Monday, May 23, 2022

Adviser must pay $1.8M to settle breach of fiduciary duty charges

By John Filar Atwood

The SEC has ordered First Republic Investment Management, Inc. to pay more than $1.8 million in disgorgement, interest, and penalties for breaches of fiduciary duties to its investment clients. The Commission determined that the adviser failed to disclose that its broker affiliate received third-party compensation from advisory client investments, and caused certain clients to invest in mutual fund share classes with terms less favorable than others available at the time (In re First Republic Investment Management, May 19, 2022).

According to the order, the adviser used a clearing broker that had a no-transaction-fee mutual fund program (NTF program) through which investors could purchase and sell mutual funds without paying a transaction fee. Mutual fund share classes sold through the NTF program generally had higher expense ratios and a higher recurring fee paid to the clearing broker than other share classes of the same fund offered by the clearing broker.

Financial incentive. The Commission determined that since at least February 2014, the agreement between the adviser’s affiliated broker and the clearing broker provided that the clearing broker would share a portion of the recurring fee with the affiliated broker based on customer assets invested in mutual funds in the NTF program. The payments the affiliated broker received under the agreement created a financial incentive for the adviser to recommend mutual funds covered by the agreement over other investments, including lower-cost share classes of the same mutual fund, the SEC stated.

The Commission noted that the adviser was obligated to disclose all material facts to its advisory clients, including any conflicts of interest between itself and its clients that could affect the advisory relationship. To meet this fiduciary obligation, the adviser was required to provide its advisory clients with full and fair disclosure about the conflicts of interest, but did not, the SEC found.

In addition to not providing the required disclosure, the SEC determined that the adviser breached its duty to seek best execution by causing certain advisory clients to invest in mutual fund share classes that paid revenue sharing when share classes of the same funds were available to the clients that presented a more favorable value at the time of the transactions. Finally, the Commission charged the adviser with a failure to adopt and implement written compliance policies and procedures reasonably designed to prevent the violations.

Disgorgement, penalty. The SEC charged the adviser with violations of Investment Advisers Act Sections 206(2) and 206(4) and Rule 206(4)-7. Without admitting or denying the charges, the adviser consented to a cease-and-desist order and a censure. It also agreed to pay disgorgement of $1.33 million, prejudgment interest of $243,289, and a civil penalty of $250,000.

The adviser will distribute funds to harmed clients and will take certain remedial steps with respect to its disclosure. It also agreed to review its accounts and to move clients to a lower-cost share class as necessary.

This is Order No. IA-6030.