Court Orders Broker-Turned-Adviser to Pay More Than $1 Million in Two Cases
It’s been a rough five years for Sage Advisory Group and Benjamin Lee Grant. Now, with more than $1 million in disgorgement and civil money penalties ordered in two final judgments, the worst, at least, may be over.
The U.S. District Court for the District of Massachusetts last month entered final judgments against the former registered investment adviser and its owner, Grant, resulting from two fraud cases filed by the SEC. The Commission itself settled with Grant in regard to both cases on June 1, barring him from the securities industry.
The two cases, while related, address separate alleged violations. In the first case, filed by the SEC in 2010, the Commission charged that Grant, a broker-dealer who became an investment adviser, engaged in misrepresentation when he "fraudulently led his brokerage customers to transfer their assets to Sage, his new advisory firm." In the second case, filed by the Commission in 2011, the SEC alleged that Sage and Grant, along with Grant’s father, John Grant (sometimes referred to in the complaint as Jack Grant), violated a Commission bar set up to prevent the elder Grant from working for an investment adviser or acting as one himself.
Sage and the younger Grant lost a jury verdict – although they beat charges that they willfully filed a materially false and misleading Form ADV – in the misrepresentation case on August 13, 2014, but it has taken almost a full year for the final judgments to come down from the court.
"The takeaway here is that even that partial victory (in being acquitted on the Form ADV charge) provided the Grants and Sage cold comfort when the process recently concluded," said Zaccaro Morgan partner Nicolas Morgan. "Based on its partial success with the jury, the SEC was able to obtain Lee Grant and Sage’s consent to pay $550,000 in disgorgement and interest as well as an additional $500,000 in civil penalties. Perhaps even more significantly, Lee Grant consented to an administrative bar prohibiting him from associating with any broker, dealer, or investment adviser."
Further, Morgan said, the damage to defendants from a loss in an SEC case can linger. "The saga may not be over, as collateral impacts of the settlement become clear going forward." For example, state regulators may pursue independent enforcement actions based on the SEC administrative order. In addition, he said, certain securities registration exemptions and other benefits may now become unavailable because of the judgments and orders entered. "And unfortunately, the reputational damage from an SEC lawsuit is tough to overcome."
The dangers of dual registration
Dually registered investment advisers and broker-dealers should pay attention to both the SEC’s allegations in the first case and the final judgment. They serve as a warning that the Commission watches their activities closely.
Firms and individuals electing to do more business under the investment adviser business model rather than the broker-dealer business model is "one of the larger risks to investors that is out there today," said Office of Compliance Inspections and Examinations former director Andrew Bowden, (ACA Insight, 11/11/13). OCIE, in both its 2015 and 2014 exam priorities, expressed concerns about the issues, such as excess fees and reverse churning, raised by entities becoming dual registrants. The 2014 priorities list described dual registration as a "significant risk."
The SEC wants to ensure that clients are provided with adequate advisory services from dual registrants in exchange for their management fee. That view was made evident by the SEC’s statement in its complaint that, "in short, even though he styled himself as an investment adviser, Grant did little more than sit back and wait for the client’s wrap fee payments to roll in."
That perceived risk includes not only dual registration, but firms deregistering as broker-dealers and re-registering (or maintaining existing registration) as investment advisers, firms shifting business and relationships from their broker-dealer side to their investment adviser side, and new market entrants choosing to start their business by registering solely as an investment adviser instead of as a broker-dealer or as a dual registrant.
Case one: Misrepresentation
In the case, the agency alleged that Grant, a former registered representative at a Los Angeles-based broker-dealer, "lied to his brokerage customers in order to induce them to transfer their assets to a new investment advisory firm (Sage) of which he was the sole owner." Grant had customer accounts representing approximately $100 million in assets, with the assets managed by a Pasadena-based investment adviser, First Wilshire Securities Management.
After resigning from the broker-dealer in 2005 to go into business for himself at Sage, Grant allegedly sent a letter to his former broker-dealer customers, telling them that Sage had been formed to handle their investments and that, at the suggestion of the former broker-dealer, their brokerage accounts were being moved from the broker-dealer to a discount broker, the SEC said.
