With SEC Chair Mary Jo White’s announcement that she will step down at the same time President Barack Obama leaves office in January, there has been much speculation about whether Chair White’s policy of pursuing minor, “broken windows” type violations will be turfed out.
That “broken windows” approach was evident in an SEC opinion issued last month against a small investment adviser and its two principals imposing a combined $150,000 penalty for purported conflicts of interest—despite the fact that there was no harm to investors and no benefit to the adviser.
In its original administrative proceeding, instituted in 2014, the SEC’s Enforcement Division claimed that the adviser failed to adequately disclose to its clients the conflicts of interest inherent in an arrangement whereby the adviser received compensation from the custodian of its clients’ accounts for maintaining client assets in certain investments. The Enforcement Division further claimed that the failure to disclose the conflicts amounted to fraud despite the fact that the adviser employed third-party compliance firms to ensure the disclosures were adequate. In June 2015, the Administrative Law Judge, who is employed by the SEC, dismissed the Enforcement Division’s case.
The Enforcement Division appealed its loss. Keep in mind that when the SEC’s Enforcement Division appeals an adverse decision by an SEC Administrative Law Judge, the appeal is made to . . . the SEC. In this case, because there are two vacancies on the five-member Commission, the Enforcement Division’s appeal was heard by a Commission made up of only three commissioners: Chair White, Commissioner Stein, and Commissioner Piwowar. Commissioner Piwowar will reportedly become the acting SEC Chair until White can be replaced.
On November 7, 2016, the three-member Commission reversed its ALJ and found in favor of its Enforcement Division. The SEC imposed a fine against the adviser and the two individuals, finding that the adviser acted negligently, rather than intentionally as the Enforcement Division contended. Regarding the fact that the adviser had hired third party compliance professionals to ensure the adequacy of disclosures, the Commission said that the adviser “could not reasonably rely on any advice that the disclosures were adequate because they knew their obligations as investment advisers, that they were required to disclose potential conflicts of interest, and that the Arrangement presented such a conflict but was not disclosed.”
Notably, although Commissioner Piwowar concurred with the opinion, he dissented on the imposition of civil penalties, stating that there was no basis for imposing a civil penalty because “there was no harm to others, none of the Respondents was unjustly enriched, none of the Respondents has committed previous violations, there are no other matters as justice may require that would lead one to conclude that civil penalties are appropriate in this matter, and there has been no showing that we need to deter such persons, based on the findings of the administrative law judge and the record before us.”
Commissioner Piwowar’s dissent may become the majority view of the SEC during the Trump administration, following campaign promises to “dismantle” Dodd-Frank, among other things. If so, it would present a 180 degree turn away from Chair White’s “broken windows” policy of enforcement, imposing penalties only in cases in which there was harm to others, unjust enrichment from law violations, and a need to deter future misconduct.
While that may or may not become the view of a majority of the SEC commissioners, advisers and brokers should assume that the SEC’s Enforcement Division will continue to actively investigate even the most minor conflicts of interest and remain vigilant about disclosure.
Attorney Jenifer Doan contributed to this article.
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