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Cady Bar the Door Insight & Commentary on SEC Enforcement Actions and Related Issues

SEC’s Asset Management Unit Focuses on Compliance Failures, Vol. 2

Posted in Compliance, Investment Advisers, Non-scienter-based Violations

As we discussed last month, the SEC’s Asset Management Unit has developed a likeness for not just big, headline-grabbing cases, but relatively small compliance-based cases that are designed to prevent minor problems from growing into large ones.  People like to say that the damage is done before the SEC ever gets involved, and that is often true.  But hitting registered investment advisers for compliance failures is about as close to preventing future fraud as the Enforcement Division is likely to get.

The second case the SEC filed on November 20 was In re Evens Barthelemy and Barthelemy Group LLC, Admin Proc. File No. 3-15102.  To understand the case, it is important to remember that for investment advisers, state registration can often be more onerous than SEC registration.  For one thing, an adviser with business that extends across state lines can be required to register in multiple states, and therefore become subject to a mish-mash of regulations that make compliance difficult.  Also, while many states model their recordkeeping requirements on Rule 204-2 of the Investment Advisers Act of 1940, many impose additional requirements.  Apparently, the differences can be enough to make an investment adviser much prefer registration with the SEC, even to the extent of fudging numbers to make it happen.

False Bases for Registration

That appears to have been the case with Evens Barthelemy.  According to the SEC’s order, he formed and registered the Barthelemy Group (“BG”) with the Commission as an investment adviser in July 2009 after having worked as a registered representative of two different broker dealers.  During the relevant period, Section 203A of the Advisers Act and Rule 203A-2(e) prohibited an investment adviser subject to state registration from registering with the Commission, unless it had over $25 million in assets under management or was required to register in thirty or more states.  BG was ineligible for SEC registration under either the multi-state or the $25 million AUM exemption, but that didn’t stop Barthelemy.  He initially registered BG with the SEC under the multi-state exemption, even though BG has never been required to register with more than three states.  In March 2010, Barthelemy changed BG’s basis for SEC registration, claiming his firm met the $25 million AUM threshold.  But BG did not have $26.28 million under management, as were reflected in a spreadsheet Barthelemy gave the SEC’s staff during a 2010 exam.  BG’s assets instead totaled $2.6 million.  Barthelemy had downloaded client account values from the custodian’s online platform, and then manually moved the decimal point for each client one place to the right.

Compliance Failures

BG also did not adopt written policies and procedures required by Rule 206(4)-7 that were reasonably designed to prevent violations of the Advisers Act and its implementing rules.  Barthelemy had a policy manual in place, but he had adopted it largely verbatim from a 2009 version he obtained from his prior employment at a registered broker-dealer.  The manual did not refer to the Advisers Act at all.  Also, no one conducted an annual review of BG’s policies and procedures as required by Rule 206(4)-7(b).

Books-and-Records Failures

Finally, Barthelemy did not cause BG to keep certain required books and records required by the Advisers.  BG did not have the written acknowledgements of the firm’s code of ethics required by Rule 204-2(a)(12)(iii).  BG also did not have a record of the dates that its ADV Part II was given or offered to clients or prospective clients as required by Rule 204-2(a)(14)(i).

Lessons

The lessons for investment advisers here hardly need to be spelled out separately.  But still:

  • If you are subject to state registration, register with the appropriate states.  You cannot game your way into less onerous registration with the SEC.
  • Rule 206(4)-7 requires you to have written policies and procedures designed to prevent violations of the Advisers Act.  Have them and tailor them appropriately for your business.  You cannot take inapposite procedures and say that they fit under the rule.
  • Finally, being an investment adviser is a complex business, and the books and records requirements under Rule 204-2 are proportionally complex.  Take the time to learn the rules and be a stickler for compliance.  The SEC will stay out of your hair that way.