Failure to Address Exam Deficiencies Leads to Compliance Program Rule Charges
Self-destructive act (definition): An action that harms oneself, i.e., an advisory firm that fails to correct compliance violations found during an SEC examination.
One cannot know for sure why a firm would choose not to act on multiple recurring deficiencies found by the SECís Office of Compliance Inspections and Examinations, but one can be fairly certain of the result: a likely SEC action resulting in a civil money penalty and other actions. The firm will still have to correct the original problems, but now will have publicity, be on the SECís watch list, and be out a significant sum of money, as well.
Thatís apparently what happened on January 21 to New York-based du Pasquier & Co., an adviser with 118 advisory accounts and $48 million in assets under management. The firm had to pay a $50,000 civil money penalty when it settled with the SEC after an investigation found there were numerous instances, from at least 2007 forward, where the firm allegedly "failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and rules thereunder," including allegedly:
Relying on an off-the-shelf template for a compliance manual without modifying certain sections of the template to take into consideration the nature of the firmís advisory business;
Failure to implement procedures it did adopt, such as not conducting adequate best execution reviews and not adequately reviewing the firmís marketing materials;
Failure to annually review the adequacy of its compliance policies and procedures, as well as the effectiveness of their implementation;
Conducting inadequate reviews of access personsí securities transactions;
Failure to amend its Form ADV to correct misstatements; and
Failure to deliver its Form ADV Part 2A and Part 2B to clients.
"A number of the violations described herein were recurring," the SEC said, "despite the firm being alerted to the potential compliance failures through examinations conducted" by OCIE in 2004 and 2007. Du Pasquier fixed some of the deficiencies cited, but not others.
"This is definitely a case of Ďthird timeís the charm,í or perhaps more appropriately, Ďthree strikes and youíre out,í" said Mayer Brown attorney Adam Kanter, noting that OCIE found deficiencies in two past examinations. "The SEC has little tolerance for recidivism, and all advisers are on notice that any issues that OCIE finds in a prior exam will often be the first things they look at in a new exam Ė thereís no excuse not to have those lingering issues totally buttoned up when the SEC comes knocking a second time. The reminder here is that youíve got to follow-through on what the staff finds, and on what you tell the staff youíre going to do based on their findings."
Compliance Program Rule charges
Itís not unusual for the agency to cite firms for violations of Rule 206(4)-7, the Compliance Program Rule, but usually such citations are tied to violations of other SEC rules and/or Advisers Act sections, such as those involving conflicts of interest, best execution, custody or marketing. Itís less often that the Compliance Program Rule violations make up the bulk, if not all, of an SECís case against an adviser.
It does happen, however. A June 2013 administrative action
against eight board members of the Morgan Keegan funds charged all with causing violations of Investment Company Rule 38a-1, the equivalent of the Advisers Act Compliance Program Rule, said Stroock partner and former SEC deputy director of the Division of Investment Management Robert Plaze.
"Recidivism is the reason behind a number of recent cases," he said.
What is interesting about the du Pasquier case is that "the SEC didnít go after the chief compliance officer in this case, as it has in cases with similar awful facts about the abdication of compliance responsibilities," he said.
In fact, according to the administrative order, du Pasquierís CCO "carried out few if any compliance responsibilities from at least 2008 to 2012, but rather devoted her time to managing individual accounts of brokerage customers." (The firm was dually registered as an adviser and a broker-dealer.) "From 2008 to 2011, one of du Pasquierís two principals performed the compliance responsibilities of the firmís investment advisory business," although, the agency said, "he had inadequate training and knowledge about the Advisers Act."
The firm did hire a designated compliance officer in 2011, but that person, who was separate from the CCO, also had little Advisers Act compliance experience and training, according to the administrative order. "More generally, du Pasquier also failed to provide adequate training to its employees regarding the firmís investment advisory compliance policies and procedures."
Compliance policies not followed
Following is a rundown of some of the SEC allegations:
Off-the-shelf compliance manual template. While the agency acknowledged that du Pasquier tailored a number of template sections appropriately, it said that the firm failed to do so with others, "leaving the firm without a customized set of established procedures." For instance, the template provided several different possible procedures for safeguarding client information and advised that certain security measures should be taken, but "du Pasquier retained that language from the template unedited, without clarifying which of the measures it would use."
Failed to ensure adopted compliance procedures were implemented. As an example, the SEC said that while the firmís compliance manual required that marketing materials be reviewed by the designated compliance officer, "two publications were disseminated to the public without such a review."
Failed to conduct adequate best execution reviews. While du Pasquier did sample trades from across the entire firm, because the firm was dominated by its brokerage business, "the number of trades reviewed in investment advisory accounts was insufficient. In addition there was no way to differentiate readily between investment advisory and brokerage accounts." This resulted in reviews where the reviewer, a du Pasquier employee, had to rely on her personal knowledge to determine whether the account in which a given trade was conducted was fee-based, commission-based, or both.
Failed to conduct annual reviews. Rule 206(4)-7 requires an adviser to review its compliance program at least annually to ensure its effectiveness. "From at least 2007 until December 2012, du Pasquier failed to conduct annual reviews of the adequacy of its investment advisory compliance program," the SEC said. Any review was limited "to the extent they were touched upon in reviews of the firmís broker-dealer policies and procedures," and when the firm added or updated policies. "Du Pasquier did not conduct any reviews that surveyed its investment advisory compliance program as a whole, or on an annual basis."
Code of Ethics and access persons. Du Pasquierís Code of Ethics, according to the SEC, while requiring that access personsí personal transactions and holdings reports be reviewed, did not specify just how those reviews should be carried out, something that the agency indicated was contrary to Rule 204A-1. That Rule, which addresses the creation and enforcement of a Code of Ethics, requires that advisers should "assess whether the access person is trading for his own account in the same securities he is trading for clients, and if so, whether the clients are receiving terms as favorable as the access person takes for himself."
Form ADV failures. Du Pasquier, from at least 2009 to 2011, allegedly misstated in its annual amendments to Form ADV the amount of assets it had under management and the number of accounts it managed. It also allegedly failed to deliver its brochure (Form ADV Part 2A) and its brochure supplements (Part 2B) to clients as required.
Violations and remedial efforts
The SEC charged du Pasquier with violating, among other things, Section 206(4) of the Advisers Act and its Rule 206(4)-7 for failure to adopt and implement certain compliance programs and procedures; Section 204A of the Advisers Act and its Rule 204A-1 for failing to conduct adequate access person reviews; and Section 204 of the Advisers Act and its Rule 204-1(a)(1) for failure to amend Form ADV.
The agency, in its administrative order instituting the settlement, gave du Pasquier credit for "remedial actions undertaken," which may explain why the civil money penalty was no more than $50,000, and why the firm was not banned from the securities industry, as firms often are for some period in SEC settlements.