The SEC sued an investment adviser for breach of fiduciary duty and undisclosed conflicts of interest related to revenue sharing arrangements that affected transactions in mutual fund shares.
According to the SEC Complaint filed in the U.S. District Court for the District of Massachusetts, Commonwealth Equity Services, LLC ("Commonwealth"), the adviser did not sufficiently disclose to its clients that it received hidden material economic benefits on certain fund investments it selected for clients, and failed to disclose that there were other funds for which the adviser did not receive any revenue sharing and thus "had an incentive not to select." According to the SEC, the adviser had disclosed that certain of its arrangements with the clearing broker may create a conflict of interest, however, the SEC alleged that the adviser received over $135 million in revenue sharing payments over a period of approximately 4-1/2 years which the SEC stated was an actual, not merely potential, conflict of interest. In addition to the fiduciary duty and disclosure violations, the SEC also alleged that Commonwealth violated the Advisers Act by failing to adopt and implement policies and procedures reasonably designed to prevent fiduciary duty and disclosure violations.
The SEC is seeking: (i) a permanent injunction from further violating the Advisers Act; (ii) disgorgement of unjust enrichment, as well as prejudgment interest; and (iii) a civil penalty.
Commentary
Although this case stands out largely due to the amount of the revenue sharing payments involved, it should not come as a surprise. The SEC has been focused on undisclosed investment adviser conflicts of interest for some time and the conduct at issue here is well within the purview of the SEC's recent pronouncement on required Investment Adviser Standard of Conduct and Fiduciary Guidance. It would certainly not be surprising if further litigation of this type were to follow. In any case, investment advisers would do well to review their revenue sharing procedures and disclosures in light of this SEC action.
What does come as a surprise is that the SEC chose to bring this case before a jury in federal court, rather than in an administrative proceeding. It had been unclear how aggressive the SEC will be in utilizing its in-house procedure since it resumed bringing contested administrative proceedings last year. That the SEC decided to bring an enforcement actions against a registered investment adviser for violations of the Investment Advisers Act - the kind of case that typically would have been brought as an administrative proceeding before the Supreme Court's decision in Lucia - in federal court suggests that the SEC will continue to be very conservative in using its home court for contested actions. Unless there is a significant change, it appears that the SEC will reserve administrative proceedings for settled actions and the few instances where the cause of action, or relief being sought, is available only in an administrative proceeding.
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