Consequences for Inflating AUM May Be Worse Than Expected
Firms may be tempted to lie about the amount of assets they have under management in order to gain SEC registration Ė and the additional clients that larger firms get. But they should keep in mind that not only is doing so illegal, it carries some unexpected consequences.
The biggest surprise for these firms may be that, once they are registered, the SEC can go after them for not complying with the same rules that properly registered firms have to comply with. The fact that they were improperly registered makes no difference.
Take the case of Logical Wealth Management and its owner/president/chief compliance officer Daniel Gopen.
The SEC on February 19 settled with the advisory firm for, among other things, overstating its assets under management in its filings between 2006 and 2011, "creating the appearance that it qualified for registration with the Commission when it did not," according to the administrative order instituting the settlement. At the time, only firms with more than $25 million could register with the SEC. Firms with fewer AUM had to register with their state.
But the firm was also charged with violations that firms correctly registered with the Commission would have to comply with. These include failure to comply with:
Rule 206(4)-7, the Compliance Program Rule, which requires advisers to adopt and implement written compliance policies and procedures, and review them at least annually.
Rule 204-2, the Books and Records Rule, including a requirement that advisers make and keep true and current books and records.
Rule 204A, which requires advisers to establish, maintain and enforce a written code of ethics.
It may come as a surprise to some that any advisory firm that registers under false pretenses still has to comply with the same SEC rules that properly registered firms do. But the fact is that until a firmís improper registration is discovered by the agency, "it is registered," said Mayer Brown attorney Adam Kanter, and as such, has to meet the same obligations as other registered firms. "If youíre going to lie and be registered, youíre going to lie and be registered and have to comply."
"It could also happen in reverse," said Sidley Austin partner Mark Borrelli. This would involve an adviser with assets under management above the SEC registration threshold that did not register. That adviser could face agency charges for not only failing to register, but for not being in compliance with the other SEC rules that registered advisers must comply with.
As for Logical Wealth Management, if what the SEC alleges is true, even after Dodd-Frank raised the minimum threshold for SEC registration in 2011 from $25 million to $100 million, the firm did not give up. Instead, it allegedly falsely represented that its principal office and principal place of business were in Wyoming, a state that does not regulate investment advisers, so firms located there have to register with the SEC.
Bottom line: Itís not clear just how many new clients Logical Wealth Management may have secured as a result of allegedly inflating its AUM, but what is clear is that the SEC fined Gopen $25,000 and banned him from the securities industry. Logical Wealth Managementís SEC registration, perhaps needless to say, was revoked. An attorney representing Logical Wealth and Gopen could not be located, and Gopen himself did not respond to a voice mail message.
Logical Wealth was created by Gopenís father in 2002 as a Massachusetts corporation that operated in the Bay State. Gopen, the son, assumed ownership of the firm after his fatherís death in 2006 and registered the firm with the SEC as an investment adviser, according to the administrative order.
But "Logical Wealth was never qualified for Commission registration," the SEC said. On nine different Forms ADV filed between 2006 and 2011, Gopen allegedly reported in Item 2.A.3 of Part 1A that its basis for registration with the Commission was having AUM of more than $25 million.
In June 2011, a month before the effective date of the new $100 million threshold amount for SEC registration, Gopen registered his firm as a Wyoming corporation, claiming in Item 1.F of Part 1A of Logical Wealth Managementís Form ADV that its principal office and principal place of business was in Cheyenne, Wyoming, the agency said. "However, Logical Wealth has never operated from any location in Wyoming. Because Logical Wealth did not have a principal office or place of business in Wyoming and had no other basis for Commission registration, it was prohibited from registering with the Commission as an investment adviser."
Logical Wealth Management was charged with willfully violating Section 203A of the Advisers Act by improperly registering with the Commission. Gopen was charged with willfully aiding, abetting and causing his firmís alleged violation. Both were also charged with willfully violating Section 207 of the Advisers Act for making an untrue statement on a registration application or report. In addition, Logical Wealth Management was charged with willfully violating, and Gopen with aiding, abetting and causing the firmís alleged violations of, Rule 206(4)-7, the Compliance Program Rule; various sections of Rule 204-2, the Books and Records Rule; and Section 204A for failing to have an effective code of ethics.