Federal Court Remands SEC's Willfulness Findings in Robare Form ADV Case

May 1, 2019

Unless you do Wall Street regulatory law for a living, you may not appreciate the dramatic -- frankly, historic -- nature of a just-published Opinion by the United States Court of Appeals for the District of Columbia Circuit in Robare Group, Ltd. v. SEC. All serious industry professionals should read the history of this SEC regulatory case from its inception through the deliberations of the federal circuit court -- and continue to follow this matter as it is remanded back to the SEC. Among the fascinating issues in dispute is whether an RIA is justified in relying upon the compliance advice of a seemingly reputable, independent consulting organization. Is it enough in 2019 for human beings to do their very, very best in order to comply with all of Wall Street's rules and regulations -- or, as the SEC asserts, even good faith may still involve sanctionable negligence. It's not that you knew but that you should have. Beyond the substantive issues on appeal, we witness, yet again, the dubious Wall Street regulatory practice of trying a case before an SEC administrative law judge, who renders a so-called "initial" decision, which is subsequently over-turned by the SEC's Chair and Commissioners, who did not sit in on the regulatory hearing, did not observe the witnesses' demeanor, and likely have less familiarity with the details of the underlying facts than the ALJ who is being reversed.

2014 SEC OIP

The Robare Group ("TRG") registered in 2003 as an independent investment adviser (an "RIA") with the SEC after being state-registered since 2001. Mark L. Robare founded the company and was a limited partner; and he also was President of Robare Asset Management, Inc (the RIA's managing general partner). Jack L Jones, Jr. was a limited partner of Robare Group and he owned about 17% of the RIA. Initially, TRG used Fidelity Investments for execution, custody, and clearing services for its advisory clients. In 2004, TRG entered into a "revenue sharing arrangement" with Fidelity whereby Fidelity paid TRG when its clients invested in certain funds "offered on Fidelity's on-line platform."  Between September 2005 and September 2013, TRG received from Fidelity approximately $400,000, which was approximately 2.5% of TRG's gross revenue. As of August 26, 2013, TRG served as investment adviser to approximately 350 separately managed discretionary accounts and had approximately $150 million in assets under management. 

In the Matter of The Robare Group, Ltd., Mark L. Robare, and Jack L. Jones, Jr. (SEC Order Initiating Proceedings; '34 Act Rel. No. 72950; Invest. Adv. Act Rel. No. 3907; Invest. Co. Act Rel. No. 31237; Admin. Proc. File No. 3-16047 / September 2, 2014) (the "SEC OIP")
https://www.sec.gov/litigation/admin/2014/34-72950.pdf, the "Summary" asserts that:

This matter involves an investment adviser's failure to disclose compensation it received through agreements with a registered broker-dealer ("Broker") and conflicts arising from that compensation. In 2004, the Broker agreed to pay adviser Robare Group, of Houston, Texas, a specified amount for all client assets that Robare Group invested in certain mutual funds. The agreement created incentives for Robare Group to favor particular mutual funds over other mutual funds or other investments and to favor the Broker's platform when giving investment advice to its clients. Robare Group failed to disclose this agreement and the resulting conflicts of interest to its clients for years, and then only provided inadequate disclosure about it and a subsequent agreement with the Broker. By doing so, Robare Group and its principal Mark L. Robare willfully violated Sections 206(1), 206(2) and 207 of the Advisers Act. In addition, Jack L. Jones, Jr., also a principal of Robare Group, aided and abetted and caused Robare Group's and Robare's violations of Sections 206(1) and 206(2) of the Advisers Act and willfully violated Section 207 of the Advisers Act.  

2014 ALJ Initial Decision

In the Matter of The Robare Group, Ltd., Mark L. Robare, and Jack L. Jones, Jr. (ALJ Initial Decision;  Admin. Proc. File No. 3-16047 / September 2, 2014) (the "ALJ Initial Decision")
https://www.sec.gov/litigation/admin/2014/34-72950.pdf, the "Summary," SEC Administrative Law Judge ("ALJ") James E. Grimes states that:

In this Initial Decision, I find that the Division of Enforcement failed to carry its burden to show that Respondents The Robare Group, Ltd. (the Robare Group or TRG), Mark L. Robare, and Jack L. Jones, Jr. (collectively Respondents), violated Sections 206(1), 206(2), and 207 of the Investment Advisers Act of 1940. The allegations against Respondents are therefore dismissed. 

