In a series of enforcement actions this week, the SEC made it clear that investment advisers need to substantiate the performance records of investment management firms they recommend to their clients. In these cases, failure to do so resulted in charges of spreading "false and misleading information" in violation of Section 206 of the Advisers Act.
Although presumably it is not necessary to recalculate performance data, the SEC staff said that when "an investment adviser echoes another firm's performance claims in its own advertisements, it must verify the information first rather than merely accept it as fact."
The SEC found in each case that the investment adviser negligently relied on performance information related to a separately managed account strategy managed by a third-party adviser. The advisers forwarded performance advertisements created by the third-party investment adviser without appropriately confirming the accuracy of the information in those advertisements. As a result, the SEC said, the advisers "failed to have a reasonable basis to believe that [the] performance was accurate," and they therefore distributed false and misleading advertisements to their clients in violation of Section 206(4) of the Advisers Act.
The advisers were also cited for failure to maintain books and records necessary to validate the performance claims.
Advisers are on notice, with these actions, that they cannot take performance claims of underlying advisers at face value. If performance is too good to be true, it just might be . . . too good to be true. The obligation for making sure that clients have full, fair and accurate information upon which to make investment decisions rests squarely with the adviser that has the client relationship. Reliance on information provided by others is, without verification, apparently not reasonable. Advisers should institute due diligence protocols to ensure that they are asking the right questions – and getting the right back-up – when it comes to performance data created by another entity.
Penalties assessed against 13 registered investment advisers caught up in the enforcement sweep ranged from $100,000 to $500,000. All 13 firms settled without admitting or denying the charges.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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