Remedies & Administrative Procedures for Investment Advisors

Instructor: Moses Muiga

Moses teaches finance and accounting. He holds undergraduate degree in finance, he is a certified accountant and studied general business at graduate school.

This lesson discusses circumstances under which the Security Exchange Commission (SEC) can establish administrative proceedings against investment advisers who violate the Investment Advisers Act of 1940 or SEC rules. It also covers enforceable remedies.

Using Law to Remedy Wrongdoings

The Security Exchange Commission (SEC) relies on the Investment Advisers Act of 1940 to establish civil and administrative proceedings against advisers. The SEC has no prosecution jurisdiction for crimes conducted by advisers, but if criminal prosecution is warranted, it forwards its findings to the Department of Justice to institute the proceedings.

The Investment Advisers Act of 1940 does not designate specific provisions as a crime, but it contains penalties and provisions that can be enforced against the investment adviser.

Circumstance That Constitute Wrongdoing

The SEC can proceed with enforcement against advisers under the following circumstances.

Failure to Disclose Material Conflict of Interest

An investment adviser should disclose a material conflict of interest, especially when an investor receives a fee or share of profit for recommending a specific product or are compensated at a higher commission for selling a specific product instead of a similar product. An adviser should disclose ownership interest if an adviser issues recommendations on such a business.

An investment adviser should pay special attention to fee and expense allocation. Fee and expense allocation should be adequately disclosed, especially when fees and expenses may influence client decisions.

Trade Allocations Practice

An investment adviser should not be involved in 'cherry-picking'. Cherry-picking is the practice of allocating profitable trades to favored customers, such as hedge funds and institutional investors, and allocating less or unprofitable trades to less favorable customers, such as individual investors and non-profit organizations.

Failing to Obtain Favorable Transaction Price

The Investment Advisers Act of 1940 requires an adviser to act in the best interest of the client. An adviser should seek the best execution price at all times under the given environment. An adviser should not seek more expensive investment in order to boost earned fees.

Disregarding Rule on Principal Trading and Executing Cross Trades

Cross trades are prohibited by Section 206(3) of the Investment Advisers Act of 1940 unless they are authorized by the client in writing and the adviser has disclosed to the client the potential of conflict of interest arising from the transaction. Cross trading involves 'crossing trades' between two clients on the different sides of the transaction.

Principal trading involves brokers who buy securities from the secondary market and use them to fill client orders. Advisers are required to use comparable market price when using the securities they're holding to fill client orders.

Breaching Insider Trading Provision

Insider trading involves profiting from the market on the basis of nonpublic material information or privileged information or tipping privileged information to traders who use the information to profit.

Misrepresentation of Information

Investment advisers should not misrepresent information to a client or to the SEC. Misrepresentation of information to the client may include misrepresenting the value of securities in order to earn higher fees, misrepresenting asset performance and misrepresenting the adviser's experience. Misrepresentation to the SEC may include filing misleading information with the SEC and failing to report material facts with the SEC.

Not Disclosing Changes in Investment Strategy

Departing from a longtime investment strategy should be disclosed to the clients. Not disclosing the change in investment strategy may result in the mischaracterization of the fund.

Failure to Register with the SEC

The Investment Advisers Act of 1940 requires investment advisers to register with the SEC if they meet the registration requirement. Advisers who are exempted from registering with SEC are required to register with state securities regulatory agency unless the state exempts them from registering.

Misappropriating Client Funds and Failing to Comply with the SEC Custody Rule

It is illegal to transfer client funds to a personal account, charge for services not rendered or not authorized by the client, borrow from client account with authorization from the client and participate in a Ponzi scheme. Misappropriation of funds also involves criminal proceedings.

Custody rule requires advisers to protect client assets and maintain client funds in a separate account, among other things.

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