On February 14, 2025, the SEC settled charges against a New York-based Registered Investment Adviser (RIA) and a former Investment Adviser Representative (IAR) of that firm. The RIA and IAR allegedly breached the fiduciary duty they owed to their clients. The RIA and IAR converted brokerage accounts to advisory accounts so they could charge higher fees, even though that conversion was not in their clients’ best interests.
The SEC’s complaint alleged that the RIA and the IAR were involved in misconduct related to advisory services provided to their retail clients from June, 2020 through October, 2023. During that time period, the IAR recommended that his customers at an unaffiliated broker-dealer convert their brokerage accounts to advisory accounts. The IAR/registered representative was employed by the RIA, as well as the unaffiliated broker-dealer.
Background of the case against the RIA and IAR
The IAR and the RIA’s conversion of brokerage accounts to advisory accounts was not a one-off. The SEC’s complaint accused the parties of converting more than 180 brokerage accounts. Most of these customers were elderly and had been working with the registered representative for many years at the broker-dealer. Before becoming advisory clients, these customers were charged commissions.
The conversion to an advisory account was very beneficial to the IAR. Pursuant to the new relationship, the IAR received approximately 75 percent of the advisory fees that the RIA charged clients. These advisory fees were far greater than the commissions these customers paid at the broker-dealer.
According to the SEC, the RIA and the IAR ignored their fiduciary duty and failed to adequately disclose that the conversions from brokerage accounts to advisory accounts would result in significantly higher fees for clients making the switch. Those conversions also increased the compensation paid to the IAR. This conflict of interest was not disclosed to clients. For many of the accounts that were converted, the RIA did not provide a Form ADV when the new account was opened.
The RIA’s compliance policies and procedures required that the firm obtain completed investment management contracts signed by clients before providing advisory services and charging advisory fees. Those policies and procedures stated that the RIA’s Chief Compliance Officer (CCO) would periodically review the fee schedule attached to the contract and review clients’ fees for accuracy. In certain cases, the IAR did not provide clients with agreements that specified the advisory fee. For approximately 60 other clients, the IAR did not send any contract to them before providing advisory services and charging fees.
In some instances, an assistant under the IAR’s supervision provided clients with blank fee schedules and then filled in the advisory fee after the contract was signed. These clients were not given the completed agreements or any other disclosures regarding the specific advisory fee they would be charged.
Once the accounts were converted, the RIA and the IAR were able to charge advisory fees based upon a percentage of assets under management instead of the brokerage commissions previously assessed by the broker-dealer. Because the converted accounts had relatively low trading activity before and after the conversions, the change in fee structure resulted in significantly higher costs for clients. Therefore, the RIA and the IAR placed their own financial interests ahead of their clients when they recommended the conversions.
Although the change from a brokerage to an advisory account increased clients’ costs, they usually did not receive any additional services or benefits. The SEC determined that the RIA and the IAR failed to adequately consider whether it was in their clients’ best interests to convert their brokerage accounts to advisory accounts.
Not all brokerage accounts are suitable to become advisory accounts
Before making their recommendations, the RIA and the IAR did not conduct meaningful reviews of the clients’ investment profiles or the characteristics of the two account types. The RIA’s CCO did not have access to sufficient information about the clients, other than age, to evaluate the suitability of their specific investments. Generally, the IAR did not obtain information in writing from clients regarding their investment objectives or risk tolerance. After certain accounts were converted in 2020, no one at the RIA other than the IAR was able to view the account activity to conduct any review whatsoever for at least four months.
These actions violated the RIA’s policies and procedures which stated that the firm reviews the suitability of any advisory services programs offered to the client at the time the account is opened. Those policies and procedures stipulated that once accounts were opened, the firm would periodically review and update its suitability determinations. Furthermore, the firm was required to retain documentation of those reviews. The RIA stated in its disclosure brochure dated March 2020 that it conducted daily and quarterly reviews of clients’ accounts.
The SEC also found that the IAR did not fulfill his fiduciary duty of care, because he did not conduct meaningful reviews to substantiate that the converted accounts were suitable to become advisory accounts. Without meaningful reviews, the RIA and the IAR did not have a reasonable basis to believe that an advisory account was in their clients’ best interests, either at the time of conversion or thereafter.
Takeaways
No matter which way the political winds blow, investment advisers must always adhere to their fiduciary obligations. In a press release issued on February 14, 2025, Tejal D. Shah, Associate Regional Director in the New York Regional Office, declared that the SEC remains committed to holding investment advisers accountable if they breach their fiduciary duties at the expense of retail clients.
The SEC found that the RIA and IAR willfully violated the anti-fraud provisions of Section 206(2) of the Investment Advisers Act of 1940. The RIA also violated the Compliance Rule by not adopting and enforcing robust policies and procedures designed to prevent this kind of misconduct.
Although neither party admitted or denied wrongdoing, the RIA was ordered to pay a $150,000 civil penalty and to hire an independent compliance consultant to review certain policies and procedures. The IAR agreed to a $75,000 fine and a nine-month suspension.
The enforcement action is available at https://www.sec.gov/files/litigation/admin/2025/34-102425.pdf.
Recent Comments