IA and BD Settle Charges for Exceeding Investment Limits

In separate settlements, an investment adviser and a broker-dealer resolved SEC charges for failing to manage client portfolios according to agreed-upon limits, resulting in unauthorized exposure, excessive fees and financial losses for clients.

In the Orders (see Order 1 and Order 2), the SEC found that the investment adviser and broker-dealer breached their fiduciary duties in connection with an options trading strategy marketed to high-net-worth clients.

According to the SEC, during the relevant period, the investment adviser failed to adjust the number of options contracts in client portfolios as required by the terms of its investment agreements, leading to excessive notional exposure. The SEC said that this failure led to higher fees for clients, calculated based on the inflated exposure levels and greater-than-expected losses when the market experienced negative returns.

The SEC said that the broker-dealer, which acted as custodian and co-advisor, also failed to inform clients about the excessive exposure or implement adequate compliance procedures to prevent these violations. The SEC found that the broker-dealer was aware of the mismanagement but did not take sufficient action to ensure clients were informed of the increased exposure and potential risks.

The SEC found that both firms violated IAA Sections 206(2) and Section 206(4) ("Prohibited transactions by investment advisers") and Rule 206(4)-7 ("Compliance procedures and practices").

To settle the charges, the investment adviser agreed to (i) a censure, (ii) cease and desist from further violations and (iii) $3.5 million in penalties, including $2.5 million in disgorgement and $2 million in civil fines. The broker-dealer agreed to pay $2.8 million, which includes $2 million in disgorgement and a $1 million civil penalty.