SEC Sanctions Investment Adviser for Failing to Refund Advisory Fees Timely

In July 2018, the SEC issued an Order sanctioning a registered investment adviser firm in Beverly Hills, California for essentially failing to refund prepaid advisory fees from clients who terminated their advisory relationship with the firm. But it didn’t stop there, the SEC also found that the firm made false and misleading statements about its own financial condition.

According to the SEC’s release, the firm had two advisors who left to go to another firm, and about 63 clients terminated their advisory agreement with the firm, either in writing or via email. The advisory fees were prepaid, and, according to the firm’s ADV, the firm would refund the unearned portion of the fee after receiving written notice of the termination from the client, and that the refund would be paid after 5 business days. Despite this, the firm did not timely refund the fees to the clients, that totaled about $131,000. Instead, the firm sought to obtain additional termination notices from clients, saying that they needed a notice with an original signature. Then, after receiving those, the firm refunded only $46,000 of the fees. By this time, the SEC’s order states that SEC staff were already seeking information and documents from the firm about the unearned fee issue. Several months later, another $85,000 or so in unearned fees were refunded to the clients, AFTER the SEC staff sent the firm a deficiency letter and had meetings with the firm about the issue.

The SEC order also states that from at least March 2013 through April 2018 that the firm has essentially been insolvent, not being able to pay its expenses from its operating income and suffered cash shortages at the end of each quarter. The firm and its owner, it seems borrowed funds to cover these shortages and for other business purposes, and the firm had a negative net worth. The SEC found that the firm failed to disclose its financial condition that “is reasonably likely to impair its ability to meet a financial commitment to the client.” The SEC found that the firm was obligated to disclose this information in its firm brochures (Form ADV), but instead, it falsely stated that the firm did not have a condition that impaired its ability to meet obligations to clients. Through this conduct, the firm was found to have violated Sections 206(2) and 207 of the Advisers Act.

The sanctions and undertakings imposed by the SEC included a civil penalty of $100,000 against the firm, and a $50,000 penalty against the majority owner, and both firm and owner were censured. In addition, the firm was required to post the SEC order on its website in a prominent location for 12 months and provide a copy of it to each client.

What’s the takeaway for RIAs here? At its most basic, I believe it is this: honor your advisory contracts with clients. Don’t make clients needlessly jump through hoops to cancel the advisory agreement, and don’t play games with prepaid advisory fees. If there are unearned fees, refund them timely and in accordance with the advisory agreement and the firm’s Form ADV. And, if the RIA is having financial difficulties, be sure to consult counsel about the disclosure obligations. Obviously, when the SEC staff gets called in to address failures like this by complaining clients, things can get messy and obviously costly.

For more information – see the SEC order here.