The Folly Of ADV Disclosures: What The Robare Decision Teaches About Trying To Do It Right

Ulmer & Berne LLP

Most of the time, the cases I write about were some other lawyer’s. In some respects, it’s easier to offer comments when it isn’t my case. I can, hopefully, be more objective, less pissed off (when the result is one I disagree with, of course), and content merely to mine the case for interesting lessons applicable to all my readers. This post, however, is entirely personal. It concerns a case that my colleague and partner, Heidi VonderHeide, and I have been working on for years for two guys – Mark Robare and Jack Jones, who own and run The Robare Group, an RIA in Texas. These are two people that anyone would be proud to represent, and who epitomize the kind of advisors that you would be comfortable recommending to your own mother to handle her nest egg. You probably think I’m biased – and perhaps I am – but even the judge who oversaw the trial stated, in his opinion, that he found Mark and Jack to be “honest and committed to meeting their disclosure requirements” and that it was “difficult to imagine them trying to defraud anyone, let alone their investment clients.”

Finally, Mark and Jack are nearing the end of what turned into a long, difficult road to clear their name. Yesterday, the D.C. Circuit Court of Appeals handed down its decision in what’s become known in legal/IA circles as the “Robare case.”

I have to concede at the outset that while the sanctions the SEC imposed against Mark and Jack were vacated, which is worth celebrating, we didn’t come away with a clean victory, as the court upheld one of the two violations that the SEC found, and remanded the case back to the SEC to determine what the appropriate sanctions – if any – ought to be now, in light of the court’s ruling.

Nevertheless, despite the finding, I can’t help but feel that Mark and Jack won. And I challenge anyone who takes the time to read the decision (and its genesis, especially the ALJ’s Initial Decision, which dismissed ALL of the SEC’s charges) to reach a contrary conclusion. The fact is, while the court partially agreed with the SEC (which had been forced to argue on appeal against the findings of its own ALJ, who had decided to dismiss all charges), the specific findings that were made by all three factfinders amply demonstrate that all my clients are “guilty” of is trying their absolute best to “meet their disclosure requirements.” The fact that THAT failure can nevertheless constitute the basis for a finding that they violated the Investment Advisors Act is, simply, silly.

And, if you work in compliance, what happened to Mark and Jack should keep you up at night.

The pertinent facts of the case aren’t too difficult to understand. Mark and Jack create model portfolios for their advisory clients comprised of no-transaction-fee mutual funds. They pick their funds from a wide variety of fund families available to them on Fidelity’s platform, based strictly on whether the funds are good performers. At one point in time, the BD with which they were – and still are – associated informed them that Fidelity offered a program that would pay them a small fee if they happened to select “eligible,” non-Fidelity NTF funds for their customers. Considering it, their sole question for Fidelity was, if they elected to participate in the program, would they be forced to select funds they otherwise would avoid, or avoid funds they would otherwise choose. They were told, no, they could continue to choose their mutual funds based on their existing, objective criteria. If one of the funds they chose happened to be “eligible” they would receive a fraction of the fund fee paid to Fidelity.

Based on that representation, they entered into a written, tri-party agreement among themselves, Fidelity and their BD. Fidelity never told them which mutual funds were “eligible” for the fee sharing, but Mark and Jack didn’t care, since they weren’t making their investment decisions based on whether the particular mutual funds they chose for their model portfolios resulted in them getting the fee. Whatever fee payments were generated were paid quarterly by Fidelity through their BD as a commission. The BD took its normal, small percentage (in accordance with the existing commission agreement between them) and the remainder was paid to The Robare Group.

Mark and Jack may be experts at making investment decisions for their advisory clients, but they are admittedly not experts at understanding what language should be used in crafting Form ADV conflict disclosures. That is hardly a knock on Mark and Jack. As our witnesses – both fact and expert – testified at the trial, the SEC’s standard for proper disclosure of conflicts of interest was a “moving target.” The scant guidance offered by the SEC was broad and general, and not of much help. Accordingly, every single time Mark and Jack filed their Form ADV, they first obtained qualified assistance. Over the years, they engaged three different compliance consultants for help with their ADV, and they never submitted a Form ADV without the help of a consultant. In addition, they paid their BD a fee in exchange for supervisory/compliance review, including review of the Form ADV disclosures.

