Articles Tagged with Conflict of Interest

In February, the Securities and Exchange Commission’s Enforcement Division announced the Share Class Selection Disclosure Initiative (the “SCSD Initiative”), encouraging investment advisers to self-report violations of federal securities laws. Specifically, the SEC is concerned with protecting advisory clients from undisclosed conflicts of interest related to 12b-1 fees charged by advisers. The SEC requests that investment advisers self-report violations of the federal securities laws relating to certain mutual fund share class selection issues prior to June 12, 2018, in exchange for more lenient treatment regarding the violations. A detailed explanation of Eligibility for the SCSD Initiative is available here. In May, the SEC also published a list of frequently asked questions and answers related to the SCSD Initiative.

Under Section 206 of the Investment Advisers Act of 1940, investment advisers have a fiduciary duty to act in their clients’ best interests. Included is an affirmative duty for the adviser to fully disclose all material facts, such as conflicts of interest. The SEC is concerned with conflicts associated with mutual fund share class selection, which the SCSD Initiative aims to address. In the SCSD Initiative, the SEC cautions that investment advisers must be mindful of their duties when recommending and selecting share classes for clients. Of particular concern are conflicts related to 12b-1 fees earned in the selection of classes of funds – conflicts which must be disclosed to clients. As explained by the SEC, a conflict of interest arises when an adviser receives compensation for selecting a more expensive mutual fund share class for a client when a less expensive share class for the same fund is available and appropriate. Such a conflict of interest must be disclosed. Compensation received either directly or indirectly through an affiliated broker-dealer is subject to scrutiny under the SCSD Initiative. As such, if the adviser failed to disclose a conflict of interest associated with the receipt of 12b-1 fees by the adviser, its affiliates, or its supervised persons for investing advisory clients, such funds are subject to disgorgement, and civil monetary penalties may be appropriate.  Continue reading

On March 8, 2017, the Securities and Exchange Commission (“SEC”) issued an Order Instituting Administrative and Cease-and-Desist Proceedings (“Order”) against Voya Financial Advisors, Inc. (“Voya”), an SEC-registered investment adviser.  The Order, to which Voya consented, obligates Voya to pay disgorgement of $2,621,324, prejudgment interest of $174,629.78, and a civil money penalty of $300,000.

The SEC’s Order claims that Voya did not inform its clients that it was receiving compensation from a third-party broker-dealer and that these receipts created a conflict of interest.  Section 206(2) of the Investment Advisers Act of 1940 (“Advisers Act”) states that investment advisers are forbidden from participating in “any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.”  Section 207 provides that investment advisers are not allowed to “make any untrue statement of a material fact in any registration application or report filed with the Commission, or to omit to state in any such application or report any material fact which is required to be stated therein.”  Finally, Rule 206(4)-7 under the Adviser’s Act compels investment advisers to “[a]dopt and implement written policies and procedures, reasonably designed to prevent violation” of the Adviser’s Act and the rules thereunder. Continue reading

The Securities Exchange Commission (“SEC”) recently filed suit against a North Carolina investment adviser for allegedly defrauding investors in the sale of certain real estate-related investments in unregistered pooled investment vehicles. The adviser, Richard W. Davis Jr., solicited investors primarily from the Charlotte, North Carolina region and was able to raise approximately $11.5 million from 85 investors, the majority of which were individuals with retirement accounts. However, he allegedly failed to disclose to clients that the money in the funds was being steered towards several other entities beneficially owned by himself.

Davis allegedly told investors in one of his funds that the fund’s capital would be invested in short term fully secured loans to real estate developers. He allegedly failed to mention, however, that many of the real estate developers receiving these loans were companies owned and operated by himself, creating an inherent conflict of interest. Furthermore, the companies never repaid the loans in full and Davis allegedly failed to inform his investors of this or reappraise the value of the fund’s investment. Instead, Davis allegedly misrepresented the value of the pooled fund by repeatedly stating that it had not lost any value.

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Investment advisers continue to get into regulatory trouble when it comes to failing to disclose conflicts of interest and related party transactions as required by both federal and state investment adviser law. Recently, the Securities and Exchange Commission (SEC) initiated proceedings against Fenway Partners, a New York-based registered investment adviser which served as adviser to three private equity funds. The conflicts arose around two related entities: Fenway Partners Capital Fund III, L.P., an affiliated fund, and Fenway Consulting Partners, an affiliate largely owned by the executives and owners of Fenway Partners.

Fenway Partners and Fenway Consulting Partners were both owned and managed in large part by respondents Peter Lamm, William Smart, Timothy Mayhew, and Walter Wiacek. The fund in question, Fund III, was operated by an Advisory Board consisting of independent limited partner representatives, pursuant to its organizational documents. According to the SEC allegations, the respondents failed to disclose several conflicts of interest and related party transactions to both the Advisory Board of Fund III and their fund investors.
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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.
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On November 17th, the Texas State Securities Board’s Office of Inspections and Compliance charged Mowery Capital Management, LLC (“Mowery Capital”) and one of its investment adviser representatives (collectively “Respondents”) with fraud for failing to disclose certain conflicts of interests, charging excessive fees, plagiarizing advertising material, and other material misrepresentations. The complaint requests that the state Securities Commissioner revoke Respondents’ registration with the state, levy an administrative fine, and issue a cease and desist order prohibiting any further fraudulent behavior.

When registering as a registered investment adviser, a Form ADV must be completed and filed with the appropriate securities authority. Part 2 of the Form ADV, or the “Brochure,” acts as the primary disclosure document for clients and requires the applicant to write in plain English general information about the business (i.e. types of services offered, fee schedule, business and educational background of employees), including any possible conflicts of interest the applicant may have.
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The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) recently jointly issued a Risk Alert and a Regulatory Notice on broker-dealer branch office inspections designed to help securities industry firms better supervise their branch offices, as well as to underscore the importance of that supervision.

“An effective risk based branch office inspection program is an important component of a broker-dealer’s supervisory system and, when constructed and implemented reasonably, it can better protect investors and the firm’s own interest,” stated Stephen Luparello, Vice Chairman of FINRA.

The risk alert specifically makes the following recommendations to firms, including:

  • Increasing the frequency of branch inspections, especially unannounced visits;
  • Customizing examinations to branch activity based on risk assessments;
  • Involving more senior personnel in exams;
  • Insuring that examiners have no conflicts of interest; and
  • Increasing supervision of certain offices based upon surveillance data and requiring corrective actions to address deficiencies noted.

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