This Week in FinTech & Compliance #1: Trouble with Two Points

This Week in FinTech & Compliance #1: Trouble with Two Points

Trouble with Two Points

On December 5th, 2022, the Securities and Exchange Commission (“SEC”) instituted administrative sanctions and a cease-and-desist order on Two Point Capital Management (“Two Points”) and its CEO, John McGowan, in violation of the Investment Advisers Act of 1940 (“Advisers Act”). Two Point Capital Management is a registered investment advisor based out of Pittsford, New York that began business in 2012, with Mr. McGowan being the founder, CEO, CCO, and sole proprietor and shareholder.

The Violations

The background of this administrative action on Two Points primarily revolves around four key violations made by Two Points and laid out in the SEC proceeding. They are as follows:

  1. Failure to Adopt and Implement Reasonably Designed Compliance Policies and Procedures
  2. Failure to Conduct Annual Reviews
  3. Failure to Establish, Maintain and Enforce a Written Code of Ethics Under Section 204A and Rule 204A-1 of the Advisers Act
  4. Failure to Timely File and Post Form CRS

Let’s take a moment to talk about each of these violations and how they were established by the SEC.

#1. Failure to Adopt and Implement Reasonably Designed Compliance Policies and Procedures

As noted in the preceding, “Section 206(4) of the Advisers Act and Rule 206(4)-(7)(a) thereunder require an investment adviser that is registered or required to be registered to adopt and implement written policies and procedures reasonably designed to prevent violations by the adviser and its supervised persons of the Advisers Act and the rules adopted thereunder.” This means that Two Points is required to have specific and inclusive policies and procedures in place to prevent any wrongdoing by the adviser themselves or any supervised persons working with or under the adviser.

Technically speaking, Two Points had a handbook regarding policies and procedures, but this handbook was from a separate professional organization and only discussed broad business ethics and preparation for an examination in that organization. The handbook did not have any specific policies tailored to Two Point’s advisory business. Furthermore, no regular compliance training was being conducted.

#2. Failure to Conduct Annual Reviews

Investment advisers must, at least annually, review their compliance procedures and the effectiveness of their overall compliance program. In this instance, the SEC found that Two Points failed to do either from 2012 to 2021. With no concrete compliance procedures or programs in place, Two Points was found to be in violation of Section 206(4) of the Advisers Act and Rule 206(4)-7(b) within.

#3. Failure to Establish, Maintain and Enforce a Written Code of Ethics Under Section 204A and Rule 204A-1 of the Advisers Act

Section 204A and Rule 204A-1 of the Advisers Act require investment advisers to maintain a written code of ethics while also stating that the code of ethics must contain provisions requiring supervised persons to comply with federal law and report any known violations to the Chief Compliance Officer (“CCO”). Given that Mr. McGowan was Two Points’ sole owner and CEO, that also meant he was the CCO from 2012 to February of 2021 when Two Points retained a new CCO and third-party compliance consulting firm.

While Two Points did maintain a general code of ethics that it had adopted from its professional trade organization, like its compliance handbook, the code of ethics was far too broad, generic, and failed to include any of the necessary requirements and mentions from the Advisers Act and its associated rules, the Securities Act of 1933, and the Securities Exchange Act of 1934.

No code of ethics, conduct or review of documentation was to be found.

#4. Failure to Timely File and Post Form CRS

The Form CRS outlines important information about an investment adviser and its broker, or brokers, and should give investors any necessary information needed to make rational, informed decisions about whether the adviser or broker is right for you and your investment.

For the Form CRS rules to be followed, the form needs to be displayed prominently on the firm’s website in an easily accessible location and needs to be both displayed and submitted to the SEC within a specific timeframe. Unfortunately, Two Points failed to do so. The SEC investigation found that Two Points only began complying with these guidelines after the SEC’s Division of Examinations conducted a review of the firm. Even after this review, Two Points did not file the Form CRS until nine months after the initial deadline and placed it on their website almost a year after the deadline.

The Remedy & The Penalty

To remedy these violations, Two Points and Mr. McGowan hired a designated CCO to continuously improve, adjust, and expand Two Points’ compliance program. Two Points also hired a third-party compliance firm to assist with these efforts and agreed to retain a third-party compliance firm through the end of 2024. Topping these efforts off, Two Points revised its written policies, procedures, and code of ethics to the SEC’s satisfaction.

But, even with these efforts, the case was not without punishment. Ultimately, Two Points was ordered to pay a hefty civil penalty to the SEC of $75,000. Also, Mr. McGowan was individually ordered to pay a civil penalty to the SEC of $25,000. The SEC will now receive a $100,000 fine from Two Points and Mr. McGowan for the misdeeds.

As we can see, efforts were made to improve upon the situation and rectify the violations, but only after the violations were noted and the consequences were enacted. With some effort, these violations and struggles could have been alleviated, to the benefit of Mr. McGowan, Two Points, and all its clients. We’ll close out this segment with a few key takeaways.

Key Takeaways

1. Compliance may not always be convenient, but it is necessary.

Unfortunately, compliance isn’t always the first thing an RIA thinks of when managing their business and clients. With millions and millions of dollars and assets to manage and account for, compliance can seem to be just another item on a checklist. But this couldn’t be further from the truth. As we see from the Two Points case, compliance is necessary not only for the protection of the firm, but also for the protection of the important clients and investors that work with the firm. When compliance is maintained and monitored, everybody wins.

2. Hiring a CCO, outsourced or internal, makes everyone’s lives easier.

Whether you’re a single person firm or a massive operation with hundreds of employees, the ideal choice is to make business operations easier and more efficient. Similarly with compliance, hiring an experienced CCO for your firm may seem like a costly expense at the time but will surely pay dividends in protection and ease of mind as time goes on. If Two Points had hired a firm for outsourced compliance services from the beginning, both the censure on their record and the six-figure fine could have been completely alleviated. Hiring an experienced CCO for your firm allows you to be proactive to any compliance issues rather than reactive.

3. Always tailor your compliance programs to the specific needs of your firm and your clients.

A firm’s most valuable assets will always be its clients. Trusting and devoted clients help a firm stay strong and profitable. A profitable firm keeps both employees and clients happy. But to keep clients happy, it’s important to make sure their best interests are kept top of mind. One of the issues in the Two Points case was the firm adopting generic and broad compliance policies that neither benefited the firm nor the clients. If Two Points had taken the time to adjust its compliance program, policies, and code of ethics to be focused on the needs of its specific clientele, perhaps the story would have ended differently. When you review your compliance procedures, be thorough, detailed, and holistic. You’ll certainly thank yourself later.

Joot Makes Outsourced Compliance Services Easy

The story of Two Points isn’t the first and unfortunately will not be the last. Many firms in the past have experienced compliance struggles and many firms will experience these same struggles in the future. Luckily, your firm does not need to experience those struggles. Joot’s outsourced compliance services can give you, your team, and your clients the peace of mind wing that you are protected and secure in your business dealings. Our veteran compliance/legal team has helped a myriad of firms just like Two Points with compliance and governance issues. As we learn from the scenario of Two Points, let’s tackle compliance together. Don’t hesitate to reach out to Joot for any and all compliance services needs.