Firm Pays the Price for Failing to Act on OCIE Deficiencies
It’s a simple lesson: Don’t promise the SEC something you can’t or won’t deliver.
One adviser and its owner last month paid the Commission $50,000 as part of a settlement because, according to the SEC, it didn’t learn that lesson. The firm, its owner and its chief financial officer also agreed to retain a compliance consultant, both the president and the CFO agreed to undergo personal compliance training, and the CFO was separately ordered to pay a civil money penalty of $10,000.
All unnecessary if the firm had simply made the changes it promised to make following two examinations by the Office of Compliance Inspections and Examinations, the agency said. The firm’s alleged failure to repeatedly put off making the changes it promised led the SEC to show, via the sanctions it levied, that it means business.
Trust & Investment Advisors, an Indianapolis-based advisory firm with approximately 270 clients and about $150 million in assets under management, along with its owner/president, Larry Pitts, and its CFO and investment committee chairman, George Prugh, allegedly failed to correct ongoing securities violations noted during on-site examinations in 2005 and 2007. When exam staff found the same deficiencies plus others during their 2011 exam, the SEC apparently decided that enough was enough.
Not acting on deficiencies is something of a hot button with the SEC, which tends to see such firm as "recidivists" that do not take compliance seriously. Advisers classified as such may well find themselves getting more attention than they otherwise might receive.
"Investment advisers should be aware that if OCIE identifies deficiencies during an exam – particularly if the deficiencies concern areas of high priority to the SEC – there is a very good chance OCIE will come back again to check whether those deficiencies have been properly addressed," said Mayer Brown partner Matthew Rossi. "The failure to address such deficiencies may result in enforcement action, as was the case here."
SEC Division of Enforcement Asset Management Unit co-chief Julie Riewe, in a February 26 speech, explained that her unit was working with OCIE on a compliance program initiative to identify advisory firms that lack effective compliance programs for possible enforcement action. "The goal is to drive firms to address repeated or systemic compliance failures that may lead to bigger problems," she said, "so the initiative targets firms that have been previously warned by SEC examiners about compliance deficiencies but failed to effectively act upon those warnings, or firms that have wide-ranging compliance failures."
It’s not that there was anything particularly complicated about the alleged deficiencies in this case. They included the firm’s failure to complete an annual compliance review or develop a compliance manual, as well as its "continued use of misleading statements in its marketing materials," according to the May 18 administrative order instituting the settlement. Trust & Investment Advisors "willfully violated, and Pitts and Prugh willfully aided, abetted and caused [the firm’s] violations of Section 206(2) and 205(4) of the Advisers Act" and its Rules 206(4)-1(a)(5) and 206(4)-7. Attorneys representing the firm and the two executives did not respond to messages seeking comment.
"Firms and their principals can and will incur regulatory liability for failing to implement an adequate compliance program even without allegations of underlying client harm," said Montgomery McCracken of counsel Terrance Reilly. "Here, clients weren’t defrauded nor was any money lost. The firm simply didn’t have a compliance program in place or a culture of compliance."
Examinations and inaction
OCIE conducted three separate on-site examinations of Trust & Investment Advisors between 2005 and 2011. Here’s what happened at each:
2005. Examiners discovered that the firm had failed to develop compliance policies as required by Rule 206(4)-7, known as the Compliance Program Rule. Following the on-site visit, the firm "reported that it had ‘made progress with our written policies and procedures designed to prevent violation of the Advisers Act and rules,’" according to the administrative order, and promised to send the agency "’a copy with the typed version of this response.’"
2007. Despite the promises made after the 2005 examination, the SEC said, "OCIE found during its 2007 exam that: (i) [the firm] still had not yet completed its compliance manual; (ii) [the firm] had not conducted an annual compliance review; and (iii) [the firm’s] designated chief compliance officer (CCO A) did not have appropriate knowledge of the Advisers Act," such as not being aware of the requirement to conduct a compliance program review. OCIE told Trust & Investment Advisers that "it was concerned that [the firm] employed a ‘cavalier approach to compliance’ that called into question [the firm’s] commitment to operate its business in accordance with the federal securities laws." Trust & Investment Advisors again assured OCIE that "it would remedy its compliance shortcomings," the SEC said. The firm said it would retain a compliance consulting firm to assist it in developing a compliance manual, and that it would provide compliance training to CCO A and other employees.
2011. "When OCIE staff returned for the 2011 exam, they discovered that [the firm] had made no progress on its compliance deficiency," the agency said. Prugh – who said he was now acting as the de facto CCO because CCO A was unable to complete the Series 65 exam – said that the firm’s compliance committee had become inactive, and that the firm "had not had time since the last exam three years ago to work with [the compliance consulting firm] to develop a compliance manual and implement a compliance program."
As if hitting one SEC hot button was not enough, Trust & Investment Advisors may have hit another when examiners found several instances where the firm provided allegedly misleading performance information in its marketing material to clients. Performance statements have a history of being closely scrutinized by the agency, as have marketing materials. A firm would really have to work to come up with better attention-grabbers than these.
Let’s break these allegations down:
Examiners in 2007 found that Trust & Investment Advisors’ one-on-one performance presentations to clients were misleading. "The presentations included gross of fee performance returns over an extended period of time; yet, the same presentations did not explain the impact that advisory fees could have on the value of a client’s portfolio," the SEC said.
Once again, however, a promise to fix did not result in an actual fix, if the agency is to be believed. "Following the 2007 exam, [the firm] indicated it had corrected this issue. However, when staff returned for the 2011 exam, they discovered that [Trust & Investment Advisors] continued to distribute marketing pieces showing bar charts with cumulative returns that did not explain the impact that advisory fees could have on the value of a client’s portfolio."
2011 and beyond
Similar allegations were made after the 2011 exam. This time they included charges that Pitts appeared on a local access public television show using PowerPoint slides to compare the firm’s cumulative returns over a 10-year period to the S&P 500’s returns over that same period. "These comparisons were misleading because they neglected to deduct applicable advisory fees from [the firm’s] cumulative returns," the SEC said. "Moreover, the charts did not include a disclosure stating that [Trust & Investor Advisor’s] cumulative returns did not reflect the deduction of advisory fees, and that such fees would reduce client returns. These TV show appearances led to client referrals."
Aside from the deficiencies OCIE discovered during the exams, the SEC also charged that the firm distributed misleading performance information in weekly summary marketing emails from at least 2009 through 2012. These allegedly included weekly summaries sent to certain clients, as well as solicitors, that compared percentage increases in the S&P 500 index to percentage increases in Trust & Investor Advisors’ portfolios. "The table materially overstated the performance of the [firm’s] portfolios vis-à-vis the S&P 500 index because [the firm’s] performance included the reinvestment of dividends, while the S&P 500 index number did not," the agency said.
At long last, change
After the 2011 examination was over and the SEC had apparently had enough, compliance began to improve at Trust & Investment Advisors. After that examination, the firm hired another CCO, this time one with Advisers Act experience, completed its compliance manual, and engaged a new compliance consulting firm to perform annual reviews, which it did in 2012 and 2013, the agency said. In addition, the new CCO reviews all marketing pieces, including those used on television.