A New Dawn for SEC Enforcement?

We have our first SEC enforcement case issued with a press release since January 20th! It turns out the Commission does still enforce the securities laws at some level. At what level? Well, let’s see . . .

The SEC said on Valentine’s Day that One Oak Capital Management is a New York-based investment adviser that had $283 million in assets under management as of April 2024. One Oak advises clients on a discretionary basis through individual representatives like Michael DeRosa.

Come on in, the water’s fine . . .

DeRosa had previously been a registered rep at a separate broker-dealer. When he joined One Oak, he recommended that his customers convert more than 180 brokerage accounts to advisory accounts at One Oak. Most of these customers were elderly and had been long-time customers of DeRosa’s at the B-D, which charged them on a commission basis.

One Oak and DeRosa never disclosed that the conversions from brokerage accounts to advisory accounts would result in (1) significantly higher fees for clients, and (2) increased compensation for DeRosa. They also didn’t disclose the resulting conflict of interest. For example, the accounts converted in 2020 and 2021 incurred a more than seven-fold increase in fees and costs, with some paying more than ten times as much as they had paid to the prior broker-dealer.

Through October 2023, One Oak charged those accounts about $268,000 in advisory fees, and DeRosa’s deal with One Oak gave him ¾ of that. The accounts converted in 2023 also incurred significantly higher fees.[1]

Did One Oak’s clients get more or better service with their increased fees? They did not. The SEC says DeRosa didn’t monitor the accounts differently or alter his investment strategies. In some cases, the number of transactions decreased significantly because DeRosa didn’t get the necessary authorizations from clients to execute options trading strategies he had previously used at the broker-dealer. Many of the accounts had few, if any, trades for more than a year after their conversion to advisory accounts.

Does One Oak have policies to prevent this?

How did this happen? One Oak’s standard investment management agreement said clients would pay an advisory fee specified in an attached schedule. One Oak’s compliance policies require a number of steps associated with these agreements:

• The firm must obtain “completed” agreements signed by clients before providing advice and charging fees;

• The investment adviser representative completes the schedule before providing it to the client for review and signature;

• One Oak’s CCO periodically reviews the fee schedules included with the agreements and reviews client fees for accuracy.

DeRosa didn’t follow all of these steps. He provided some clients with agreements that didn’t attach a completed fee schedule specifying the advisory fee, and for about 60 others didn’t provide an agreement at all before providing advisory services. Sometimes DeRosa’s assistant provided clients with blank fee schedules, and then filled in the advisory fee after the clients signed. One Oak also failed to deliver Form ADV Part 2A (a.k.a. the “brochure”) to some clients of the converted accounts before account openings in 2023.

Suitability

As you probably know if you’re reading this, an investment adviser’s fiduciary duty includes a duty of care. It’s a broad obligation! It encompasses basically everything associated with the adviser-client relationship, and certainly extends to advice about the type of account a client should open. Also, if a particular account or trading strategy makes sense in Year 1, it needs to be reviewed from time to time to be sure it continues to make sense as circumstances evolve.

Did One Oak give sufficient diligence to its analysis of the converted customers’ accounts and periodically review those accounts? Well, their March 2020 brochure and compliance policies said they would, but they did not. One Oak’s CCO didn’t even have enough information to do a suitability analysis on these accounts because DeRosa generally didn’t get information regarding his clients’ investment objectives or risk tolerance in writing. For at least the first four months after some accounts were converted in 2020, no one at One Oak other than DeRosa was able to view the account activity to conduct any review whatsoever.

Statutes and Rules

One Oak and DeRosa are settling to violations of the Advisers Act Section 206(2). One Oak is also settling to violations of:

• Advisers Act Section 206(4) and Rule 206(4)-7, the “compliance” rule; and

• Advisers Action Section 204 and Rule 204-3, which requires advisers to deliver a copy of the firm’s brochure before entering into an advisory agreement with the client.

This case is a little weird.

For the SEC’s first press-released case of the new administration, this case is a little weird. Two things jump out.

First, the order implies that DeRosa did his clients a disservice by not executing as many trades on their behalf after they switched accounts as before. But that’s not a very good measure of the care he was exercising over their money? Would it have been a better fact if DeRosa had done three times as many trades as he had before? The order implies more activity would have been better for the clients but that is surely not always the case.

Second, this case is not costing One Oak and DeRosa very much money. One Oak will pay a civil penalty of $150,000, and DeRosa $75,000. One Oak will have to take on an independent compliance monitor. The order calls for no disgorgement, probably because “One Oak refunded to clients the majority of the advisory fees charged during the relevant period.” This note from the order is remarkably imprecise. A majority? Like 51%? If you’re in the crosshairs of an SEC investigation, you do this sort of thing to demonstrate good faith and get ahead of a disgorgement order, and I guess they did. But what did they pay back? We don’t know.

[1] The order says One Oak “voluntarily” refunded those fees in October 2023 after recognizing that it had not provided these clients with IMAs. As part of the staff’s investigation, One Oak refunded to clients the majority of the advisory fees charged during the relevant period.