Federal appeals court rules against advisers on disclosure failure
In a recent article published in InvestmentNews, Reporter Mark Schoeef, Jr. reported that a federal court has ruled that a Texas investment advisory firm did fail to disclose conflicts related to the sale of mutual funds. But, the court added, the advisory firm did not do so willfully and vacated the civil penalties and sent the case back to the Securities and Exchange Commission (SEC).
Despite an April 30 decision by the U.S. Court of Appeals for the D.C. Circuit that gave both sides a partial victory, the message to registered investment advisers is to beef up disclosure language in their Form ADVs, according to a compliance lawyer. In fact, many lawyers now say the case gives SEC enforcement more ammunition on share-class crackdown.
Compliance requires full disclosure, full transparency
The case involved Robare & Jones Wealth Management in Houston. The SEC alleged the firm inadequately disclosed conflicts of interest from 2005 to 2013 related to a revenue-sharing agreement with Fidelity Investments that gave the firm a payment when it recommended certain funds on the Fidelity platform. The advisory firm received approximately $400,000 from Fidelity.
The SEC said the arrangement wasn’t disclosed at all until 2011, and after that point, the disclosure fell short of full transparency because it said the firm “may” receive revenue-sharing when, in fact, it did.
The firm’s principals, Mark Robare and Jack Jones, appealed the SEC enforcement case to an in-house SEC administrative law judge (ALJ) and won. But the full commission overturned the ALJ decision and imposed $50,000 in penalties on Mr. Robare, Mr. Jones, and the firm.
Mr. Robare and Mr. Jones then appealed to the D.C. Circuit, which found they were negligent in disclosing conflicts of interest but did not hide them willfully. The court vacated the civil penalties. Now, it’s back in the SEC’s hands to decide what kind of punishment to mete out.
Should financial services lawyers blog about their clients?
Perhaps if they want to “try” their case in the public domain. Or maybe not…
Mr. Robare and Mr. Jones created model portfolios for their clients comprised of no-transaction-fee mutual funds, according to a blog post by the firm’s lawyer, Alan Wolper, partner at Ulmer & Berne. He said Fidelity told them they would receive a “small fee if they happened to select ‘eligible'” funds, but that they could choose funds based on objective criteria.
The two entered the agreement and then hired consultants to write their Form ADV disclosure.
Quoting from Wolper’s blog post, Schoeef wrote, “Having surrounded themselves with experts and advisers, they firmly believed that any conflict of interest, whether actual or potential, that was created by the deal with Fidelity was adequately disclosed to the world on their Form ADV.”
But the D.C. Circuit still found they committed fraud.
The case has direct implications for the recent share-class disclosure initiative the SEC conducted. In that program, the agency encouraged investment advisers to report themselves if they failed to disclose they received 12b-1 fees for selling the funds. The firms that stepped forward had to repay their clients but avoided fines.
It now appears the SEC is starting enforcement investigations into firms that didn’t self-report. Those probes are extending into revenue-sharing. The D.C. Circuit’s decision appears to strengthen the SEC Enforcement Division’s hand.
Investment advisers should review their Form ADV disclosures and sharpen language about possible conflicts of interest based on financial incentives to “stop” the disgorgement clock from ticking.
Was it a lack of compliance oversight?
Hard to say. The offending firm did hire an outside consultant to publish report conflict of interest disclosures. But was it enough? That’s where Patrina can help. We’ve built our business based on helping organizations keep track of “bad apples,” and stay on the “straight and narrow” efficiently and cost-effectively. So, let’s talk. Call 212-233-1155 to ask about Patrina’s cost-effective, designated third-party services, our comprehensive 8-module compliance solution, and compliant data capture & file archiving, and records archiving specifically designed for the financial services community. Be smart. Be covered. Let’s talk