Why it matters: On April 20, 2015, the SEC announced that it had charged BlackRock Advisors LLC with breach of fiduciary duty for failing to disclose to clients and fund boards a conflict of interest created by the outside business activity of one of its top-performing portfolio managers. BlackRock agreed to pay $12 million to the SEC to settle the charges. BlackRock’s former chief compliance officer was also found to be at fault and agreed to a $60,000 settlement. The case was the first brought under an SEC rule requiring investment advisors to report compliance violations.
Detailed discussion: The SEC announced on April 20, 2015 that Delaware-based financial manager BlackRock Advisors LLC (BlackRock) agreed to pay a $12 million penalty to settle charges that it had breached its fiduciary duty by failing to disclose to clients and fund boards a conflict of interest arising from the outside business activity of one of its top-performing portfolio managers. As part of the settlement, BlackRock also agreed to engage an independent compliance professional to conduct an internal review of BlackRock’s written policies and procedures relating to the outside activities of BlackRock employees. BlackRock’s former chief compliance officer, Bartholomew A. Battista (Battista), was separately charged and agreed to pay $60,000 in settlement.
“This is the first SEC case to charge violations of Rule 38a-1 for failing to report a material compliance matter such as violations of the adviser’s policies and procedures to a fund board,” said Julie M. Riewe, Co-Chief of the SEC Enforcement Division’s Asset Management Unit.
A brief recap of the findings contained in the SEC’s order: In January 2007, one of BlackRock’s portfolio managers, Daniel J. Rice III (Rice), formed family-owned and operated oil-and-natural gas company Rice Energy L.P. (Rice Energy) at the same time as Rice was managing energy-focused funds and separately managed accounts at BlackRock. Rice personally invested approximately $50 million in Rice Energy and was its general partner; his three sons were the CEO, CFO and a VP. The SEC found all of this to be in violation of BlackRock’s private investment policy. In early 2010, Rice Energy formed a joint venture with publicly-traded coal company Alpha Natural Resources, Inc. (“ANR”). By June 2011, ANR stock was, at 9.4%, the largest holding in the $1.7 billion BlackRock Energy & Resources Portfolio, which was managed by Rice.
The findings show that BlackRock’s senior executives, including Battista, were told about Rice’s investment and involvement in Rice Energy as early as January 2007, and that BlackRock’s legal and compliance departments reviewed the matter, but no conflict of interest was found and no disclosures were made to any of the boards of Rice’s managed funds or his advisory clients. The findings also show that, from January 2007 to January 2010, BlackRock did not monitor or reassess Rice’s activities with respect to Rice Energy. In January 2010, Rice informed BlackRock that he intended to go on the board of directors of the Rice Energy-ANR joint venture. The legal and compliance department again reviewed the situation and this time issued a memorandum highlighting the conflicts of interest arising from Rice’s involvement in the joint venture and investment in and access to information about a company (ANR) that is held by funds he manages. BlackRock nonetheless permitted Rice to continue with his activities so long as he agreed to certain parameters, such as not joining the joint venture’s board and pre-clearing with BlackRock any future Rice Energy-related board positions he intended to take. Again, no disclosures were made to any boards of Rice-managed funds or advisory clients, and Rice’s activities were not monitored or followed up on by the company going forward, even though the findings show that Rice raised with and got approval from certain senior BlackRock executives for Rice Energy, related transactions through December 2011. On June 1, 2012, the Wall Street Journal published the first of three articles detailing Rice’s connection to Rice Energy and his simultaneous role as an energy sector portfolio manager at BlackRock.
The SEC found that BlackRock breached its fiduciary duty by failing to disclose to the boards of the Rice-managed funds and advisory clients the conflict of interest created when BlackRock permitted Rice to “form, invest, and participate in [Rice Energy] while Rice was simultaneously managing several billion dollars in energy sector assets held in BlackRock funds and separate accounts… The conflict of interest became more acute once Rice Energy finalized its joint venture with ANR, as the Rice-managed funds and separate accounts held significant positions in ANR stock.”
The SEC also found that BlackRock failed to adopt and implement written compliance and disclosure policies and procedures regarding the outside activities of employees as required by the Advisers Act and its rules. Moreover, the SEC found that these “compliance-related violations” were specifically “caused” by chief compliance officer Battista: “As BlackRock’s CCO, Battista was responsible for the design and implementation of BlackRock’s written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules. Battista knew and approved of numerous outside activities engaged in by BlackRock employees (including Rice), but did not recommend written policies and procedures to assess and monitor those outside activities and to disclose conflicts of interest to the funds’ boards and implement to advisory clients. As such, Battista caused BlackRock’s failure to adopt and these policies and procedures.”
The SEC further found that BlackRock and Battista “knew or should have known” that Rice’s violation of BlackRock’s private investment policy was a “material compliance matter” that had not been reported to the boards of BlackRock’s registered funds, and that BlackRock and Battista “caused” that reporting failure, in violation of Rule 38a-1 under the Investment Company Act.
In addition to paying the $12 million penalty, BlackRock is required to engage an “Independent Compliance Consultant” to conduct a “comprehensive review” of BlackRock’s written policies and procedures “regarding the outside activities of BlackRock employees and any conflicts of interest derived therefrom” to ensure compliance with the relevant provisions of the Advisers Act and the Investment Company Act.
See here to read the SEC’s press release dated 4/20/15 entitled “SEC Charges BlackRock Advisors With Failing to Disclose Conflict of Interest to Clients and Fund Boards.”
See here to read the SEC’s Order In the Matter of BlackRock Advisors, LLC and Bartholomew A. Battista (4/20/15)