Presented below is a highlight of eight noteworthy enforcement actions the Securities and Exchange Commission has taken against investment advisers through the second quarter of 2023. Since the beginning of this year, the SEC’s actions have targeted a range of investment advisers, from large institutional advisers to robo-advisers, focusing on the advisers’ duties to provide full and fair disclosures to their clients, to avoid unreasonable and undisclosed conflicts of interest, to create and implement effective policies to carry out the SEC’s rules and regulations, and to make informed and sound investment decisions in line with such rules. We encourage our clients to review the actions fully detailed below for more specific information on the SEC’s findings and for a lens into the SEC’s enforcement priorities with regards to these market participants.

Failure to Disclose Conflicts of Interest

In the Matter of Randy Robertson, Administrative Proceeding No. 3-21268 (January 5, 2023)

In January of 2023, the SEC charged Randy Robertson, a former BlackRock Advisors, LLC, portfolio manager, for failing to disclose that a fund that he managed was an investor in a film print and advertising company, from which he sought professional acting opportunities for his daughter.[1] Specifically, starting around February 2014, Robertson, who had no experience in the print and advertising business, looked into a BlackRock investment opportunity regarding a potential secured lending investment relating to print and advertising expenses associated with film distribution. During discussions with a firm that sourced potential investment opportunities in this space, Robertson requested that the sourcing firm help his daughter with potential acting opportunities in the film industry. The sourcing firm made arrangements to have Robertson’s daughter meet with people involved in casting actors in films.[2]

At some point in the discussions, the sourcing firm introduced Robertson to the principal of a new film distribution company, Aviron.[3] The two attended some meetings to discuss financing opportunities, and Robertson then brought his daughter to a meeting, where they again discussed her acting career.[4] The principal, William Sadleir, offered to be helpful to Robertson’s daughter, regardless of whether BlackRock moved ahead with an investment.

While at that point communications between Robertson and Sadleir did not lead to any investments between the two businesses, they re-engaged in discussions the following year, and ultimately BlackRock’s fund executed a note providing Aviron up to $38 million in funding.[5] Meanwhile, Sadleir continued to help Robertson’s daughter pursue acting, flying her to Cannes and offering her a job at Aviron, which she did not pursue.

Over the course of the next several years, Robertson recommended continued funding of Aviron and expanded the investment, and Robertson’s daughter continued to interact with Aviron executives regarding roles in film.[6] By 2019, recognizing that the volatility and risk of the large Aviron position in the portfolio was adversely impacting the fund, a member of the investment team sent an email to Robertson advising that he take steps to reduce or cut the fund’s exposure.[7] Yet, Aviron requested more funding, this time for a 2018 film in which Robertson’s daughter made a small appearance.[8] Robertson approved the continued influx, and never disclosed to the Board that his daughter appeared in the Film.

BlackRock terminated Robertson in 2020 after learning about his conflict involving Aviron, and as a result of his conduct, the SEC charged him with violating Section 206(2) of the Investment Advisers Act of 1940 (“Advisers Act”).[9] Without admitting or denying the SEC’s findings, Robertson agreed to a cease-and-desist order, a censure, and a $250,000 penalty.

While the conflict and duty to disclose here may be obvious, this case reminds investment advisers that they should always be aware of potential conflicts arising out of familial relationships, even those which may seem innocent or inconsequential. Independent arrangements or business dealings between associated persons of investment advisors and individuals or entities that are the target of potential investment from the advisor will always serve as a red flag for the SEC.

Undisclosed Fees

In the Matter of Huntleigh Advisors, Inc. and Datatex Investment Services, Inc., Administrative Proceeding No. 3-21313 (February 27, 2023)

In February of 2023, the SEC announced settled charges against investment advisers Huntleigh Advisors, Inc. (“Huntleigh”) and its affiliate Datatex Investment Services, Inc. (“Datatex”) for various disclosure failures in violation of Section 206(2) of the Advisers Act, including failingto disclose (1) compensation Huntleigh received based on client transaction fees; (2) revenue sharing payments an affiliated broker-dealer—Huntleigh Securities Corp. (HSC)—received and shared with Huntleigh from advisory client cash sweep accounts; and (3) the revenue HSC received and shared with Huntleigh based on the rate of margin interest charged to advisory clients.[10]

