SEC: Adviser Shortchanged Clients by Putting Interests of Affiliated Firms First
The SEC’s crackdown on conflicts of interest continues. This time the agency has accused a Virginia-based advisory firm of failing to meet its fiduciary duty to its clients by putting the interests of its parent company and an affiliated broker-dealer first.
In a complaint filed December 15 with the U.S. District Court for the Southern District of New York, the SEC charged that Atlantic Asset Management in August 2014 and April 2015 "committed securities fraud by, among other things, investing over $40 million of client funds in debt securities (illiquid bonds) without telling its clients that the investments would benefit individuals affiliated with one of [the firm’s] owners." In addition, the agency said that the adviser did not disclose that the investments contained "a hidden financial benefit to a broker-dealer connected with the firm."
"Atlantic violated a fundamental duty to its clients by placing its own financial interests ahead of client interests," said SEC New York Regional Office director Andrew Calamari. The firm’s clients "should have been informed that the investments in illiquid bonds would financially benefit people with ownership control over [Atlantic]."
In an early win for the agency, the court on December 21 granted the SEC’s request for a preliminary injunction that would prevent Atlantic from engaging in fraudulent activity, and also appointed a temporary monitor to watch over the firm’s affairs.
This case is the SEC’s second from December involving an alleged conflict of interest. On December 16, it reached a settlement with J.P. Morgan for $267 million involving two of the financial giant’s wealth management subsidiaries (ACA Insight, 1/4/16). The case involved agency allegations that the two subsidiaries invested client dollars into J.P. Morgan proprietary funds without properly disclosing to clients the subsidiaries’ affiliation to the funds.
The conflict over conflicts of interest
Conflicts of interest have long been an area of focus for the SEC, but that focus was more formally spelled out by the Division of Enforcement’s Asset Management Unit co-chief Julie Riewe last March when she stated in a speech that such conflicts were an "overarching concern" of her unit – although the SEC did not state to what extent, if any, the Asset Management Unit was involved in its case against Atlantic.
"Chief compliance officers need to ask questions that probe these kinds of issues," said Greenberg Traurig partner Steven Felsenstein. "Is your disclosure thorough and complete in your private placement memorandum and in your Form ADV? Is the money the adviser is managing being used in compliance with the account’s investment objectives and policies?"
"The message to advisors from the SEC on this case is clear," said Zaccaro Morgan partner Nicolas Morgan. "The SEC may charge an adviser with fraud for any undisclosed financial benefit enjoyed by entities affiliated with the adviser. In this case, the adviser’s parent company owned a placement agent that earned an undisclosed fee, but the SEC would no doubt apply the same principle to any affiliated entity."
Ownership and affiliations
Much of the SEC’s complaint relates to its allegations that an entity known as BFG Socially Responsible Investments, which was incorporated in August 2014, used its ownership interest in Atlantic to influence the adviser’s investments. That influence was continuing at the time the agency filed its court complaint, the SEC said.
The ownership and interests involved are a bit complicated. Atlantic is "ostensibly owned and controlled," according to the SEC, by two individuals identified in the agency’s complaint as "Officer 1" and "Officer 2." BFG has an undisclosed capital investment in Atlantic and, as a result, has a "significant ownership interest" in Atlantic’s parent company, GMT Duncan. That company was incorporated in December 2013 "with the stated business purpose of providing socially responsible fixed income investment management and advisory services as a minority business enterprise," the agency said. The aforementioned Officer 1 and Officer 2 hold all of GMT’s Class A interests, while BFG holds all of GMT’s Class B Interests. As of April 2015, according to the SEC, GMT "has been purportedly operating under the name "Atlantic Capital Holdings."
At the suggestion of BFG representatives, Atlantic purchased the "dubious, illiquid bonds," which were issued by a Native American tribal corporation, on behalf of clients "while aware that the sales would generate a private placement fee for a broker-dealer affiliated with BFG," the agency said. Atlantic was also "aware that the proceeds from the bond sales were to be used to purchase an annuity provided by BFG’s parent company."
An Atlantic officer "evaluating whether or not to make the investment discussed balancing the ‘fiduciary duty’ owed to the placement agent with the duty owed to [Atlantic’s] clients," the SEC said. The adviser "ultimately decided to put its owner’s financial interests first, approving the bond purchases without telling clients about the conflict of interest."
The August 2014 investment was made by Atlantic’s then-chief investment officer, who, the agency said, was someone that BFG "insisted" that Atlantic hire, and who was subsequently charged, along with BFG’s principal representative, with an unrelated securities fraud.
Clients want their money back
Several of Atlantic’s clients, after learning of the bond investments, "expressed concern regarding the bonds’ value and suitability, and demanded the investments be unwound," the agency said. Unfortunately for them, however, Atlantic was unable to find buyers for the bonds and "none of its clients has been able to liquidate its position in the bonds."
Then there’s this statement in the complaint: "Recently, a BFG representative informed [Atlantic] that there is no market for the bonds and that they cannot be priced."
At the time the SEC filed its complaint, it wrote that BFG was "again soliciting [Atlantic’s] agreement to invest more client funds in transactions from which its principals and affiliates would financially benefit. At the same time, as [Atlantic] resists these overtures, BFG is attempting to gain full control over [Atlantic] by seeking to remove [Atlantic’s] officers."
Hence the SEC’s request for the preliminary injunction and a temporary monitor.
The SEC charged Atlantic with violating Sections 206(1) and (2) under the Advisers Act, both of which prohibit fraud, as well as Section 206(4) and its Rule 206(4)-8, which prohibit an adviser from making untrue statements of material fact.
In addition, it charged the firm with violating Section 207, for making untrue statements in its registration materials to the Commission. The attorney representing Atlantic did not respond to an email and voice mail seeking comment, and a spokesperson for BFG could not be located.