Adviser Settles SEC Charges for Impermissible Joint Legal Fee Arrangement with Client

An investment adviser settled SEC charges for entering into an impermissible joint legal fee arrangement with its client, an open-end management investment company. The legal fees related to SEC inquiries and private lawsuits over losses in a "series fund" managed by the investment company.

According to the Order, the SEC initiated inquiries after the series fund experienced significant losses from its options-trading investment strategy. The adviser and its client, the series fund, incurred $2.7 million in legal costs associated with the inquiries and two related lawsuits which involved overlapping facts and legal issues. The adviser and its client retained the same legal counsel to represent them in the inquiries and lawsuits. Without the approval or knowledge of the client’s independent trustees, the adviser arranged for its client to pay, at least initially, all of the legal fees and related costs resulting from the inquiries and lawsuits, including the expenses associated with the adviser’s legal representation. The adviser accrued as liabilities certain amounts of the legal expenses and later reimbursed its client for a portion of the adviser’s expenses. After the SEC opened its investigation, the client requested that counsel allocate expenses, and the independent trustees thereafter approved the recommended allocation and directed the adviser to reimburse the client in accordance with that allocation for most of its remaining unreimbursed expenses, with interest.

The SEC found that the adviser benefited from this arrangement by deferring payment on its legal costs for multiple years, and by ultimately agreeing to an allocation that was more advantageous to the adviser than the allocation determined by the client's insurance carrier (which covered legal costs the carrier determined were allocable to and incurred by the client in connection with the inquiries and lawsuits.) 

As a result of the arrangement, the SEC found that the investment adviser violated Investment Company Act Section 17(d) ("Joint Ventures") and Rule 17d-1 ("Applications regarding joint enterprises or arrangements and certain profit-sharing plans") thereunder and Section 206(2) of the Advisers Act ("Prohibited transactions by investment advisers"). 

To settle the charges, the adviser agreed to (i) a censure; (ii) cease and desist from committing further violations; and (iii) pay disgorgement of $280,902, representing unreimbursed legal expenses.