SEC Settles with Dually Registered Adviser Over Best Execution, Disclosure and Principal Transactions

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The SEC settled administrative proceedings against an investment adviser, Dominick & Dominick LLC, a firm registered with the SEC both as an investment adviser and a broker-dealer (the “Adviser” or “D&D”), and Robert X. Reilly, the Adviser’s Chief Operating Officer (the “COO”), over the Adviser’s practices related to achieving best execution for advisory clients, Form ADV disclosure, and compliance with the principal transactions prohibitions of Section 206(3) of the Investment Advisers Act of 1940 (the “Advisers Act”).  This article summarizes the SEC’s findings in the settlement order (the “Order”), which the respondents have neither admitted nor denied, and related exemptive relief.

Background

During the relevant time period, the Adviser offered its clients five types of advisory programs.  The Adviser also provides brokerage services to nearly all of its advisory clients, serving in the capacity of introducing broker.  The COO was responsible for adopting and implementing D&D’s best execution policies and procedures and conducting the Adviser’s best execution analyses for its advisory clients.

Best Execution Analysis

Consideration of Commissions.  The SEC faulted monthly best execution analyses conducted by the Adviser from March 2008 through December 2012 on selected advisory client trades because they only compared the price for a security obtained by the clearing broker used by the Adviser to the Bloomberg price for the same date and time without considering the commissions that certain advisory clients paid.

Comparison of Actual Commissions Paid.  During the same period, the SEC found that when the Adviser did examine the brokerage commissions advisory clients were charged, it did so only twice, once in 2008, and again following a 2012 SEC exam, and in each instance the Adviser only compared its schedule of brokerage commissions with other advisers’ brokerage commission schedules without examining the actual commissions charged to certain advisory clients.

Renegotiated Clearing Agreement.  The SEC faulted the Adviser for not analyzing whether certain of its advisory clients continued to receive best execution after it negotiated an amendment to the agreement with its clearing broker in August 2012 that reduced the clearance and execution costs the Adviser paid for equity, options and fixed income transactions and increased the Adviser’s share of the commissions charged to all of its customers (including certain of its advisory clients) without altering the allocation of responsibilities between the Adviser as an introducing broker and its clearing broker.

Best Execution Procedures

The SEC found that from January 2008 through December 2012, the Adviser did not meet its obligation to adopt and implement written best execution policies and procedures reasonably designed to ensure compliance with the Advisers Act.  The SEC cited the fact that the Adviser’s written policies and procedures “made little mention of any actual policies or procedures,” “referred only to fixed income transactions,” and “did not consider commissions charged to advisory clients as part of its overall best execution analysis.”

Disclosure – Margin Loan Rebates and Commission Rates

The SEC found that until corrected following a 2012 SEC staff examination, the Adviser failed to disclose the conflict to which it was subject because it received a rebate from its clearing firm consisting of a significant portion of the interest paid by certain advisory clients to the clearing firm for margin loans.  The SEC also found that the portion of the Adviser’s Form ADV provided to clients (the “Brochure”) contained the following misleading statement of material fact: “[w]e have negotiated commission rates with D&D for our clients which we believe to be competitive with rates available elsewhere for similar services.”  The SEC determined that this statement wrongly suggested that there had been an arms-length negotiation between the Adviser in its capacity as investment adviser and the Adviser in its capacity as broker.

Principal Transactions

The SEC found that from January 2008 through August 2012, the Adviser engaged in approximately 140 principal transactions with advisory clients without obtaining consent prior to completion of the transactions as required under Section 206(3) of the Advisers Act.  The Order also found that this practice was not consistent with the Brochure disclosures that the Adviser would “not act as principal in any transaction for your accounts or act as agent on both sides of any transaction, unless you have granted us permission to do so prior to the completion of the transaction.”  The Adviser’s actual practice was to “send a letter to the advisory client after a transaction was executed but before settlement, providing details of the transaction and stating that it had engaged in the transaction as a principal.”  The letter did not seek client consent to proceed with or settle the transaction, and the Adviser did not otherwise obtain client consent.

Violations

The SEC found that the Adviser violated, and the COO caused the Adviser to violate, (1) Section 206(2) of the Advisers Act, which makes it unlawful for an adviser to engage in any transaction, practice, or course of business that operates as a fraud or deceit upon any client, (2) Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which require registered advisers to adopt written programs designed to ensure compliance with the Advisers Act, (3) Section 206(3) of the Advisers Act governing principal transactions, and (4) Section 207 of the Advisers Act, which prohibits material misstatement or omissions in any registration application or report filed under the Advisers Act.

Sanctions

Among other sanctions, the Adviser agreed to pay disgorgement of $136,523 and prejudgment interest of $11,083.60 into a fund to be paid to affected current and former advisory clients.  The Adviser also agreed to pay a civil monetary penalty of $75,000.  The COO agreed to pay a civil monetary penalty of $10,000.

The Adviser was also required to retain for one year an independent compliance consultant to assist it in developing and implementing policies and procedures reasonably designed to promote compliance with the Advisers Act, including best execution and related disclosures to advisory clients, and Section 206(3) requirements for principal transactions.  The Order notes that the SEC’s decision to enter into the Order included consideration of remedial acts promptly undertaken by the Adviser, specifically (A) revisions to the Adviser’s best execution policies and procedures to include “consideration of the total cost of effecting advisory client transactions” and (B) the engagement of a compliance consultant.  The Order also cites cooperation afforded the SEC staff.

“Bad Actor” Exemptive Relief.  On the same date as the Order, the Adviser received exemptive relief from the “bad actor” disqualification provisions of Rule 506 under the Securities Act of 1933.  The Adviser sought the relief because it understood that the Order could prevent certain affiliated and third party issuers that have retained the Adviser or certain of its affiliated persons from relying on the Rule 506 private offering exemption.  Specifically, the Adviser understood that the requirement in the Order that it “hire a qualified consultant would be considered a ‘disqualifying event’ as it places certain limitations on [the Adviser]’s ‘activities, functions or operations’ under Rule 506(d)(1)(iv) of Regulation D.”  As a condition of the exemptive relief, the Adviser agreed to “furnish (or cause to be furnished) to each purchaser in a Rule 506 offering that would otherwise be subject to the disqualification under Rule 506(d)(l) as a result of the Order, a description in writing of the Order a reasonable time prior to sale.”

Dominick & Dominick LLC and Robert X. Reilly, SEC Release No. IA-3881 (Jul. 28, 2014).

 

Topics:  Broker-Dealer, C-Suite Executives, Compliance, Investment Adviser, Investment Advisers Act of 1940, SEC, Settlement

Published In: Administrative Agency Updates, General Business Updates, Finance & Banking Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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