On June 30, 2022, the SEC issued an order detailing the settlement reached with an investment adviser and its principal and Chief Compliance Officer (CCO) relating to the alleged failure to adopt and implement required written compliance policies and procedures.

Under the adviser’s compliance program, investment advisory representatives were required to disclose outside business activities to the adviser and to comply with the compliance policies of the broker-dealer used by the adviser in its advisory business. In the order, the SEC alleged several instances between December 2019 and June 2021 in which the CCO knew, or should have known, that the adviser’s compliance program was inadequate in this regard. For example, in February 2020, the CCO is alleged to have received communications from an investment advisory representative about an outside business activity but did not require the representative to submit a formal reporting form, did not review whether the outside business activity presented any conflicts of interest and did not take sufficient steps to verify that the adviser or the representative disclosed the outside business activity to clients. In addition, despite receiving notices later in 2020 from the broker-dealer to review transactions conducted by the same representative involving transfers of client assets to the representative’s outside business activity, the CCO allegedly did not conduct a review of the legitimacy of the transactions. This pattern is alleged to have continued despite the broker-dealer subsequently flagging that the representative in question took steps to avoid the broker-dealer’s compliance program. Ultimately, following repeated warnings and notices, when the CCO reported the representative’s outside business activity to the broker-dealer, the broker dealer terminated its relationship with the adviser.

The SEC found that the adviser willfully violated Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder, which require that investment advisers adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act. Furthermore, the SEC found that the CCO willfully aided and abetted and caused the adviser to commit the foregoing violations.

In settlement of the charges, the adviser agreed to a censure, to cease and desist from future violations and to pay a $150,000 civil penalty. The CCO agreed to cease and desist from future violations, to refrain from acting in a supervisory or compliance capacity with any broker, dealer, investment adviser, municipal securities dealer, municipal adviser, transfer agent or nationally recognized statistical rating organization for five years and to pay a $15,000 civil penalty.

SEC Commissioner Hester Peirce issued a statement in response to the actions surrounding the order. She remarked that this was an opportunity to examine how a potential CCO liability framework might work in practice. She discussed several considerations to determine whether a CCO should be held personally responsible for a violation, particularly in distinguishing conduct that is “’debatably inappropriate’ from conduct that is ‘wildly inappropriate’—or, as it has been called in the past—’a wholesale failure’ to carry out compliance responsibilities.” These considerations include whether the CCO made a good-faith effort to fulfill his or her responsibilities, whether the failure related to a fundamental or central aspect of a well-run compliance program, whether the failure persisted over time, whether the failure related to a discrete specified obligation under securities laws or the firm’s compliance program, whether the SEC issues rules and guidance on point related to the failure and whether an aggravating factor contributed to the seriousness of the CCO’s conduct.

The SEC’s order is available here.

Commissioner Peirce’s statement is available here.