The SEC issued an order instituting administrative and cease-and-desist proceedings against a registered investment adviser (the “Adviser”) and its founder and majority owner, who also served as its chief executive officer and chief compliance officer (the “Owner” and, collectively with the Adviser, the “Respondents”) for misrepresenting in Form ADV the Adviser’s assets under management and for failing to disclose the Adviser’s poor financial condition to clients. This article summarizes the SEC’s principal allegations, which have not been proven.
Assets Under Management. The Adviser registered with the SEC on June 11, 2008 in reliance on Rule 203A-2(d) under the Investment Advisers Act of 1940 (the “Advisers Act”) pursuant to which the Adviser represented that it expected to have $25 million in assets under management within 120 days of registering. In Form ADV, and amendments thereto, filed with the SEC and made available to clients in June 2008 to May 2010, the Adviser represented that it had assets under management ranging from $30 million to approximately $125 million. The Respondents further represented to the SEC staff during an examination of the Adviser in 2009 that the Adviser had $98 million in assets under management. In an October 1, 2010 letter to the SEC staff, the Adviser acknowledged that it failed “to satisfy the $25 million threshold set forth in Section 203A of the Advisers Act.” The SEC alleges that the Owner knowingly inflated the Adviser’s assets under management by, among other things, including estimated values of prospective clients’ assets in various calculations of the Adviser’s assets under management.
Financial Condition. The SEC further alleges that the Adviser did not disclose its “poor” financial condition to its clients – despite a net loss of $436,277 in fiscal year 2009 and an inability to pay the salaries and consultant fees of some staff members that resulted in several employees leaving the Adviser in 2010, according to the order.
Alleged Violations. The SEC alleges that, based on the conduct described above, the Adviser willfully violated, and the Owner willfully aided and abetted the violation of, the following Sections, and relevant rules, of the Advisers Act:
Section 203A: The SEC alleges that, but for the Adviser’s inflated assets under management, it would have been prohibited from registering with the SEC as an investment adviser for failing to meet the relevant $25 million threshold.
Section 204 and Rule 204-2(a)(8): The SEC alleges that the Respondents failed to “make and keep, true, accurate and current” books and records relating to its advisory business.
Section 206(4) and Rule 206(4)-4(a)(1): The SEC further alleges that the Respondents failed to properly disclose all material facts regarding the Adviser’s financial condition that are reasonably likely to impair its ability to meet contractual commitments to clients. The order notes that Rule 206(4)-4(a)(1) applied during the period of the alleged violations, but was repealed effective October 12, 2010 in favor of comparable requirements now included in Items 9 and 18 of Form ADV Part 2A (also known as the “brochure”). (The SEC release adopting the foregoing disclosure requirements and rescinding Rule 206(4)-4 cautioned “advisers that their fiduciary duty of full and fair disclosure may require them to continue to disclose any precarious financial condition promptly to all clients, even clients to whom they may not be required to deliver a brochure or amended brochure.”)
Section 207: The SEC further alleges that the Respondents made untrue statements of material facts in registration applications or reports Respondents filed with the SEC and willfully omitted to state in such applications or reports material facts which were required to be stated therein.