by T. GormanPosted on Posted in SECActions

The Commission’s focus on retail investors met with the public’s fascination with all things high tech in the agency’s newest action involving four affiliates of the Transamerica firm. Those entities were involved with nine different products and strategies created by an inexperienced developer that were launched without substantial testing. The errors inherent in such a process were largely ignored while the inexperienced developer was kept out of sight. In the end, however, the four affiliates paid $97 million based on violations of various provisions of the federal securities laws to resolve the actions. In the Matter of Aegon USA Investment Management, LLC, Adm. Proc. File No. 3-18681 (August 27, 2018).

The Order names as Respondents: AEGON USA Investment Management or AUIM, a registered investment adviser that is a subsidiary of Aegon N.V, a multinational insurance and asset management company based in the Netherlands. Also named as Respondents are affiliates: Transamerica Asset Management, Inc. or TAB, a registered investment adviser; Transamerica Capital, Inc. or TCI, a registered broker-dealer; and Transamerica Financial Advisors, Inc. or TFA, a dual registered investment adviser and broker-dealer.

Nine different products and strategies were involved: Transamerica AEGON Active Asset Allocation – Conservative VP Portfolio, Transamerica AEGON Active Asset Allocation – Moderate VP Portfolio, Transamerica AEGON Active Asset Allocation – Moderate Growth VP Portfolio, Index 35 VP Portfolio, Index 50 VP Portfolio, Index 75 VP Portfolio and Tactical Allocation Fund; each is a series of Transamerica Funds and an open-ended mutual fund.

In 2010 AUIM instructed an analyst with an MBA and no portfolio management experience or formal training in modeling to develop quantitative models for use in managing investment strategies. By the next year AUIM had identified potential risks associated with using models to manage third-party assets. By late 2011 however, it had not reviewed the models created for accuracy or formally validated them.

Nevertheless, AUIM decided to launch a new product, the TTI Fund, before its model had been finalized and validated. An internal warning regarding the lack of testing was ignored. Rather a peer review process was employed. That process exposed several glaring errors. While those were corrected no further testing was used. To the contrary, AUIM launched each of the products and strategies without taking the steps necessary to confirm that the models worked as intended. AUIM’s parent did have a policy requiring that its firms test models, but it was not followed.

Respondents TAM, TCI and TFA knew the models were launched without taking the proper steps to confirm them. Nevertheless, marketing materials were created noting that the products were model driven, eliminating emotions and the emotional bias. In contrast the prospectuses for the products did not reference the models or disclose the risks associated with their use. The inexperienced analyst who created the products was not disclosed.

TAM and AUIM stated in filings made with the Commission that the primary objective for one of the Products was high current income with a goal of consistent monthly dividend that ranging from 4% to 7%. The dividend would be calculated based on estimates of expected dividends from the fund’s holdings. Neither TAM nor AUIM determined if the Fund’s holdings could support such a dividend. In fact most of the initial dividends were attributed at least in part to an estimated return of investors’ capital. Several of the payments actually came from a return of capital.

TAM and AUIM also added volatility guidelines to the variable life insurance and variable annuity investment portfolios in 2011. Under certain market conductions the overlays could reduce their exposure to the equity markets below the stated target percentages, a fact not disclosed. Two years later the error was discovered. TAM disclosed the error; AUIM did not.

During the summer of 2013 AUIM concluded that its allocation models used to manage the TTI Fund and AAA Portfolios contained material errors. The firm determined that one asset allocation model was not fit for its purpose. AUIM halted the use of that model but failed to inform the board. Ultimately over 50 errors were discovered in certain AUIM models used to manage the Products and Strategies. TAM and TCI learned of the errors. Rather than disclose these facts the prospectuses were revised to state that they “may” be using a proprietary quantitative model. Ultimately TAM terminated its Investment sub-advisory agreement with AUIM. That firm terminated its model manager agreement with TFA in April 2015.

