SEC Appeals Its In-House Agency Judge’s Decision to Throw Out Charges Against Financial Advisers Paid by Fidelity to Push Specific Mutual Funds

Securities and Exchange Commission employees are appealing a ruling by an administrative law judge dismissing charges against two financial advisers accused of not notifying clients that Fidelity Investments (FNF) had paid them to sell specific mutual funds. In the Texas securities case, SEC Administrative Law Judge James E. Grimes rejected claims that The Robare Group and two of its owners violated the law by failing to adequately disclose that they had a financial relationship with the brokerage firm. Grimes said that from listening to Mark L. Robare and his son-in-law Jack L. Jones Jr. testify, he was hard pressed to imagine them attempting to bilk anyone. This is one of the few cases presided over by one of its judges that the SEC has lost.

Fidelity is The Robare Group’s custodian. For the last 11 years, the registered investment advisor has been part of a program in which Fidelity pays it a portion of the revenue earned from the sale of certain third-party mutual funds. The payment goes to the adviser who made the mutual fund sale happen.

Advisors are given access to the funds without any transaction fees. As the custodian, Fidelity refers to payments made to advisers not as commission but as compensation for shareholder administrative fees.

In their appeal, the SEC staffers said that they feared Grimes’ ruling in this case establishes a troubling precedent that shifts the burden of full disclosure of a conflict interest from an investment adviser to a compliance consultant. They said this could allow an investment adviser to be excused from certain securities violations as long as he has a compliance consultant that has not “affirmatively” objected to a “particular disclosure.”

Fidelity is not the only adviser custodian to pay RIAs for fund picks. Charles Schwab & Co. (SCHW), like Fidelity, pays advisers up to .2% of assets held in specific no-transaction-fee mutual funds. InvestmentNews, on its website, named a number of firms who accept fund pick payments from custodians, including: HighTower Advisors, GV Financial Advisors Inc., Mariner Wealth Advisors, and Encompass Wealth Advisors.

Some people consider this type of arrangement to be a conflict of interest. They say that this provides an adviser with incentive to push certain mutual funds over others. Also, while advisers that accept payment for selling custodian picks must disclose this on their Form ADV that they submit to the SEC, not a lot of investors know where to go to find this information or what it might mean in terms of a possible conflict of interest.

In the wake of the appeal to Grimes’ ruling, the five SEC Commissioners will now have to decide whether to reverse the decision. Should anyone appeal that ruling, the case would go to a traditional courtroom forum.

The SEC has come under fire for its administrative law court proceedings. Critics feel that defendants the SEC are going up against are at a disadvantage and more likely to lose their case in this setting.

Shepherd Smith Edwards and Kantas, LTD LLP is a Texas securities fraud law firm.

SEC appeals own judge’s decision in case on custodians’ payments to advisers for fund picks, Investment News, June 29, 2015