RIA Compliance Blog
Filing annual updating amendments to Form ADV is an important requirement for all registered investment advisers. All information contained in Parts 1 and 2 of Form ADV must be both accurate and complete. Unfortunately, this is not always the case, and the Securities Exchange Commission (“SEC”) and state regulators have not hesitated in bringing enforcement actions against investment advisers who misrepresent or fail to disclose certain information in their annual filings and amendments.
Based on 1170 routine state-coordinated investment adviser examinations in 2015, as reported by the North American Securities Administrators Association (“NASAA”), the most common errors that are routinely found on Form ADVs include inconsistencies between Form ADV Part 1 and Part 2, inconsistencies between fees charged and fees listed on the ADV, inconsistencies between services provided and services described in ADV, misrepresentations in business description, overstatements or understatements of assets under management, and failure to disclose conflicts of interest.
Specifically, 17.4% of the examined state-registered investment advisers had inconsistencies between their Form ADV Part 1 and Part 2. This is a common error that is also easily avoided. Unfortunately, many investment advisers do not take the time or lack the know-how to do so. Fee structure is another problem area for many investment advisers. 10.6% of examined investment advisers in 2015 had inconsistencies between fees actually charged and fees listed on their ADV.
Of the 1170 state-registered investment advisers who were examined in 2015, 9.1% had issues regarding inconsistencies between services provided and services described in the ADV. In addition, 8.1% had misrepresentations in their business description.
Another common error on ADVs involves overstatements or understatements on assets under management (“AUM”). NASAA found that 6.2% of state-examined investment advisers in 2015 had understated their AUM, while 2.9% had overstated their AUM. Firms may choose to understate their AUM in order to avoid having to register with the SEC and be subject to SEC regulations. On the other hand, firms may also choose to overstate their AUM in order to appear larger than they are and attract bigger clients. Both are prohibited and can lead to enforcement proceedings.
Similarly, failing to disclose conflicts of interest has been the subject of many SEC enforcement proceedings; however, in 2015 4.1% of examined state-registered investment advisers had deficiencies in their ADVs regarding disclosure of conflicts of interest.
While above-listed deficiencies were observed in state-registered investment advisers last year, recent SEC enforcement proceedings show that SEC-registered investment advisers make similar errors. This past September, the SEC charged a Philadelphia-based investment advisory firm with retaining exchange fees arising from restructuring transactions of collateralized debt obligations (“CDOs”). The firm attempted to conceal its receipt of those fees by failing to report them on its Form ADV. Those fees rightfully belonged to their CDO clients. The firm settled with the SEC for $21 million.
A couple of SEC-registered investment advisers were recently sanctioned by the SEC for misrepresenting their place of business on their Form ADV. These investment advisers incorrectly stated their place of business was Wyoming. Firms frequently seek to list Wyoming as its place of business because Wyoming doesn’t regulate investment advisers, and firms registered in Wyoming automatically default to SEC oversight. Both these firms had less than $100 million in assets, but by registering in Wyoming they were able to state that they were SEC-registered on their advertisements, giving the impression that they were larger than they were.
In order to minimize Form ADV deficiencies, investment advisers should thoroughly and accurately disclose all relevant material as required by the Investment Advisers Act of 1940 and the rules and regulations thereunder. This information should be updated routinely as circumstances change, and annually 90 days after the end of the firm’s fiscal year. Special care should be made to ensure that both Part 1 and Part 2 contain the same information and are kept consistent. By avoiding these common errors, investment advisers can go a long way to ensure the stability and growth of their firms.
Parker MacIntyre provides legal and compliance services to investment advisers, broker dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Visit our website for more information.