SEC Sanctions Registered Investment Adviser for Compliance Failures and Disclosure-Related Violations

July 9, 2015

On June 23, 2015, the SEC sanctioned a registered investment adviser (the “Adviser”) and its control persons for various compliance failures, most notably failure to conduct annual compliance program reviews. The SEC also sanctioned the Adviser for disclosure-related violations in connection with the Adviser’s practice of investing certain of its separately managed account clients in a higher expense share class of a mutual fund managed by the Adviser even though such clients were eligible for a lower expense share class.

This SEC administrative proceeding and settlement highlight the importance of an adviser dedicating sufficient resources to its compliance program, particularly when its chief compliance officer (“CCO”) has other roles in addition to compliance, and disclosing conflicts of interest between an adviser and its clients, particularly when the conflict involves the adviser using its discretionary authority to benefit itself.

I.  Compliance Program Failures

Despite repeated requests for compliance support from the CCO during the period from 2007 to 2011, the Adviser and its control persons prioritized investment research over compliance and minimized compliance spending. As a result, the CCO, who performed multiple functions for the Adviser, was unable to timely complete annual reviews for 2009 and 2010 or perform other routine compliance functions such as reviewing pre-clearance and other reports submitted by advisory personnel under the code of ethics.

The extent of the Adviser’s compliance deficiencies was identified by SEC staff during a routine examination of the Adviser in 2011. The staff identified the following deficiencies, among others:

  • The Adviser lacked documentation supporting pre-clearance of employees’ trades;
  • The Adviser failed to receive all required documentation of all employee trading and personal account statements;
  • The Adviser failed to maintain documentation of the Adviser’s best execution reviews; and
  • The Adviser failed to conduct regular reviews of its code of ethics and to conduct annual compliance meetings for its personnel.

The foregoing failures lead the SEC to sanction the Adviser for violating various requirements under the Advisers Act, including Rule 204A-1 (for failing to establish, maintain, and enforce a written code of ethics), Rule 206(4)-7 (for failing to adopt and implement written compliance policies and procedures and to conduct an annual review of those policies), and Section 207 (for various disclosure failures arising from these compliance and code deficiencies).

II.  Conflicts and Related Disclosure Violations

The Adviser served as investment adviser to a proprietary mutual fund and, using its discretionary authority, invested certain of its separately managed account clients in shares of the fund. When the fund established a second, lower expense share class, the Adviser determined to transfer some, but not all of its managed account clients to the new lower expense share class. The Adviser directly benefited from the differences in share classes, as it received the shareholder servicing fees that distinguished the classes.

During the SEC staff’s routine examination of it, the Adviser self-reported this conflict of interest and the lack of disclosure relating to it the SEC staff. The SEC sanctioned the Adviser for violating various requirements under the Advisers Act, including Sections 206(2) and 207 (for failing to adequately disclose to its clients the conflicts of interest relating to this practice of investing client assets in the higher expense share class (which directly benefited the Adviser) despite such clients’ eligibility for the lower expense share class of the fund). The sanctions also included the failure to adequately disclose that the Adviser was not seeking best execution with respect to client investments in the mutual fund.


If you have any questions regarding the matters covered in this memo, please contact any of the partners and counsel listed below or your primary attorney in Seward & Kissel’s Investment Management Group.