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Fund Manager Barred for Misusing Soft Dollar Credits

The principal of a hedge fund manager was fined and barred from the industry, and his firm’s registration was revoked, for misusing soft dollar credits and cherry-picking trades. According to the SEC, the fund manager misused over $1.1 Million in soft dollar credits to pay such expenses as alimony to his ex-wife, inflated rent to an affiliated company, salary to an employee, and timeshare expenses. The SEC notes that such payments contradicted disclosures in the PPMs and the Form ADV. The SEC also charges the firm with engaging in an illicit cherry-picking scheme to enrich certain hedge fund clients over other clients.

We are seeing a renewed SEC interest in how firms use soft dollar credits. Although the facts of this case date back several years, this action may portend future regulatory and enforcement initiatives.

Advisers Failing Best Execution Compliance Obligations

The SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert listing the most common deficiencies cited in recent examinations of advisers’ best execution obligations.  Reviewing over 1,500 exams, the OCIE staff highlighted advisers’ failures to (i) conduct any best execution reviews, (ii) consider qualitative factors (e.g. execution capability, responsiveness), and (iii) utilize multiple brokers or to compare execution quality against other brokers.  The OCIE staff also witnessed widespread failures to fully disclose best execution practices such as client preferences and soft dollar arrangements.  The staff reports that many advisers either had inadequate policies and procedures or failed to follow them.  The staff encourages advisers “to reflect upon their own practices, policies, and procedures in these areas and to promote improvements in adviser compliance programs.”

OUR TAKE:  In its recent fiduciary interpretation release, the SEC specifically identified best execution as core to an adviser’s fiduciary obligation.  As a core obligation, it concerns OCIE that they have identified pervasive compliance failures during examinations.  Ensuring a best execution review should be part of every compliance testing program.


Wrap Sponsor Fined for Failing to Monitor Trading Away Practices

The SEC fined and censured a wrap fee sponsor for failing to provide sufficient trading away information to financial advisers and their clients.  The wrap program’s third-party sub-advisers had full discretion to direct trades to any broker, but a program client would only be charged additional fees and commissions if a sub-adviser chose a broker other than the respondent’s affiliate.  According to the SEC, the sponsor discovered that many of the sub-advisers placed a majority of trades with third-party brokers.  The SEC faults the program sponsor for failing “to inform its clients when they have incurred these additional trading away costs or provide its clients with the amount of the additional trading away costs.”  As a result neither the clients nor their financial advisers could assess suitability or best execution.  The SEC found that the wrap sponsor violated the compliance rule (206(4)-7) for failing to implement reasonable policies and procedures to monitor brokerage practices and costs.

OUR TAKE: The SEC will scrutinize wrap programs and other sub-advisory relationships to ensure proper supervision and full transparency to clients.  It is noteworthy that the SEC is concerned that the clients didn’t have sufficient information to make an assessment about execution quality and suitability, but the SEC did the not allege the clients failed to receive best execution.


Executing Broker to Pay $22.6 Million for Misrepresenting Order Filling Process

hidden ball

A large executing broker agreed to pay $22.6 Million to settle charges that it misled broker-dealers clients about the mechanism for filling orders.  The SEC charges that the executing broker claimed that it would deliver best price but, instead, used two algorithms that capitalized on price discrepancies that often benefited the respondent.  An SEC official warned, “We are focused on the execution of retail orders and encourage investors to ask brokers, and brokers to ask internalizers, how they are determining best prices for retail orders.”

OUR TAKE: This case looks like a disconnect between the front office and the back office.  It appears that the folks talking to clients did not understand how the firm actually filled orders.  “Don’t let the facts ruin a good story” is a recipe for an enforcement action.