Kovack Advisors pays $900,000 to settle SEC charges over wrap program

The agency charged the firm with failing to monitor whether wrap-fee accounts were in the best interests of clients who did little trading.

Set it and forget it isn’t a good approach for investment advisory firms that are putting clients into wrap programs, and another SEC enforcement action is making that point.

Last Friday, Kovack Advisors Inc. agreed to pay nearly $900,000 to settle charges by the Securities and Exchange Commission that the firm failed to monitor wrap accounts from 2015 through August 2018 to determine whether they were suitable for the clients using them.

In a wrap program, a client pays a single fee for advisory and brokerage services. They are meant to be a cost-effective account for investors who don’t frequently make transactions. Clients in the Kovack wrap program paid an all-inclusive fee for asset management, trade execution and other costs, according to the settlement.

During the time period covered by the enforcement action, Kovack didn’t monitor the accounts for inactivity to determine whether the wrap accounts were in clients’ best interests, the SEC said in the settlement. Kovack also failed to disclose to clients that they would have to pay a fee for trade execution by clearing brokers in addition to the wrap fee.

“As a result, certain [Kovack] wrap clients remained in wrap accounts despite the lack of activity in their accounts, and/or paid transaction costs on top of the wrap account fee,” the settlement states.

Kovack agreed to pay $899,513 to settle the SEC charges. That payment consisted of a $700,000 civil penalty; $163,239 in disgorgement; and $33,274 in prejudgment interest. The money will be distributed to harmed investors.

Kovack stopped offering wrap accounts to clients in August 2018, according to the settlement. From that point, some Kovack advisers had agreements with their clients to cover some transaction costs. Kovack neither admitted nor denied the SEC’s findings.

“We moved expeditiously to correct this oversight on our firm’s part, while putting in place enhanced processes and protocols to prevent the chances of this occurring again,” Kovack spokesperson Donald Cutler said in a statement. “We reached a definitive conclusion to this matter, so all parties can move forward from it.”

Kovack Advisors Inc. is a registered investment advisory firm that is a subsidiary of Kovack Financial, which is headquartered in Fort Lauderdale, Florida. Last week, the Financial Industry Regulatory Authority Inc. reached a settlement with Kovack Securities Inc., the Kovack Financial broker-dealer arm, over the firm’s supervision of trades of mutual fund A shares.

The SEC has long focused on the use of wrap accounts and issued a risk alert about them last year. In the settlement with Kovack Advisors Inc., the agency explained why such accounts aren’t always in a client’s best interests.

“Advisory clients with infrequent trading activity, for example, may pay higher fees on a wrap account than they would if they maintained their assets in a non-wrap account or brokerage account where the client would otherwise pay trading costs as incurred, but a lower advisory fee in a non-wrap account, or no advisory fee in a brokerage account,” the settlement states.

The SEC’s settlement with Kovack Advisors Inc. was first reported by Financial Advisor IQ.