The SEC issued an order instituting administrative and cease-and-desist proceedings against a registered investment adviser (the “Adviser”) and its sole owner, who also served as its president, chief executive officer and chief compliance officer (the “Owner” and collectively with the Adviser, the “Respondents”) for failing to properly disclose in Form ADV that the Adviser received fees for promoting a third-party investment manager (the “Investment Manager”) and misrepresenting the Adviser as “independent” in promotional materials and on the firm’s website. This article summarizes the SEC’s allegations, which have not been proven.
Form ADV Disclosures. The Adviser provided institutional investors with fee-based investment advisory services, which included recommending investment managers, and claimed to provide “independent” investment advice. Form ADV updates filed with the SEC and made available to clients in 2009 and 2010 included representations about the Respondents’ independence. Specifically, the Adviser’s response to Item 8.B.3 of Form ADV Part I, which required a registered adviser to disclose whether it has any sales interests in the securities it recommends, stated that the Adviser did not have any such sales interests. Also, the Adviser’s response to Item 13 of Form ADV Part 2, which required a registered adviser to disclose whether it receives an economic benefit from a non-client in connection with giving advice to clients, stated that the Adviser received no such economic benefit. Schedule F of the Adviser’s Form ADV Part 2 also represented that the Adviser would “disclose to clients … all matters that reasonably could be expected to impair [the Adviser’s] ability to make unbiased and objective recommendations” and specifically stated that the Adviser did “not accept any fees from investment managers or mutual funds.”
Website and Promotional Materials. The Adviser represented in its promotional materials and on its letterhead that it was an independent investment adviser. Articles on the Adviser’s website touted the benefits of independent investment advice, stating that “[t]he best investment advisors are independent – without affiliations to … money managers” and that clients “need a strategy they can trust, because investments … should be based on merit, not … undisclosed compensation.”
Payments from Investment Manager. The SEC alleges that the Adviser received payments in 2010 from the Investment Manager for recommending to the Adviser’s clients that they transfer their accounts to, invest/continue to invest with and make additional investments with the Investment Manager. The first payments related to recommendations by the Adviser that clients move their accounts from an advisory organization that the owner of the Investment Manager left to found the Investment Manager. In the aggregate payments to the Adviser by the Investment Manager for referrals represented approximately 25% of the Adviser’s total revenue in 2010. The Respondents’ clients invested over $80 million with the Investment Manager, including investments in funds managed by the Investment Manager. Their assets represented approximately 90% of the Investment Manager’s total assets under management. The Adviser did not to disclose to its clients the services rendered to, or fees paid by, the Investment Manager. In addition, the Adviser failed to update the disclosures in the relevant portions of its 2009 Form ADV filings (as discussed above) when those disclosures became materially inaccurate and subsequently made disclosures in 2010 filings that were materially false when filed. (In January 2011, the SEC filed an emergency civil injunctive action against the Investment Manager regarding alleged misappropriation of client assets by the Investment Manager’s owner and subsequently obtained orders appointing a receiver for the Investment Manager’s assets and barring the Investment Manager’s owner from association with various types of SEC-registered securities industry participants.)
Alleged Violations. The SEC alleges that based on the conduct described above, Respondents willfully violated Sections 206(1) and 206(2) of the Advisers Act by employing devices, schemes or artifices to defraud clients or engaging in transactions, practices or courses of business that defrauded clients or prospective clients. The SEC further alleges that the Respondents willfully violated Section 207 of the Advisers Act by making untrue statements of a material fact in registration applications or reports Respondents filed with the SEC and willfully omitting to state in such applications or reports material facts which were required to be stated therein. The SEC also alleges that the Owner willfully aided and abetted and caused the Adviser’s violations of, Section 204 of the Advisers Act and Rule 204-1(a)(2) thereunder by failing to update registration applications or reports the Respondents filed with the SEC when the information contained therein became materially inaccurate.