U.S. Court of Appeals for the D.C. Circuit Decision May Narrow SEC Sanction Authority for Investment Advisers

The United States Court of Appeals for the District of Columbia published a decision on April 30, 2019, that may have long-term ramifications for the U.S. Securities and Exchange Commission's ("SEC") sanction authority of investment advisers. In The Robare Group, Ltd., et al. v. SEC, No. 16-1453, (D.C. Cir. April 30, 2019), the D.C. Circuit vacated $150,000 in fines the SEC had imposed against an investment advisory firm ("Robare") and Robare's owners. The SEC had fined Robare for its failure to properly disclose certain fee arrangements. The D.C. Circuit agreed Robare had been negligent in its failure to disclose those fee arrangements, but held that negligence does not constitute "willful" conduct as those terms are defined and understood within the Investment Advisers Act of 1940 ("Advisers Act"). The D.C. Circuit remanded the proceedings for consideration of appropriate sanctions.

Per the D.C. Circuit decision, Robare had entered into a revenue sharing agreement with Fidelity Investments where Robare could be paid fees if its clients invested in particular funds offered by Robare. Robare failed to disclose this fee arrangement or any conflict of interest that may arise from the arrangement to clients or prospective clients, either through its Form ADV filing or otherwise. The Administrative Law Judge hearing the case ruled in favor of Robare and its owners, finding there had been no intent to deceive, manipulate or defraud and no proof of negligence or of a willful violation on Robare's part. On an appeal initiated by the Division of Enforcement, the SEC found Robare was negligent for failing to disclose the fee arrangement and conflicts of interest that may have arisen from that arrangement and Robare "willfully" made false statements to the SEC by failing to properly disclose those conflicts in its Form ADV filing.

While the D.C. Circuit supported the SEC's finding of negligence based on "substantial evidence" presented in the proceedings, the D.C. Circuit concluded the SEC "could not rely on the same failures" as evidence of willful misconduct. Per the decision, willfulness and negligence are regarded as "mutually exclusive." The SEC's decision on appeal from the Administrative Law Judge supported the D.C. Circuit conclusion since the SEC found Robare and its personnel did not act with an intent to deceive, manipulate or defraud in falling to disclose the fee arrangement with Fidelity.

Investment Advisers have a fiduciary duty to act for the clients' benefit. This duty includes an affirmative duty to act with the utmost good faith and disclose all material facts and all conflicts of interest. See 15 U.S.C. § 80b-6(2); SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-92 (1963). This affirmative duty can lead to a violation of Section 206(2) through an act or omission rising to simple negligence. Section 207 of the Advisers Act prohibits investment advisers from "willfully" making false statements of material fact or omitting any material facts in applications or reports filed with the SEC. See 15 U.S.C. § 80b-7.

The SEC has historically relied on a prior D.C. Circuit case for the definition of "willful." See Wonsover v. SEC, 205 F.3d 408 (D.C. Cir. 2000). That case held that, regardless of a person's intent, he or she acts willfully when he or she is "charged with a duty of care and know [what he or she is doing]." Many violations of the Advisers Act require "willful" action on a person's part for the SEC to take action against that person. The D.C. Circuit states in Robare that the SEC misapplied the standard for "willful" conduct outlined in Wonsover. Completing or filing a Form ADV that turns out to contain a material omission is not the same as willfully omitting a material fact in that filing. Under the Robare guidance, willful action must be separate and distinct from negligent action leading to a potential violation of the Advisers Act.

It is not unusual to see investment advisers charged with violations of Section 206 and 207 for the same violation or violations. While on a practical level the Robare decision is unlikely to noticeably affect the SEC's ability to charge investment advisers, it may limit the SEC's ability to find multiple violations from the same basic set of facts without a finding of a more purposeful and "willful" intention to act by investment advisers and their personnel. Going forward, the SEC will likely have to ensure it makes a separate, factually distinct finding of "willful" intent where violations require such intent.

If you have additional questions, please contact Matt Fornshell, Erik Hansen, or another member of our Broker-Dealer and Investment Advisors Group.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.