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Timely and Accurate Disclosure

 
Saturday, July 30, 2016

Timely and accurate disclosure of a company’s policies and procedures is essential in business especially when the company manages the assets of others.  For Registered Investment Advisory (RIA) firms, that disclosure is made through the Form ADV which details how a firm conducts business, how they charge for services provided and discloses any issues of the firm and/or its Representatives that the public should be aware of.  The Securities and Exchange Commission (SEC) requires annual filing of Form ADV as well as “prompt” filing of an amendment should there be any material change to the business.  The SEC does not provide a specific time that an amendment should be filed but many States require that amendments be filed within 30 days of the material change.  A very recent example provides insight into how a firm can run afoul of this requirement how the public can be harmed when disclosures are not made.

The example involves a firm providing services for wrap fee programs intended to “wrap” or combine services for a set fee which would include trading costs and execution.  In order to provide trading services covered by the wrap fee, client trades would be executed through a designated broker-dealer (BD) disclosed in the wrap agreement.  Trades can be directed to another BD if the firm believed it is in the best interest of the client to do so by providing better pricing or faster trade execution as an example.  By directing trades to another BD (aka trading away) the client may be charged additional fees that would have been covered if the trades were executed at the designated BD.  The benefit to the client should obviously be greater than the additional fee.

Beginning in 2008 RiverFront Investment Group, LLC (RiverFront) was directing almost all of its wrap trades to the designated BD for execution as outlined in the ADV and so, almost all transaction costs were covered by the annual wrap fee charged.  In the second quarter of 2009, RiverFront began trading away all exchange-traded fund securities; by the third quarter of the same year they were trading away trades in small and mid-cap securities; by the end of 2009 all fixed income securities were being traded away and by mid-2010 RiverFront was trading away all equity securities including large cap equities.  At the beginning of 2010 RiverFront was trading away approximately 74% of the market value of its overall wrap fee program and approximately 82% in 2011.

Although RiverFront did not profit by trading away, and it claims to have obtained improved execution pricing by doing so, this practice cost its clients millions of dollars in fees that would have been covered if the same trades had been executed through the designated BD.  Additionally, as the firm began to shift towards a practice of trading away, it failed to disclose that change in procedure to its clients who could have made a more informed decision if they wanted to stay or move their accounts.

This failure to provide accurate information cost the clients greatly and as a result RiverFront was fined, censured and required to disclose on a quarterly basis (on its public website) the volume of trades by market value executed away from sponsor firms and the associated transaction costs charged by non-designated BD’s and passed on to clients.

About Red Oak Compliance Solutions

Red Oak Compliance Solutions is a leading provider of intelligent compliance software, offering a range of AI-powered solutions designed to help firms of all sizes successfully navigate the increasingly complex regulatory landscape. Our suite of 17(a)-4/WORM compliant features offer risk minimization, cost reduction, and process optimization capabilities with features that are designed to evolve with our client’s needs. Our flagship advertising review software enables firms to deliver compliant content to the market with confidence, faster. Our Disclosure Management and Intelligence solution simplifies the management of disclosures, while our Registration Management solution automates and streamlines the licensing and registration process, further enhancing your internal processes. 

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