SEC Sues Investment advisers For Compliance Failures, Part 3

In the final chapter of this Cady Bar the Door investment adviser extravaganza, we examine In re Feltl & Company, Inc., Admin. Proc. File No. 3-14645 (Nov. 28, 2011). Minneapolis-based Feltl & Co. is a dually-registered broker-dealer and investment adviser, and substantially larger than the other two IAs in the trio, OMNI and Asset Advisors. Feltl’s brokerage business consists of 125 registered representatives and over 12,000 accounts holding nearly $1.2 billion in assets. As of March 2011, its advisory business had 547 non-discretionary advisory accounts with $107 million in assets under management (AUM”). All the advisory accounts are wrap fee accounts that pay one bundled or “wrap” fee for advisory, execution, clearing and custodial services in the form of a percentage of the accounts’ AUM.

The SEC found that from February 2008 through March 2011, Feltl failed to adopt and implement comprehensive a written compliance program designed to prevent violations of the Advisers Act and its rules. This failure in turn resulted in some substantive lapses. Specifically, Feltl:
•engaged in hundreds of principal transactions with its advisory clients’ accounts without making the proper disclosures and obtaining consent in violation of Advisers Act Section 206(3); and
•charged its clients undisclosed fees by charging both wrap fees and sales commissions in violation of Advisers Act Section 206(2).
Feltl also neglected to adopt a code of ethics and collect required securities disclosure reports from its staff.

Initially, Feltl viewed its advisory business as an accommodation to brokerage customers who were active traders and preferred to pay one bundled, asset-based fee (versus multiple transaction-based fees) through Feltl’s wrap fee program. Unfortunately, as the advisory business grew, and compelled registration as an investment adviser, the chief compliance officer’s time remained focused almost solely on Feltl’s brokerage business. Two SEC exams in 2009 and 2010 revealed the firm’s failure to implement an effective written compliance program. What Feltl had was an off-the-shelf compliance manual that mainly addressed the brokerage business and lightly touched on the advisory side. This fairly perfunctory manual led to the substantive failures described above.

The Commission ordered Feltl to pay disgorgement of $142,527 to account for the undisclosed principal transactions and sales commissions, as well as prejudgment interest of $10,465 and a civil penalty of $50,000. Feltl also had to submit to a fairly extensive set of undertakings to be sure this sort of thing does not happen again. But unlike OMNI and Asset Advisors, its business survives.

Two things before we move to the exciting hedge fund coda of Asset Management Unit week here at Cady Bar the Door: First, while Rule 206(4)-7 doesn’t dictate the content of an adviser’s compliance program, the SEC has stated that an adviser’s manual should at least address certain topics, such as portfolio management processes, proprietary trading by the adviser, and the valuation process of client assets. That guidance is not a secret and is available for your perusal in the form of the Commission’s adopting release for the rule. See Compliance Programs of Investment Companies and Investment Advisers, Release Nos. IA-2204 and IC-26299; 68 F.R. 74714 (Dec. 24, 2003). Second, if you are a dually-registered broker-dealer and investment adviser, you have to pay attention to both sides of your shop. Ignoring half of your compliance responsibilities is not a reasonable option and will be punished.