The letter also allegedly said that the charge for the customer accounts would be changed: Instead of the customers paying a 1 percent management fee to First Wilshire, plus brokerage commissions to the broker-dealer, they would pay a 2 percent wrap fee to Sage. The letter went on to say that, according to First Wilshire, such a wrap fee was slightly less expensive, the SEC said.
The SEC, however, said that the statements in the letter ware "materially false and misleading. … First Wilshire had not suggested the transfer of the customers’ accounts from [the broker-dealer] to [the discount broker], and First Wilshire had not refused to continue managing their assets at [the broker-dealer] – meaning that the customers were not forced to transfer their business to Sage and [the discount broker] if they wanted to retain First Wilshire as their money manager," the agency said in its complaint.
Nor did Grant tell his customers that "the only person likely to benefit from the new 2 percent wrap fee was himself," the agency charged.
As it turned out, Grant’s "scheme" to induce his brokerage customers to follow him to Sage was a success. "Virtually all of his brokerage customers at [his brokerage firm] became his advisory clients at Sage, and his compensation more than doubled as a result – from less than $500,000 in 2004 and in 2005 to more than $1 million in 2006 and in 2007," the SEC said.
Case two: Ignoring the bar
The elder Grant, despite a bar that prevented him from associating with an investment adviser or from acting as an adviser himself, "continued to provide investment advice to individuals and small businesses," the SEC charged. The bar was the result of a 1988 Commission enforcement action against Jonathan Grant alleging that he sold $5.5 million of unregistered securities and misappropriated investors’ funds, the agency said. The elder Grant, who was also an attorney, was indicted for bankruptcy fraud in 1990 and was subsequently convicted, with Massachusetts Supreme Judicial Court suspending him from the practice of law in 1994 for one year.
According to the SEC, the elder Grant, after he joined his son’s firm, in order to elude the bar on investment adviser activities, simply "retooled his service as the Law Office of Jack Grant and used his son, Lee Grant, to help implement his investment advice." Further, neither of the Grants, nor Sage, advised their clients that the elder Grant was barred from associating with advisers, the agency said.
The two cases are related in more than the last name of two of the parties. "Lee Grant understood that Jack Grant often advised his clients to place their assets with First Wilshire Securities Management … and to do so through Sage and his son Lee Grant, who previously worked at First Wilshire," the agency said.
"As of 2011, Sage’s client base had come almost exclusively from referrals from Jack Grant," the SEC charged. "The overwhelming majority of Sage’s clients were clients of Jack Grant or had some familial or other relationship with one of Jack Grant’s clients. In fact, approximately 25 percent of Lee Grant’s clients at Sage had been Jack Grant’s brokerage customers before he was barred from associating with a broker-dealer or investment adviser back in 1988."
The lesson here for a compliance officer at an adviser or broker-dealer is to perform due diligence on the source of their client referrals, said Eaton & Van Winkle partner Paul Lieberman. In this case, according to the SEC’s complaint against John Grant, he was allegedly referring clients to his son when the son was still employed at First Wilshire and then later at the broker. Effective due diligence should have discovered that an individual who was barred from adviser activities was related to the broker, he said. "That is a red flag right there. Alarm bells should have gone off."
Violations and fines
Sage and Lee Grant, as part of the final judgment in the misrepresentation case, were ordered to pay $500,000 in disgorgement plus more than $51,000 in prejudgment interest. In addition, Lee Grant was handed a $350,000 civil money penalty. The final judgment in the second case resulted in an additional $150,000 judgment against Grant. The court reached a separate final judgment against the elder Grant in May 2013 for violating the SEC bar, ordering him to pay a total of more than $201,000, the agency said.
Among the charges against Sage and Lee Grant, in addition to violating a Commission bar, were violations of Section 17(a) of the Securities Act for committing fraud; Section 10(b) of the Exchange Act and Rule 10b-5, also for committing fraud; Sections 206(1) and 206(2) of the Advisers Act; Section 206(4) of the Advisers Act and Rule 206(4)-7 for failing to have a proper compliance program in place; Section 207 of the Advisers Act for making untrue statements on an SEC registration application or report; and Section 204A of the Advisers Act and its Rule 204A-1 for failing to adopt a code of ethics with certain minimum standards. Attorneys representing Sage and Lee Grant, as well as attorneys representing Jonathan Grant, did not respond to telephone messages or emails seeking comment.