In March of this year, the Securities and Exchange Commission (SEC) took a bold stance in regard to its regulatory authority over advisers who offer annuities. In the recently filed lawsuit, the SEC announced several charges made against an investment adviser for recommending annuities to clients without properly disclosing potential commissions or conflicts of interest. The lawsuit signals a recent change in pace for the SEC, indicating that their jurisdiction covers all adviser recommendations, not just stocks.
The majority of sections and provisions within the Advisers Act are meant for SEC-registered advisers. However, the anti-fraud provisions, which the SEC claims were violated in this recent complaint, can apply to both registered and unregistered investment advisers. The SEC, as is evident by its recent actions, will not shy away from pursuing cases in which negligence-based anti-fraud violations impact investors and their money.
For any investment adviser, recent litigation like this is a good reminder that the anti-fraud provisions of the Advisers Act are important and compliance is critical.
What are the anti-fraud provisions?
In 2007, the SEC adopted Section 206 titled, “Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles.” In short, this rule prohibits investment advisers “to engage in any act, practice, or course of business which is fraudulent, deceptive or manipulative.” The ruling not only applies to buying or selling securities, but to transactions regarding pooled investments, including hedge funds and other investment vehicles as well. As evidenced by its recent suit, the SEC also includes insurance products, like annuities, under this ruling.
Advisers are required under Section 206 to adequately disclose information to clients that could impact their decision regarding a certain product or investment vehicle. For example, an adviser must tell clients if there are conflicts of interest in promoting certain products — such as if they will directly or indirectly receive compensation as a result of the sale. Other conflicts of interest that should be disclosed include:
- If the adviser (or someone affiliated with the adviser) will also be buying or selling the same security as the adviser recommends to the client.
- If a third-party referral is made.
- If the adviser is affiliated with or owns a broker where the clients’ securities will be traded.
While the SEC provides a few examples in which a conflict of interest disclosure is necessary, such as those listed above, the nature of disclosing isn’t always black and white. There are certain circumstances and facts surrounding individual cases that will dictate whether or not an adviser needs to disclose conflicts.
How to comply with anti-fraud provisions
With the SEC cracking down on anti-fraud violations, advisory firms need to understand what they can do to proactively protect themselves and best serve their clients.
As a good place to start, ensure your firm is in compliance with Rule 206(4)-7 of the Advisers Act, “Compliance Programs of Investment Companies and Investment Advisers,” which advises firms to do the following:
- Create and adhere to firmwide written policies regarding the procedures and actions every team member must follow to avoid compliance violations.
- Review your written policies at least once a year.
- And designate a Chief Compliance Officer (CCO), who is responsible for overseeing all compliance efforts.
If you have these initial safeguards in place, it’s much easier to identify potential violations before they occur or adjust your actions accordingly.
Once your firm has its own guidelines regarding disclosures and addressing conflicts of interest, each adviser needs to be trained on these policies and regularly reminded of their importance. Your anti-fraud guidelines should reflect the SEC’s Section 206 ruling by incorporating disclosures about various products and pooled investment vehicles, not just standard securities.
As the SEC continues to identify fraud violations, it’s possible they may amend their ruling to further clarify or include additional guidelines for firms to follow. Your CCO should monitor the rulings closely, and adjust written policies accordingly.