The SEC has said that the practices of dual registrant investment adviser / broker-dealers were going to be an area of emphasis for them. Two cases that were just settled show they mean what they said this time. In the Matter of A.R. Schmeidler & Co., Inc. (ARS) and In the Matter of Goelzer Investment Management, Inc. and Gregory W. Goelzer (GIM) both involved dual registrants whose broker-dealers were primarily utilized to trade investment adviser client accounts. Dual registrants and firms that allow registered representative affiliations with broker-dealers should ensure that clients are receiving best execution, and policies and procedures and disclosures are accurate.
In the ARS case, the firm began using a new clearing firm in 2005. ARS received 80% of commissions on taxable accounts. In 2007 the deal was renegotiated and ARS received 90% of such commissions. The commission rate charged to clients was consistent at 6 cents per share regardless if the account was taxable or non-taxable. It’s assumed that ARS did not receive any of the non-taxable commission due to ERISA requirements.
The SEC claimed that upon entering the new commission split arrangement, ARS did not conduct an analysis to determine whether the relationship resulted in best execution on behalf of clients. The firm did have policies and procedures in place that dictated such a review be done, but it was not followed. Therefore, the SEC claimed that ARS willfully violated the Investment Advisers Act (failure to conduct sufficient best execution analysis and failure to implement effective policies and procedures).
ARS agreed to fix its shortcomings, including hiring a consultant to review and confirm the practices, and pay at total of $1,011,565.45. The payments include $757,876.88 in disgorgement, $78,688.57 in prejudgment interest, and a $175,000 civil penalty.
Of note, the SEC did not seem to take issue with the non-taxable accounts. It appears that the SEC was questioning whether the renegotiated commission should have benefited clients rather than the firm. We come to this conclusion, because if the SEC was concerned with overall best execution, then ARS should have also been reviewing the sufficiency of the 6 cents per share commission for non-taxable accounts as well. We would also question if the pro-ARS split and its further renegotiation was a way of indirectly compensating ARS for the non-taxable accounts, which could be an ERISA (DOL) violation.
The Goelzer facts were somewhat more commonplace. In essence, GIM had standard ADV disclosures and policies and procedures that said they would seek best execution for clients. It further included a statement that clients would get benefits for using GIM as broker-dealer, including access to block trading (which directed brokerage clients would not get access to). None of this turned out to be accurate, however, as GIM did not review other firms’ execution or pricing. GIM also didn’t do block trading. Under GIM’s commission arrangement, block trading would have saved clients$309,994.
GIM agreed to hire a consultant similar to ARS, but GIM also agreed to provide notice to clients and prominently post a summary of the Order on its website. The firm (and its CEO/CCO) also agreed to pay $498,793, made up of disgorgement of $309,994, prejudgment interest of $53,799, and a civil penalty of $100,000 assessed to GIM. In addition, the GIM’s CEO and CCO, Gregory Goelzer agreed to pay a civil penalty of $35,000 for not properly implementing and enforcing effective policies and procedures.
This case was a bit more straightforward than the ARS case. It is worth noting, however, that GIM was also cited for not properly disclosing its fee schedule or the negotiability of the schedule. The firm had a set fee schedule, but 75% of the clients paid less than the stated amount. Many firms engage in this same practice, assuming that clients aren’t harmed if they pay less than the schedule, but the SEC focuses on those clients that are paying the scheduled fee. The SEC believes that these clients are harmed by the disclosure of an inflated schedule. It does not appear, however, that this deficiency resulted in any additional fine.