The SEC recently announced a settlement regarding (1) an investment adviser’s breach of its fiduciary duty by failing to disclose a conflict of interest that resulted from a $50 million loan that one of its senior executives received from an advisory client, and (2) the investment adviser’s violation of the Investment Advisers Act when, among other things, the adviser (a) inadvertently billed a client for asset management fees on non-managed assets and (b) failed to enforce its gifts and entertainment policy. The SEC stated that “as fiduciaries, investment advisors must be vigilant about disclosing all material facts to their clients, including actual and potential conflicts of interest … and the $20 million penalty reflects the significance of this and other regulatory failures.”
Failure to Disclose Conflict of Interest
The investment adviser’s client (Client A) made a $50 million loan to a senior executive of the adviser (Adviser Executive). Client A maintained accounts managed by the investment adviser and non-managed accounts outside of the adviser. The loan was negotiated and made by Client A, through one of its affiliates, as principal and not by the investment adviser on Client A’s behalf.
At the time of the loan, the investment adviser’s Code of Ethics (the Code) stated, “This Code is based upon the principle that [the adviser’s] employees owe a fiduciary duty to [the adviser’s] clients to conduct their affairs ... in such manner to avoid ... any actual or potential conflicts of interest[.]” The Code further directed that employees be familiar with the investment adviser’s compliance manual. The compliance manual explained the requirement that the investment adviser, as a fiduciary, “make full and fair disclosure of all material facts, including potential conflicts of interest,” to its clients. The investment adviser’s Code also referred its employees to the guidance in a code of conduct for one of its affiliates, which prohibited employees from accepting loans from clients.
The SEC found that the investment adviser did not act reasonably in connection with the Adviser Executive’s loan from Client A because it failed to adopt measures to provide meaningful oversight of the Adviser Executive’s non-advisory business dealings that impacted the adviser’s obligations as a registered investment adviser. Specifically, multiple senior individuals within the investment adviser and the adviser’s corporate parent knew about the loan, but none of these individuals communicated its existence to the adviser’s compliance staff because the adviser had an insufficient compliance process. As a result, the investment adviser did not inform its clients of the potential conflict of interest created by the loan, and the adviser failed to enforce its Code and implement its compliance policies and procedures regarding conflicts of interest.
Advisory Fees Charged on Non-Managed Assets
The SEC found that during a multi-year period, for one institutional client, the investment adviser inadvertently charged approximately $6.5 million in asset management fees for investments it did not manage. The charges resulted from inaccurate coding of the investments on the investment adviser’s books and records. That coding, in turn, caused the investment adviser’s accounting system to interpret the investments – incorrectly – as investments managed by the adviser on behalf of the client.
Violations Regarding Gifts and Entertainment
The investment adviser’s Code stated that “Supervised Persons may only accept appropriate and reasonable gifts and entertainment of a de minimis value as provided in [the adviser’s] Gifts and Entertainment Policy.” The investment adviser’s Code further defined de minimis as having a value of $250 or less. The investment adviser’s policies and procedures required the chief compliance officer to approve any exceptions to the gift and entertainment limitation on a case-by-case basis.
The SEC found that at least 7 of the investment adviser’s employees took at least 44 unreported flights on the private planes of the adviser’s clients. However, the investment adviser’s compliance logs only reflected one such flight, which had been mentioned to the adviser’s chief compliance officer after the flight occurred. As a result, the investment adviser failed to enforce its Code with respect to gifts and entertainment and implement its compliance policies and procedures regarding gifts and entertainment.