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Tall tales are a red flag for regulators

May 18, 2014 @ 12:01 am

By Les Abromovitz

regulators, compliance, red flags, aum, sec, securities and exchange commission, exam, regulator
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If you're a fisherman, exaggerating the size of the fish you caught is a tradition. When you're an investment adviser, however, exaggerations can get you caught up in compliance problems.

Like all business owners, advisers need to sell themselves to prospective clients, but they should never oversell their abilities and experience. Although they might hook a few more clients with exaggerations, they are also likely to lure examiners to their offices.

Registered investment advisers and investment adviser representatives operate in a highly regulated environment. Examiners will review an RIA's advertisements to determine if they are false or misleading. They will also review an RIA's Form ADV to determine if it is accurate, truthful and complete. For example, an adviser should never misstate the number of employees or accounts managed.

INHERENTLY MISLEADING

State and SEC advertising rules prohibit the use of content that is false or misleading. Marketing hype and exaggerations are inherently misleading. An RIA must be able to prove all statements made in advertisements with objective evidence.

Small RIAs occasionally use words on their website, such as “we” and “our team,” that exaggerate the size of the firm. It would be misleading for a sole practitioner's website to use stock photos of numerous people around a conference table, which might imply that the firm is larger than it actually is.

In some instances, RIAs exaggerate their assets under management because they believe it is necessary to appear larger in order to compete for institutional clients. Some advisers also inflate their AUM in order to fall under the jurisdiction of the SEC, which they might prefer as opposed to a state regulator.

Conversely, some RIAs' advertising pitches focus on their small size to convince prospects that they will receive personal attention and better service. As part of this marketing strategy, the adviser might misrepresent the firm's client-to-IAR or client-to-staff ratio. There have also been instances where RIAs under-report their AUM in order to avoid having to register with the SEC, preferring a state regulator.

UPDATE YOUR AUM

Too many advisers fail to update their AUM on their website or in other marketing materials. If an advertisement refers to AUM, the RIA should state the date on which those figures were calculated. Even if the date of the calculation is stated, outdated AUM can cause problems for the RIA.

AUM should be accurate and consistent with figures mentioned on Form ADV and in social media profiles. During a regulatory examination, SEC and state examiners will often verify the existence of assets managed by the RIA by asking clients and custodians to confirm that account balances are consistent with the firm's books and records.

Examiners will scrutinize RIAs' books and records to ensure that firms are not exaggerating their performance returns in advertisements. Furthermore, returns must be presented on a net-of-fees basis and should be accompanied by numerous disclosures.

In recent years, securities regulators have expressed a great deal of concern about advisers who exaggerate their qualifications, especially when they use designations that imply special expertise relating to senior citizens.

Although senior-related designations and certifications are most likely to cause a compliance problem, IARs should exercise restraint when describing any of their credentials. They should never embellish the educational requirements, qualifications and expertise required to earn their designations and certifications.

Advisers should be precise when describing their qualifications. For instance, it may be misleading for an IAR to advertise that he is an attorney if he never passed the bar. Similarly, an IAR should not use the CPA designation unless she has an active license or discloses that her designation is inactive.

An advisory firm's chief compliance officer should ensure that all information provided by the firm to regulators and investors is accurate, thorough and complete. The CCO should put a stop to exaggerations and inconsistencies in disclosure brochures and advertisements, as well as in social media.

In many cases, advertisements and social media profiles contain misinformation, because they are not kept up-to-date. CCOs should stay on top of this information to ensure that it has not become stale and misleading.

Les Abromovitz is an attorney and senior consultant with National Compliance Services.

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