SEC Charges Former Investment Advisory Firm President with Stealing Clients' Funds; Commissioner Gallagher Dissents (with Lofchie Comment)

The SEC announced fraud charges against an investment advisory firm's former president, who is accused of stealing clients' funds.

The SEC Enforcement Division alleges that the former president of SFX Financial Advisory Management Enterprises ("SFX") used his control of and discretionary authority over the accounts of several clients to steal approximately $670,000 over a five-year period by writing checks to himself and initiating wires from client accounts for his own benefit.

The SEC filed a separate charge against SFX and its chief compliance officer ("CCO"), finding that the firm failed to supervise the former president, violated the custody rule, and made a false statement in a Form ADV filing. Additionally, the SEC found that the CCO caused some of SFX's compliance failures through negligence by failing to conduct reviews of cash flows in clients' accounts and not performing an annual compliance review.

Commissioner Daniel Gallagher issued a statement regarding the current charges against SFX's CCO and a similar enforcement action from April 2015, both of which involve violations of Investment Advisers Act Rule 206(4)-7 ("Compliance Procedures and Practices"). Commissioner Gallagher explained that he voted against the two settled enforcement actions because he has "long called on the Commission to tread carefully when bringing enforcement actions against compliance personnel."

According to Commissioner Gallagher, both settlements illustrate the SEC's trend "toward strict liability for CCOs under Rule 206(4)-7." He stated that actions like these are "undoubtedly sending a troubling message that CCOs should not take ownership of their firm's compliance policies and procedures, lest they be held accountable for conduct that, under Rule 206(4)-7, is the responsibility of the adviser itself." Commissioner Gallagher said that he is especially worried about the potential impact of this trend on small advisers. He placed much of the blame for these actions on Rule 206(4)-7 itself, and encouraged the SEC to consider whether amendments or SEC-level guidance are needed to clarify the roles and responsibilities of compliance personnel under the rule "so that these individuals are not improperly held accountable for the misconduct of others."

Lofchie Comment: The SEC's April 2015 enforcement action against a CCO attracted a good deal of industry comment that was largely negative, since the action was viewed as something of a stretch as applied to a CCO. Regulators might take pride in aggressive or clever enforcement actions that move the law, but such actions are largely inappropriate. Excessive cleverness generally means that market participants were not made aware of the regulators' view of the law, thus participants had no opportunity to conform their behavior to that view. Commissioner Gallagher's argument that the SEC should be cautious in bringing enforcement actions against CCOs is correct. Such actions will simply dissuade the most qualified persons from taking the job and the risk. As things stand, any senior-level compliance person who can credibly appoint a junior person as a firm's CCO would be wise to consider the possibility of further actions, given the risks of serving in that position.

See: SEC Order against SFX and CCO; SEC Order against Former SFX President; SEC Press Release; Commissioner Gallagher's Statement.