HCR Wealth Advisors agreed to a cease-and-desist order, a $220,000 penalty, and a $328,912 payment to its harmed clients in order to settle charges with the U.S. Securities and Exchange Commission (“SEC”). The SEC complaint alleged that HCR had failed to reasonably supervise and implement its own compliance-related policies and procedures in response to fraudulent actions by one of its former investment advisors.
In parallel criminal proceedings, adviser Jeremy Joseph Drake plead guilty to defrauding two of his clients and committing wire fraud. He was sentenced to 30 months custody and ordered to pay $1.2 million. Drake had managed over $50 million in assets for more than 20 HCR clients during his tenure at the firm.
Management Fee Fraud and Misappropriation of Client Funds
Over the course of three years, Drake defrauded a married couple by telling them they were paying a management fee at a VIP client rate of 0.15 to 0.20 percent of their assets under management. In reality, the clients paid the traditional HCR client fee of 1 percent of their managed assets. The difference in rates led to them pay an excess of $1.2 million more in fees than Drake falsely promised them over the course of the three-year period. Of the $1.2 million received, HCR paid nearly $900,000 of it to Drake and the firm retained the remaining $300,000.
Drake further misappropriated over $200,000 from four clients, transferring the funds to accounts belonging to a failing restaurant to which he had obtained 3 percent ownership interest.
As part of the scheme to mislead his clients, Drake created false and misleading documents and statements. He also created a misleading email address, which he used to send emails from someone he claimed was a manager at the firm.
Failure to Supervise and Implement Policies and Procedures
The SEC Order found that HCR violated the Advisers Act by failing to engage in reasonable supervision over Drake and also violated the act by failing to implement established policies and procedures designed to prevent violations of the Advisers Act.
HCR had been warned by an outside compliance consultant that Drake might attempt to use client funds in order to fund the restaurant; however, HCR did not investigate further to determine the source of the investments or monitor accounts related to the restaurant despite the consultant’s advice. Furthermore, HCR did not follow its policies and procedures by monitoring Drake’s activities and emails for potential violations of the company policies and procedures or federal securities laws.
Though HCR had policies and procedures in place to conduct prompt, thorough and fair reviews of all client complaints, the firm failed to do so when it received two client complaints from Drake’s clients. Instead of performing an investigation and documenting its findings, allegedly the firm only relied upon Drake’s own false description of his actions.
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Internal controls are of paramount importance for they serve to detect circumvention of firm policies and federal securities laws. Though it can be difficult to sometimes detect if someone is actively committing fraud, this risk can be mitigated by investment advisers implementing robust supervisory programs, educating their employees and implementing effective policies and procedures. It is crucial for firms to follow up on red flags, track deceptive behaviors, and document investigations.
Jacko Law Group, PC is highly experienced in developing supervisory internal controls (e.g., policies and procedures) and risk mitigation techniques for detecting “red flags” so that areas of concern, such as suspicious activities or complaints can be timely investigated and illegal activity stopped. For more information, contact our team of attorneys today.