With regards to the disclosure failures, according to the complaint, Huntleigh represented to clients in its Form ADV Part 2A brochures that clients would be responsible for certain fees and expenses charged by custodians and imposed by broker-dealers including, but not limited to, transaction fees, but that the adviser would be responsible for paying execution and clearing charges to the clearing broker. The disclosures did not explain what a “transaction fee” was as opposed to the other charges, nor did they disclose that their affiliate, HSC, determined the amount of such fees, or that they financially benefited.[11] Those disclosures were “inadequate and misleading.”[12]

Huntleigh and Datatex also failed to disclose to clients that some of their “cash sweep accounts” (accounts in which uninvested cash balances would be directed until the investors decide how to invest the money), paid a revenue share to the financial firms whose clients used the accounts, and some of the payments were directed to HSC (the affiliate broker-dealer), who in turn credited the revenue back to Huntleigh.[13] HSC did provide a document to cash sweep account clients describing the revenue sharing program and the introducing firm’s interest in the various sweep account options, but the document did not make clear that the introducing firm was HSC, did not address that the advisers had a conflict of interest, and did not disclose that Huntleigh was profiting from the relationship.[14]

These investment and fee arrangements also formed the basis of the SEC’s findings that Huntleigh and Datatex violated their fiduciary duty of care and duty to seek best execution.[15] For its violations, Huntleigh agreed to pay disgorgement of $608,251 with prejudgment interest of $105,251 and a civil penalty of $130,000. Datatex agreed to pay a civil penalty of $50,000.

This action reminds investment advisers that even if these types of vertical and horizontal integrations in the financial services industry are relatively common, they still must be disclosed to clients.

In the Matter of Merrill Lynch, Pierce, Fenner & Smith Inc., Administrative Proceeding No. 3-21356 (April 3, 2023)

In April of 2023, the SEC charged Merrill Lynch, Pierce, Fenner & Smith Inc. for charging its advisory clients over $4 million in undisclosed foreign exchange fees for transfers to or from their accounts, in violation of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and related rules.[16]

Between 2016 and July 2020, Merrill Lynch offered “wrap fee” programs to advisory clients in which the clients paid Merrill a fee based on percentage of assets under management (the “wrap fee”) in exchange for a range of investment advisory services, including foreign currency exchanges.[17]In the program’s client agreements and brochures, Merrill Lynch disclosed that it charged a markup or markdown on foreign currency exchanges, but it did not disclose an additional fee it referred to as a production credit, which, in more than 80 percent of the transactions, was equal to or greater than the disclosed markup or markdown.[18]As an example of how the fee was calculated, the SEC notes that on January 23, 2020, Merrill processed an outgoing international wire transfer of $19,342,946.07 involving an exchange from U.S. dollars to British pounds. For this exchange, Merrill charged the wrap fee client a total fee of $105,798.45, consisting of a markup of $9,524.79 and a production credit of $96,273.66.[19] In total, Merrill charged its wrap fee clients $4,134,610 in undisclosed production credits during the Relevant Period. Merrill Lynch paid a percentage of these production credits to its financial advisors and referred to this charge as a commission in internal documents.[20]

In June of 2020, pursuant to SEC’s newly implemented rules relating to registered investment advisers, Merrill provided new and existing clients with an updated document explaining, for the first time, the production credits that Merrill had been charging its wrap fee clients for these transactions.[21]

In settlement of the SEC’s charges, Merrill Lynch agreed to a cease-and-desist order, a censure, and to pay disgorgement of approximately $4.1 million, prejudgment interest thereon of $760,000, and a civil penalty of $4.8 million. Merrill Lynch agreed to distribute funds to harmed advisory clients.

Investment Advisers must be sure not to selectively disclose some fees but not others relating to a particular service. Here, although the markups and markdowns on foreign currency exchanges were disclosed, many clients were unaware that there were actually much larger fees exacted from these transactions that were undisclosed for years.

Inadequate Disclosures and Client Losses Due to Errors

In the Matter of Betterment LLC, Administrative Proceeding No. 3-21373 (April 18, 2023)

In April of 2023, the SEC and Betterment settled charges against the robo-advisor due to Betterment’s alleged failures relating to its tax-loss harvesting (“TLH”) service.[22] As part of Betterment’s investment advice, it offers portfolio strategies consisting primarily of exchange traded funds (“ETFs”) that provide exposure to different asset classes, and Betterment recommends a particular fixed income versus equity allocation based on a client’s reported goals.[23] The tax-loss harvesting technique seeks to reduce or eliminate taxes owed on investment profits by offsetting them with losses from other investments.

