Captain Obvious is a fictional character in commercials who is portrayed as a being a tall and thin sea captain with a beard. It should not take Captain Obvious to warn Registered Investment Advisers (“RIAs”) about their duty to return unearned advisory fees when clients terminate their advisory relationship. Furthermore, Captain Obvious should not need to tell RIAs that misstatements on their Form ADV will trigger a tsunami of serious compliance problems.
On July 20, 2018, the SEC settled an enforcement action brought against an RIA in California and its majority owner. The RIA failed to refund unearned advisory fees to 63 clients who severed their relationship with the firm. The enforcement action alleged that the RIA and its owner improperly withheld $131,000 in prepaid unearned advisory fees. These former clients emailed the RIA to end their advisory relationship. The RIA and its owner initially refused to honor those requests and asserted that these emails were not proper termination notices. They told these former clients that original signatures, also known as “wet signatures,” were required to end their relationship with the firm.
In fact, original signatures were not required to terminate the advisory relationship these clients had with the firm. The RIA’s advisory agreements and written disclosures permitted clients to utilize email to bring their relationship with the firm to an end. The firm’s policies and procedures also allowed clients to use email to terminate their advisory contract with the RIA. The firm did not return all of the unearned advisory fees for a number of months. The RIA and its owner delayed making refunds, even though examiners had pointed out that compliance problem to them. In addition, they were aware that the SEC’s enforcement division was looking into this very serious compliance transgression.
The firm and its owner also made material misstatements to clients regarding the RIA’s financial condition. In thirteen brochures issued between March 2013 and April 2018, the RIA stated that the firm did not have a financial condition or commitment that impaired its ability to meet contractual and fiduciary obligations owed to clients. The RIA made those representations, even though it had borrowed $700,000 to keep the business solvent and was in default on those loans.
You should not need to ask Captain Obvious what happened next. Although they did not admit or deny the SEC’s findings, the RIA and its owner were forced to walk the plank and were sanctioned by the SEC.
The SEC’s enforcement action is available at: https://www.sec.gov/litigation/admin/2018/ia-4975.pdf.
https://www.ncsregcomp.com/team/les-abromovitz/
NCS Regulatory Compliance
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