SEC Emphasizes Building a Culture of Compliance and Avoiding Misrepresentation

During a speech at the Regulatory Compliance Association’s (RCA) 2013 program on regulation, operations, and compliance, U.S. Securities and Exchange Commission (SEC) commissioner Luis Aguilar highlighted the importance of compliance practices being developed and maintained in the interest of investors. His introductory remarks provided statistics on the growth in the number of firms registered with the SEC under new requirements, as well as the increasing number of enforcement actions filed by both the SEC and state regulators.

Aguilar shared these statistics to stress the important role that trust plays in the relationship between investors and their financial advisers. An earlier blog post discussed how both the investing public and investment professionals recognize the damage recent scandals and events have had on market trust. According to Aguilar, “the statistics indicate that more work needs to be done to earn investor trust.” He further emphasized:

• The importance of building a culture of compliance that will result in a robust and effective compliance environment that works for investors.
• The corrosive impact on investor trust that arises as a result of certain practices and conduct by investment advisers — particularly insider trading and problems in the area of valuation.

In his speech, Aguilar did overlook another trend that I have seen developing in other recent enforcement actions. In two different April announcements, the SEC cited individuals and firms for misrepresenting specific types of information that were provided to clients, yet these situations were unrelated to actual trading activities.

The first enforcement action touched on a firm’s misrepresentation of its adherence to and verification of compliance with the GIPS standards. ZPR Investment Management, through Max Zavanelli, allegedly provided advertising material that omitted key information concerning performance comparisons to the relevant benchmark. When a firm claims compliance with the GIPS standards, it provides a signal to investors as to the quality of its reported performance. Investors can be misled when a firm makes such a claim, without actually meeting the reporting requirements.

According to the announcement, “in view of the allegations made by the Division of Enforcement, the Commission deems it necessary and appropriate in the public interest that public administrative and cease-and-desist proceedings be instituted.” A final resolution on this case has not been reached at this time.

The second enforcement action dealt with the misrepresentation of a firm’s assets under management (AUM) to potential clients and to the SEC. Umesh Tandon allegedly made false and material overstatements of the AUM of his firm, Simran Capital Management, to meet the minimum AUM requirements of specific investors. This misstatement allowed the firm to earn the business of these investors without actually meeting the necessary requirements. Once the business was earned, Tandon (and others as he instructed) continued to provide the fraudulent values, even in required SEC form ADV filings.

Simran Capital Management withdrew its SEC registration in 2012 and closed out of its investment positions. According to the announcement, “Tandon neither admitted nor denied the findings and agreed to be barred from the securities industry and pay disgorgement of $20,018, prejudgment interest of $1,680, and a penalty of $100,000.”

CFA Institute standards and guidance highlight the importance of honesty and transparency in the information provided to both current and prospective clients. The CFA Institute Code of Ethics and Standards of Professional Conduct states that “members and candidates must not knowingly make any misrepresentations related to investment analysis, recommendations, actions, or other professional activities.” The Asset Manager Code of Professional Conduct includes the provision where managers must “ensure that disclosures are truthful, accurate, complete, and understandable and are presented in a format that communicates the information effectively.” Individuals and firms that fail to maintain these principles when dealing with clients are further eroding the clients’ trust just as someone trading on inside information.

The SEC is clearly taking steps to protect the interest of investors. Enforcement actions of this nature demonstrate to firms the need to conduct all their activities within the guidelines of the regulations. And it could not hurt for firms to step beyond those minimum requirements to always engage and communicate with their clients with honesty and transparency.