In recent years, the SEC has been conducting a nationwide and industry-wide “sweep” of investment advisory firms, pursuant to which it has opened investigations and brought enforcement actions against a multitude of investment advisory firms related to their disclosures and practices concerning revenue sharing and other alleged financial conflicts.¹  We have previously blogged about litigated disclosure cases² and given the fact that litigated decisions are the true test of enforcement theories, compared to settlements that may pose untested legal theories regarding potential violations, contested proceedings should be followed closely.

In one of the most recent of these actions, on March 1, 2022, the SEC filed an action against Cambridge Investment Research Advisors, Inc. (“CIRA”), a registered investment adviser.³  The SEC alleges CIRA failed to adequately disclose conflicts of interest and failed to seek best execution in connection with its receipt of revenue sharing from client investments in no-transaction fee mutual funds (“NTF mutual funds”) and money market sweep funds (“sweep funds”), its conversion of client accounts to wrap account programs, and its investment adviser representatives’ receipt of compensation of forgivable loans in exchange for meeting certain investment criteria.  These undisclosed investment practices, the complaint alleges, also allowed CIRA to avoid paying millions of dollars in transaction fees.  In addition, according to the complaint, CIRA converted hundreds of accounts to its more expensive wrap account program without adequate disclosure and without analyzing whether doing so was in its clients’ best interests.  The complaint further alleges that CIRA failed to disclose that its investment adviser representatives received compensation in the form of forgivable loans in exchange for meeting certain criteria such as maintaining certain asset levels and tenure with CIRA.

Specifically, first, the SEC alleges that CIRA failed to adequately disclose purported conflicts of interest regarding revenue sharing received from client accounts invested in NTF mutual funds and sweep funds, and it failed to act in its clients’ best interest by investing in those funds.  It alleges that beginning in at least 2014 and in some instances continuing to the present, CIRA invested clients in NTF mutual funds and sweep funds that generated revenue sharing for its affiliated broker-dealer, Cambridge Investment Research, Inc. (“CIRI”).  It alleges CIRA invested clients in NTF mutual funds and sweep funds that paid revenue sharing when less expensive options that did not pay such additional compensation were available.  It further alleges CIRA failed to adequately disclose the conflicts of interest associated with its investment of clients in these funds, it failed to seek best execution, and it failed to evaluate whether clients should be placed in lower cost-share funds.

Second, the SEC alleges that CIRA failed to adequately disclose conflicts of interest and failed to act in its clients’ best interest when, from January 2014 through at least December 2016, it invested its “wrap account” advisory clients in NTF mutual funds, rather than lower-cost options.  Clients who hold wrap accounts pay an all-in advisory fee, which covers both investment advice and transaction fees.  Thus, the SEC alleges, CIRA was incentivized to invest its wrap fee clients in NTF mutual funds, because those funds did not require CIRA to pay transaction fees.  The SEC alleges CIRA failed to adequately disclose the conflicts of interest associated with recommending NTF mutual funds to its wrap account clients.  And it violated its fiduciary duty to clients by (1) investing wrap account clients in NTF mutual funds that were not in its clients’ best interest; (2) failing to seek best execution; and (3) failing to evaluate whether clients should be moved to a lower-cost share option.

Third, and relatedly, the SEC alleges that, from 2017 through the present, CIRA violated its fiduciary duty by converting clients’ traditional accounts to wrap accounts, without providing full and fair disclosures concerning the conversions and associated conflicts of interest.  It alleges that CIRA made false and misleading statements concerning the conversions, including by telling its clients the conversions were necessary to comply with the Fiduciary Rule⁴ requirement that all fees and commissions be clearly disclosed to clients, when the conversion was not necessary for all converted accounts.  It alleges that CIRA failed to disclose it had financial incentive to convert clients from traditional accounts to wrap accounts, because it collected higher advisory fees from wrap accounts.  And, it alleges CIRA failed to adequately assess whether the conversions were in its clients’ best interest.

Fourth, the SEC alleges that from January 2015 to March 2018, CIRA failed to adequately disclose that CIRI gave forgivable loans to CIRA investment advisor representatives (“IARs”), and the related conflicts of interest.  It alleges that CIRI offered CIRA IARs forgivable loans, and it offered to cancel or forgive these loans if the IARs maintained certain asset levels and tenure with CIRA.  The SEC thus alleges these loans created a conflict of interest, as CIRA IARs who received these loans had a financial incentive to maintain a relationship with CIRI and recommend CIRI to clients to ensure their loans were forgiven.

