SEC Enforcement Action: Investment Adviser Fails to Disclose Affiliate Broker-Dealer Conflicts of Interest

March 14, 2017

The U.S. Securities and Exchange Commission (“SEC”) issued an enforcement action recently against an investment adviser firm for its alleged failure to disclose fee sharing arrangements that the investment adviser firm entered with its third-party broker dealer. The investment adviser firm consented to the order without admitting or denying the SEC findings, except as specified within the SEC’s Order. Click here to read the full SEC Order Instituting Administrative and Cease-And-Desist Proceedings.

According to the SEC, the investment adviser firm failed to disclose two fee sharing arrangements it entered with its third-party broker dealer. Under the first arrangement, which began in 2006, the broker dealer agreed to share with the investment adviser a portion of revenues received by the broker-dealer from mutual funds in which the investment adviser firm’s clients were invested. Under the second arrangement, the broker dealer shared a percentage of fees it received from the mutual funds with the investment adviser in exchange for administrative services. In both cases, the SEC alleged that the arrangements created a financial incentive for the investment adviser to recommend its clients invest in mutual funds of the broker-dealer and the conflict of interest was not disclosed to the investment adviser firm’s clients or in its Form ADV.

The SEC alleged the failure to properly disclose these conflicts of interest stemmed from the investment adviser firm’s lack of adequate policies and procedures relating to conflicts of interest. The SEC alleged that such policies would have enabled the investment adviser firm to identify, disclose, and mitigate its conflicts of interests. Instead, the investment adviser firm compounded the problem when, upon entering the administrative services agreement with the broker-dealer, the investment adviser firm allegedly represented to the broker-dealer that it had disclosed the conflict of interest to its clients despite never having done so.

In consenting to the SEC Order, the investment adviser firm is required to provide written notice of the SEC Order to its investment advisory clients and to disclose the Order as a material change in its Form ADV. Additionally, the investment adviser firm is required to provide the SEC with a certification of compliance, including exhibits demonstrating its compliance, within 60 days. Finally, the SEC ordered the investment adviser firm to pay approximately $3 million in disgorgement, pre-judgement interest, and civil money penalties.

Investment adviser firms should regularly review new and existing business arrangements with third-parties for conflicts of interest.  If your investment adviser firm needs help reviewing its business practices or creating new policies and procedures to identify, disclose and mitigate conflicts of interest, RIA Compliance Consultants can help. Contact your compliance consultant today or click here to schedule an introductory call.

Posted by Grant Parr
Labels: Enforcement, SEC
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