November 19, 2019

November 19, 2019

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November 18, 2019

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The SEC Files Another Litigated Disclosure Case – With More Violations

On August 29, 2019, the SEC filed a complaint against a registered investment adviser alleging failures to disclose four categories of conflicts of interest and seeking disgorgement of $10 million in undisclosed compensation. This litigated action was filed within a month of the SEC filing a litigated complaint against another firm alleging failing to disclose material conflicts of interest related to revenue sharing, despite that advisory firm having self-reported pursuant to the SEC’s Share Class Selection Disclosure Initiative (“SCSD Initiative”).

Based on these litigated actions (and despite the SCSD Initiative being over 18 months old), the SEC’s Division of Enforcement continues to focus its investigative and litigation resources on “Main Street” and to aggressively pursue registered investment advisory firms for disclosure violations involving actual or potential conflicts of interest.

In this most recent litigated action, not surprisingly, the SEC’s allegations with respect to share class selection conflicts and disclosure violations are consistent with the guidance released with the SCSD Initiative. This firm, however, did not fail to self-report its 12b-1 fee purported violative conduct. Rather, this alleged violative 12b-1 fee conduct was apparently uncovered during an examination by the SEC’s Office of Compliance Inspections and Examinations (“OCIE”). The SEC also alleged disclosure violations related to revenue sharing, a longstanding priority for the SEC that has continued to expand since the SCSD Initiative.

The SEC’s ongoing efforts on disclosure violations about share class selection and revenue sharing have been discussed widely in the financial press and by industry groups.

The latter two alleged disclosure theories, however, have not received similar attention, but provide information and insight into other legal theories that OCIE and Enforcement may now be prioritizing in their examination and enforcement programs. Specifically, the third group of alleged disclosure violations relate to the adviser’s receipt of administrative service fees. While Enforcement has brought cases using similar fee disclosure theories in the past, the number of cases focused on the disclosures and conflicts for these types of fees, as opposed to 12b-1 fees and revenue sharing, pales by comparison. Lastly, the SEC also alleged that the adviser failed to disclose compensation that it received in the form of non-transaction-based mark-ups on charges imposed by the clearing firm. The first time that we observed the SEC charge this type of undisclosed mark-up theory was just within this past year, in December 2018.

For both of these recent SEC actions, the advisers have apparently chosen to litigate and fight the SEC’s ever expanding efforts to regulate specific disclosure language, despite the D.C. Circuit’s ruling in Robare. The D.C. Circuit’s ruling, while troublesome for the SEC as it related to “willfulness” and that aspect of the opinion, supported and favored the SEC’s disclosure theory relating to the use of general disclosure terms such as “may” when, in fact, the adviser “was” receiving compensation. Interestingly though, the SEC chose to not file these two recent matters as administrative proceedings. Doing so would have allowed for the D.C. Circuit’s Robare opinion to serve as precedent. The SEC instead chose to file these as civil complaints in U.S. District Courts outside of the D.C. Circuit. Thus, potentially opening the door for the defendants to attempt to minimize that aspect of Robare by arguing that this opinion is not precedential in those appellate circuits, but only persuasive.

We will continue to follow these litigated matters and report back on any developments likely to impact the industry.

©2019 Drinker Biddle & Reath LLP. All Rights Reserved

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About this Author

Mary P. Hansen, White Collar Criminal Defense Attorney, Drinker Biddle Law Firm
Partner

Mary Hansen is a partner on the firm’s White Collar Criminal Defense & Corporate Investigations team, where she focuses her practice on defending clients in regulatory investigations as well as white collar criminal proceedings in the securities industry.  She also assists clients with internal investigations and compliance and prevention strategies.

Prior to joining the firm, Mary was an Assistant Director of the U.S. Securities & Exchange Commission’s Division of Enforcement, where she was a member of the division’s Market Abuse and...

215-988-3317
James G. Lundy, Drinker Biddle, regulatory investigations lawyer, financial services compliance attorney
Partner

James G. Lundy represents clients in Securities and Exchange Commission (SEC), Commodities Futures Trading Commission (CFTC), self-regulatory organization, and other financial regulatory agency investigations and examinations, and compliance and governance counseling, white collar criminal investigations, and complex business litigation.

With 12 years of senior SEC experience and more than two years of in-house experience at a futures and securities brokerage firm, Jim has developed an in-depth working knowledge of the various regulatory bodies with enforcement, examination, and policy oversight of the securities and futures industries.

312-569-1120