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Advisor Reliance on Compliance Consultants Hangs in the Balance

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October 26th marked the final day of briefing before the SEC in what could be a very precedential case for investments advisors, compliance officers and the independent compliance consulting community. In the Matter of The Robare Group, Ltd. began its life in September 2014 as an order instituting administrative and cease-and-desist proceedings against a Houston-based advisor and its principals for alleged undisclosed conflicts of interest.

In June 2015, an administrative law judge found that the SEC’s Division of Enforcement failed to meet its burden in proving Robare’s alleged violations, and dismissed the matter in its entirety. It was a rare win by a defendant in the much-maligned administrative proceeding process, but the victory was short lived: the Division of Enforcement filed a petition for review of the dismissal, which was granted in August 2015. Now that briefing by both sides is complete, Robare’s fate is back in the hands of the SEC. 

What’s intriguing about this case – and what makes it all the more important – is the way that it has morphed from a “simple” alleged undisclosed conflicts of interest case into a case that calls into the question reliance on compliance consultants.

In his lengthy and articulate assessment of the facts and the law, the administrative law judge that rebuked the Division of Enforcement noted that Robare “relied in good faith on compliance consultants.” He went on to conclude that “So long as the advice given is facially valid… and based on [Robare’s] full and honest disclosure, [Robare] could rely on that advice in good faith.”

In other words, the SEC shouldn’t be allowed to play Monday morning quarterback to an advisor that justifiably relies on the counsel and judgment of a compliance consultant. This should especially hold true when the advisor has not acted with a knowing intent to mislead (aka, scienter). 

If Robare had concealed facts from its compliance consultants or if the advice rendered by the compliance consultants was patently wrong, then the reliance defense is out the window. But that’s not the facts of Robare, and that’s not what the administrative law judge is saying; reliance on “facially valid” advice must be in “good faith” based on “full and honest disclosure.” 

The Division of Enforcement disagrees, and asserts that the administrative law judge’s findings “significantly weaken the long-standing fiduciary standards applicable to investment advisers.” By using the magical F-word (no, not that one), the Division of Enforcement seemingly convinced its regulatory compatriots that advisors’ reliance on compliance consultants is an “important matter of public interest” that warrants full appellate review. Curiouser and curiouser.

The logic is effectively one of inappropriate burden-shifting; advisors can’t assign their fiduciary duty to somebody outside the purview of the ’40 Act and then act with reckless abandon. And this is true. But to make the inferential leap that reliance-on-counsel equals fiduciary evisceration requires a bridge too long and fragile to cross. 

Tapping into the experience and expertise of the compliance consulting community has become mainstream for advisors whether the SEC likes it or not, and the fact that many such consulting firms are flourishing is due in large part to the SEC itself.

With an ever-increasing regulatory burden and a moving target of enforcement, it’s no wonder that advisors need outside expertise to stay on top of their compliance programs. Without the ability to justifiably rely on such outside compliance expertise in good faith, there becomes a disincentive to retain such expertise in the first place – which in turn could limit the full potential of advisors’ compliance programs.

Partnering with a compliance consultant (many of whom are SEC alumni) appears to this observer to be something that should be encouraged as in the investing public’s best interest. 

Again, this is not to suggest that the role of compliance consultants is to hand out “get out of jail free” cards to their clients, and the SEC would be right to impose appropriate limitations on the reliance defense (facially valid advice followed in good faith based on full and honest disclosure). Third-party delegation should not act as a liability shield for the malicious or the willfully ignorant.

In the end, this article may be much ado about nothing and the SEC may reaffirm the administrative law judge’s initial decision without addressing what it suggested was an “important matter of public interest.”

But for both investment advisors and the compliance consultants they retain, the final episode of the Robare saga will be one to watch.

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