The Order alleges violations of Securities Act section 17(a)(2) and Advisers Act sections 204, 206(2) and 206(4). To resolve the proceedings each Respondent consented to the entry of a cease and desist order and a censure: AUIM based on sections 17(a)(2), 206(2) and 206(4); TAM on sections 206(2), 206(4); TCI on section 17(a)(2); and TFA on 204 106(2) and 206(4). Collectively respondents paid $97,602,040 in penalties, disgorgement and prejudgment interest. See also In the Matter of Bradley J. Beman, Adm. Proc. File No. 3-18682 (August 27, 2018)(proceeding naming as Respondent the Global CIO for AUIM and based on the same conduct; resolved with a consent to a cease and desist order based on Advisers Act section 206(4) and the payment of a $65,000 penalty); In the Matter of Kevin A. Giles, Adm. Proc. File No. 3-18683 (August 27, 2018)(proceeding naming as Respondent AUIM’s Director of New Initiatives during the period; resolved with a consent to the entry of a cease and deist order based on Advisers Act section 206(4) and the payment of a $25,000 penalty).

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by T. GormanPosted on Posted in SECActions

Last week began and ended in the same way for the Commission’s Enforcement Division – with settled proceedings based on adviser conflicts built on false statements that disadvantaged clients. At the beginning of the week the Commission announced the settlement of proceedings captioned In the Matter of Merrill Lynch, Pierce, Fenner and Smith, Inc., Adm. Proc. File No. 3-18516 (August 20, 2018). There the adviser disclosed its evaluation policies for products on client Platforms but then permitted a product to be discontinued to remain based on a pitch by the sponsoring entity tied not just to the merits of the product as the adviser’s disclosure claimed, but also on the “broader relationship” between the advisory firm and the sponsor – the adviser’s self-interest took precedence over the disclosure and the client interest. The week ended in the same way, this time with an adviser not disclosing the fact that in its capacity as a broker-dealer the firm was paid fees on the mutual fund shares recommended by the adviser whose ADV stated no fees were paid. In the Matter of First Western Advisors, Adm. Proc. File No. 3-1863 (August 24, 2018).

First Western is a dual registered investment adviser and broker-dealer. Its advisory services are generally delivered through its Investment Adviser Representatives, many of whom were also registered representatives with the broker-dealer. During the period advisory services were delivered through a program called Private Client Accounts. Clients were offered a variety of mutual fund products over a number of fund complexes. First Western acted as the adviser through its Investment Adviser Representatives. The firm also acted as the introducing broker-dealer on all of the Private Client Account transactions.

The adviser’s ADV stated that the firm did not accept compensation for the sale of securities or investment products. That included the sale of mutual funds.

During the period some of the shares purchased for clients paid 12b-1 fees. Generally funds offer investors different types of shares. Each share class represents an interest in the same portfolio of securities with the same investment objectives. The key difference is the fee structure. For certain shares there are sales charges or loads based on the dollar amount of the investment. In certain instances, such as wrap fee programs or fee-based advisory accounts, the fees are waived. The load bearing shares generally charge 12b-1 fees to cover fund distribution and shareholder services. The fees are deducted from the mutual fund assets and paid to the distributor which typically transmits a portion of the fees to the broker-dealer that sold them. Some classes of shares do not carry these fees.

During the period the adviser here recommended, purchased or held on behalf of some of its advisory clients mutual fund shares that charged 12b-1 fees. Thus the firm received fees on those investments. That was contrary to the disclosures in the Form ADV. It also meant that clients did not receive best execution on the purchase of the shares – they did not receive the lowest price. And, the firm’s compliance program was not properly implemented because the procedures failed to provide that its Investment Adviser Representatives must explain to clients the costs and fees on the various types of fund shares. Accordingly, the Order alleges violations of Advisers Act sections 206(2), 206(4) and 207.

To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order and a censure. In addition, Respondent will pay disgorgement of $139,698.50 and prejudgment interest of $13,068.62 which will be placed in a distribution fund for the benefit of the investors. The firm will also pay a penalty of $50,000.

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