Category Archives: conflicts of interest

EB-5 Program Operator Settles With SEC For Over $7.9 Million

The SEC has announced that an Idaho man who operated an EB-5 regional center has agreed to settle a case against him alleging that he took millions of dollars to pay for luxury cars and investments unrelated to the purpose of the particular EB-5 program at issue, i.e., to develop luxury real estate and invest in gold mining ventures in Idaho and Montana.

The EB-5 program is a special expedited path to a green card for foreign investors who provide a set minimum of investment capital that creates at least 10 U.S. jobs within 2 years of the investment. The program is designed to incentivize investment in rural areas (e.g., Idaho) or high unemployment areas. Whereas the minimum for such “targeted employment areas” is $500,000, the minimum for more affluent areas is $1 million.

The respondent, Serofim Muroff, and his assistant and bookkeeper are alleged to have diverted about $5.5 million of the $140.5 million in investment money provided by Chinese investors. In addition to disgorging the allegedly diverted proceeds, Muroff has agreed to a $2 million penalty plus interest, and to be barred from conducting further EB-5 offerings. Neither Muroff nor his assistant admitted or denied the allegations in the SEC’s complaint.

Here is the press release.

https://www.sec.gov/litigation/litreleases/2017/lr23818.htm

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Trump Administration May Suspend DOL Fiduciary Rule

The DOL Fiduciary Rule, effective April 2017, is among the items that the new administration may put on hold upon taking office in January 2017. Once effective, the Rule makes all financial advisers providing rollover and other advice to retirement investors “fiduciaries” required to put retail customers’ interests before the advisers’ interests in getting compensated. Broker-dealers, investment advisers, and mutual fund complexes have already sunk millions of dollars into upgrading and changing their compliance and business models in anticipation of the Rule.

At the center of the Rule is the so-called “Best Interest Contract” Exemption or BIC. It permits fiduciaries to enter into prohibited transactions (e.g., accepting commissions in connection with providing rollover and other investment advice) if the financial firm and professional enter into a BIC with the customer, provide certain disclosures, adhere to Impartial Standards of Conduct, charge only “reasonable” compensation, and acknowledge fiduciary status.

Due to its complexity and related compliance costs, some firms have announced that they will not be opening new commissions-based retirement accounts. Others have said that they will continue to open such accounts but will make continuous efforts to review accounts for the appropriateness of commission-based versus fee-based compensation based on a number of factors (e.g., the amount of trading in the account).

The new administration may ask the SEC to step in and issue a unifying rule covering investment advice to retirement accounts. Currently, the SEC’s regime for registered investment advisers under the 1940 Investment Advisers Act provides that investment advisers (who typically charge a percentage of assets under management) are fiduciaries. Such advisers may enter into conflicted transactions if adequate disclosures are made to the customers and if not otherwise prohibited by law.

By contrast, SEC Rules do not impose a fiduciary duty on brokers who provide rollover and other advice to retirement accounts in return for a commission. Brokers charging a commission for transactions are not considered fiduciaries and are instead held to the lesser “suitability” standard.

Regardless of whether the DOL Rule survives, the kinds of changes and industry introspection that have occurred are probably not a complete waste of time and money. FINRA and the SEC are already monitoring investment advisers and broker-dealers for conflicted transactions and policies with respect to compensation. For example, FINRA tends to take a very broad view of whether an investment recommendation, including a rollover recommendation, is “suitable”. Further, the plaintiffs’ litigation bar has long been asserting claims for breach of fiduciary duty in FINRA arbitrations even in the technical absence of such a duty.

Bottom line: regardless of the durability of the DOL Rule, advisers and their firms should continue evaluating their business practices to conform to a “best interests” standard.

For further discussion, here is a recent article from The Hill:

http://thehill.com/policy/finance/305287-financial-adviser-rule-could-be-in-trumps-crosshairs

 

 

 

 

 

 

“Nothing Succeeds Like Success” Unless “Success” Is Based On Inflated AUM

Having substantial assets under management (AUM) can really boost an investment adviser’s ability to attract new money. Accordingly, there is tremendous pressure to report strong numbers to the investing public, including through news sources (e.g., Barron’s top advisors list). As one adviser has found out, the price of inflating such AUM numbers can be millions in dollar in fines and a permanent bar from the industry.

Specifically, an SEC Administrative Law Judge (ALJ) has found that Dawn Bennett and her firm falsely claimed between $1 – $2 billion in AUM when the most she ever had was $400 million. Ms. Bennett made such claims on a radio show she hosts and to Barron’s magazine in order to secure “top Barron’s advisor” recognitions for three years. In addition, Ms. Bennett provided performance information based upon “model portfolios” while representing that such returns were actual customer returns. Ms. Bennett and her firm also face FINRA customer arbitrations relating to the above issues as well as alleged account churning.

In its decision, the ALJ fined Ms. Bennett $600,000 and her firm $2.9 million. The ALJ also ordered $556,000 in disgorgement and imposed a permanent industry bar finding that Ms. Bennett “is not fit to remain in the industry in any capacity.”

Bottom line — while the temptation to inflate performance is very strong, especially in this competitive market, advisors who make false statements do so at their own peril.

