SEC Fines Investment Adviser for Failure to Disclose Material Conflicts of Interest to Clients

June 20, 2017

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The United States Securities and Exchange Commission (“SEC”) recently obtained final judgments by consent against an investment adviser firm and its chief executive officer, who allegedly failed to disclose material conflicts of interest to some of the firm’s clients. The investment adviser firm and its chief executive officer consented to the decree without admitting or denying the allegations in the SEC’s complaint.


In its May 2016 complaint against the chief executive officer, the SEC alleged that the chief executive aided and abetted the investment adviser firm’s violations of the Investment Adviser’s Act of 1940 by moving client assets into recently created mutual funds managed by the investment adviser without seeking client permission or disclosing that the transfer would result in clients paying additional fees without receiving additional or different services. Click here to read the complaint. The chief executive officer is alleged to have further aided and abetted the investment adviser firm’s violations by failing to adopt appropriate policies and procedures relating to conflicts of interest and submitting a Form ADV Part 2A that contained material misrepresentations and omissions regarding the firm’s conflicts of interest surrounding the mutual fund transfers.


The mutual funds at issue were created and managed by the investment adviser firm, which subsequently sought to use client funds as seed money for the new mutual funds. The new mutual funds utilized the same investment strategies, yet caused clients to pay an additional annual management fee on assets held in the mutual funds. This fee ranged from 1.15%-1.45%, which was incurred in addition to the regular annual assets under management fee clients paid to the investment firm. In effect, by creating the mutual funds the investment adviser was able to become its own middle man, collecting new fees without providing new services.


The SEC estimated that approximately 60-70% of each client’s portfolio was liquidated and subsequently transferred to the newly created mutual funds. During the single year in which clients were invested in these mutual funds, the SEC alleges that the clients paid nearly $110,000 in extra fees of which $61,000 ultimately went to the investment adviser as management fees. Furthermore, the SEC alleges that neither the chief executive officer nor the investment adviser firm advised clients their assets would be reinvested before the transfer took place, nor were clients ever notified that the overall fees paid to the investment adviser on their accounts would increase – in some cases by more than double – as a result.


Compounding the alleged violation, the investment adviser had no policies or procedures in place to mitigate the conflicts of interest and other risks inherent in managing the mutual fund. The SEC also alleged that this failure to disclose extended to the disclosures in the investment adviser firm’s Form ADV Part 2A. In Item 5.C, for example, the disclosure state that clients may pay mutual fund fees in addition to the usual management fee paid to the investment adviser, but did not explain the increased compensation that the investment adviser firm would receive if clients invested specifically in the adviser’s mutual funds. Similarly, in Item 14.A of the Form ADV Part 2A, the investment adviser firm failed to specify the conflict of interest inherent in the transfer of clients’ assets to the mutual fund, even though it did note that the investment adviser “may receive additional compensation” if clients were invested in the mutual fund. More pointedly, Item 5.E of the Part 2A explicitly stated that the investment adviser did not receive any compensation for client transactions “other than the Management Fees noted above.” The SEC found this statement to be false and misleading, given that the investment adviser did not disclose that clients would pay additional management fees if they moved their assets from other investments into the adviser’s mutual fund.


In the final judgment, the SEC has enjoined the investment adviser firm and its chief executive officer from violating the Investment Advisers Act of 1940 and ordered disgorgement of nearly $69,000 in ill-gotten gains and prejudgment interest. The investment adviser firm also has been ordered to pay a civil penalty of $125,000 while the chief executive officer has been ordered to pay a civil penalty of $40,000. Click here to read a press release by the SEC regarding the final judgment.


RIA Compliance consultants encourages every investment adviser to review its current practices and disclosures to ensure the firm accurately and completely discloses all material conflicts of interest, particularly those related to outside or additional compensation. 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.

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