. Les can be reached at NCS (www.ncsonline.com) by calling (561)330-7645 (ext. 213) or by e-mailing [email protected]