Advisory Firms Pay $37 Million over Conflicts Disclosures
It’s fun to make money as an investment adviser. You can study market inefficiencies and invest in or against those, and when clients benefit, you get paid. Also, if you just have a lot of your clients’ money under your management, you can get paid for that, too. Of course, there are other ways for an adviser to get paid, and to save money along the way. And feel free to take advantage of those! But if you do, you have to tell your clients what you’re doing.
BMO learned that lesson the hard way in September when it agreed to pay over $37 million to settle charges regarding two of its advisers’ alleged failure to tell clients about certain aspects of how the advisers selected investments in their “Managed Asset Allocation Program” (or, the “MAAP”).
According to the SEC, and we’re paraphrasing its allegations here: BMO Harris Financial Advisors and BMO Asset Management Corp. maintained some proprietary mutual funds and invested roughly 50% of MAAP client assets in those proprietary funds. BMO Asset Management received some additional management fees for assets that were invested in those funds. Also, the SEC says BMO Harris invested MAAP client assets in higher-cost share classes of its proprietary funds when lower-cost share classes were available. By doing that, BMO Harris did four things: (1) it received compensation via revenue sharing arrangements that it would not have otherwise received; (2) it avoided paying transaction costs to its clearing broker that it otherwise would have paid; and (3) it reduced the returns of BMO Harris Financial Advisors’ clients; and (4) violated its duty of best execution to those clients.
We have some thoughts! First, note that the SEC is mad at the BMO advisers both for not disclosing that it had a “preferred” practice of investing half of their client’s MAAP assets in their proprietary mutual funds and also for going ahead and proceeding with that preferred practice. If it had disclosed the preference, would the financial benefits to BMO be problematic? Second, if you are a retail client in this situation, it seems like you should be asking these questions. What are the rates? How much does BMO get for recommending a BMO proprietary fund? What are the alternatives? Yes, an investment adviser has a fiduciary duty to put for your interests but no adviser is going to care about you as much as you care about you. Third, at Cady we tend to think about best execution in the broker-dealer context, but the SEC has sued investment advisers for best execution failures before. It’s baked right into Advisers Act Section 206(2). OCIE issued a risk alert on the issue in July 2018. As it said then, “[a]n adviser must execute securities transactions for clients in such a manner that the client’s total costs or proceeds in each transaction are the most favorable under the circumstances.”
BMO Harris and BMO Asset Management are jointly and severally liable to pay $29.3 million in disgorgement and prejudgment interest, plus an $8.25 million penalty. The SEC alleges violations of Sections 206(2) and 206(4) of the Advisers Act, plus Rule 206(4)-7.