Adviser Found to Have Operated a Deficient Compliance Program

May 18, 2015

The SEC brought an enforcement action against Trust & Investment Advisors, Inc. (TIA), based in Indianapolis, Indiana, Larry K. Pitts, its principal, and George M. Prugh, its Senior Vice President and CFO for failing to complete an annual compliance review and failing to develop a compliance manual. In additon, the SEC found that TIA continued use of misleading statements in its marketing materials. OCIE, the inspection unit of the SEC, gave repeated warnings of deficiencies after its 2005 and 2007 exams; nevertheless OCIE identified the same deficiencies in its 2011 exam.

OCIE conducted three on-site examinations of TIA’s advisory business between 2005 and 2011 (first in 2005, second in 2007, and third in 2011). These examinations revealed repeated deficiencies by TIA in the areas of performance advertising and compliance.

During the 2005 exam, OCIE discovered and alerted TIA that it had failed to develop compliance policies required by Rule 206(4)–7 under the Advisers Act. Following the 2005 exam, TIA reported that it had “made progress with our written policies and procedures designed to prevent violation of the Advisers Act and rules. We will forward you a copy with the typed version of this response.” Notwithstanding TIA’s promise to remedy its compliance deficiency, OCIE found during its 2007 exam that:   • TIA still had not yet completed its compliance manual; • TIA had not conducted an annual compliance review; and • TIA’s designated Chief Compliance Officer (CCO) did not have appropriate knowledge of the Advisers Act (e.g., the CCO was not aware of the requirement to conduct an annual review of TIA’s compliance program).

OCIE alerted TIA that it was concerned that TIA employed a “cavalier approach to compliance” that called into question TIA’s commitment to operate its business in accordance with the federal securities laws. In response to this exam, TIA again assured OCIE that it would remedy its compliance shortcomings. TIA said it would engage a compliance consulting firm to assist TIA’s development of a compliance manual, and that it would provide compliance education to the CCO and other advisory personnel at TIA. However, when OCIE staff returned for the 2011 exam, they discovered TIA had made no progress on its compliance deficiency. At that time, Prugh told OCIE staff that TIA’s compliance committee had become inactive, and TIA had not had time since the last exam three years ago to work with Firm A to develop a compliance manual and implement a compliance program. Prugh also told OCIE staff that he was acting as the de facto Chief Compliance Officer of TIA because its CCO was unable to complete the requirements of the Series 65 exam.

In its 2005 and 2007 exams, OCIE identified several instances where TIA provided misleading performance information to clients in its marketing materials. For example, in its 2007 exam, OCIE found that TIA’s one-on-one performance presentations to clients were misleading. The presentations included gross of fee performance returns over an extended period of time; yet, the same presentations did not explain the impact that advisory fees could have on the value of a client’s portfolio. Following the 2007 exam, TIA indicated it had corrected this issue. However, when staff returned for the 2011 exam, they discovered that TIA continued to distribute marketing pieces showing bar charts with cumulative returns that did not explain the impact that advisory fees could have on the value of a client’s portfolio.

OCIE identified additional misleading advertisements in its 2011 exam. In particular, Pitts appeared on a local public access television show called Investing Today” and used PowerPoint presentations with charts comparing TIA’s cumulative returns over a ten-year period to the S&P 500 returns over that same period. These comparisons were misleading because they neglected to deduct applicable advisory fees from TIA’s cumulative returns. Moreover, the charts did not include a disclosure stating that TIA’s cumulative returns did not reflect the deduction of advisory fees, and that such fees would reduce client returns. These TV show appearances led to client referrals for TIA.

Not only did TIA have the deficiencies OCIE discovered during its exams, but the SEC fount that TIA also distributed misleading performance information in weekly summary marketing emails from at least 2009 through 2012. In particular, TIA distributed a table on a weekly basis to some of its current clients and to its solicitors (who are responsible for soliciting new investment advisory business for TIA) that compared percentage increases in the S&P 500 index to percentage increases in TIA’s portfolios. The table materially overstated the performance of the TIA portfolios vis-à-vis the S&P 500 index because the TIA performance included the reinvestment of dividends, while the S&P 500 index number did not. At least one of the recipients of one of these summary emails found the table misleading, emailing Prugh that: “[the] performance table is a bit misleading, though. It really should reflect the total return of the S&P 500 (including the dividends) for a more apples-to-apples comparison vs. the TIA strategies, which include the reinvestment of dividends … .” Notwithstanding this critique, TIA continued to send out the same misleading performance information in its weekly marketing emails.

The SEC stated that Pitts and Prugh were the ultimate decision-makers at TIA. Pitts was and is CEO and Portfolio Manager of TIA. In that position, Pitts managed and supervised TIA’s staff (including Prugh) and took primary responsibility for meetings with clients and prospective clients as well as TIA’s TV show “Investing Today.” Prugh was and is Senior Vice President, CFO, and Chairman of the Investment Committee for TIA. In that position, Prugh assisted in picking the stocks that made up TIA’s portfolios and was responsible for TIA’s accounting function and tax returns. Both Pitts and Prugh were heavily involved in OCIE’s examinations and both failed to prioritize compliance with the Advisers Act.

After receiving deficiency letters from OCIE, the SEC stated that Pitts and Prugh repeatedly failed to ensure that TIA was in compliance with Advisers Act rules. Neither Pitts nor Prugh took an active role n ensuring compliance with the Advisers Act rules or making sure TIA did not repeat violations identified by OCIE.

Click here to access the enforcement action.


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Investment Advisers, Investment Companies