NEW YORK(Thomson Reuters Regulatory Intelligence) - The U.S. Securities and Exchange Commission’s $8 million settlement with investment adviser deVere USA, Inc. over charges that New York firm the charges it failed to disclose conflicts of interest to hundreds of clients with UK pensions, drawing the firm’s oversight of important aspects of its compliance program into question.
The SEC announced the settlement last week. The SEC also announced[here] the filing of an action in federal court in Manhattan against two deVere USA investment adviser representatives, British citizens, one of whom was the CEO of the firm and the other who served as a manager up to last year.
DeVere served as an adviser to U.S. residents who once worked in Britain on the transfer of pension assets to overseas retirement plans that qualified for special British tax treatment.
The SEC's cease and desist order[here] filed as part of the settlement alleges that between June 2013 and March 2016, deVere failed to disclose agreements with overseas product and service providers that resulted in compensation being paid to deVere advisers and an overseas affiliate.
The SEC order says that the undisclosed compensation created an incentive for deVere USA to recommend a pension transfer and products or service providers. It said the arrangements and this advice resulted in undisclosed compensation to the firm and to CEO Benjamin Alderson and to Bradley Hamilton, a manager.
The order also found that deVere USA made materially misleading statements concerning tax treatment and available investment options.
The settlement will result in the establishment of a “Fair Fund” for the distribution of the penalty amount to affected clients. The firm is also required to hire an independent compliance consultant.
DeVere consented to the SEC order without admitting or denying its findings that that the firm violated several of the anti-fraud provisions of the Investment Advisers Act of 1940 including Sections 206(1) and 206(2)[here], by making material misstatements and omissions in the offer and sale of securities. The order imposes an $8 million penalty and the engagement of the compliance consultant.
The complaint against Alderson and Hamilton alleges aiding and abetting violations of those same sections of the Advisers Act. It seeks an injunction, disgorgement of improper gains plus interest, and fines.
“Investment advisers have an obligation to disclose direct and indirect financial incentives,” Marc Berger, director of the SEC’s New York office, said in a statement. “DeVere brushed aside this duty.”
DeVere said in a statement reported by Reuters[here] that "it is committed to treating clients fairly" and that it settled the action "to put the matter behind it."
As noted in the SEC’s order, deVere’s clients are primarily U.S. residents or citizens who held U.K. defined benefit and defined contribution pensions.
The firm provided investment advice to its clients in connection with the transfer of these U.K. pension assets to overseas retirement plans that qualified under the U.K. tax authority’s regulations as a Qualifying Recognised Overseas Pension Scheme (QROPS).
Between at least June 2013 and March 2016, deVere failed to disclose arrangements in which third-party product and service providers it recommended in connection with its pension advice compensated an overseas affiliate of deVere that, in most cases, in turn compensated the deVere investment adviser representative who had made the recommendations.
The undisclosed payments constituted the primary form of compensation received by deVere’s investment adviser representatives for their advisory services.
Each of these arrangements created an economic incentive for the firm to recommend a transfer to a QROPS or recommend certain product and service providers, the SEC said.
The SEC said in its order that deVere failed to satisfy disclosure requirements with respect to its Form ADV filings by not informing clients about the compensation arrangement it had with these service providers. Form ADV is the uniform form used by investment advisers to register with the SEC and state securities authorities.
The Form ADV, in Item 5 of the Part 2A brochure section requires disclosure of how the investment adviser was compensated for its advisory services, including, whether the adviser or any of its supervised persons accepts compensation for the sale of securities or other investment products — and an explanation that this practice constitutes a conflict of interest.
The adviser, the SEC said, “failed to both tailor its compliance program to its actual business and to undertake many of the responsibilities laid out in its existing compliance manual.”
In documents filed in Manhattan federal court against Alderson and Hamilton, the SEC said that Alderson, as the top executive at the firm, was responsible for the omissions in these filings and for failing to ensure the firm’s supervisory procedures were sufficient and actually being used.
DeVere agreed to undertake actions including providing notice of these proceedings to its clients, implement training, and the retain the SEC-ordered independent consultant to review the firm’s policies and procedures and make recommendations that the firm should adopt.
In a similar case, the SEC also announced last week that it had fined Lyxor Asset Management[www.sec.gov/enforce/ia-4932-s] -- a fund-of-funds manager -- $500,000 for failing to disclose that it received revenue-sharing compensation from two affiliates that managed funds that Lyxor recommended.
