Client Dollars Are Not a Piggy Bank to Pay SEC Settlements
It may be the perfect example of "not getting it." An adviser saw its potential settlement with the SEC scuttled after it allegedly attempted to misappropriate at least $150,000 from clients to pay for part of the settlement cost.
Sometimes there are things you just can’t make up.
Adviser Total Wealth Management and its owner, Jacob Keith Cooper, were charged with the theft by the SEC February 5 in a complaint before the U.S. District Court for the Southern District of California. The agency, after learning of the alleged use of client monies to partially pay the pending settlement of a 2014 administrative action, terminated the settlement. The court then froze both the firm’s and Cooper’s assets, and issued an emergency temporary restraining order preventing the firm from any continued misappropriation.
"Cooper’s misappropriation of investor funds to fund his settlement with the SEC is material to investors because he took money invested and entrusted to Total Wealth by investors, in breach of his fiduciary duty, for his own benefit and without any disclosure or approval from investors," the SEC said in its complaint to the court. "It is also material because it shows that there are inadequate financial controls to protect the investors’ funds from unauthorized use by Cooper and Total Wealth."
The original case
Total Wealth Management, a San Diego-based investment adviser with approximately $103 million in assets under management, reached its tentative settlement with the SEC in regard to a case that "featured a grand slam of hot issues for the SEC: 1) conflicts of interest, 2) misleading representations to clients, 3) due diligence failures, and 4) custody rule violations," said
Foley Hoag partner Daniel Marx.
Total Wealth Management and Cooper, according to the SEC’s 2014 administrative order, "breached their fiduciary duties to their clients and investors through a fraudulent scheme to collect, and conceal their receipt of, undisclosed revenue sharing fees derived from investments they recommended to their clients." They and two other Total Wealth Management employees each allegedly received undisclosed revenue sharing fees and allegedly materially misrepresented to investors and clients the extent of the due diligence conducted on the investments they recommended.
"The precise wording of disclosures (for example, in ADVs) really matters," Marx said. "Total Wealth Management disclosed that it ‘may’ receive revenue sharing fees for placing client assets in certain investments. That disclosure was misleading because, at the time it was made, the firm already had in place agreements to receive significant revenue sharing fees and was, in fact, receiving those fees. The disclosure should have said that Total Wealth Management ‘receives’
revenue sharing fees, not that it ‘may’ receive them."
The lesson for advisers is that they "must be careful to use ‘administrative fees’ only for proper purposes and also to provide accurate disclosures about those purposes, so that clients understand what they are paying for," Marx said. "Relatedly, advisers must be ready and able to explain any fees if and when clients ask about them."
The settlement and the escrow
As a condition of the proposed settlement, Cooper had to escrow $150,000, part of the monetary relief to be ordered against him, in advance of Commission consideration of the offer.
Cooper, however, said that he was in a period of "deep financial distress," had "no income" and "no job opportunities," the SEC said. He allegedly misappropriated the $150,000 in client money from one of the funds his firm managed, and placed that in escrow to meet the SEC’s condition for consideration of the settlement. The agency said he acknowledged using client money, but said he had the fund record it as a loan to the fund’s general partner.
Although Cooper said in a signed document that he had determined it would be "advantageous" to investors for the funds to provide the loan so he could satisfy the SEC’s condition, he nonetheless "had an inherent conflict of interest in deciding whether client funds should be used to fund his personal obligation to the SEC," the agency said. "By misappropriating assets of [the fund] to pay the personal obligations of Cooper, Total Wealth and Cooper breached their fiduciary duties to their clients."
"The SEC is always going to provide more scrutiny when a client is providing a loan to an adviser," said
Mayer Brown attorney Adam Kanter. "A loan is not inherently illegal, but there is something a little bit odd about an adviser getting a loan from a client. It’s not normal."
Unexplained administrative fees
But the use of money from clients does not stop with the $150,000.
Total Wealth Management and Cooper began charging investors "inflated and unexplained ‘administrative fees,’ thus dissipating the investors’ remaining assets," the SEC said in its complaint. Some investors were charged several thousand dollars per account in such fees, "without any notice or consent." One investor, who had an agreement with Total Wealth Management to debit his credit card for all fees, found a charge of $6,500 there, the agency said.
What were these fees allegedly used to fund? According to the complaint, they were used , among other things, to pay legal and other expenses incurred to defend against a class action in California state court that "mirrors" the allegations in the SEC administrative proceeding that led to the pending settlement.
Total Wealth Management informed its clients through an October 6, 2014 email of the fees. "’Many of you were aware of a class action lawsuit brought on by only a few clients, causing increased fees for all,’" the SEC quoted the email as saying, and that "’[t]he irony is that [the class action] counsel and a very small group of investors have caused a significant amount of those increased fees they have complained about.’"
"Cooper has an inherent conflict of interest since he is using investor money to defend himself in a lawsuit brought against him by investors," the agency said. "The unexplained administrative fees are particularly egregious because in October 2014 Cooper and Total Wealth informed investors that they would have restricted withdrawals and investor funds would be distributed slowly over an extended period because [a fund and another fund’s assets] are illiquid and impaired."
Total Wealth Management and Cooper were charged with violating, with scienter (which means intent), Sections 206(1) and 206(2) of the Advisers Act, both of which prohibit fraud, and Section 206(4) and its Rule 206(4)-8, for making untrue statements of material fact. Attorneys representing Total Wealth Management and Cooper could not be reached for comment, and a call to a number listed for Total Wealth Management was no longer in service.