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Regulators to crack down on phony AUM

Jan 18, 2013 @ 3:32 pm

By Dan Jamieson

Assets under management
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The deadline for reporting annual assets under management is fast approaching for many registered investment advisers, and overstating those assets — either by design or out of ignorance — is putting them at risk of enforcement actions by state and federal regulators.

Inflating assets is a real temptation for some firms near the $100 million threshold for registering with the Securities and Exchange Commission, said Brian Hamburger, founder of MarketCounsel LLC, a compliance firm.

Under the Dodd-Frank Act, firms with assets under that amount must register with state securities regulators, who generally conduct examinations more frequently than the SEC. The old threshold was $25 million.

Being an SEC-registered adviser also carries a certain prestige, according to Mr. Hamburger.

“There's mounting pressure to show that mine's bigger than yours,” he said.

Another problem is that some RIAs apparently don't know how to calculate assets under management accurately.

Steve Thomas, director of compliance at RIA in a Box LLC, points to one case into last year in which a financial adviser reported $900 million in assets to the SEC when in reality the firm had no assets that qualified under SEC rules.

The firm had to transfer to state registration.

In a similar situation, Mr. Hamburger recently began working with an adviser who had never taken on a contractual obligation to supervise customer assets regularly, which is required under the SEC's definition.

The adviser “went from $150 million to zero” under management, Mr. Hamburger said. The firm was able to stay registered with the SEC by rewriting its client contracts.

More such problems could crop up soon.

Advisers with fiscal years ending in December will have to calculate regulatory assets for their annual ADV updates by the end of the first quarter.

NEW CALCULATION

Adding to adviser confusion is a new method for calculating assets that the SEC implemented last year under Dodd-Frank. The new method came with a new moniker, as well — “regulatory assets under management.”

“There's always been confusion about calculating assets, and it just got more confused last year when the whole switch process was going on,” said Marilyn Miles, vice president of investment adviser services at National Regulatory Services.

Ms. Miles expects to get more questions from advisers this quarter during annual updates.

The SEC changed the rules so that advisers now have to include family and proprietary accounts, accounts for which they're not paid and accounts of foreign clients. Also, assets are now reported on a gross basis rather than net of margin debt.

The objective was to reduce regulator shopping by playing games with asset figures.

In another new twist, the SEC now lets advisers report a separate asset figure on the narrative Part II of the ADV form, a change that has resulted in further confusion among advisers.

“The Part II figure usually includes nonmanaged assets that an adviser is just monitoring,” Ms. Miles said. “Part I [of the ADV] has regulatory assets that have to be managed continuously and regularly” under the SEC's strict definition, she said.

Some refer to that more expansive Part II number as “assets under advisement.”

But “there's no reason to calculate [assets under advisement], other than to make marketing claims” and move up on lists of top advisers, Mr. Hamburger said.

Mr. Thomas agrees. “The major reason most of our clients want to list these assets [under advisement], especially if it is a large number, is for image purposes,” he said.

Compliance pros said advisers need to be sure to document and explain how the assets-under-advisement figure is calculated.

“As long as this figure is not overstated, there should be no problems with allegations of misleading the client,” Mr. Thomas said.

Since last summer when the new regulatory structure took effect, the SEC and state regulators have been paying close attention to discrepancies in Form ADV filings and other issues at advisory firms they regulate.

The SEC has implemented a program some have dubbed Operation ADV to scrutinize high-risk advisers, and state regulators have said they expect more enforcement actions to come from stepped-up reviews of the additional 2,300 midsize advisers they now oversee.

“All regulators are spending more time now reviewing assets under management,” Mr. Thomas said.

SUBHEA

“I think the SEC, during recent inspections, has actually focused more on how advisers are calculating assets,” Ms. Miles said. “At the very least, it's resulted in [some] deficiencies.”

“Misstated AUM have been an aspect to several enforcement actions arising out of exams,” said SEC spokesman John Nester in an email.

A few formal enforcement cases have popped up recently.

Last November, the SEC settled with New York-based Barthelemy Group LLC over allegations that the firm inflated its assets under management.

And in September, Massachusetts regulators claimed that CCR Wealth Management LLC of Westborough, Mass., overstated its assets for several years prior to switching to state oversight. The state is seeking to deny registration to CCR.

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