Recently, the U.S. Court of Appeals for the First Circuit consolidated and
affirmed a lower court’s decision requiring an investment advisor and the related firm (appellants) to pay civil penalties to the SEC due to fraudulent activity related to the promotion of an investment strategy for exchange-traded funds (ETFs). Following the U.S. District Court for the District of Massachusetts ruling in favor of the SEC, which included a disgorgement order of more than $22 million, the appellants challenged the decision via several appeals, which were consolidated in this ruling.
According to the 1st Circuit’s opinion, the issue at hand involved alleged violations of the Advisors Act, specifically sections 206(1) and 206(2). Section 206(1) forbids an investment adviser to use deceptive methods, strategies, or tricks to defraud clients or potential clients, as stated in 15 U.S.C. § 80b-6(1). Section 206(2) similarly forbids investment advisers from participating in any dealings, activities, or behavior that results in fraud or deception against any client or potential client.
The 1st Circuit determined that the appellants’ failure to inform clients about the unverified performance record of the strategy, despite internal communications suggesting awareness of potential issues, was deemed a “high degree of recklessness” and “an extreme departure from the standards of ordinary care.” The 1st Circuit’s decision to uphold the summary judgment and disgorgement order, including prejudgment interest and civil penalties, resulted in a total liability of roughly $31.7 million.
