FYI: The SEC has brought a settled enforcement action against three respondents — an adviser, its principal and its founder — for breach of fiduciary duty to a client with senile dementia. According to the SEC’s order, the respondents recommended to their client that she change her trust agreement in a manner that would benefit the respondents. Recommending this change was viewed as entailing a financial conflict of interest for the respondents, yet the respondents sought to obtain the client’s consent to the amendment when they knew or should have known that she could not provide truly informed consent because she suffered from senile dementia.
Noteworthy facts in the SEC’s order included:
- In 2015, respondents were informed that the client, who had just moved to an elder-care residence, had been diagnosed with senile dementia. When the respondents received this information, they were also informed that the client’s short-term memory was significantly impaired, that she might not be able to make significant decisions or to know what she had done after she had done it, and that her family desired to be a part of her financial decision-making.
- In January 2016, one of the respondents, along with an attorney, travelled to the client’s elder-care residence for the purpose of having her execute the amendment to her trust agreement, which would benefit the respondents. The respondents did not inform the client’s family in advance of the visit, and no family member of the client was present during the visit.
- During the visit, the client signed the trust amendment. Discussing the visit the next day with her social worker, the client declared that she had been scammed. The client recalled receiving visitors but did not recall signing any document and was unaware she had changed her trust. The elder-care residence reported the incident to the relevant authorities.
The SEC found respondents had violated Section 206(2) of the Advisers Act, an anti-fraud provision into which courts have read an adviser’s federal fiduciary duty, and which can rest on a finding of simple negligence. Sanctions included a censure, cease and desist, and civil money penalties. Respondents also undertook to quit charging or accepting compensation for providing services to the client and the client’s trust after the date of the SEC’s order and to notify all their clients about the SEC’s order.
With increased focus in recent years on “senior investor” issues, questions have been raised about whether or to what degree advisers could be held to have a fiduciary duty to assess a client’s mental competence, since advisers generally do not have the expertise or training to make that type of assessment. This case is an important development in helping to answer that question. Here, the adviser was found to have breached its fiduciary duty as read into the anti-fraud provisions of Section 206(2). A ‘fraud’ was found to have occurred when the adviser requested a client’s consent to a conflict of interest at a time when the adviser knew – or should have known – that the client did not have the mental capacity to provide effective consent. Before requesting the client to amend her trust (which would benefit the adviser and thus posed the conflict of interest requiring client consent), the adviser had been informed of the client’s senile dementia diagnosis, her decision-making disability and her memory issues. It remains to be seen what would happen in a more subtle case where the adviser did not have direct notice in advance of the client’s capacity issues.
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