Understand the corporate importance of a comprehensive Compliance Manual and recordkeeping in order to avoid legal liability.
My name is Steve Hart, and I am a contributing journalist for Compliance Mitigation. I am a Partner at Conformity 360, a compliance consulting firm, serving as the resident subject matter-expert in buy-side Compliance. Prior to joining Conformity360, I was Chief Compliance Officer (“CCO”) for the prestigious firm Allen & Company, and prior to that, served as the Global Chief Administrative Officer for Compliance at BlackRock, the world’s largest asset management company. I hold an Investment Adviser Core Certification, an M.S. in Banking and Financial Services from Boston University and a B.A. in Political Science from the University of Pennsylvania.
Having worked as the CCO for RIAs, I have been through numerous regulatory audits and examinations. Experience gives me insight into how the SEC conducts investigations and attempts to obtain enforcement actions.
After completing this case study, the participants will be able to:
- Define key components of a Compliance Manual.
- Define Recordkeeping.
- Understand why failure to have a Compliance Manual causes risk to an RIA.
- Understand what prompts the SEC to bring enforcement actions against RIAs concerning failure to maintain an adequately tailored Compliance Manual.
- Identify Compliance Manual and Recordkeeping best practices.
Compliance Manual, Recordkeeping, Form ADV, Broker-Dealer, Fiduciary Duty
The Investment Adviser Act of 1940 (“Advisers Act”) Rule 206(4)-7 requires advisers to adopt written policies and procedures, contained within a Compliance Manual, that are designed to prevent violation (by the principal and all supervised persons of the principal) of the Adviser Act and SEC rules related to it.
Firms often largely adopt template Compliance Manuals verbatim without making the extra effort to tailor policies and procedures to a RIA’s lines of businesses. As is often the case, a general boilerplate Compliance Manual may have policies and procedures in place for lines of businesses that are not applicable. There have been enforcement actions by the SEC against RIAs for using a standard Broker-Dealer Compliance Manual, without making specific changes to better reflect the specific needs of the RIA using the manual.
The ignores the importance of creating appropriate policies and procedures in a firm’s Compliance Manual in order to meet required record keeping obligations. Registered Investment Advisers (“RIAs”) with the Securities and Exchange Commission (“SEC”), under Rule 206(4)-7 of the Investment Advisers Act of 1940 (“Advisers Act”), must adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules.
One such example of failure to include appropriate information involves the fact that Broker-Dealers do not engage in the advisory business so, most commonly, no reference exists in a Broker-Dealer Compliance Manual to the Advisers Act. In addition, a Broker-Dealer Compliance Manual refers to duties of suitability and fairness but does not mention the fiduciary duty that RIAs owe their clients.
SEC enforcement actions are increasing against RIAs for failure to adopt policies and procedures reasonably designed to implement a compliance program through the RIA’s Compliance Manual. From these enforcement actions, the SEC is also bringing tangential enforcement actions relating to failure to maintain an adequate Compliance Manual.
For example, RIAs that are non-compliant with Adviser Act Rule 206(4)-7, which requires advisers to adopt written policies and procedures, also violate Rule 204-2(a), which requires RIAs “to make and keep true, accurate and current certain books and records relating to the advisory business.”
In addition, RIAs must implement a Code of Ethics, along with an acknowledgement from employees that they have read the Code of Ethics and will abide by it. This requirement to every employee of the RIA within a certain number of days of hiring, and annually thereafter, as part of supplemental recordkeeping requirements. In turn, the SEC is bringing enforcement actions going forward for violations of recordkeeping rules that state RIAs must have written acknowledgements of the RIA’s Code of Ethics.
Particularly egregious violations may also involve criminal liability exposure from a parallel investigation run through the Department of Justice.
Barthelemy Group LLC and its sole owner and adviser Evens Barthelemy, operate as a SEC RIA. Mr. Barthelemy forms the firm after having previously worked as a registered representative for two Broker-Dealers. After registering for two years as a RIA, the firm withdraws its SEC registration after the SEC discovers that the firm does not have the required amount of assets under management ($25 million at the time). The SEC uncovers many compliance failures by Barthelemy Group LLC.
