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Securities Compliance Sentinel Analysis of cutting-edge securities industry issues

You Need a “Shadow” If You Want to be a RIA Today

Posted in Compliance and Supervision, Internal Investigations, Investment Adviser Regulation, SEC Enforcement

The SEC, recently, sued a private equity fund adviser for, among other things, allegedly violating Investment Advisers Act of 1940 Rule 206(4)-7, for failing to have procedures requiring verification of client signatures and instructions by a second person.  See http://www.sec.gov/litigation/complaints/2012/comp-pr2012-244.pdf.

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The SEC stated that the RIA and its principal made certain unauthorized transactions and used clients’ funds to pay off debt owed by the principal.  The specific violations related to Rule 206(4)-7, involved the RIA’s failure in not having a second set of eyes review client signatures and other instructions.  The SEC believed this would have prevented these defalcations.  Essentially, the SEC argues that a “shadow” is necessary to avoid these unlawful acts.  Interestingly, however, this type of illegal activity alleged seems to take place even with the best of compliance programs.

Nonetheless, RIAs must be vigilant in ensuring that more than one person reviews both client signatures as well as instructions, and, who knows, the “shadow” may just save the firm.