SEC Fines Registered Investment Adviser for Misrepresentation of Investment Performance and Marketing Violations

Publish Date

Type

Compliance Alert

Topics

  • Performance
  • SEC Advertising Rule

On June 3, 2021, the U.S. Securities and Exchange Commission (SEC) instituted a cease-and-desist order against a previously registered investment adviser for alleged violations, including:  

  1. Misrepresentation of investment performance and omitted disclosure information; 
  2. Using paid bloggers to solicit U.S. investors without adequate disclosure; and 
  3. Failure to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act.

Background

The adviser operated a “robo-adviser,” an automated digital investment advisory program that was marketed to individuals through its website and social media platforms. Below outlines how the adviser marketed performance: 

  • On their website, the adviser used modeled returns to claim that their portfolios had outperformed the market for the last 11 years. In reality, the adviser was only in operation for less than two years, from June 2018 to October 2019, during which it underperformed the S&P 500 index (the index they used for the comparison).
  • The website stated that the adviser had achieved an “average annual return of 16.86%.” This number was based on the modeled testing, which implied that their operations had begun in 2007 rather than 2018. By the adviser’s own calculation, it achieved a return of 5.03% during its period of actual operation, which it did not advertise. 
  • The website stated that the adviser’s “technology has been tested for 11 years and has outperformed our closest competitor since inception.” The adviser failed to disclose that it had been in operation for less than two years and that the performance was hypothetical and based on modeled testing. Additionally, the adviser’s modeled performance was compared to the actual performance of another unnamed robo-advisor identified by the adviser as its closest competitor despite a significant difference in their assets under management.
  • The adviser conducted a client referral program through which it paid cash compensation to certain bloggers for successfully soliciting new clients to open accounts with the firm. The adviser did not have written solicitation agreements with these bloggers. As such, solicited clients were not provided with the required disclosure documents before entering into an advisory contract.
  • The adviser failed to implement its policies and procedures requiring the review and approval of any marketing or advertising materials. The policies and procedures failed to include a process for confirming the accuracy of statements made on the adviser’s website. The policies and procedures manual also stated that the adviser did not pay referral fees. 

Allegations made by the SEC

The SEC made the following allegations against the adviser:

Misrepresentation of investment performance and omitted disclosure information   

  • The advertisements on the adviser’s website failed to disclose that hypothetical, model performance was used to calculate the 11-year track record. The adviser falsely claimed that it had outperformed the market, when in fact the adviser’s actual investment performance had underperformed. The adviser misleadingly compared its modeled performance to the actual returns of another adviser identified as a close competitor despite significant differences in their assets under management.
  • The adviser paid bloggers, which were a significant source of the adviser’s new clients, without fulfilling the disclosure and documentation requirements under the Cash Solicitation Rule. Bloggers would place a hyperlink for the adviser’s website in or near a favorable blog post about the adviser. The investment adviser paid the participating bloggers for referring new clients and for their reviews of the adviser.

Failure to adopt implement policies and procedures reasonably designed to prevent violations of the Advisers Act 

  • The adviser’s compliance manual included policies and procedures that required the review and approval of any marketing or advertising materials, which it failed to implement.
  • The adviser failed to include policies and procedures for confirming the accuracy of statements made on the adviser’s website. The adviser’s policies and procedures incorrectly stated that the advisor did not pay referral fees. The adviser did not implement policies and procedures in connection with payments made to bloggers for successfully soliciting new clients.
  • Sanctions imposed by the SEC

The SEC imposed the following sanctions on the adviser:

  • Cease-and-desist order
  • Censure
  • The adviser was ordered to pay a civil monetary penalty in the amount of $25,000 to the SEC.

How we help

ACA works with investment advisers to review performance, marketing materials, and policies and procedures to meet regulatory expectations. 

  • Focused Performance Reviews: We offer focused performance reviews to assist firms in validating investment performance and the supporting books and records. The focused performance review includes a review of the appropriateness of the construction of the track record, calculation methodologies underlying investment performance, adequacy of controls around the creation and review of investment performance, and the completeness of accompanying disclosures. The focused performance review helps firms prepare for regulatory scrutiny by strengthening the tools used to demonstrate global capabilities across strategies and the controls in place to govern how performance is produced.   
  • Marketing Reviews: We provide outsourced marketing reviews and technology to manage the marketing review process.
  • Policies and Procedure Updates: We review existing policies and procedures and provide guidance for updating and training to employees.
  • Cash Solicitation Rule: We have been assisting clients with complying with the cash solicitation rule, which was recently amended as part of the SEC’s new marketing rule, for over 15 years.   

SEC Marketing Rule Resources

Please visit our new marketing rule resource page available here for additional information.  

For more information

If you have questions about the SEC’s recent performance-related enforcement cases or would like more information on our focused performance reviews or how we can assist with an update or a review of any policy or procedure, please reach out to your ACA consultant or contact us here.