Over the past few years, the SEC has conducted a nationwide and industry-wide “sweep” of investment advisory firms, under which it has initiated investigations and filed lawsuits. against a slew of investment advisory firms related to their revenue sharing disclosures and practices. and other alleged financial conflicts.¹ We’ve blogged before about contentious disclosure cases² and since disputed rulings are the true test of enforcement theories, versus settlements which may pose untested legal theories regarding potential violations, disputed proceedings should be closely monitored.

In one of the most recent of these actions, on March 1, 2022, the SEC filed suit against Cambridge Investment Research Advisors, Inc. (“CIRA”), a registered investment adviser.³ SEC alleges CIRA failed to adequately disclose conflicts of interest and seek best execution in its receipt of revenue sharing from clients’ investments in mutual funds no transaction fees (“NTF Mutual Funds”) and money market sweep funds (“Fund Sweeps”), its conversion of client accounts into wrap account programs and receipt by its Investment Advisor Representatives remuneration in the form of forgivable loans in exchange for meeting certain investment criteria. These undisclosed investment practices, the complaint alleges, also saved CIRA from paying millions of dollars in transaction fees. Additionally, according to the complaint, CIRA converted hundreds of accounts to its more expensive wrap account program without adequate disclosure and without analyzing whether it was in the best interests of its customers. The complaint further alleges that CIRA failed to disclose that its investment advisor 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 alleged conflicts of interest regarding revenue sharing received from client accounts invested in NTF mutual funds and sweep funds, and that it did not did not act in the best interests of its clients by investing in these funds. He alleges that from at least 2014 and in some cases to the present, CIRA has invested clients in NTF Mutual Funds and Sweep Funds which have generated revenue sharing for his affiliate broker, Cambridge Investment Research, Inc. (“CIRI”). He alleges that 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. He further alleges that CIRA failed to adequately disclose conflicts of interest associated with its clients’ investment in these funds, failed to seek best execution, and failed to assessed whether clients should be placed in lower cost shared funds.

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

The third, and related, the SEC alleges that, from 2017 to the present, CIRA breached its fiduciary duty by converting traditional customer accounts to wrap accounts, without providing full and fair disclosure regarding conversions and conflicts of interest. associated interests. She alleges that CIRA made false and misleading statements regarding the conversions, including telling its clients that the conversions were necessary to comply with the fiduciary rule⁴ the requirement that all fees and commissions be clearly disclosed to clients, where conversion was not required for all converted accounts. She alleges that CIRA failed to disclose that it had a financial incentive to convert customers from traditional accounts to wrap accounts because it charged higher advisory fees on wrap accounts. Further, he alleges that CIRA failed to properly assess whether the conversions were in the best interest of its customers.

Fourth, the SEC alleges that from January 2015 to March 2018, CIRA failed to adequately disclose that CIRI made forgivable loans to CIRA’s Investment Advisor Representatives (“RIA”), and conflicts related interests. He alleges that CIRI offered forgivable loans to CIRA’s RIAs, and he offered to cancel or waive those loans if the RIAs maintained certain levels of assets and seniority with CIRA. The SEC therefore alleges that these loans created a conflict of interest because the CIRA IARs who received these loans had a financial incentive to maintain a relationship with CIRI and to recommend CIRI to clients to ensure that their loans were forgiven.

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

The complaint alleges that, by the foregoing alleged conduct, CIRA breached sections 206(2) and 206(4) of the Advisers Act 1940 and rule 206(4)-7 thereunder. this. She seeks a permanent injunction, restitution of any unjust enrichment or ill-gotten gains, including prejudgment interest, and civil penalties.

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

1. See, for example, In Landaas & Company and Robert W. LandaasFile No. 3-18926 (December 12, 2018) (settled action involving allegations of securities violations regarding undisclosed mark-up fees and inadequate disclosure of DSF revenue sharing; best execution failures and compliance deficiencies correspondents); In VALIC Financial Advisors, Inc.File No. 3-19895 (July 28, 2020) (settled action involving allegations of securities violations relating to inadequate disclosures of DSF revenue sharing, avoidance of transaction fees and receipt of 12b-1 fees, as well as best execution failures and corresponding compliance deficiencies); In SCF Investment Advisors, Inc.., File No. 3-19963 (September 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, LLCCase No. 3-20190 (December 23, 2020) (settled action involving allegations of securities violations relating to inadequate disclosures of money market fund revenue sharing through bank sweeps, NTF revenue sharing, avoidance of transaction fees and receipt of fees 12b-1); In Hancock Whitney Investment Services, Inc.File No. 3-20074 (September 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 gaps ); In Kestra Private Wealth ServicesFile No. 3-20391 (July 9, 2021) (settled action involving alleged breaches relating to inadequate conflict of interest disclosures related to his receipt of NTF, iNTF and TF revenue sharing and transaction fee surcharges)
2. To see SEC files another contentious disclosure case – with more violations (enforcementhighlights.com); The Robare decision regarding “May” disclosures and “deliberation” (enforcementhighlights.com).
3. To see Cambridge Investment Research Advisors, Inc., et al. (sec.gov).
4. In April 2016, the United States Department of Labor (“DOL”) issued a final rule (effective June 2017) that imposed a fiduciary duty on investment advisers advising clients on pension and retirement (the “fiduciary rule”) . This settlement was overturned by the Fifth Circuit of Appeals on June 21, 2018, in the decision of United States Chamber of Commerce v DOL.

   Subsequently, on December 18, 2020, the DOL passed Prohibited Transaction Exemption (PTE) 2020-02, Improving investment advice for workers and retirees, a new prohibited transaction exemption under ERISA and the Code for investment advisory trustees with respect to employee benefit plans and Individual Retirement Accounts (IRAs). Investment advisory trustees relying on the exemption must provide advice that is in the best interests of their plan and IRA clients (and meet other conditions) in order to receive compensation that would be otherwise prohibited in the absence of an exemption, including commissions, 12b-1 commissions, revenue sharing, mark-ups and mark-downs in certain principal transactions. Two other requirements of PTE 2020-02 are that (i) conflicts must be adequately disclosed for the exemption to be available and (ii) company and investment professional conflicts must be mitigated. To see DOL’s New Fiduciary ‘Rule’ Completed and Returned to Counsel‒‒‒ for Investment Advisors and Brokers and December 20 Deadline: Now is the Time to Act | Faegre Drinker Biddle & Reath LLP ‒ JDSupra. This requirement is in contrast to the SEC’s Best Interest (“Reg BI”) regulation, which only requires that the investment professional’s conflicts be mitigated.