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U.S. Securities and Exchange Commission

2006 CCOutreach Regional Seminars
Investment Adviser Case Study

This case study is designed to illustrate compliance issues that arise with investment advisers of varying size and complexity. The discussion will begin with a very small adviser of limited complexity, and will continue with the growth of the adviser and the sequential addition of complexities. You are asked to participate in the discussions for each scenario presented in this case study to determine the following:

  • What risks or concerns does the scenario raise (e.g., potential harm to clients, violation of securities laws and/or fiduciary duty, litigation exposure, etc.)?
  • What key control processes have been or can be implemented and what policies and procedures are needed to address the concerns?
  • What forensic tests could be performed?
  • What disclosures may be necessary?

You will be given worksheets to document our discussions (“risk matrix”). Information to complete the risk matrix will come from both the audience and SEC staff presenters.1 The discussions are meant to assist you in understanding processes that can be used to create a risk inventory and determine what policies and procedures may be necessary based on the risks present at your firm. Further, discussions of various forensic tests may be helpful in structuring your compliance program review, both on an ongoing basis and for purposes of the required annual review.

Basic Scenario

SEC Registered Advisers, Inc. (“SRA”) has $47 million under management. It also:

  • Employs four staff; all of whom work from the same location
    • The sole owner of SRA manages all portfolios
    • One employee places all orders
    • One employee serves as director of marketing and CCO
    • One employee provides clerical assistance
  • Invests all client portfolios exclusively in no-load, unaffiliated mutual funds through the fund platform of a large, nationally-known broker-dealer

Variation One — More Complex Investment Strategy

Now, assume that the number of employees remains the same, but SRA:

  • AUM increase to $200 million
  • Manages equity, fixed-income, and balanced portfolios
  • Offers a highly complex arbitrage strategy that uses significant leverage
  • Offers an affiliated hedge fund to advisory clients
  • Offers unaffiliated, private placements to clients
  • Starts a small mutual fund

Variation Two — SRA Grows

Analyze the fact patterns in Variation One while assuming SRA’s AUM increase to:

  • $400 million and the number of employees increases to 12
  • $3 billion and the number of employees increases to 30

Variation Three — Affiliations

Assume SRA is:

  • Dually registered as an investment adviser and broker-dealer and has advisory reps in 80 different offices around the country
  • Acquired by a large financial services firm that owns other advisers and broker-dealers

Variation Four — Brokerage and Trading

Assume the various size scenarios in Variation Two and that SRA’s trading and brokerage practices include the following:

  • Discretion over client brokerage
  • Use of an affiliated introducing broker-dealer
  • Use of an affiliated clearing broker
  • SRA’s employees acting as registered reps of an affiliated broker-dealer
  • Soft dollar arrangements
  • Directed brokerage
  • Use of brokers that refer clients to SRA
  • Allowing brokers to cover SRA’s trade errors
  • Acting as adviser to various wrap fee programs
  • Principal transactions
  • Cross transactions

Variation Five — Marketing

Assume SRA markets its services:

  • By advertising performance
  • Through a website
  • On websites sponsored by others
  • Through consultants
  • By using solicitors
  • By responding to RFPs
  • By paying “finders fees” for referrals to its hedge funds

Variation Six — Additional Complexities

Assume SRA:

  • Charges performance fees
  • Meets regularly with issuers and serves on creditors’ committees
  • Allows certain employees to serve on boards of directors
  • Publishes a newsletter
  • Chooses securities lending agents for clients
  • Acts as trustee for client accounts
  • Serves as business manager for advisory clients
  • Recommends a private company in which SRA’s principals have a significant ownership interest




Modified: 06/06/2006