Who may be interested: Investment Advisers; Registered Investment Companies; Boards of Directors
Quick Take: The SEC recently settled charges with an investment adviser relating to the adviser’s alleged failure to disclose, to the independent trustees of a new ETF, the details of an index licensing fee arrangement and a social media influencer’s role in the launch of the ETF.
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According to the SEC’s order, the adviser created a new ETF that would track an index based on “positive insights” from social media, news articles, blog posts and other alternative datasets, and obtained an exclusive license to use the index. In negotiating the license agreement, the index provider informed the adviser that it planned to retain a controversial, well-known social media influencer to promote the index. To incentivize the influencer’s promotional efforts, the index provider requested a sliding scale licensing fee structure, under which the index provider would receive a greater percentage of the management fee paid to the adviser if the ETF’s assets increased beyond significant thresholds. The index provider also gave the influencer an ownership interest in the index provider. The adviser was aware of and agreed to these terms.
According to the SEC, in seeking the approval of the trustees for the launch of the ETF and approval of the advisory agreement, and in connection with the subsequent renewal of the advisory agreement, the adviser misstated the terms of the licensing arrangement, and failed to disclose information about the influencer’s planned involvement in promoting the index, and the influencer’s compensation arrangements. The adviser also failed to disclose to the board information about the controversies surrounding the influencer and the potential brand risk this posed to the other funds overseen by the trustees and advised by the adviser. The SEC’s order states that the board materials for the board approvals did not reflect the full economic arrangements, and thus, the board did not have information for an assessment of profitability and economies of scale, two of the Gartenberg factors.
In addition, the SEC’s order found that the adviser did not have adequate written policies and procedures designed to provide trustees with accurate information reasonably necessary for the evaluation of the terms of an advisory contract, as well as material information relating to the launch of a new fund.
As a result of the alleged conduct, the SEC’s order found that the adviser violated Section 15(c) of the 1940 Act, which requires an investment adviser to a registered investment company to furnish such information as may reasonably be necessary for the investment company’s directors to evaluate the terms of any investment advisory agreement with respect to such company. The SEC’s order also found that the adviser violated Section 206(2) and 206(4) of the Advisers Act and Rule 206(4)-7 thereunder.
Without admitting or denying the findings set forth in the SEC’s order, the adviser agreed to a cease-and-desist order, a censure, and to pay a civil penalty of $1.75 million.
The SEC’s order can be found here.