Having surrounded themselves with experts and advisors, they firmly believed that any conflict of interest, whether actual or potential, that was created by the deal with Fidelity was adequately disclosed to the world on their Form ADV. They testified – and it was not rebutted any witness the SEC called – that anytime anyone told them to make a change to their ADV, they said, “no problem,” and promptly made the amendment.  In fact, in the middle of the time period at issue here, The Robare Group was audited by the SEC and that audit included a review of the Form ADV. In the end, the SEC examiners expressed no problems whatsoever with the Firm’s disclosures.

Despite all that, many years later, the SEC concluded that Mark and Jack’s ADV failed to disclose the conflict the Fidelity program created. The SEC offered them the chance to settle, and even though it was a “neither admit nor deny” deal, it still included a finding that they had violated an anti-fraud provision of the Advisors Act. While that would have been the easy – and certainly cheaper – way out, Mark and Jack couldn’t do it. They did not believe they committed fraud, and would not sign a settlement agreement that made such a finding. So, off we went to trial with the SEC’s Division of Enforcement.

You have undoubtedly read all the literature out there taking issue with the SEC’s increased use of administrative proceedings in recent years, rather than litigating in court. For years, the SEC ferociously defended its right and ability to bring cases before its own ALJs. The Supreme Court, of course, recently reached the opposite conclusion, finding that the SEC’s ALJs had been unconstitutionally appointed. That aside, however, from a statistical point of view, you can’t argue with the SEC’s choice of forum: rightly or wrongly, the SEC won almost every case it filed before an ALJ.

But not this case. Mark and Jack beat the odds and won their case. ALJ Grimes, after hearing the evidence, dismissed all charges against Mark and Jack. In my favorite line from his Initial Decision, worth quoting again, he said this: “[I]n listening to Mr. Robare and Mr. Jones testify and observing their demeanor under cross-examination, it is difficult to imagine them trying to defraud anyone, let alone their investment clients.”

The Division of Enforcement appealed the dismissal to the Commission. It’s worth pausing briefly here to remember that the Commission is the very entity that authorized the filing of the case in the first place. Then, on appeal, it sits as the appellate body where, because it’s a de novo review, it is empowered to agree with, disagree with, or modify the factual or legal findings of the ALJ however it likes.

Not surprisingly, when presented with this rare instance where an ALJ bucked the statistics and dismissed the case, finding it devoid of the required evidence, the Commission reversed, although not entirely. The Commission agreed with the ALJ that there was simply no evidence of intentional conduct. It found instead that my clients acted negligently, and that they “willfully” violated Section 207 in submitting the Forms ADV. The SEC is empowered to assess first, second, or third tier monetary sanctions where someone willfully violates the Act. Here, the Commission imposed second tier sanctions (i.e., aggravated sanctions), notwithstanding the ALJ’s findings. Notably, though, the imposition of sanctions was a split decision, with one Commissioner determining no sanctions were warranted.

We then appealed to the DC Circuit, our first foray into “neutral territory.” Well, as noted above, the court didn’t entirely buy our arguments. In the most perplexing finding I can imagine, the court concluded that although Mark and Jack subjectively believed that their Form ADV was complete and accurate, based on their decision to let experts handle that difficult task, they were still “negligent.” Negligent, it seems, because even though they realized they didn’t know enough about the standards governing the disclosures in Form ADV to be able to draft them themselves, according to the court, they somehow should nevertheless have known that the disclosures drafted by their paid experts were “plainly inadequate.”

So, Mark and Jack hired experts to draft their ADV disclosures because they were NOT expert at that. Yet, they were supposed to have realized that the language their experts drafted, language that was reviewed and approved by their BD, language that was reviewed by SEC examiners, and language that the ALJ found to be just fine, wasn’t just inadequate but “plainly inadequate.” That, my friends, is a standard that exists only in the minds of jurists, but not in the real world. There is no one who could successfully thread that needle.

And that is why you can see how I am able with a very straight face to say that Mark and Jack won. Everyone agrees that they had no scienter. Heck, they didn’t even act willfully (which is why the Section 207 claim was dismissed, something for another blog post, another day). They tried their level best to meet a standard of disclosure that, apparently, even industry experts could not successfully figure out. If that makes them guilty of committing fraud, then there is a real problem with the very law they supposedly violated. That mere negligence, indeed, negligence accompanied by a good faith intent to do the right thing, can still be deemed fraudulent, is utterly nonsensical and absurd.

We are not going to ask the Supreme Court to consider this case, but I wonder…..

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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