To obtain the benefit of the TLH strategy, clients had to affirmatively enable TLH by selecting it through the online user interface, at which point it would scan client accounts for harvesting opportunities to reduce tax burden. For those clients who selected the service, the SEC found that Betterment misstated or omitted material information concerning its function.[24] For example, in January 2016, Betterment changed the TLH scanning frequency for individual client accounts from daily to alternating days, but until April 2019 continued to state in certain marketing materials and other disclosures that client accounts were scanned daily. Further, from September 2017 through January 2019, Betterment failed to disclose certain constraints regarding TLH for clients that selected a third-party portfolio strategy available on Betterment’s platform together with a Betterment-constructed portfolio. Finally, at different times, Betterment had two computer coding errors that prevented TLH from harvesting losses for certain impacted clients. Collectively, these issues adversely impacted the value of TLH for over 25,000 client accounts, and as a result, clients lost approximately $4 million dollars in potential tax benefits.[25]

Based on this conduct, the Settled Order alleged that Betterment willfully violated Section 206(2) of the Advisers Act, which prohibits an investment adviser, directly or indirectly, from engaging “in any transaction, practice or course of business which operates as a fraud or deceit upon any client or prospective client”; Section 206(4) and Rule 206(4)-7, which requires registered investment advisers to adopt and implement written compliance policies and procedures reasonably designed to prevent violations of the Advisers Act; and Section 204 of the Advisers Act and Rule 204-2(a)(10) thereunder, for failing to preserve certain books and records. Betterment agreed to pay a $9,000,000 penalty as part of the settlement.

In the digital age, the SEC’s action shows that robo-advisers will be monitored and will have the same obligations as all investment advisers to ensure transparency about their services and to be upfront about any material changes to those services or issues with them that may have a negative impact on their clients.[26]

Rule 105 of Reg. M: Prohibited Short Selling During Restricted Period

Securities and Exchange Commission v. HITE Hedge Asset Management LLC et al, No. 1:23-cv-10351 (D. Mass. filed Feb. 17, 2023)

In February of 2023, the SEC filed a settled complaint against HITE Hedge Asset Management LLC for violating SEC Rule 105, which prohibits short selling an equity security during a restricted period (generally five business days before a covered public offering) and then purchasing the same security in the covered offering, absent an exception.[27] The Rule applies regardless of the trader's intent, and is designed to prevent potentially manipulative short selling before the pricing of covered offerings.[28]

According to the SEC’s complaint, HITE violated the rule when it sold common stock of one company, and three days later purchased the same common stock in a secondary offering, without qualifying for an exception from the prohibition in Rule 105.[29] At the time of the violation, HITE had no formal written policies relating to Rule 105, and it was not until after the SEC began its investigation into the illegal trading that HITE implemented a written Rule 105 policy, conducted a review of its trading history to determine if other Rule 105 violations had occurred, and otherwise enhanced its compliance measures.[30]

To settle the complaint, the various HITE entity defendants agreed to pay $220,155 in penalties and disgorgement.[31]

HITE’s straightforward and avoidable violation of the Rule shows the need for advisers to implement effective and robust policies that will ensure compliance with the relevant laws.

Breach of Fiduciary Duty

SEC v. Sapere Wealth Management, LLC and Scott Trease, No. 3:23-cv-00172 (W.D.N.C. filed Mar. 22, 2023)

In March of 2023, the SEC filed a lawsuit in the Western District of North Carolina against Sapere Wealth Management, LLC, and its principal, Scott Trease, for unsuitably recommending that three clients invest $7.3 million in risky, alternative-investment deals in breach of their fiduciary duties and in violation of Section 206(2) of the Investment Advisers Act of 1940.[32] Trease allegedly heard of these deals through a self-described financier whom he met in Bible study,[33] and he falsely believed the investments the man described were collateralized by a gold safekeeping receipt.[34] From 2018 through early 2019, the financier presented Trease with several investment opportunities, which consistently fell apart and raised red flags indicating that these types of alternative investments were unsuitable for Sapere's and Trease's clients.[35]

Nevertheless, in May 2019, Sapere and Trease recommended three clients invest a total of $7.3 million in two such alternative investments.[36] The SEC alleges that Sapere and Trease did not reasonably understand the investments and thus lacked a reasonable basis to recommend them to clients, in violation of their duty of care. Specifically, even though Sapere's compliance officer encountered hurdles trying to review the legitimacy of the transactions, Trease still convinced one of his clients to invest.[37] The SEC alleges that based on this conduct, Respondents breached their fiduciary duties owed to their funds under Section 206(2) of the Advisers Act. In consenting to the entry of final judgment, Trease agreed to pay a $100,000 civil penalty.

