The Investment Advisers Act of 1940 (IAA), codified in Title 15 U.S. Code § 80b-1 et seq., is the fundamental regulatory framework for investment advisers in the United States, administered by the Securities and Exchange Commission (SEC).

Some common violations of the Investment Advisers Act include improper handling of client assets, and failure to supervise employees.

The primary purpose of this law is to protect investors from fraudulent practices, ensure transparency in the financial advisory industry, and establish fiduciary standards by outlining guidelines and prohibitions for advisers to maintain ethical and lawful practices.

Simply put, the IAA is a federal law regulating investment advisors in the United States. It aims to protect investors by ensuring advisors adhere to ethical and professional standards.

However, violations of these provisions are not uncommon and often lead to significant civil and, in some cases, criminal charges. The SEC closely monitors the behaviors and transactions conducted by financial advisors, and perceived breaches of the rules may result in legal scrutiny.

Common violations of the Investment Advisers Act include inadequate written policies and procedures, improper handling of client assets (custody rule), failure to supervise employees, misleading marketing materials, and inadequate regulatory filings.

Violations of this act can result in severe consequences for both the advisor and their clients. These consequences can include substantial fines, SEC-imposed sanctions, and potential criminal charges, particularly when fraud involves willful misconduct. Let's take a closer look at some of the more common violations for which financial advisors may be targeted under the Investment Advisers Act.

What Does Federal Law Say?

15 U.S. Code § 80b-1 - Findings says -

"Upon the basis of facts disclosed by the record and report of the Securities and Exchange Commission made pursuant to section 79z-4 of this title, and facts otherwise disclosed and ascertained, it is found that investment advisers are of national concern, in that, among other things.

(1) Their advice, counsel, publications, writings, analyses, and reports are furnished and distributed, and their contracts, subscription agreements, and other arrangements with clients are negotiated and performed by the use of the mails and means and instrumentalities of interstate commerce.

(2) Their advice, counsel, publications, writings, analyses, and reports customarily relate to the purchase and sale of securities traded on national securities exchanges and in interstate over-the-counter markets, securities issued by companies engaged in business in interstate commerce, and securities issued by national banks and member banks of the Federal Reserve System; and

(3) The foregoing transactions occur in such volume as substantially to affect interstate commerce, national securities exchanges, and other securities markets, the national banking system, and the national economy."

Fraud and Misrepresentation

The Investment Advisers Act of 1940 (IAA) specifically prohibits advisers from employing fraudulent schemes, making untrue statements, or engaging in any practices that defraud or mislead clients. Common examples of fraud under this provision include:

• Misrepresentation of Qualifications. Advisers may exaggerate their credentials or past investment returns to attract clients.
• Omission of Material Facts: Failing to disclose critical information, such as conflicts of interest, risks associated with investments, or hidden fees, misleads clients and violates trust.
• Cherry-Picking Trades: Allocating profitable trades to preferred accounts while leaving less profitable or losing trades to other clients.
• Front-Running: Placing personal or proprietary trades ahead of client orders to gain an unfair advantage.
• Undisclosed Kickbacks or Revenue-Sharing: Receiving undisclosed payments in exchange for directing client transactions.
• Inadequate Written Policies: Advisers are required to have written policies and procedures to prevent and detect violations of securities laws. Failure to establish and implement such procedures is a common violation.
• Custody Rule Violations: The Custody Rule (Rule 206(4)-2) under the Advisers Act addresses the handling of client funds and securities. Violations can occur when advisors have unauthorized access to client assets or fail to safeguard them properly.
• Failure to Supervise: Advisers must supervise their employees to prevent violations of the law. Failing to supervise a subordinate who commits a violation reasonably can lead to sanctions for the adviser.
• Misleading Marketing Materials: Advisers must ensure their marketing materials are truthful. This includes advertisements, brochures, and any other forms of communication used to solicit clients. Violations can involve making untrue or unsubstantiated statements, providing testimonials without proper disclosures, or misrepresenting investment performance.
• Inadequate Regulatory Filings: Investment advisors are required to submit various regulatory filings with the Securities and Exchange Commission (SEC). Failure to file required reports or making inaccurate filings can lead to violations.
• Conflicts of Interest: Advisers are required to disclose any potential conflicts of interest to their clients. Failing to do so can be a violation of the fiduciary duty they owe to their clients.
• Theft of Assets: Advisers are entrusted with managing client assets. Any fraudulent activity or theft of those assets constitutes a serious violation, including the misuse of client funds for personal benefit or the misrepresentation of investment performance to deceive clients.
• Insider Trading: Advisers who use non-public information to trade securities for their benefit or the benefit of others can be subject to harsh penalties.
• Fair Fees: Investment advisors must ensure that their fees are fair and appropriate for the services provided to the client.
• Trades During Blackout Periods: Certain situations, such as plan changes, may cause blackout periods during which participants are unable to make investment changes. Violations can occur if trading is permitted during these limited periods.
• Pay-to-Play Rule Violations: This rule prohibits investment advisors from providing services to government entities if they have made political contributions to certain officials in the prior two years.

Violations like these can result in substantial fines, SEC-imposed sanctions, and potential criminal charges, particularly when fraud involves willful misconduct. Advisers should prioritize compliance with all applicable rules and regulations to avoid penalties and maintain the trust of their clients.

