DC Circuit Reverses SEC On Willfulness

The “willfulness” requirement in Commission administrative proceedings may well be the “Rodney Dangerfield” element – it gets no respect and is rarely mentioned. The definition of the term typically used is no mystery. On a petition for review the debate before the courts typically does not focuses on the element. To the contrary, arguments usually center on questions about “abuse of discretion,” the “sufficiency of the evidence,” or other elements. But not willfulness.

There is, however, a time for everything. And the time for the Rodney Dangerfield element has come. The District of Columbia Circuit recently granted in part a petition for review by an investment adviser based on willfulness, or rather a lack of proof for that element. The Robare Group, Ltd. v. SEC, No 16-1453 (D.C. Cir. Decided April 30, 2019).

The Robare Group is a registered investment adviser located in Houston, Texas. In 2004 the advisor executed an agreement with Fidelity Investments under which the mutual fund giant would provide execution, custody and clearing services for advisory clients. Fidelity also agreed to pay the advisor when advisory clients invested in certain Fidelity products. Between 2004 and September 2013 the advisor was paid about $400,000 under the terms of the agreement. That represented about 2.5% of Robare Group’s gross revenue. In 2013 the advisor served 350 clients and managed discretionary accounts with an AMU of $150 million.

In 2014 the Division of Enforcement instituted administrative proceedings which named as Respondents the Advisor, Mark Robare, the majority owner and Jack Jones, a minority owner. The Order alleged a failure to disclose the conflicts arising from the payments made to the advisor by Fidelity under the agreement. The Order alleged violations of Advisers Act Sections 206(1), 206(2) and 207. Following a hearing the ALJ concluded that the Division had failed to prove its case. The Commission however, found that the evidence established violations of Sections 206(2) and 207 but not 206(1).

The D.C. Circuit considered the case on a Petition for Review of the agency findings as to Sections 206(2) and 207. Respondents stipulated that the advisory received the payments from Fidelity. Messrs. Robare and Jones also conceded that the arrangement created an incentive for them to maximize the payments from Fidelity by advising client to invest in eligible funds rather than non-eligible funds. They argued, however, that the Division failed to establish the requisite standard for proving a violation. This argument was predicated in part on disclosures which stated in part that certain arrangements “may create a conflict of interest.”

The Circuit Court agreed with the Commission. Specifically, the Court concluded that such statements, and other similar ones, “did not disclose that [the advisory] had entered into an [a]rrangement under which it received payments from Fidelity from maintaining client investments in certain funds Fidelity offered.’” (internal citations omitted).

Equally clear is the fact that the Division established negligence by the Respondents under the circumstances here. “Negligence is the failure to ‘exercise reasonable cause under all the circumstances,’ citing Restatement (Third) of Torts: Liability for Physical & Emotional Harm Section 3 (2010).” The Commission found that in view of their obligations Respondents “should have known” that their disclosure were inadequate. The Circuit Court agreed.

The Commission “erred in ruling that they violated Section 207 of the Advisers Act by willfully omitted material information about the payment arrangement with Fidelity from . . .” the Advisor’s Form ADV, according to the Circuit Court. In reaching that conclusion on the element of willfulness the agency relied on the same evidence it cited to establish that Respondents’ negligently violated Section 206(2) and 207. Petitioners argued this was not sufficient because there was “not substantial evidence to support the Commission’s findings of willfulness. . .” The Court agreed.

Since the parties agreed that the standard for “willfully” under Section 207 – a point the Court has not addressed – is Wonsover v. SEC, 205 F. 3d 408 (D.C. Cir. 2000), the term means “intentionally committing the act which constitutes the violation,” according to the Court. The SEC’s finding that Respondents violated Section 207 because each owner of the advisory reviewed the ADV disclosure, is not thus not sufficient. To the contrary, the “statutory text signals that the Commission had to find, based on substantial evidence, that at least one of TRG’s principals subjectively intended to omit material information from TRG’s Forms ADV.” While the Commission did find that Respondents’ conduct was negligent the Court rejected this finding as inadequate since “We are aware of no appellate case holding that negligent conduct can be willful within the meaning of Section 207, and we conclude that it cannot.”

Event: On June 3, 2019, the SEC Historical Society will host a gala celebration to commemorate the 85th Anniversary of the founding of the U.S. Securities and Exchange Commission and its 20th Anniversary. The event will be held at the Building Museum, Washington, D.C. Following a brief program featuring SEC Chairman Jay Clayton, there will be cocktails and dinner. For further information regarding tables, tickets and advertisements in the program please contact the Society here (full disclosure Mr. Gorman is the President of the Society).

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