SEC Announces $37.9 Million Settlement with Two RIAs over Conflicts of Interest Violations

The SEC has just concluded settlement negotiations with two large RIA subsidiaries of the Bank of Montreal, resulting in a total settlement of almost $38 million—with $25 million of that in disgorgement. The SEC’s announcement and administrative order resolves enforcement proceedings against BMO Harris Financial Advisors, Inc. (“BMO Harris”) and BMO Asset Management Corp. (“BMO Asset”)(together, the “BMO Advisers”) involving conflicts of interest violations under the Advisers Act antifraud provisions.

The SEC’s administrative settlement with the BMO Advisers marks yet another significant action by the Commission against RIAs for failing to disclose material conflicts of interest. As fiduciaries, RIAs must seek to avoid conflicts of interest with clients, and, at a minimum, must fully disclosure all material conflicts. The SEC enforces violations of this requirement pursuant to Advisers Act Section 206(2), which prohibits RIAs from engaging in “any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.”

The BMO Advisers case implicates familiar issues that we have seen repeatedly in SEC conflicts of interest enforcement actions—namely, failures to disclose material aspects of mutual fund share class selection and mutual fund revenue sharing arrangements. This case also involves an apparently egregious preference of BMO Advisers-affiliated proprietary mutual funds over other comparable opportunities, without any commensurate disclosure.

BMO Harris offered a wrap-fee advisory program known as the Managed Asset Allocation Program (“MAAP”) to allocate mutual fund assets for its retail clients. BMO Asset, in turn, managed MAAP, making all of the decisions to include, maintain, or remove a mutual fund from MAAP. At one point, the assets managed through MAAP reached $2.7 billion. According to the SEC’s statement of facts, as part of its management of MAAP, BMO Asset gave great preference to proprietary mutual funds managed by BMO, investing approximately 50% of MAAP assets in such proprietary funds. Notably, while BMO Asset received significant management fees for its management of these proprietary funds, neither of the BMO Advisers disclosed the obvious conflicts of interest implicated by this practice.

Additionally, the SEC found that BMO Asset engaged in a questionable process in connection with the selection of both proprietary and non-proprietary mutual funds for MAAP. Specifically, BMO Asset analyzed lower-cost institutional shares for both proprietary and non-proprietary mutual funds as part of its evaluation process for MAAP. However, while BMO Asset generally selected the lower-cost institutional share class of a non-proprietary fund, BMO Asset never selected such lower-cost alternative of its proprietary funds. Accordingly, in all cases, the higher-cost proprietary fund alternative was always selected for MAAP. Again, neither of the BMO Advisers disclosed this clearly conflicted practice to clients.

BMO Harris also failed to disclose additional conflicts in connection with its retail clients’ investment via MAAP in higher-cost share classes when more affordable alternatives were available for the same fund. Specifically, the SEC cited (i) BMO Harris receiving revenue sharing payments from its clearing broker tied to the higher-cost share class alternatives and (ii) BMO Harris’ avoidance of certain transactional fees that it would have paid for client purchases of lower-cost institutional shares.

Again, while the issues presented in this case are not new to SEC-watchers, the magnitude of the settlement is notable. Pursuant to the SEC’s order, a total of $37.9 million shall be deposited by the respondents into an escrow account within 10 days of the order. Of this total amount, $25 million has been earmarked for disgorgement, which essentially entails restitution to adversely affected clients. Additionally, a civil monetary penalty of $8.25 million, payable to the US Government, has been assessed.

Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser 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 Investment Adviser Practice Group page for more information.


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