Our Investment Funds Group examines why the Securities and Exchange Commission penalized a registered investment adviser for inadequate disclosure of fees it received.

• The SEC found that the RIA did not seek “best execution” for its clients’ transactions
• The RIA only disclosed that it “may” receive compensation from the clearing broker when it did in fact receive compensation
• The SEC also found that the RIA did not have adequate compliance policies and procedures in place

On August 12, 2024, the Securities and Exchange Commission (SEC) ordered Cadaret, Grant & Co. Inc., a registered investment adviser (RIA) based in New York, to pay $6 million in penalties and disgorgement to investors for breaches of its fiduciary duty of care and its compliance failures.

Inadequate Disclosure and Best Execution (Duty of Care) Failures – Advisers Act Section 206(2)

The SEC found that Cadaret Grant breached its fiduciary duty of care to investors by not properly disclosing compensation it received from a clearing broker from client investments in certain mutual funds and certain share classes and the related conflicts of interest. An RIA’s duty of care includes a duty to seek “best execution” for client transactions, which refers generally to an RIA’s obligation to select the share classes (e.g., among classes available in a given mutual fund) that result in the lowest fees charged to its advisory clients. These best execution issues arise when an RIA selects a share class associated with higher fees and cannot show that it has undertaken an analysis to determine that its selection of the class was in its clients’ best interest.

In this case, the SEC found that Cadaret Grant inadequately disclosed both the availability of other share classes with lower fees and the conflicts of interest that arise from the revenue sharing arrangements it had with the clearing broker. Importantly, before August 2019, Cadaret Grant only disclosed in its brochure that it “may” receive compensation from its clearing broker (while it did in fact receive this compensation), and the SEC maintained that even when Cadaret Grant revised its brochure to remove the “may” language, its disclosures remained deficient due to their failure to disclose the availability of other money market funds on the clearing broker’s platform that paid no or lower revenue sharing, generally charged lower fees, and had at times returned higher investment yields to clients.

The SEC previously instituted a Share Class Selection Disclosure (SCSD) Initiative (see the Alston & Bird advisory on this topic), which may have been able to mitigate a portion of the penalties for this adviser occurring before mid-2018. However, admission of an illegal conflict and disgorgement of certain fees would still be required under the SCSD program.

Written Compliance Policies and Procedures Failures – Advisers Act Section 206(4); Rule 206(4)-7

The SEC also found that Cadaret Grant did not adopt and implement adequate written compliance policies and procedures for its practices involving mutual fund share class and money market fund selection reasonably designed to prevent violations of the Investment Advisers Act of 1940. Although Cadaret Grant had written policies and procedures that explained that it has an obligation to always act in its clients’ best interest, the SEC found that it did not adequately implement those policies and procedures. Finally, the SEC found that Cadaret Grant failed to adopt or implement policies and procedures for its obligation to seek best execution for its clients reasonably designed to prevent violations of the Advisers Act.

What’s Next?

Cadaret Grant, without admitting or denying the findings, agreed to pay disgorgement and comply with certain remedial undertakings, including an evaluation of its written policies and procedures. We take this opportunity to remind clients of the importance of:

• Regularly ensuring that offering documents and Forms ADV both include adequate disclosure of compensation arrangements and conflicts of interest.
• Carefully and sparingly using the word “may” in advisory client-facing materials, which continues to be a point of contention in SEC reviews in recent years.
• Reviewing with counsel, updating, and properly implementing written compliance policies and procedures, including adequate training of compliance personnel.

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