RIA Compliance Blog
Earlier this year, the Kansas Court of Appeals affirmed a district court decision holding that Mark R. Schneider (“Schneider”), an investment adviser representative and broker-dealer, violated the Kansas Uniform Securities Act by recommending nontraditional exchange-traded funds (“ETFs”) to a client whose investment objective was to produce income. Schneider was ordered to pay $94,720.60 in restitution and a $25,000 civil penalty.
For over 20 years, Schneider acted as investment adviser to Mary Lou and Jeffrey Silverman. Schneider oversaw the Silvermans’ assets, tax returns, and life insurance, and he had discretionary authority over their investments. In 2010, Mr. Silverman died, and Mrs. Silverman obtained $1,150,000 from Mr. Silverman’s life insurance policy. In May 2010, Schneider formulated a financial plan to help Mrs. Silverman garner income from investments she would make using the money from the life insurance policy.
Schneider placed Mrs. Silverman’s funds in nontraditional ETFs. Schneider placed practically all of his 160 retail investors in nontraditional ETFs, including Mrs. Silverman. He also held the nontraditional ETFs for time frames covering more than one trading session. However, in 2009, the Financial Industry Regulatory Authority (“FINRA”) published Regulatory Notice 09-31 informing members that nontraditional ETFs were “’highly complex financial instruments’ and unsuitable for retail investors who hold them for more than one trading session, particularly in volatile markets.”
In 2012, the Kansas Securities Commissioner (“Commissioner”) issued a notice of intent to apply administrative sanctions against Schneider for alleged violations of the Kansas Uniform Securities Act. The Commissioner alleged that Schneider’s investing Mrs. Silverman’s funds in nontraditional ETFs amounted to “unsuitable recommendations and a breach of his fiduciary duty as an investment adviser representative.” In February 2015, an Administrative Law Judge found that Schneider had violated the Kansas Uniform Securities Act, and ordered the adviser to pay about $94,000 in restitution and a $25,000 civil penalty. In May 2015, a district court upheld the decision of the Administrative Law Judge and the Commissioner’s findings. Schneider appealed to the Court of Appeals.
Schneider’s first argument on appeal was that the Administrative Law Judge and the Commissioner had treated Regulatory Notice 09-31 as a binding authority regarding whether Schneider had violated the Kansas Uniform Securities Act, resulting in the application of an incorrect standard. However, the Commissioner demonstrated that it merely used Regulatory Notice 09-31 as evidence. The Commissioner also pointed out that it used the Kansas Uniform Securities Act’s standards regarding unsuitable recommendations to determine whether Schneider violated it.
Schneider’s second argument on appeal was that the Commissioner had not shown that Schneider did not have a reasonable basis for determining that the nontraditional ETFs were not suitable for Mrs. Silverman. However, the Commissioner showed that Mrs. Silverman was a retail investor and that multiple publications concerning nontraditional ETFs clearly stated that they were generally unsuitable for retail investors. Moreover, evidence showed that Schneider did not inform Mrs. Silverman that he planned to place her funds in nontraditional ETFs, nor did he inform her of the risks connected to investing in nontraditional ETFs.
Schneider’s third argument on appeal was that the Commissioner did not demonstrate that Schneider breached his fiduciary duty because the Commissioner made no showing of scienter. However, the Commissioner demonstrated that a finding of negligence is sufficient to establish breach of fiduciary duty. Moreover, the Commissioner showed that Schneider lacked a sufficient understanding of nontraditional ETFs.
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 compliance with federal and state laws and rules. Please visit our website for more information.