SEC Charges Another Adviser With Failing to Disclose Conflicts

Last week began and ended in the same way for the Commission’s Enforcement Division – with settled proceedings based on adviser conflicts built on false statements that disadvantaged clients. At the beginning of the week the Commission announced the settlement of proceedings captioned In the Matter of Merrill Lynch, Pierce, Fenner and Smith, Inc., Adm. Proc. File No. 3-18516 (August 20, 2018). There the adviser disclosed its evaluation policies for products on client Platforms but then permitted a product to be discontinued to remain based on a pitch by the sponsoring entity tied not just to the merits of the product as the adviser’s disclosure claimed, but also on the “broader relationship” between the advisory firm and the sponsor – the adviser’s self-interest took precedence over the disclosure and the client interest. The week ended in the same way, this time with an adviser not disclosing the fact that in its capacity as a broker-dealer the firm was paid fees on the mutual fund shares recommended by the adviser whose ADV stated no fees were paid. In the Matter of First Western Advisors, Adm. Proc. File No. 3-1863 (August 24, 2018).

First Western is a dual registered investment adviser and broker-dealer. Its advisory services are generally delivered through its Investment Adviser Representatives, many of whom were also registered representatives with the broker-dealer. During the period advisory services were delivered through a program called Private Client Accounts. Clients were offered a variety of mutual fund products over a number of fund complexes. First Western acted as the adviser through its Investment Adviser Representatives. The firm also acted as the introducing broker-dealer on all of the Private Client Account transactions.

The adviser’s ADV stated that the firm did not accept compensation for the sale of securities or investment products. That included the sale of mutual funds.

During the period some of the shares purchased for clients paid 12b-1 fees. Generally funds offer investors different types of shares. Each share class represents an interest in the same portfolio of securities with the same investment objectives. The key difference is the fee structure. For certain shares there are sales charges or loads based on the dollar amount of the investment. In certain instances, such as wrap fee programs or fee-based advisory accounts, the fees are waived. The load bearing shares generally charge 12b-1 fees to cover fund distribution and shareholder services. The fees are deducted from the mutual fund assets and paid to the distributor which typically transmits a portion of the fees to the broker-dealer that sold them. Some classes of shares do not carry these fees.

During the period the adviser here recommended, purchased or held on behalf of some of its advisory clients mutual fund shares that charged 12b-1 fees. Thus the firm received fees on those investments. That was contrary to the disclosures in the Form ADV. It also meant that clients did not receive best execution on the purchase of the shares – they did not receive the lowest price. And, the firm’s compliance program was not properly implemented because the procedures failed to provide that its Investment Adviser Representatives must explain to clients the costs and fees on the various types of fund shares. Accordingly, the Order alleges violations of Advisers Act sections 206(2), 206(4) and 207.

To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order and a censure. In addition, Respondent will pay disgorgement of $139,698.50 and prejudgment interest of $13,068.62 which will be placed in a distribution fund for the benefit of the investors. The firm will also pay a penalty of $50,000.