Let's take a closer look below at some of the most commonly alleged violations.

Breach of Fiduciary Duty

Investment advisers owe a fiduciary duty to act in their clients' best interests, a core principle enforceable under the Act. Breaching this duty can take many forms, including:

• Self-dealing: Advisers prioritize their financial interests over those of their clients. This may involve recommending products that generate higher commissions rather than those better suited for clients.
• Failure to seek best execution: Not ensuring that client trades are executed efficiently and at the lowest possible cost.
• Undisclosed conflicts of interest: Advisers may engage in activities where their interests conflict with those of their clients without providing adequate disclosure or implementing effective measures to mitigate these conflicts.

Unregistered Investment Advisers

The Act mandates that most individuals and firms providing advisory services register with either the SEC or state regulators, depending on the size of their operations. Operating without proper registration constitutes a violation of the law.

Some advisers mistakenly believe they qualify for exemptions from registration, but misclassification or oversight often leads to enforcement actions. Additionally, individuals who continue to operate while suspended or barred from registration may face not only civil penalties but also criminal prosecution.

Marketing Rule Violations

Advertising and promoting advisory services are subject to strict rules designed to prevent deceptive claims. Many advisers inadvertently or willfully violate these rules due to their complexity, especially following the modernization of the SEC Marketing Rule in 2020. Common breaches include the following:

• Using unsubstantiated performance claims: Inflating past performance data without a factual basis or omitting the full context.
• Misleading testimonials or endorsements: Promoting cherry-picked client reviews that inaccurately reflect client experiences.
• Failure to disclose required details: Omitting information about fees, risks associated with advertised strategies, or relevant disclaimers.

Such violations, while seemingly less severe than fraud, can still invite SEC investigations, fines, and reputational damage.

Custody Rule and Records Violations

For advisers with direct custody of client funds, the Act imposes stringent requirements under the Custody Rule (Rule 206(4)-2). Advisers must safeguard client assets, obtain surprise examinations by independent accountants, and avoid commingling funds. Non-compliance with these safeguards can jeopardize clients' assets and lead to enforcement actions.

Similarly, maintaining accurate books and records is essential for maintaining transparency and ensuring regulatory compliance. Failure to retain necessary records, falsifying documents, or obstructing SEC examinations constitutes a serious breach of trust and a violation of legal obligations.

What are Related Federal Laws?

15 U.S. Code Chapter 2D Subchapter II has several related federal statutes, including the following:

• 15 U.S.C. 80b-1: Findings.
• 15 U.S.C. 80b-2: Definitions.
• 15 U.S.C. 80b-3: Registration of investment advisers.
• 15 U.S.C. 80b-3a: State and Federal responsibilities.
• 15 U.S.C. 80b-4: Reports by investment advisers
• 15 U.S.C. 80b-4a: Prevention of misuse of nonpublic information.
• 15 U.S.C. 80b-5: Investment advisory contracts.
• 15 U.S.C. 80b-6: Prohibited transactions by investment advisers.
• 15 U.S.C. 80b-6a: Exemptions.
• 15 U.S.C. 80b-7: Material misstatements.
• 15 U.S.C. 80b-8: General prohibitions.
• 15 U.S.C. 80b-9: Enforcement of subchapter.
• 15 U.S.C. 80b-10: Disclosure of information by Commission.
• 15 U.S.C. 80b-10a: Consultation.
• 15 U.S.C. 80b-11: Rules, regulations, and orders of the Commission.
• 15 U.S.C. 80b-12: Hearings.
• 15 U.S.C. 80b-13: Court review of orders.
• 15 U.S.C. 80b-14: Jurisdiction of offenses and suits.
• 15 U.S.C. 80b-15: Validity of contracts.
• 15 U.S.C. 80b-16: Omitted.
• 15 U.S.C. 80b-17: Penalties.
• 15 U.S.C. 80b-18: Hiring and leasing authority of the Commission.
• 15 U.S.C. 80b-18a: State regulation of investment advisers.
• 15 U.S.C. 80b-18b: Custody of client accounts.
• 15 U.S.C. 80b-18c: Rule of construction relating to the Commodities Exchange Act.
• 15 U.S.C. 80b-19: Separability,
• 15 U.S.C. 80b-20: Short title.
• 15 U.S.C. 80b-21: Effective date.

What are the Criminal Implications?

Although many violations of the Investment Advisers Act result in civil penalties, serious or willful infractions can cross the threshold into criminal liability. Any willful violation of the IAA, for example, may result in fines of up to $10,000 and imprisonment for up to five years (15 U.S.C. 80b-17).

However, federal prosecutors have also been known to file additional charges for IAA violations, such as:

• Mail Fraud (18 U.S.C. 1341).
• Wire Fraud (18 U.S.C. 1343).
• Conspiracy (18 U.S.C. 371).

Charges such as these may result in significant prison time and hefty fines upon conviction. If you are suspected of violating one or more provisions of the IAA, hiring our experienced federal criminal defense attorneys is crucial for mitigating these threats and enhancing your chances of a favorable outcome.  

For more information, contact our federal criminal defense law firm, Eisner Gorin LLP, located in Los Angeles, CA.

Related Content:

• Title 15 U.S. Code § 80b-1
• Investment Advisers Act
• Investment Company Act
• SEC Laws and Rules