According to the SEC, Lyxor negotiated side letters supposedly intended to benefit clients but that directly benefited the firm through payments routed through what was a common parent company to Lyxor and the affiliates located in France.
The commission said Lyxor failed to implement policies and procedures to detect and prevent conflicts of interest and failed to maintain accurate books and records reflecting the receipt of fees from the affiliates. This violated Section 206(4) of the Advisers Act and the SEC’s Compliance Program Rule, or Rule 206(4)-7, for failing to implement an adequate compliance program.
In a 2016 case, the SEC determined that investment adviser The Robare Group, Ltd.[here] and its principals negligently failed to fully and fairly disclose potential conflicts of interest arising from a revenue-sharing arrangement with a mutual fund manager.
The commission acknowledged that Robare Group had disclosed the revenue-sharing arrangement, but that the adviser nonetheless violated section 206(2) of the Advisers Act by failing to disclose adequately and completely the material conflict of interest arising from that agreement.
Also in 2016, Belvedere Asset Management LLC[here] was found to be in violation of Section 206(2) of the Investment Advisers Act of 1940[here] (“Advisers Act”) when the adviser crafted disclosure in SEC filings that said a conflict of interest "may" occur when the conflict already actually existed.
Belvedere disclosed to some account clients that the adviser “may” invest client assets in the adviser’s affiliated mutual fund — and that this “may” create a conflict of interest relating to the fees it charged, the SEC said.
The SEC said this disclosure was not adequate at the time it was made because the clients’ assets had already actually been invested in the affiliated mutual fund. So the adviser had an actual conflict of interest rather than either a potential or possible one.
These enforcement decisions highlight the commission's steady focus on conflicts of interest and other areas involving investor protection, aided recently by its creation of a Retail Strategy Task Force last September[here].
To begin implementing best practices in this area, adviser firms should consider doing identifying and disclosing in its Form ADV all sources of compensation to make sure any potential or actual conflicts of interest are fully disclosed to clients.
Advisers must be explicit and comprehensive in describing any actual or potential compensation, the fees that clients will incur and whether the firm has taken measures to eliminate the conflict.
With potential of for a whistleblower to report a conflict of interest to the SEC, companies should pay close attention to the reports coming in-house about any suspicions of conflicts.
All appropriate personnel must be trained to be able to spot a conflict of interest. Any conflicts must be reported to regulators sufficiently — if not totally eliminated by the firm — and continuously monitored.
Employees tasked with such monitoring should be identified, and how they survey this terrain can include regulatory technology that alerts them to when conflicts are being triggered by any relationship or transaction, among other tools.
The compliance consultant assigned to deVere to shore up its compliance program showcases the importance of any regulated financial service firm undertaking a fully resourced, board-sponsored, independent review of the current arrangements in place for the management of conflicts of interest.
Part of the work should include a detailed examination of any practice deficiency the regulator has highlighted. A review should also detaile what “good” looks like, so everyone is on the same page. It should note how to find specific, up-to-date provisions in the firm’s compliance handbook.
Monitoring conflicts is more effective when conducted by both business and compliance functions so compliance staff members can point to how they credibly challenged investment and trading decisions made by senior investment professionals.
Compliance monitoring work should not just consist of routinely checking specific procedures; it involves looking at whether controls continue to meet their objectives and whether compliance standards used to manage conflicts reflect developments in market practices and new regulations.
Conflicts may best be handled when boards have committees specifically dedicated to conflicts of interest management. Such governance bodies can challenge and approve conflict identification processes and the controls implemented via technology and human monitoring that should be updated as the business evolves.
Regulated financial services firms that run afoul of best practice in this arena should be prepared for questions on why they have chosen not to follow stated regulatory expectations, particularly the clearly delineated instructions in enforcement decisions against themselves or peers.
Such questions could come from clients and shareholders none too pleased with the reputational hit that any discussion of poorly managed conflicts of interest can enact.
(Julie DiMauro is a regulatory intelligence expert in the Enterprise Risk Management division of Thomson Reuters Regulatory Intelligence. Follow Julie on Twitter @Julie_DiMauro. Email Julie at firstname.lastname@example.org.)
This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on June 12. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters