FYI: This week, the DC Circuit Court of Appeals issued its opinion in the Robare case, originally brought as an SEC administrative proceeding against an investment adviser and two principals, alleging misleading disclosure regarding a revenue sharing arrangement. While the adviser’s disclosure about the revenue sharing arrangement evolved over time, this case in part raised a question the SEC has now raised in a number of cases, that is, whether disclosure is misleading if it states an arrangement “may” result in certain payments to an adviser when in fact the arrangement is already in place and has already resulted in payments to the adviser (posing related conflicts of interest).
Based on the adviser’s allegedly inadequate disclosure of the revenue sharing arrangement in this case, charges were brought in 2014 by the SEC Division of Enforcement under Sections 206(1) and (2) of the Advisers Act (anti-fraud), as well as Section 207 (willful material misstatements or omissions in an SEC filing).
In 2015, an ALJ heard the case initially and dismissed all the charges, finding that the respondents had not acted with scienter or any intent to deceive, manipulate or defraud their clients, and that the SEC Division of Enforcement had failed to prove a negligent violation under Section 206(2) or a willful violation under Section 207. The ALJ’s opinion expressly stated that use of the word “may” in disclosure of the arrangement in that case was not misleading but, rather, accounted for the possible cessation of payments that could occur under the operative arrangement agreements.
In 2016, the full Commission conducted an independent review of the case de novo, and came to a different conclusion than the ALJ, basing its conclusions imposing liability in large part on periods when the revenue sharing arrangement was not disclosed at all in the adviser’s ADV and periods where the potential for compensation was disclosed, but the attendant conflicts of interest were inadequately disclosed. The Commission concluded that the adviser had failed to make adequate disclosure of the revenue sharing arrangement, but that it acted with negligence and not scienter, and had thus violated Section 206(2) (which can be violated by mere negligence), but not Section 206(1) (which requires proof of scienter). The Commission also found that the respondents had violated Section 207 (which requires willfulness) and imposed sanctions, including a cease-and-desist order and civil money penalties.
Appellate Court Decision
The Commission’s decision was appealed to the DC Circuit Court of Appeals. The applicable standard of review required the appellate court to uphold the Commission’s decision unless the decision was arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law. In addition, the Commission’s findings of fact were to be considered conclusive if supported by substantial evidence.
On April 30, 2019, the appellate court issued its opinion, concluding that the record contained substantial evidence that the adviser’s disclosure regarding the revenue sharing arrangement was materially misleading, and that the adviser’s conduct was negligent, thus supporting the Commission’s decision that the respondents violated Section 206(2).
However, the appellate court did not support the Commission’s decision finding a violation of Section 207. Rather, the court opined that because the Commission found the disclosure failures were no more than “negligent” for purposes of Section 206(2), the Commission could not rely on the same failures as evidence of “willfulness” for purposes of Section 207. Under Section 207, willfulness has historically been considered to mean the intentional commission of an act which constitutes the violation. The court’s opinion cites authorities supporting the proposition that “intent” and “negligence” are mutually exclusive grounds for liability and that any given act can be intentional or negligent, but not both. Ultimately, the court held that negligent conduct cannot be “willful” within the meaning of Section 207, and thus the Commission’s decision that the respondents violated Section 207 was erroneous as a matter of law.
Unfortunately, the appellate court’s opinion does not discuss the specific question of whether disclosure stating that compensation “may” be paid to an adviser is misleading in circumstances where the compensation is already being paid. To support its opinion, the appellate court (like the Commission) did not focus as much on the adviser’s later evolved disclosures stating that compensation “may” be paid to the adviser under the revenue sharing arrangement. Rather, it seemed to focus more on earlier periods where the revenue sharing arrangement was not disclosed in the adviser’s ADV at all and on years where compensation was referenced but the attendant conflicts of interest were not disclosed in a manner that would enable clients to understand the source and nature of the conflicts. As a result, we will have to await future court cases to see if and how courts decide the “may” issue head-on.
In the meantime, the appellate court in Robare vacated the earlier Commission order imposing sanctions and remanded the case to the Commission to determine the appropriate sanction for the Section 206(2) violations that it found supported by the record.
ALJ Initial Decision — In the Matter of The Robare Group, Ltd., Mark L. Robare, and Jack L. Jones, Jr., Initial Decision Release No. 806 (June 4, 2015): https://www.sec.gov/alj/aljdec/2015/id806jeg.pdf
Commission Decision – In the Matter of The Robare Group, Ltd., Mark L. Robare, and Jack L. Jones, Jr., Advisers Act Release No. 4566 (November 7, 2016): https://www.sec.gov/litigation/opinions/2016/ia-4566.pdf
DC Circuit Court of Appeals Decision – The Robare Group, Ltd., et al., Petitioners v. Securities and Exchange Commission, Respondent (USCA-DC April 30, 2019): https://www.cadc.uscourts.gov/internet/opinions.NSF/07E87BDE8C16B83E852583EC00503A45/$file/16-1453.pdf
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