RIA Compliance Blog
On July 18, 2016, the Securities and Exchange Commission (“SEC”) settled charges against two SEC-registered investment advisers (“investment advisers”). The investment advisers, Advantage Investment Management, LLC (“AIM”) and Washington Wealth Management, LLC (“WWM”) failed to disclose receipt of revenue from third-party broker-dealers in the form of forgivable loans and the consequent conflicts of interest.
Investment advisers are prohibited from engaging in any transaction, practice, or course of business that operates as a fraud upon any client or prospective client under Section 206(2) of the Investment Advisers Act of 1940 (“Advisers Act”). They are also prohibited from making any untrue statement of a material fact or omitting any material fact in any report filed with the SEC under Section 207 of the Advisers Act.
The first case involved AIM, a Cedar Rapids, Iowa-based registered investment adviser. AIM entered into an agreement with a third-party broker-dealer in August 2012 under which the broker-dealer became AIM’s primary broker-dealer. The agreement also stated that the broker-dealer would provide trade execution, custody, and reporting services to clients and sponsor advisory programs that AIM offered. Finally, under the agreement, the broker-dealer issued a forgivable loan of about $3 million to persons associated with AIM, which was forgivable over a five-year period. When AIM filed its Form ADV, it did not disclose the forgivable loan. It also did not disclose the fact that its investment adviser representatives received compensation from the broker-dealer in the form of forgiveness of the forgivable loan, nor the fact that AIM simultaneously used the broker-dealer for various investment services, recommended that clients open brokerage accounts with the broker-dealer, and received investment research from the broker-dealer. The above conditions of the forgivable loan gave AIM financial incentive to use the broker-dealer’s services, which created a conflict of interest.
In the second case, WWM, a San Diego, California-based registered investment adviser, entered into an agreement with a broker-dealer in September 2012 under which the broker-dealer would provide trade execution, custody, and other services to WWM’s clients. Under this agreement, WWM or its representatives received four loans totaling about $1.8 million from September 2012 through March 2013 of which more than $1.1 million was intended to be forgivable. Under the first two loans’ terms, they were to be forgiven over a five-year period so long as WWM continued its relationship with the broker-dealer and maintained certain asset levels on Broker-Dealer custody platforms. The other two loans were interest-free for six months and then bore an interest rate of 4.25% until their maturity dates approximately three years after the loans were made. The fact that the loans required WWM to use services that the broker-dealer provided and to maintain assets with the broker-dealer to obtain loan forgiveness created a conflict of interest for WWM. WWM did not disclose the existence of the loans from the broker-dealer to its clients until October 16, 2013, approximately a year after it received its first forgivable loan. In addition, the disclosure took place after the SEC’s Office of Compliance Inspections and Examinations performed an examination of WWM and informed WWM in July 2013 of its failure to disclose the loans.
The SEC’s orders each found that AIM and WWM had violated Sections 206(2) and 207 of the Advisers Act by failing to disclose to their clients and in their Form ADVs their receipt of the loans from the broker-dealers. AIM consented to the entry of the SEC’s order censuring it, requiring it to cease and desist from further violations, and to pay a $60,000 civil penalty. WWM also consented to the entry of the SEC’s order censuring it, requiring it to cease and desist from further violations, and to pay a $50,000 civil penalty.
The charges against AIM and WWM each reflect a continued effort by the SEC’s Office of Compliance and Inspections and the Enforcement Division’s Asset Management Unit to address undisclosed compensation arrangements between investment advisors and broker-dealers. Because these loans obligated AIM and WWM to use the services of the broker-dealers who issued the loans, they created conflicts of interest in breach of their fiduciary duties to their clients.
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.