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Non-Compliant Compliance: SEC Sanctions Chief Compliance Officer

Non-Compliant Compliance

On Thursday, June 30, 2022, the U.S. Securities and Exchange Commission (“SEC”) instituted Administrative and Cease-And-Desist Proceedings against a Georgia registered investment adviser, Hamilton Investment Counsel (“HIC”), and its principal and Chief Compliance Officer, Jeffrey Kirkpatrick (“JK”) for failure properly to supervise and to ensure compliance by a HIC investment adviser representative (“IAR”) regarding his outside business activities (“OBA”). Responding to settlement offers by HIC and JK, the SEC issued an Order on June 30, 2022, reflecting the Commission’s Proceedings. The Order notes that HIC, organized in 2016 and registered with the Commission since March 9, 2018, managed assets of some $196 million. JK was also a registered representative of an SEC-registered broker/dealer (“B/D”) used by HIC in its advisory business.

JK was the principal of HIC and, notionally, its owner.  He also served, as noted, as the Chief Compliance Officer for HIC, and as such, was responsible (per the Order) “for administering HIC’s compliance program and … for implementing the firm’s compliance policies and procedures.” In accordance with that program, IARs were required to disclose OBAs to HIC and to comply with the B/D’s compliance policies. By February 2020, the IAR to JK that he had OBA, but as stated in the Order, JK did not require the IAR to complete and submit the HIC form for reporting an OBA, nor did JK undertake “sufficient review to determine whether the OBA presented any conflicts of interest,” as required by HIC’s compliance manual. JK received additional information in June 2020 about the IAR’s OBA. Then in August 2020, the B/D “flagged” certain transactions “conducted by the IAR involving transfers of HIC client assets to the IAR’s OBA,” but JK did not investigate the legitimacy of the transactions. In September 2020, JK learned that the IAR was avoiding the B/D’s compliance program, but JK again elected not to review the IAR’s actions. In November 2020, JK discovered that the IAR was using his office at HIC for a second OBA but did not check to see that this second OBA had been accurately reported to HIC or that the IAR complied with the B/D’s compliance requirements. When JK finally did report information about the IAR’s OBAs to the B/D in June 2021, the B/D ended its relationship with HIC.

The Commission found that HIC willfully violated the Investment Advisers Act of 1940, as amended, and SEC rules thereunder, and that JK had aided and abetted HIC and caused HIC to engage in those violations. HIC and JK were ordered to cease and desist from violating the securities laws and to pay civil money penalties: $150,000 in the case of HIC and $15,000 in the case of JK. Additionally, JK was barred from serving in any supervisory or compliance capacity with any broker/dealer, investment adviser, municipal securities dealer or advisor, transfer agent, or nationally recognized statistical rating organization, with a right to apply to end the bar after five years. On April 26, 2022, HIC terminated its registration as an investment adviser.

The Commission adopted rules effective Feb. 5, 2004, requiring investment companies and investment advisers (such as HIC), to have “policies and procedures reasonably designed to prevent violation of the federal securities laws … and designate a chief compliance officer (like JK) to be responsible for administering the policies and procedures,” according to the SEC Adopting Release of Dec. 17, 2003. That Release goes on to note that in 2003, “the Commission and state securities authorities … discovered unlawful conduct involving several fund advisers, broker-dealers, and other service providers. … We are taking … [these] regulatory actions to curb the abusive practices recently discovered and to prevent their recurrence.” The Chief Compliance Officer of an investment adviser or other capital market participant is to some extent the functional cognate of quality control personnel employed by manufacturing companies; if quality control personnel do not carry out their tasks, both the quality of the products manufactured, and the safety of customers are at risk. When a Chief Compliance Officer does not perform his or her assigned tasks, the investment adviser is at risk of delivering compromised advice, harming advisory clients, and/or allowing fraudulent activity to occur and continue.

It appears from the Order that JK clearly neglected his duties, perhaps from distraction, overwork, or even boredom. In any event, HIC clients were both imperiled and ill-served, and so was the B/D, thus requiring the five-year bar imposed by the Commission on JK. I have previously written about derelict compliance officers in my Dec. 15, 2020, Blog “When the CCO Is Not Compliant: Failure to Have Independent Testing of Broker/Dealer AML.” The importance of compliance officers cannot be overstated. It may be appropriate to consider in this connection the concerns expressed by Plato in his “Republic,” where Plato has Socrates (in his Dialogue) propose a guardian class to protect society against the risks of imperfection. Certainly, the SEC seeks to protect the capital markets, including investors, from abuses carried out by those whom investors have engaged to give them wise advice.

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