SEC Charges Advisory Firm For Breaches Of Fiduciary Duties
12/19/2017On December 11, 2017, the United States Securities and Exchange Commission (“SEC”) filed a complaint against two investment advisers, Westport Capital Markets, LLC (“Westport”) and its controlling shareholder, Christopher McClure, alleging that the advisers violated various provisions of the Investment Advisers Act of 1940 (“Advisers Act”) by failing to disclose conflicts of interest and receipt of fees and profits related to their investment decisions on behalf of clients, and by failing to seek the best execution for client transactions. Complaint, SEC v. Westport Capital Mkts. LLC, No. 3:17-cv-02064 (D. Conn. Dec. 11, 2017), ECF No. 1.
Section 206 of the Advisers Act imposes fiduciary obligations on investment advisers. Among other things, courts and the SEC have interpreted this provision to require investment advisers to disclose their compensation and any conflicts of interest, to seek “best execution,” and to obtain client consent before engaging in principal transactions with their clients. See 15 U.S.C. § 80b-6; United States v. Tagliaferri, 820 F.3d 568, 572 (2d Cir. 2016). The SEC has also interpreted the best execution requirement to prohibit an investment adviser from causing a client to purchase a more expensive share class of a particular mutual fund when a less expensive class of that same fund is available. See, e.g., In the Matter of Cadaret, Grant & Co., Inc., Admin. Proc. File No. 3-18087, at 6 (Aug. 1, 2017) (settled matter).
The SEC’s complaint alleges that from 2012 to 2015, Westport directly purchased shares of offerings for its own brokerage account at a discount, and then sold those same securities at full price to its advisory clients’ accounts. According to the SEC, Westport thus received a “mark-up” equivalent to the price differential, which it did not disclose to its clients. These undisclosed mark-ups totaled $650,000. Further, the complaint alleges that the investments included high-risk securities—despite the instructions of at least one client to select low-risk investments—and the poor financial performance of certain of the issuing companies caused Westport’s investors to suffer nearly $890,000 in realized losses. The SEC also alleges that Westport violated Section 206 by failing to obtain client consent before engaging in principal transactions, and by failing to disclose the compensation it earned from mark-ups.
Separately, the SEC also alleges that from 2012 to 2017, Westport invested clients in mutual fund share classes that charged marketing and distribution fees (“12b-1 fees”), see 17 CFR 270.12b-1, even when lower-fee share classes of the same funds were available. As such, Westport received around $130,000 in 12b-1 fees, which were paid by the Westport clients and other investors that invested in those higher-fee share classes. The SEC alleges that Westport’s investments were not consistent with its duty of best execution and that Westport failed to adequately disclose the revenues it received from 12b-1 fees.
This case is another example of the SEC’s continued focus on investment advisers’ commissions and fees, both to ensure disclosure and to police how advisers trade on behalf of their clients. Further, the case is poised to present the interesting question of whether the best execution requirement prohibits investment advisers from selecting a higher-cost class of a given security for their clients when there are lower-cost classes available. That is how the Commission has interpreted the requirement, see Shearman & Sterling LLP, Investment Adviser Settles SEC Allegations Over Directing Clients to High-Fee Mutual Fund Share Classes¸ Need-to-Know Litigation Weekly, Aug. 8, 2017, available at http://www.lit-wc.shearman.com/investment-adviser-settles-sec-allegations-over-d, but the court could take a different view.
We will continue to monitor and report on developments in this case.CATEGORY: Regulatory Enforcement Matters