Even coupled with the ever popular “I didn’t know it was a crime” defense, an Investment Advisor loses. Lessons in securities regulation for the self-help minded.
Too often I hear clients, or more appropriately, potential clients, explain to me that they did not use an attorney for their compliance matters because they can handle it. Sometimes I hear a similiar explanation when a client is faced with an investigation or an enforcement proceeding for failing to comply with a rule or regulation.
As I explain to them, ignorance of the law is no excuse, and the fact that no one uses an attorney to complete government forms is not going to help if they fail to properly comply with the regulations which apply to their business.
The SEC has just reminded an Investment Advisors of these truisms when it upheld the suspension of its license and a series of fines and a disgorgement order.. In a recent opinion, the Commission upheld sanctions against an Investment Adviser for failing to disclose a conflict of interest between the advisers and their clients, in that the Adviser had a financial interest in recommending certain securities. Part of the Adviser’s defense was that it did not use an attorney to complete its documents, the forms were too confusing and they did not understand the law.
Admittedly the details of the problem were complex, and it may be that the Adviser was in fact attempting to hide its financial interest in a fund that it was recommending to its clients. That is what the Commission believed in reviewing the original decision, but Adviser’s defense, and the Commission’s response, was the more interesting part of the decision.After a lengthy analysis of an Investment Adviser’s relationship with an accounting firm, another investment advisor, and two investment funds, the Commission found that the Adviser had a financial interest in the recommendations they made to their clients to invest in the Fund, and that payments under the Servicing Agreement between the Advisor and the second investment advisor were in the nature of fees or commissions for the referrals, rather than for any services performed under the agreement. None of these payments were reflected in the Advisor’s, engagement letters, and advisory contracts, making those documents false. The full opinion of the Commission is posted at the web site.
Further, when entering into the agreements, the Advisor never amended that portion of the Form ADV requiring disclosure if an adviser: recommends securities to clients in which it directly or through a related person has a sales interest (Part I, Item 21); recommends to clients that they buy investment products in which the adviser or a related person has a financial interest (Part II, Item 9D); or has an arrangement whereby the adviser or a related person receives an economic benefit from a non-client in connection with giving advice to clients (Part II, Item 13A).
However, in order to be found guilty of a securities law violation, a defendant must have acted with scienter. Scienter has been defined by the Supreme Court as a “mental state embracing intent to deceive, manipulate or defraud.” To avoid the scienter element of the offense, the Adviser claimed that it did not intentionally conceal from their clients the receipt of fees from the Fund, that their disclosure on Form ADV was merely inartful, that they prepared the documents and Form ADV without the assistance of an attorney, and that failure to check particular boxes on the Forms ADV that would have exposed the conflict of interest was based on a misunderstanding of what they were required to disclose.
The Advisor also argued that the incorrect language in the engagement letters and disclosure documents was old language remaining from and earlier time when they were not receiving compensation They argued that retention of this language was merely an oversight, “sloppy business practices,” and not a deliberate attempt to conceal from their clients their receipt of fees from Fund.
The Commission rejected the arguments simply: “These arguments are unpersuasive. Their disclosures were not ‘inartful,’ they were false.”
The Advisor also attempted to argue, by calling an expert witness, that Form ADV is usually prepared without the help of an attorney and does not have helpful instructions, that the Advisor did not answer any of the questions in Form ADV incorrectly, and that Servicing Agreements “have only recently evolved and there are no set rules as to what they do or do not include,” all of which was designed to remove the intent aspect of the offense.
The Administrative Law Judge refused to hear such expert testimony, and the SEC agreed: “Whether Form ADV is difficult or not is irrelevant; investment advisers are obligated to respond to questions in Form ADV correctly and seek whatever assistance they need in fulfilling this obligation. This obligation is not diminished by any purported industry practice in eschewing assistance from counsel.”
Like your mother told you “Just because your friends are all doing it doesn’t mean you can. If your friends are all out jumping off a cliff, are you going to jump off a cliff?”
Listen to Mom. Just because your friends are not using a securities attorney, that is no excuse for you not to do so. Maybe you will get it right. Maybe you won’t. And if you don’t, you could wind up losing your license and paying back your fees to your clients.
Copyright 2001, Mark J. Astarita. All Rights Reserved. Mark J. Astarita, Esq. is a partner in the law firm of Sallah Astarita & Cox, and represents financial professionals in a wide variety of matters. He is also the sponsor of The Securities Law Home Page and can be reached at (212) 509-6544 or by e-mail at email@example.com. Or visit Securities Lawyer.
Nothing herein is intended as legal or financial advice. The law is different in different jurisdictions, and the facts of a particular matter can change the application of the law. Please consult an attorney or your financial advisor before acting upon the information contained in this article.
Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.
He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page - SECLaw.com, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.