Registered investment adviser and broker-dealer Hefren-Tillotson, Inc. agreed to settle charges from the Securities and Exchange Commission (“SEC”) for undisclosed compensation it received from its unaffiliated clearing broker. The firm will pay disgorgement of $254,060, prejudgment interest of $45,905 as well as a civil penalty of $80,000 and will distribute the funds to the investors who were harmed.
Hefren Tillotson, a Pennsylvania-based, full service wealth management firm earned its compensation primarily from an advisory fee based on a percentage of the assets under management. Hefren began using an unaffiliated clearing broker in 2002 and disclosed that its clients would pay a $7.95 service charge for each transaction to cover the costs of the clearing and executing services on each trade, which was described in addition to the management fee in the firm’s Investment Advisory Agreement (IAA).
Over time, Hefren’s clearing and execution costs decreased to $6.00 per trade; however, Hefren did not decrease the service charge, and instead received the difference of $1.95 on each client trade from 2014 to 2017. The company gained a total of $254,060 from transactions during that time period.
Hefren did not disclose, either in its Form ADV Part 2A or its IAA that it had begun to receive compensation from its clearing broker once the clearing and execution costs decreased. The SEC requires advisers to disclose any economic relationship with a broker dealer or any third party that it gets compensation for having arrangements related to client accounts. By receiving this transaction-based compensation, Hefren created a conflict of interest that should have been disclosed to its clients. This compensation created an incentive for Hefren to increase the number of transactions performed for its clients.
Best Execution Violations
Hefren additionally breached its fiduciary duty to seek the best execution for its advisory clients and violated Section 206(2), an antifraud provision of the Investment Advisers Act of 1940. Hefren did not describe its best execution policies in its Form ADV and did not document any effort to seek and obtain quotes from any other clearing firms in order to provide services at a more efficient cost for its clients.
Though Hefren did outline in its brochure that clients were not required to use the services of the preferred clearing brokerage firm, it did not disclose the compensation relationship, so clients were not provided with crucial information in evaluating whether or not to use the designated clearing brokerage firm. The compensation arrangement with its clearing broker caused a conflict of interest by providing an incentive for Hefren to continue its relationship rather than seek a clearing firm that would provide best execution to its clients.
Firms are required to take appropriate steps to eliminate, mitigate and disclose conflicts of interest. It’s important to frequently assess and perform detailed analysis of any compensation arrangements in order to properly disclose them to clients. Firm’s IAA, Form ADV 2A and other disclosure documents must be updated on an annual basis and as soon as material conflicts are detected.
Core Compliance and Legal Services, Inc. and our team of experts provide guidance in identifying and properly disclosing, eliminating and mitigating conflicts of interests. Our team may also assist in creating policies and procedures related to best execution practices.
For more information or for assistance, contact our team of experts today.