Finally, in connection with the foregoing, the SEC alleges CIRA failed to adopt and implement written policies and procedures designed to prevent violations of the Advisers Act of 1940 (the “Advisers Act”) in connection with its investment selection—including selecting investments that were in the best interest of its clients, and disclosure of conflicts of interest.

The Complaint alleges that, by the foregoing alleged conduct, CIRA violated Sections 206(2) and 206(4) of the Advisers Act of 1940 and Rule 206(4)-7 thereunder.  It seeks a permanent injunction, disgorgement of any unjust enrichment or ill-gotten gains, including prejudgment interest, and civil penalties.

Cambridge Investment Research Advisors, Inc. vehemently denies the SEC’s allegations, and intends to dispute the charges.  We will continue to monitor and provide updates on this action as it evolves.

1. See, e.g., In the Matter of Landaas & Company and Robert W. Landaas, File No. 3-18926 (Dec. 12, 2018) (settled action involving allegations of securities violations regarding undisclosed markup fees and inadequate disclosure of NTF revenue sharing; corresponding best execution failures and compliance deficiencies); In the Matter of VALIC Financial Advisors, Inc., File No. 3-19895 (July 28, 2020) (settled action involving allegations of securities violations regarding inadequate disclosures of NTF revenue sharing, transaction fee avoidance, and receipt of 12b-1 fees, and corresponding best execution failures and compliance deficiencies); In the Matter of SCF Investment Advisors, Inc., File No. 3-19963 (Sept. 3, 2020) (settled action involving allegations of securities violations regarding inadequate disclosures of receipt of 12b-1 fees, corresponding best execution failures and compliance deficiencies); In the Matter of Pruco Securities, LLC, File No. 3-20190 (Dec. 23, 2020) (settled action involving allegations of securities violations regarding inadequate disclosures of bank sweep money market fund revenue sharing, NTF revenue sharing, transaction fee avoidance practices, and receipt of 12b-1 fees); In the Matter of Hancock Whitney Investment Services, Inc., File No. 3-20074 (Sept. 25, 2020) (settled action involving allegations of securities violations regarding inadequate disclosures of NTF revenue sharing, cash sweep revenue sharing, and receipt of 12b-1 fees, corresponding best execution failures and compliance deficiencies); In the Matter of Kestra Private Wealth Services, File No. 3-20391 (July 9, 2021) (settled action involving allegations violations relating to inadequate disclosures of conflicts of interest relating to its receipt of NTF, iNTF, and TF revenue sharing and transaction fee markups)
2. See The SEC Files Another Litigated Disclosure Case – With More Violations (enforcementhighlights.com); The Robare Ruling Regarding “May” Disclosures and “Willfulness” (enforcementhighlights.com).
3. See Cambridge Investment Research Advisors, Inc., et al. (sec.gov).
4. In April 2016, the United States Department of Labor (“DOL”) issued a final regulation (effective in June 2017) that imposed a fiduciary duty on investment advisers who advised clients with regards to pension and retirement funds (the “Fiduciary Rule”).  That regulation was vacated by the Fifth Circuit of Appeals on June 21, 2018, in the decision of U.S. Chamber of Commerce v. DOL.

    
   Subsequently, on December 18, 2020, the DOL adopted Prohibited Transaction Exemption (PTE) 2020-02, Improving Investment Advice for Workers & Retirees, a new prohibited transaction exemption under ERISA and the Code for investment advice fiduciaries with respect to employee benefit plans and individual retirement accounts (IRAs).  Investment advice fiduciaries who rely on the exemption must render advice that is in their plan and IRA customers’ best interest (and satisfy other conditions) in order to receive compensation that would otherwise be prohibited in the absence of an exemption, including commissions, 12b-1 fees, revenue sharing, and mark-ups and mark-downs in certain principal transactions.  Two other requirements of PTE 2020-02 are that (i) conflicts must be adequately disclosed in order for the exemption to be available and (ii) the conflicts of both the firm and the investment professionals must be mitigated.  See The New DOL Fiduciary “Rule” Completed and returned to Attorney‒‒‒ For Investment Advisers and Broker-Dealers and the December 20 Deadline: The Time to Act is Now | Faegre Drinker Biddle & Reath LLP ‒ JDSupra.  This requirement is in contrast to  SEC’s Regulation Best Interest (“Reg BI”), which only requires that the conflicts of the investment professional be mitigated.