In the Matter of Classic Asset Management, LLC, and Douglas G. Schmitz, Administrative Proceeding No. 3-21403 (May 4, 2023)

On May 4, 2023, the SEC announced that it had settled charges against Classic Asset Management (“CAM”), a North Dakota-based investment adviser, and CAM indirect part-owner and investment adviser representative Douglas G. Schmitz for their violations of Sections 206(2) and 206(4) of the Investment Advisers Act.[38] The charges brought by the SEC were for breach of fiduciary duty in connection with CAM’s investments in leveraged exchange traded funds (“ETFs”) in discretionary client accounts. These charges and the subsequent settlement appeared less than a week after the SEC staff released a bulletin on broker-dealer and investment adviser Duty of Care, in which staff notes the first overarching care obligation is to understand the risks, rewards, and costs associated with every product, investment and strategy.[39] This case provides an example of an adviser that did not do so.

According to the SEC’s order, from 2017 to near the end of 2020, CAM and Mr. Schmitz invested advisory client funds in leveraged ETFs for extended periods, often in high concentration, despite warnings in each of the funds’ prospectuses that the ETFs carry unique risks, required frequent and diligent monitoring, and were specifically designed to be held for no more than a single trading day.[40]The SEC found that CAM and Schmitz misunderstood these characteristics and lacked reasonable belief that the LETFs were in their clients’ best interests.[41] Further, CAM and Schmitz failed to appropriately monitor the products’ performance and therefore did not evaluate whether the LETFs were in the clients’ best interests throughout the holding period.[42] In settlement of the charges, CAM and Schmitz agreed to pay $195,228 and $738,113, respectively, in disgorgement, prejudgment interest, and civil penalties.[43]

In line with the SEC’s bulletin, the SEC’s press release on this case reminds investment advisers that in carrying out the investment manager’s duty to act in a client’s best interests, advisers must ensure that they understand the nature of complex products, such as leveraged ETFs, and must know there is a reasonable basis to recommend these products before purchasing them for clients.[44]

Fund Valuation

In the Matter of Chatham Asset Management, LLC, and Anthony Melchiorre, Administrative Proceeding No. 3-21355 (April 3, 2023)

In April of 2023, the SEC charged Chatham Asset Management and its founder, Anthony Melchiorre, for improper trading of certain fixed income securities in violation of Sections 206(2) and 17(a)(1) and (a)(2) of the Investment Advisers Act.[45] The violations were based out of Chatham and Melchiorre’s trading, on behalf of fund clients, in three high-yield debt securities issued by American Media Inc. (“AMI”).[46]

Through a “high conviction” strategy, Chatham caused their clients to acquire substantial positions in AMI bonds, often consisting of 11% of the client portfolios. [47] These AMI bonds were generally illiquid investments and traded over the counter. There were few purchasers of the AMI Bonds other than the Chatham clients, and when the next largest holder of AMI Bonds attempted to sell them on the open market during the relevant period, they were unable to find any purchaser aside from Chatham clients.[48]

To address portfolio constraints such as industry or issuer fund concentration limits, to meet investor redemptions, and to allocate capital inflows and outflows, Chatham engaged in “rebalancing trades” that involved the sale of AMI Bonds by one or more Chatham clients and an offsetting purchase of the AMI Bonds by one or more different clients. These trades were executed at prices Chatham and Melchiorre proposed.[49] Over time, the prices at which Chatham and Melchiorre traded the securities in the rebalancing trades increased at a significantly higher rate than the prices of similar securities, and therefore, Chatham’s and Melchiorre’s trading in the AMI Bonds had a material effect on their pricing.

As a result of the inflated trading prices of the securities, the net asset values of their client’s funds were higher than they would have been if the rebalancing trades were removed from the market, which, in turn, resulted in higher fees being charged to the clients.[50]

The parties agreed jointly and severally to pay $11 million in disgorgement and about $3.4 million in prejudgment interest, and civil penalties of $4.4 million and $600,000, respectively.

