May 8, 2023
Who may be interested: Registered Investment Advisers.
Quick Take: The SEC recently settled charges against an investment adviser (Adviser) and one of the Adviser’s partial owners for breach of fiduciary duty in connection with the use of leveraged ETFs in discretionary client accounts.
The SEC Order stated that the Adviser and the partial owner of the Adviser, who was an investment adviser representative of the Adviser (the Representative), purchased and held leveraged ETFs in client accounts for extended periods of time and often in significant concentrations. Such actions were inconsistent with warnings in the prospectuses for the leveraged ETFs, which stated that the products carried unique risks, were designed to be held no longer than a single trading day and required frequent monitoring. The SEC highlighted in the Order that leveraged ETFs are complex products that carry significant risks and alleged that because the Adviser and Representative misunderstood the fundamental characteristics of the leveraged ETFs, they lacked a reasonable belief that the leveraged ETFs were in their clients’ best interests. The SEC Order further stated that the Adviser and Representative failed to appropriately monitor the leveraged ETFs’ performance throughout the holding period, resulting in substantial losses for certain clients.
As a result of the conduct described above, the SEC Order stated that the Adviser and Representative violated Section 206(2) of the Advisers Act, which prohibits an investment adviser from engaging in any transaction, practice or course of business that operates as a fraud or deceit upon a client. The SEC Order further stated that the Adviser violated Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder by failing to adopt and implement policies and procedures reasonably designed to prevent violations of the Advisers Act.
Without admitting or denying the findings in the SEC Order, the Adviser and Representative agreed to a cease-and-desist order and censures. Further, the Adviser and Representative agreed to pay $195,228 and $738,113, respectively, in disgorgement, prejudgment interest and civil penalties.
The SEC Order can be found here.
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The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm or its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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