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A Blast from the Past: The SEC Fines Investment Adviser/Broker-Dealer for Breakpoint Violations

Posted in Broker-Dealer Regulation, Enforcement, Investment Adviser Regulation, SEC Enforcement

In a case reminiscent of the “breakpoint” enforcement actions brought 10 years ago by securities regulators, the SEC recently found that a registered investment adviser and broker-dealer overcharged clients because it improperly calculated advisory fees.

According to the SEC’s settlement order, the firm offered breakpoint discounts designed to reduce advisory fees payable by clients who increased their assets in certain investment programs.  In particular, the firm permitted clients to aggregate balances in certain related family accounts in order to achieve advisory-fee breakpoints or discounts.  The firm informed clients in account opening documents about the opportunity to aggregate certain account balances to qualify for breakpoint discounts in the advisory fee.  Starting in 2009, however, the firm failed to process all client aggregation requests.  In addition, the firm had conflicting policies on whether representatives were required to pass on to clients the savings from breakpoint discounts.

According to the SEC, its examiners first identified this deficiency during a routine examination of a branch office.  The staff notified the firm of its failures in 2010, and the firm provided refunds to affected clients.  The firm failed, however, to undertake the SEC’s recommended firmwide review of all client accounts.

In a subsequent firm-wide examination, the SEC found that the firm was still failing to aggregate certain related accounts, and that the problem went beyond any one specific branch office.  In fact, the SEC found the failures occurred because of inadequate policies and procedures at the firm’s headquarters.  For example, the procedures did not clearly delineate which of two teams responsible for opening new accounts was required to review new account forms for account aggregation purposes.  As a result, the firm failed to review many new account forms for aggregation purposes and to appropriately link accounts together to apply breakpoints in the billing process.  The firm also had conflicting branch office policies on whether representatives were required to provide breakpoint discounts to advisory clients.

This enforcement action reminds us of the 2004 enforcement actions brought by the SEC and the NASD against 15 prominent firms for failure to deliver mutual fund breakpoint discounts.  The SEC’s actions at that time were intended to send a message that broker-dealers had to exercise due care to provide breakpoint discounts to mutual fund investors consistent with the promises made to customers.

This enforcement action highlights two important issues for investment advisers.  First, advisers must charge advisory fees consistent with their disclosures and stated policies.  Second, and equally important, firms must ensure that they have procedures in place to take appropriate remedial steps when SEC examiners identify a deficiency in an exam.  As demonstrated here, today’s deficiency can be tomorrow’s enforcement action if the deficiency is not remedied before the SEC’s next visit.

The firm agreed to settle the enforcement action without admitting or denying the findings.