The Chat Group That Became an Advisory Business
You supervise sales conduct at a PSE trading participant. For 18 months, registered salesman R.M. has run a private chat group of about 60 retail clients called 'RM Capital Circle.' He posts model portfolios, accepts 'copy trade' instructions through the chat, and charges 1% per quarter plus 20% of gains, billed by a sole proprietorship he owns. Clients' trades are entered in their individual cash accounts; there are no written advisory agreements and no discretionary authority forms. R.M. is also an unpaid director of a start-up 'digital asset advisory' company that is not registered with the SEC. The firm's outside-business-activity register has no entry for either activity. After a 22% drawdown, a client complains that R.M. described the strategy as 'capital protected with a guaranteed 12% floor' and demands to be made whole. R.M. says he is 'just sharing views with friends' and that the 20% is a 'success fee' that is common abroad.
1. Identify the registration, licensing and conduct issues raised by R.M.'s activities, and explain which facts matter most in deciding whether he is acting as an investment adviser rather than merely expressing views.
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Registration and licensing. Dealing in securities for clients requires the firm's broker-dealer registration and R.M.'s salesperson registration; neither authorises managing money or charging advisory fees. Advising on securities for compensation as a business requires SEC registration as an investment adviser, and discretionary authority requires the appropriate investment-management authorisation. The 20% profit share is compensation; calling it a 'success fee' does not change its character, and performance-based fees are restricted because they reward risk-taking.
Advice versus views. The decisive facts are: (i) compensation; (ii) personalised recommendations and model portfolios; (iii) acceptance of 'copy trade' instructions, which shows reliance and de facto discretion; (iv) repetition and business-like organisation; and (v) holding out to 60 people. A one-off opinion to a friend is not the same as a 60-client fee business.
Conduct issues. Unregistered advisory activity; undisclosed outside business activity; possible misuse of the firm's name and resources; supervision and recordkeeping failures because instructions exist only in chat; the false 'capital protected/guaranteed 12% floor' statement, which is a material misrepresentation that no disclaimer cures; and a conflict from the digital-asset directorship. The 22% drawdown proves the guarantee was false.
2. As supervisor, set out the immediate actions you would take, including client remediation, record preservation and any regulatory reporting.
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Containment. Suspend R.M.'s ability to accept new clients or orders pending review. Preserve all chat logs, model portfolios, billing records and order tickets, and image his devices under the firm's e-communications policy. Stop the fee arrangement; do not let him 'clean up' the chat group or contact complainants unsupervised.
Client remediation. Identify every client in the group, test suitability, and determine which trades were unsolicited. Where the guarantee induced investment, treat it as a mis-selling complaint: consider rescinding fees, compensating losses attributable to the misrepresentation, and written redress. Notify insurers and legal counsel.
Regulatory. Escalate to the compliance officer and board. Assess whether the firm must report to the SEC and the PSE, and whether the unregistered adviser and the digital-asset entity should be referred. Cooperate fully and do not destroy records. Run a disciplinary process for the outside business activity and for failure to supervise.
Fixes. Outside-business-activity attestations, pre-clearance, social-media monitoring, a ban on servicing firm clients through personal chat, and a written policy that advisory services are offered only through a registered entity.
3. How should the firm treat the 'guaranteed 12% floor' statement and the performance fee?
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Treat the statement as a material misrepresentation. A 'guaranteed floor' promises a result the firm cannot make; it is misleading under the anti-fraud provisions (SRC Sec. 26) and under fair-dealing standards even when oral. The client's sophistication, or a disclaimer in the chat, does not cure a false statement of protection.
The performance fee is not automatically unlawful for a registered adviser, but it must be disclosed, agreed in writing, and consistent with SEC restrictions. Here it is billed through an unregistered sole proprietorship and never disclosed to the firm. Structurally, a 20% share of upside with no participation in losses encourages excessive risk, which is inconsistent with the 'capital protected' pitch.
Remedy. Stop the fee, quantify amounts received, and consider disgorgement. If the client was told the product was guaranteed, the firm should not defend on a 'mere opinion' theory; it should assess rescission or compensation. Record the complaint and the redress in the complaint register, and use the file to test whether other clients received the same representation.