Evens Barthelemy and his firm Barthelemy Group LLC operate as an RIA but lack sufficient funds to meet the requisite capital requirements. The firm misleads SEC examiners by inflating the firm’s claimed assets under management (AUM) ten-fold in an apparent attempt to show that the firm was eligible for SEC registration.
According to the SEC’s enforcement against Barthelemy and his firm, when examiners ask for a list of client assets, Barthelemy misrepresents his firm’s assets under management as $26.28 million instead of the actual $2.628 million. He downloads “client account balances from the firm’s online custodial platform onto a spreadsheet, and then manually moves the decimal points for each client one place to the right before providing it to the SEC staff.” For two years, Barthelemy improperly registers Barthelemy Group with the SEC on the basis of the assets under management that were 10 times higher than reality. Barthelemy Group, through Barthelemy’s actions as Chief Compliance Officer, also fails to adopt reasonable compliance policies and procedures or to maintain required books and records concerning Codes of Ethics and providing the firm’s disclosure brochure to clients, the ADV Part 2.
The SEC finds that Barthelemy Group LLC does not institute written policies and procedures in accordance with Adviser Act Rule 206(4)-7. That rule requires advisers to adopt written policies and procedures designed to prevent violation (by the principal and all supervised persons) of the Act and SEC rules related to it. The settlement order notes that Mr. Barthelemy prepares the firm’s compliance manual, but that he largely adopts it “verbatim from a version he obtained from his prior employment at a registered broker-dealer.” Given that a Broker-Dealer does not engage in the advisory business, the SEC finds that the firm’s Compliance Manual violates Rule 206(4)-7, noting that the manual refers to the Securities Act of 1933 and the Securities Exchange Act of 1934 but makes no reference to the Advisers Act. Concurrently, the manual refers to duties of suitability and fairness but never mentions the fiduciary duty that advisers owe their clients. The firm’s Compliance Manual also references commission-based compensation and Broker-Dealer filings, none of which are relevant to comply with Rule 206(4)-7. Finally, the SEC finds that the firm does not undertake an annual review of the adequacy of the Compliance Manual.
The firm is found to be non-compliant with Rule 204-2(a) which requires advisers to make and keep true, accurate and current certain books and records relating to the advisory business. Specifically, the SEC states that the firm does not have copies of the written acknowledgements of the firm’s Code of Ethics. Additionally, the firm does not have records of delivery of the ADV Part 2 brochure required by Rule 204-2(a).
The SEC finds that the firm is not eligible for SEC registration due to failure to meet the minimum threshold test ($25 million at the time). The SEC finds that the firm managed nowhere near the $26.5 million it claimed, but rather the total was approximately $2.6 million. This misrepresentation violates Section 207 of the Advisers Act, which makes it unlawful for any person to willfully make untrue statements of material fact in a registration statement. In addition, this conduct violates Section 203A of the Act, which prohibits SEC registration as an adviser unless the firm meets a relevant exemption.
An RIA must implement an adequate Compliance program with a Chief Compliance Officer knowledgeable with the Advisers Act and all rules thereunder. It is of utmost importance that an RIA adopts reasonably designed policies and procedures in its Compliance Manual specifically tailored to a RIA’s given advisory business. Further, it is imperative during a regulatory examination to provide accurate records to the SEC. Doing otherwise will only lead to more serious enforcement actions, material reputational risk, fines, and potential bars from the industry. For Barthelemy Group, LLC, the following penalties were instituted:
- The firm must furnish a copy of the SEC order to each existing client;
- The firm must post a copy of the order on its website for a period of two years;
- The firm must evidence in writing the steps taken to comply with all violations of the Act and its rules;
- Mr. Barthelemy is barred from employment in the financial services industry for a period of two years; and
- Mr. Barthelemy is censured.
Lastly, an RIA must comply with all recordkeeping requirements under the Advisers Act and obtain written acknowledgements of the Code of Ethics from all employees of the RIA within a certain number of days of hire, and annually thereafter. RIAs must also obtain documentation that it has furnished all clients with the ADV Part 2 brochure within 120 days after fiscal year-end.