Here is a link to the ALJ opinion — https://www.sec.gov/alj/aljdec/2016/id1033jeg.pdf

SEC to Increase Focus on Advisor Fee Disclosures

The SEC’s investor advocate, Rick Fleming, has told Congress that one of the SEC’s focuses in the coming budgetary year (starting October 2016) will be the quality of advisor and broker dealer fee disclosures. The SEC is concerned that such disclosures (referencing things like advisory, trailer, administrative, “regulatory,” and custodial fees) are confusing to retail investors who don’t know industry parlance. Broker dealers are likely to be paying extra attention to the quality of their disclosures, not only because of this initiative but because the “best interests” standard under the DOL’s fiduciary rule will take effect in April 2017.  For further discussion, please see the link below.

http://www.investmentnews.com/article/20160701/FREE/160709997/sec-investor-advocate-fleming-targets-fees-charged-by-advisers

It’s Here! DOL Issues Final Fiduciary Rule

The long awaited and much contested DOL Rule imposing a fiduciary duty on brokers providing advice to retirement accounts is now final. Though it provides a significant runway for implementation (at least a year), the Rule is already changing business models from small brokerages right up to the biggest wirehouses.

The Big Change

Under current rules, brokers, for the most part, operate under a standard that only requires advice to clients to be suitable, but not necessarily in the client’s bests interests. Investment advisers, by contrast, are always operating under a best interests fiduciary duty standard.

The DOL, with strong support from the White House, has moved to plug this gap by using its powers to issue a best interests standard for ALL advisers providing advice over retirement plans. (Such plans are defined as 401(k)s and other employer-sponsored plans, IRAs and other tax-deferred accounts, such as health savings accounts.) The Rule is supposed to provide increased protection for retail investors, who the DOL says are more likely to use brokers on commission than their more expensive counterpart – investment advisers paid as a percentage of assets under management.

While it was already the case that brokers providing repeated investment advice (e.g., asset allocation and rebalancing advice) for a fee had a fiduciary duty, the new DOL Rule broadens the definition to include even one-time investment consultations or recommendations. Rollover recommendations also would be considered fiduciary advice.

Potential Impact 

The potential impact on brokerage houses and their representatives is immense.  For one thing, investors who bring suit or arbitrations against their representatives will have a broader claim basis – representatives could be personally liable for losses caused by a breach of the best interests duty. 

Fiduciaries also are subject to potentially large excise taxes for engaging in prohibited transactions, unless they qualify for an exemption. ERISA currently prohibits fiduciaries from completing transactions that involve conflicts of interest unless they disclose the conflicts and operate under the oversight of an independent fiduciary.

Commissions/Annuities Still Ok

The Rule permits brokers to charge commissions provided they comply with the Best Interest Contract Exemption (BICE) and other requirements. BICE permits a firm to charge commissions if the adviser and the client enter into a contract that specifies that all advice be in the best interests of the client, clearly discloses all conflicts, directs the customer to a webpage disclosing the compensation arrangements entered into by the adviser and firm, and makes customers aware of their right to complete information on the fees charged. In addition, broker-dealers will need to have procedures in place to encourage advisers to make recommendations in the client’s best interests.

Finally, there was industry concern that the sale of certain financial products considered to be riskier or more expensive than others (i.e., annuities, insurance, and mutual funds) on commission would have been barred under the Rule. However, the Rule permits such sales under the BICE.

When Does a Broker Become a Fiduciary?

There has been much discussion around the Department of Labor’s fiduciary rule, which looks like it will take effect soon. Basically, it would make registered representatives (brokers) fiduciaries to all retirement accounts. This is a change from the current “suitability” standard, which, while important, is not the same as a best interests duty of loyalty. At the moment, however, brokers can still step into a fiduciary role, depending on what they are doing for a client and how they are being paid (commissions v. fees). Here’s a diagram to help figure it out:

broker

Investment Advisors Beware: Ten Things OCIE Is Looking At

The SEC is increasing the number RIA inspections by the Office of Compliance Inspections and Examinations (OCIE) and has signaled an aggressive agenda for such exams. Here is a non-exhaustive list of items a Chief Compliance Officer and his or her staff may want to consider well in advance of getting a call from OCIE:

  1. Cybersecurity Policies and Procedures: Make sure the firm’s policies are periodically reviewed and cover key issues (e.g., electronic security (passwords, encryption, “need to know” segmentation), physical security, employee training, incident response planning, and vendor due diligence).
  2. Product Selection: For both RIAs and BDs, the SEC is taking a close look at certain products (e.g., variable annuities) sold to retail investors. Ensure proper monitoring of client recommendations and allocations.
  3. Performance Advertising: Pay particular attention to the distinctions between true actual performance, model performance, and back-tested performance.
  4. Third-Party Affiliations: Disclose any business relationships with 3d parties (e.g., solicitor and sub-advisory relationships) and the potential conflicts they pose.
  5. Fee Structure/Reverse Churning: OCIE is looking at disclosures re: fee structure and the appropriateness of fee-based compensation (e.g., is a firm actively managing an account or just collecting fees).
  6. Custody: “Custody” is broadly defined in Rule 206(4)-2. Firms that have custody need to comply with the Rule’s requirements (e.g., hire an independent CPA to conduct an annual surprise audit).
  7. Code of Ethics/Insider Trading: Make sure the Code is up to date and has adequate personal trading and disclosure restrictions.
  8. Best Execution: If firm has authority to pick BDs, make sure to disclose how firm selects BDs and any “soft dollar” arrangements.
  9. Principal Trading: Disclose it; make sure Rule 3T being followed.
  10. Anti-Money Laundering Policies: For firms that are also BDs, make sure to have AML policies and procedures designed to pick up on suspicious activity (e.g., lots of relatively small transactions).