SEC suit raises disclosure questions for breakaway reps

Commission claims RIA misled clients by failing to disclose he would make more as an independent

Oct 31, 2010 @ 12:01 am

By Dan Jamieson

Do breakaway brokers have to disclose to clients how much they stand to gain by going independent?

Industry lawyers are asking that question after the Securities and Exchange Commission last month sued Benjamin Lee Grant, founder of Sage Advisory Group LLC, for failing to tell his brokerage clients that he would make more money as an adviser.

The SEC does not allege that Mr. Grant's clients ended up paying more after he set up the advisory firm in 2005 and moved to The Charles Schwab Corp.'s custody platform from Wedbush Morgan Securities Inc., for which he had worked as an independent contractor.

As an RIA, Mr. Grant began using a wrap program charging a 1% transaction fee in addition to the 1% clients had paid to a third-party money manager. The SEC claims that the new arrangement was far more lucrative than the cut of the trading commissions he earned as a broker.

The SEC alleges that Mr. Grant's compensation more than doubled from less than $500,000 in 2004 and 2005 to more than $1 million in 2006 and 2007.

Even though Mr. Grant disclosed on his ADV form that he “may” have had a financial incentive to recommend the wrap program, that disclosure was “materially false and misleading,” the SEC said in its complaint. “The financial benefit to Sage and Grant was not merely possible, it was certain,” the complaint stated.

That the case seems to suggest a duty for advisers to disclose how much more they might make by going independent shocked some legal observers.

“I haven't seen [the SEC] take that [type of disclosure] position before,” said Bryan Hill, president of RIA Compliance Consultants Inc.

“It's a real wake-up call for a lot of breakaway brokers,” he said.

“It's a new frontier to say the adviser has to disclose what they're making, if it's more,” said Daniel Bernstein, director of professional services at MarketCounsel LLC, an RIA compliance consultant. “That's a slippery slope” for the SEC to go down, he added.

“That focus [on what Mr. Grant earned] in the complaint did trouble me,” said Sylvia Scott, a partner at Freeman Freeman & Smiley LLP. Making more money “is what being in business is about,” she said.

However, legal observers said, the SEC might not have filed the case against Sage had Mr. Grant not been accused of other misdeeds.

The SEC said that a letter Mr. Grant sent to clients in October 2005 asking them to transfer their accounts to Schwab indicated that the money manager he used, First Wilshire Securities Management Inc., had “suggested” that clients move to Schwab and that Mr. Grant told customers that First Wilshire no longer was willing to manage assets at Wedbush. Both claims were false, the SEC said.

The SEC also alleged that he failed to consider other money managers for his clients and did not provide follow-up reporting as promised.

Mr. Grant is fighting the charges.

“The SEC's case is pretty much based on that [October 2005] letter,” said Sage's attorney, Michael Unger, a partner at Rubin & Rudman LLP. The SEC is making a “very subjective [and] an incorrect interpretation of that letter,” he said.

Mr. Grant did not double his income after setting up his advisory shop, Mr. Unger added. The $500,000 in income the SEC used as a starting point was based on just nine months of income, he said, and the SEC didn't account for the fact that Mr. Grant's assets under management grew over the period.

At the time he set up Sage, Mr. Grant managed more than $100 million, the SEC said. Sage's ADV form, updated this month, shows $115 million in assets.

Furthermore, Mr. Grant “had a very distinct and clear impression that First Wilshire wanted to use Schwab as a platform and custodian, and we believe we have evidence to that effect,” Mr. Unger said.

Frank Huntington, senior trial counsel at the SEC's Boston office, did not return calls seeking comment.

Not every legal observer is troubled by the case, though.

“I don't think the SEC is saying you have to disclose your cost structure to clients,” said Marc Dobin, founder of an eponymous law firm.

Mr. Grant, according to the SEC's complaint, gave a false impression that his customers had to follow him to Sage, Mr. Dobin said, and concealed a “strong financial incentive behind the 2% wrap fee.”

“He should have said, "I'm making more money under this new arrangement,'” said Jane Stafford, founder of Stafford Law Firm LLC.

Ms. Stafford and others think the Sage case portends more actions against retail RIA firms concerning conflicts of interest in general.

The SEC clearly has been warning industry participants about conflicts, she said. “More than likely, we'll see these types of cases where you have a fiduciary who is not adhering to clients' best interests.”

“This [Sage] complaint reflects a new commitment [by the SEC] to aggressively pursue these conflicts,” Mr. Hill said.

“Conflicts of interest [are] one of five exam priorities,” said SEC spokesman John Nester.

E-mail Dan Jamieson at


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