This enforcement action highlights the SEC’s continued vigilance in rooting out misconduct in the fixed income sector of the market, where investments can be less liquid.[51]

[1] https://www.sec.gov/news/press-release/2023-3.

[2] https://www.sec.gov/litigation/admin/2023/ia-6211.pdf at ¶ 8.

[3] Id. at ¶ 9.

[4] Id. at ¶ 9.

[5] Id. at ¶¶10-14.

[6] Id. at ¶ 15, 17-18.

[7] Id. at ¶ 16.

[8] Id. at 19.

[9] Id. at 21.

[10] https://www.sec.gov/litigation/admin/2023/ia-6251.pdf at ¶ 1. Also, during the relevant period, Huntleigh and Datatex advised clients to purchase or hold mutual fund share classes that charged 12b-1 fees, including when lower-cost share classes of those same funds were available to those clients. These fees were paid to HSC, which in most cases would not have collected them had Huntleigh’s advisory clients been invested in the available lower-cost share classes.

[11] Id. at ¶¶ 11-16.

[12] Id. at ¶ 16.

[13] Id. at ¶¶ 19-24.

[14] Id. at ¶ 22.

[15] Interestingly, Commissioners Peirce and Uyeda issued a statement dissenting from the Order, asserting that it provided no legal authority for finding that a mutual fund share class selection implicates an investment adviser’s duty to seek best execution or find the most favorable costs or proceeds of a transaction for clients. The Commissioners said that this decision is the latest in “ a long line of actions alleging that mutual fund share class selection implicates the duty to seek best execution,” and that this is a problematic interpretation. Instead, mutual fund share classes should be evaluated under the duty to provide advice in the best interest of the client, rather than under the “duty to seek best execution.” See Statement Regarding Huntleigh Advisors, Inc. and Datatex Investment Services, Inc. (Feb. 27, 2023), available at https://www.sec.gov/news/statement/peirce-uyeda-statement-huntleigh-datatex-022723.

[16] https://www.sec.gov/news/press-release/2023-73.

[17] https://www.sec.gov/litigation/admin/2023/34-97242.pdf at ¶1.

[18] Id. at ¶¶ 1-2.

[19] Id. at ¶ 15.

[20] Id. at ¶ 3.

[21] Id. at ¶ 18.

[22] https://www.sec.gov/news/press-release/2023-80.

[23] https://www.sec.gov/litigation/admin/2023/ia-6288.pdf at ¶5.

[24] Id. at ¶ 1.

[25] Id. at ¶ 2.

[26] See https://www.sec.gov/news/press-release/2023-80.

[27] https://www.sec.gov/litigation/litreleases/2023/lr25643.htm.

[28] https://www.sec.gov/litigation/complaints/2023/comp25643.pdf at ¶¶ 1, 15.

[29] Id. at ¶¶ 16-20.

[30] Id. at ¶¶ 21-31.

[31] https://www.sec.gov/litigation/litreleases/2023/lr25643.htm.

[32] https://www.sec.gov/litigation/litreleases/2023/lr25681.htm.

[33] The relied-upon financier was later sentenced to more than two years in prison for unrelated felony charges on wire fraud and conspiracy. See https://www.law360.com/articles/1589234/nc-adviser-took-bad-bets-from-bible-study-buddy-sec-says.

[34] https://www.law360.com/articles/1589234/attachments/0 at ¶¶1-2.

[35] Id. at ¶ 3.

[36] Id. at ¶¶ 4-6.

[37] Id. at ¶ 24.

[38] https://www.sec.gov/news/press-release/2023-88.

[39] See Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Care Obligations, https://www.sec.gov/tm/standards-conduct-broker-dealers-and-investment-advisers.

[40] https://www.sec.gov/litigation/admin/2023/34-97427.pdf at ¶1.

[41] Id.

[42] Id.

[43] https://www.sec.gov/news/press-release/2023-88.

[44] https://www.sec.gov/news/press-release/2023-88.

[45] https://www.sec.gov/news/press-release/2023-72/.

[46] https://www.sec.gov/litigation/admin/2023/ia-6270.pdf at ¶1.

[47] Id. at ¶ 9.

[48] Id. at ¶ 11.

[49] Id. at ¶ 1, 21-22.

[50] Id. at ¶ 2.

[51] https://www.sec.gov/news/press-release/2023-72.