RIAs need to take a hard look at their use of soft dollars
Some advisors are landing in hot water with the SEC
4 min read- Soft dollars create conflicts of interest requiring full disclosure by RIAs.
- SEC scrutinizes soft dollar arrangements, citing potential fiduciary duty breaches.
- Misappropriation of soft dollars can lead to fraud charges and penalties.
- Examiners actively seek undisclosed or inconsistent soft dollar arrangements during RIA audits.
The other evening, with the word “dollar” echoing in my head after hearing Subway’s “five dollar foot-long” jingle for the 85th time, I started thinking about soft dollars.
In the financial advisory world, soft dollars are commission rebates or credits from broker-dealers. The rebates or credits are derived from commissions paid by clients for trades in their accounts managed by a registered investment advisor. Mishandling of soft dollar arrangements can cause serious problems for RIAs.
Accepting soft dollars creates a conflict of interest that must be fully disclosed. An RIA must disclose its soft dollar arrangements with brokerage firms in its Form ADV disclosure brochure. Assuming the firm has made the appropriate disclosure, an RIA may use soft dollar credits and rebates to pay for certain types of brokerage and research services that benefit clients.
Soft dollar arrangements are viewed skeptically by regulators because they may affect the best execution of securities transactions and might cause the client to pay more than the lowest-available commission. Soft dollar credits and rebates raise questions as to whether an RIA has breached its fiduciary duty. Because soft dollar credits and rebates are generated by commissions paid by advisory clients, they are viewed as assets of the client.
How much should RIAs shake in their boots after the SEC punished three firms then put out a detailed press release?
SEC plays hardball
On Sept. 28, the Securities and Exchange Commission charged a San Francisco-area RIA with fraud for lying to clients about how brokerage commission rebates were being used. The complaint alleged that the RIA also used phony documents in an attempt to cover up the fraud and avoid detection by the SEC.
The SEC’s complaint alleges that the RIA and its principals misappropriated more than $178,000 in soft dollars and that firm’s principals falsely claimed they were using the soft dollars to pay for legitimate investment research. According to the complaint, the RIA and the firm’s principals were surreptitiously using the money for office equipment, rent, computer hardware and a relative’s salary. It further alleges that principals of the firm instructed a research provider paid with soft dollars to inflate its invoices and kick-back money to the RIA to help pay for a new computer server.
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Additionally, the SEC charged a principal of the RIA with creating a shell research company to cover up the firm’s improper use of soft dollars. According to the complaint, one of the RIA’s principals created phony research reports when the SEC examination team asked for proof to substantiate its use of soft dollars.
Marc Fagel, director of the SEC’s San Francisco regional office, summarized his agency’s position in a statement: “We take a particularly dim view of those who compound their fraud on investors by providing false information to our examiners.”
Recent SEC enforcement actions make annual policies and procedures exams even more important
The SEC’s complaint can be found here.
Lesser violations also in play
Most soft-dollar violations are not so blatant. An RIA might inadvertently use soft dollars to pay for inappropriate products or services.
Examiners are always on the lookout for undisclosed soft dollar arrangements. It is also common to find situations where an RIA’s disclosures regarding soft dollars are inconsistent with the firm’s policies and procedures pertaining to these credits and rebates.
At an educational seminar on Oct. 20, sponsored by the Pennsylvania Securities Commission, a compliance examiner discussed what he looks for during examinations of RIAs. While the examiner is sitting in the firm’s waiting room, he will routinely look around for financial publications that are available for visitors to read. During the exam, he looks at whether those publications are being paid for with soft dollars. The examiner will also look at whether the soft dollar arrangement was disclosed by the RIA.
Just so you’ll know, compliance consultants do not receive soft dollars. Furthermore, I don’t receive product placement payments for mentioning Subway’s five dollar foot-long sandwich in my article. All I really want is to get that jingle out of my head.
Les Abromovitz, an attorney, can be reached at NCS by calling 561-330-7645, Ext. 213, or by e-mailing him at labromovitz@ncsonline.com. Les is the author of Growing Within the Lines: The Investment Adviser’s Advertising and Marketing Compliance Guide.
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