Investment Adviser Settles Charges of Failure to Disclose Conflicts of Interest

Last month, the Securities and Exchange Commission (SEC) announced that registered investment adviser Guggenheim Partners Investment Management, LLC had consented to settle charges that it breached its fiduciary duty to its clients in connection with a $50 million loan made by a client to one of Guggenheim’s senior executives. Specifically, Guggenheim failed to disclose the existence of the loan and the conflicts of interests created by the loan, to its clients. Guggenheim agreed to pay a total of $20 million dollars to settle the charges.

According to the order instituting the administrative proceeding, the senior executive borrowed the funds from an advisory client so that he could make a personal investment in another corporation that was being acquired by Guggenheim’s parent company. The client who made the loan was one of several advisory clients of Guggenheim that invested, at Guggenheim’s recommendation, in two unrelated transactions. The client who made the loan, however, was permitted to invest in the unrelated transactions on different terms than the investors who had not made a loan to Guggenheim.

More specifically, beginning in 2007 Guggenheim made several investments on behalf of its advisory clients in a privately held company. By 2010, after the client who had made the loan to Guggenheim had complained about the performance of this particular investment, Guggenheim worked out a plan whereby the company in which the clients had invested would be restructured. As a result of that plan, in 2010, the company issued senior notes to the client who had made the loan but issued junior notes to the Guggenheim clients. The effect of this transaction limited the upside for the client who had made the loan but also gave it greater protection against downside losses on the investments in this third party company. The clients of Guggenheim who had not made the loan, however, received the opposite position by virtue of their junior notes.

In another transaction that started in 2009, Guggenheim made investments in another private company on behalf of its advisory clients. About a year later, when that company refinanced all of its debt, it did so through a private offering of secured notes which was co-underwritten by an affiliated broker-dealer of Guggenheim. Guggenheim’s advisory clients participated in that offering.

As part of that transaction, Guggenheim promised third-party debtholders that they would receive $10 million for warrants that they were issued in the transaction within ninety days of the debt offering. This promise was made as a condition for the debtholders’ participation in the offering. The warrants were later purchased by Guggenheim on behalf of its advisory clients and held in their accounts. Later, however, when the client who had made the loan to Guggenheim expressed an interest in investing in the company, Guggenheim arranged for a “swap” transaction by which the company would repurchase the warrants from the Guggenheim advisory clients for a purchase price that reflected a return to those clients of their cost basis plus the stated warrant interest. Simultaneously, however, the company issued $10 million of preferred equity to the client who had made the loan to Guggenheim and a 2¼% share of common equity in the company to the same client for a purchase price that equaled the amount paid for the warrants. Guggenheim never disclosed the loan to the five clients that participated in the swap transaction.

The SEC’s administrative order alleged that Guggenheim violated Section 206(2) of the Investment Advisers Act by engaging in a transaction, practice, or course of business which operates as a fraud or deceit upon any client or perspective client. The basis of the violation was a failure by Guggenheim to inform their clients of the conflicts of interest that affected the terms of the investments made by the adviser’s clients. The order also alleged that Guggenheim violated Section 206(4) and 206(4)-7, among other things. In addition to the penalties imposed, the order required Guggenheim to retain an independent consultant which would review the adviser’s operations and make recommendations involving remediation of deficiencies.

Parker MacIntyre provides legal and compliance services to investment advisers, broker dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our website for more information.

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