The Dangers of Living in the Land of RIA Make-Believe

The Seventh Circuit just ruled that a company could not enforce a mandatory arbitration clause in a contract because the company name in the contract did not match the company name trying to enforce the arbitration clause. So what does that have to do with investment advisers and financial advisers in general?

My experience has been that professionals in the investment industry tend to have big egos. They want to present the best image possible in order to gain clients and grow their AUM. Only problem is that they often violate the applicable fraud provisions because they either do not know and/or understand the applicable laws and regulations.

Case I point. An investment advisers was recently censured for violations of the anti-testimonial rules in connection with Yelp. The SEC has already addressed the issue of testimonials on social media sites. RIAs are general prohibited from using testimonials. The regulators do allow third-party ratings subject to various conditions.

I have never understood why the SEC does not crack down on all the violations I see on LinkedIn. As the referenced article points out, the fact that a site cannot or will not prevent the posting of any prohibited testimonials is irrelevant. Compliance with all applicable laws and regulations is solely the responsibility of the RIA, not the social media site.

RIA says violation was unintentional, RIA was not aware of the rule. SEC and the courts will simply cite my favorite investment related court saying-“a pure heart and an empty head are no defense.”

When a potential investor or RIA client contacts me, the first thing I do is verify that the firm legally exists. What I often find is that the firm does not actually legally exist, that the financial adviser is using what is known as a “fictitious name”, also known as a dba, or “doing business as” name. An example of a fictitious or dba name would be “John Smith dba America’s Greatest RIA Firm.”

So when I run into such as situation, the next thing I do is review the investment advisory contract the firm is using. More often than not, the contract is between a client and the firm’s fictitious name, i.e., “America’s Greatest RIA Firm.” That means the firm’s contract is void and we will be ordered to return of all fees the adviser collected on the account, with interest. I also contact the regulators to advise them that the adviser is in violation of the anti-fraud laws and regulations. This will allow other defrauded clients to get their money back.

Fictitious names are just that, a legal fiction. Since they do not actually exist legally, they cannot contact in their fictitious name. In our example, the proper disclosure in a contract would have been ” “John Smith dba America’s Greatest RIA Firm.” However, advisers using a dba do not want to properly identify the RIA because it “doesn’t look good” or is not as marketable/”makes me look small.” My advice-properly register the RIA as the form of business entity you desire, e.g., limited liability company (LLC). S-corporation, C-corporation then market to your heart’s content.

An interesting development I have seen recently are registered representatives using their broker-dealer’s RIA, which uses a fictitious name for the RIA activities, with the registered representative doing RIA business under yet another fictitious name. Double fictitious names, with all contracts and marketing using the last fictitious names. All contracts using only the fictitious names are void and clients are entitled to return of all fees paid to the non-existent firm, with interest.

When RIAs ask me what their contracts should say, I tell them just look at the name that appears on the RIA registration approval letter and make sure that that name appears on all advisory contracts and marketing materials. It’s that simple. Forewarned is forearmed.

About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ member and an Accredited Wealth Management Advisor™. I am a 1977 graduate of Georgia State University and a 1981 graduate of the University of Notre Dame Law School. I am the author of "CommonSense InvestSense: The Power of the Informed Investor" and " The 401(k)/403(b) Investment Manual: What Plan Sponsors and Plan Participants REALLY Need To Know. " As a former compliance director, I have extensive experience in evaluating the legal prudence of various types of investments, including mutual funds and annuities. My goal is to combine my legal and compliance experience in order to help educate investors on sound, proven investment strategies that will help them protect their financial security.
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