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Wrap Sponsor Pays $97 Million for Inadequate Due Diligence

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.

https://www.sec.gov/litigation/admin/2017/33-10355.pdf

Private Equity GP Barred and Fined for Charging Undisclosed Fees

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.

https://www.sec.gov/litigation/admin/2017/ia-4641.pdf

Adviser Barred in Connection with Receiving Asset-Based Fees and Commissions

fee-disclosurefee-disclosureshell-game

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.

https://www.sec.gov/litigation/admin/2016/34-79126.pdf