Knowing firm requirements as set forth in the Investment Advisers Act is essential, and learning from the mistakes of others in this area can be a valuable and motivating tool for striving for compliance in the financial services industry. In an atmosphere where Chief Compliance Officers (CCO) are being added to disciplinary proceedings, learning and taking immediate corrective action is the name of the game. No longer is the firm the only name blasted across SEC complaints; regulators will ensure that individuals are equally held responsible.
In February of this year, one such CCO learned a painful lesson resulting in his debarment from the industry. Below are a few key facts from the decade prolonged battle with SEC vs. Nutmeg Group LLC in 2009 and the subsequent individual administrative proceedings that followed for both the CEO, Randall Goulding, in 2020 and 2019, as well as his CCO, David S. Goulding, in 2019.
Summary
The U.S. District Court for the Northern District of Illinois ordered an investment adviser to pay over $1.8 million in disgorgement and penalties for multiple violations of the Investment Advisers Act. The SEC asserts that the adviser ignored the Investment Advisers Act’s custody, recordkeeping, valuation, and disclosure rules while commingling assets and engaging in insider transactions. Even after the SEC discovered these violations, the firm failed to remedy the findings and made additional false statements to the SEC.
Tips and Best Practices
Maintain Accurate Books and Records
In this case, the firm’s records were in disarray. More specifically, this included updates to the fund that were not documented and disclosed, agreements and forms with no signature, and missing documents. Maintaining files in a manner that allows the firm to produce them is essential for a successful exam. Maintaining accurate files allows regulators to see the trail of any efforts made by your firm to conduct business. Additionally, the SEC complaint had undertones of frustration over the staff’s inability to obtain consistent books and records.
Conduct Required Reviews and Maintain Required Compliance Records
Nutmeg failed to maintain policies and procedures. They did not have a Code of Ethics. They did not have internal or independent audits of the fund nor audits for the firm as a whole. Registered Investment Advisors (RIA) must have certain foundation compliance items in-place. At the bare minimum, regulators expect firms to have certain items, such as procedures, code of ethics, and testing.
Financial Institutions Must Have Financial Records
Although this may sound obvious, it needs to be communicated. Nutmeg failed to provide accurate quarterly statements to investors and failed to maintain a complete record of the funds’ investments. Likewise, the firm also did not maintain basic financial records (trial balances, income, and expense statements) for its own operations. Unlike other industries, RIAs will not get a pass in this area. RIAs manage and advise the finances of others; therefore, they must ensure to maintain proper financial statements, blotters, and representations of investments.
Disclose, Disclose, Disclose
The SEC examiners found that the firm failed to disclose many materials facts. For example, this included the comingling of assets; money from the fund going to third parties; expenses and fees that were not properly disclosed and documented; inaccurate financials and calculations of the fund; and personal payments to the firm. Investor protection and market protection are compromised when investors are not told material facts. The disclosure requirements set forth in the Investment Advisers Act aim to protect investors, as well as firms. Be conservative and disclose.
What You Don’t Know Will Hurt You
In some cases, CCOs are not aware of the requirements and responsibilities of their role or for their firm as a whole, and unfortunately, the SEC does not care. CCOs must ensure that they have the knowledge, training, and resources to do their job. In Nutmeg’s case, the CCO admitted that he was unaware of the existence of the Investment Advisers Act or the duties that it imposes upon the firm and its principals. Generally speaking, and according to the rule’s adopting release, the CCO must be competent and knowledgeable in the Investment Advisers Act. An unqualified CCO violates the compliance rule and can result in significant firm and personal liability.
Remediate if Possible
Lastly, following the summary of their violations, the firm noted that it would hire an accounting firm to perform audits, fix material disclosures, and return funds. The firm did not do this. If material corrections need to happen, hiring an outside consultant firm to provide support and guidance can be invaluable.
We have assisted many firms in remediation efforts following regulatory examinations. Contact our firm today to learn more.