The SEC has commenced enforcement proceedings against an adviser that it alleges lied to his professional athlete client about management fees. The SEC asserts that the adviser told representatives of the client that the client paid between .15% and .20% of assets in management fees when the client actually paid 1.00%, resulting in significant payments to the adviser who received 60% of the revenue earned by his firm. According to the SEC, the adviser misled the client and his representatives by using false account statements, forged documents, an impostor acting as a Schwab representative, and multiple misrepresentations in emails and meetings. The client’s representatives ultimately contacted Schwab, who then informed his employer. The adviser tried to convince the client to lie on his behalf to protect his job, although the client refused.
OUR TAKE: This type of case shows the problem with assuming that wealthy people are financially sophisticated. Many wealthy people earn their income in fields (e.g. sports, medicine, technology) that would not necessarily make them qualified to make investment decisions. Instead, these successful professionals rely on advisers who are supposed to act as fiduciaries and protect their clients’ interests.
The SEC imposed a $3 Million civil monetary penalty on a dually registered RIA/BD for retaining prepaid advisory fees, collecting revenue sharing payments from fund companies, and failing to invest in the lowest-cost share classes available. The respondent billed clients at the beginning of each quarter, but the SEC charges that the adviser’s services – portfolio management, trade execution, performance reporting and account servicing – occurred during the quarter. Therefore, the SEC maintains that the respondent unlawfully retained the prepaid advisory fees when clients terminated before the conclusion of a quarter. The SEC also charges the firm for failing (i) to fully disclose conflicts of interest when receiving revenue sharing and marketing support payments from fund companies and (ii) to utilize the lowest share classes available. The SEC cites violations of the Adviser’s Act’s antifraud provision (206(2)) and the compliance rule (206(4)-7).
OUR TAKE: Charging advisory fees at the beginning of a period drops you into choppy regulatory waters. As the SEC asserts here, how does a firm justify this practice when it has not yet performed services? This practice comes under more scrutiny when a firm fails to refund the fees to terminating clients, thereby creating a financial penalty for clients to sever a relationship.
A fund manager was barred from the industry and ordered to pay $550,000 for multiple breaches of fiduciary duty including failure to observe the fund’s investment limitations. According to the SEC, the respondent did not comply with the fund’s investment concentration policies, including the fund’s status as “diversified,” as described in the Registration Statement and as disclosed to the fund’s Board of Directors. The SEC also accuses the respondent, the sole proprietor of the fund manager, with double-charging separate account clients invested in the fund. Additionally, the SEC charges that the respondent cherry-picked trades for his personal benefit to the detriment of clients. The SEC cites violations of the anti-fraud provisions of the Exchange Act, the Advisers Act, and the Investment Company Act.
OUR TAKE: Registered funds are highly-regulated investment vehicles that require strict adherence to the Investment Company Act, SEC rules, the Registration Statement, and the Board of Directors. Advisers have much less flexibility with respect to disclosure and fees than separate accounts or private funds.
A large bank agreed to pay $97 Million, including a $30 Million fine, for compliance failures in its wrap programs. The bank represented in marketing materials and Form ADV that it performed significant initial and ongoing manager due diligence. However, according to the SEC, during a 5-year period from 2010 to 2015 (when it sold its wrap business), the respondent failed to perform such due diligence on several programs and managers because of a lack of internal resources and miscommunications between functions, even though the bank continued to charge significant account level fees to provide such services. The respondent was also charged with overbilling clients as well as using more expensive mutual fund share classes when lower-fee classes were available. As part of the settlement, the bank agreed to pay $3.5 Million in customer remediation and $49.7 Million in fee disgorgement in addition to interest and the fine.
OUR TAKE: Over the last 2 years, the SEC has warned about wrap programs (See e.g. SEC 2017 Exam Priorities Letter) and has brought several cases against wrap sponsors alleging a number of violations: trading away, reverse churning, revenue sharing, mutual fund share classes. In this case, the SEC adds a requirement that the fees charged must be commensurate with the due diligence services provided. This analysis appears borrowed from mutual funds where Boards must ensure the reasonability of fees charged. We recommend that compli-pros perform an internal sweep of wrap practices before the SEC shows up at the front door.
A private equity manager was barred from the industry and agreed to pay a $1.25 Million fine for taking £16.25 Million in unauthorized fees. The respondents also agreed to reimburse the funds over $24 Million. According to the SEC, the respondent, in its capacity as GP, invoiced the funds for real estate workout fees pursuant to an oral agreement it made with an affiliate. The SEC asserts that the respondents needed additional cash because the financial crisis reduced their fees and increased their workload and expenses, but the LP advisory committee refused. The SEC asserts that the purported agreement with the affiliate was never disclosed to the LPs or the auditors. When the LPs objected to the additional fees, the respondent sued the limited partners but ultimately agreed to reimburse the funds after the SEC’s investigation commenced.
OUR TAKE: Way back when (before Dodd-Frank?), a GP may have had unfettered power to engage in conflicts of interest and assess undisclosed fees. As a fiduciary under the Advisers Act, private equity GPs must seek approval for additional fees and fully disclose all potential conflicts. Otherwise, they won’t be a GP for long.
The SEC fined and barred the principal of an investment adviser for lying to clients about why he made investment recommendations and changed custodians. According to the SEC, the respondent recommended that clients move assets to a proprietary fund from a third-party fund because he could no longer receive trail commissions from the third party fund. The SEC also faults the respondent for failing to explain to clients that he had to change custodians because the incumbent custodian terminated its relationship due to a prior regulatory action. The adviser failed to “disclose important facts to his clients so they could make their own informed decisions.”
OUR TAKE: An adviser walks a very treacherous regulatory path when it charges a client both asset-based fees and commissions. It is possible that no amount of disclosure could cure this inherent conflict of interest that compromises an adviser’s fiduciary responsibility.