Compliance Consultants

In a compelling and thoughtful Initial Decision spanning some 44 pages, ALJ Grimes meticulously explains his findings and rationale. Pointedly, ALJ Grimes walks us through the various amendments that the Robare Group made to its Form ADV, and, notably:

TRG attempted to meet its responsibility for determining what it needed to disclose in its Form ADV by hiring outside consultants. Tr. 368. When TRG first started, it used National Regulatory Services, to which it had been referred by Allmerica. Tr. 369. National Regulatory Services assisted TRG with its first Form ADV and with the disclosures necessary when TRG first registered with the Commission. Tr. 369. In 2004, Mr. Robare decided to switch to a compliance consultant that understood TRG's situation as a small, hybrid investment adviser. Tr. 369. TRG used a firm called Capital Markets, referred to it by Triad, from 2005 to 2007 and then moved to Renaissance in 2007. Tr. 369, 507. TRG switched to Renaissance because Mr. Jones and Mr. Robare "knew some people from Triad that had gone to work for Renaissance." Tr. 682. Mr. Jones and Mr. Robare "met them . . . at a conference" and "felt confident about them and their reputation." Tr. 682. Mr. Jones testified that the reputation of their compliance consultant mattered because compliance was not TRG's "area of specialization." Tr. 682-83. Renaissance remains TRG's compliance consultant. Tr. 550. 

Mr. Robare testified that he discussed the Program Agreement with National Regulatory Services and Capital Markets. Tr. 507-09. He conceded however that he could not remember giving Capital Markets a copy of the Program Agreement or asking Capital Markets about how to disclose TRG's participation in the Program. Tr. 509. He also could not remember "giving [Renaissance] a physical copy of the [Program] [A]greement." Tr. 510. Mr. Robare nonetheless asserted that he did discuss the matter with Renaissance. Tr. 510. He then speculated that his discussion led to changes in 2008 in TRG's Form ADV. Tr. 510. Mr. Robare quickly retracted this comment when he realized that TRG had not changed its Form ADV in 2008. Tr. 510. Because of the lapse of time, he also could not specifically recall his discussions with Renaissance. Tr. 511. 

According to TRG's agreement with Renaissance, TRG was "solely responsible for the adequacy and accuracy of any information or documentation provided to" Renaissance and that Renaissance had "no responsibility to verify the accuracy of any information [TRG] provided" it. Div. Ex. 16 at 6. . . .

Page 18 of the ALJ Initial Decision

As to the importance of the Robare Group's retention of outside compliance consultants and the impact such a factor had on the ALJ's deliberations:

In the end, it is sufficient that when TRG's principals paid Renaissance for support "in administering [TRG's] compliance program," assistance in preparing TRG's disclosures, and review and updating of its Form ADV, Resp. Ex. 43 at 1-2, those principals reasonably thought they were getting what they paid for, see Tr. 412. No doubt, Mr. Robare and Mr. Jones paid Renaissance in hopes of avoiding the very proceeding of which they are now the subject.

Page 20 of the ALJ Initial Decision

Scienter

In explaining why he found that Enforcement had failed to establish the Respondents' "intent" to engage in conduct that would be in violation of SEC rules, ALJ Grimes explains in part that:

Cutting to the chase, even assuming the Division is correct that the Robare Group failed adequately to disclose the Program until December 2011, the Division cannot prevail on its claim under Section 206(1) because it cannot show scienter. Scienter refers to "a mental state embracing intent to deceive, manipulate, or defraud." Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1323 (2011) (quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319 (2007)). 

Here, the Division's evidence of scienter consists of nothing more than assertions that Mr. Robare was knowledgeable about the Program and possessed ultimate authority over TRG's Form ADV filings. Div. Br. at 33-34. These facts are not enough to meet the Division's burden to show scienter. Instead, the evidence developed at the hearing demonstrates that the Robare 39 Group and its principals did not act, at any time, with scienter or any intent to deceive, manipulate, or defraud. 

Pages 38 - 39 of the ALJ Initial Decision

2016 SEC Opinion

Following the issuance of the ALJ Initial Decision, Enforcement appealed the dismissal of its case. In the Matter of The Robare Group, Ltd., Mark L. Robare, and Jack L. Jones, Jr. (SEC Opinion, Invest. Adv. Act Rel No. 4566; Admin. Proc. File No. 3-16047 / November 7, 2016) (the "SEC Opinion") Based upon its independent de novo review, the SEC agreed with ALJ Grimes that scienter was not proven; however, the Chair White and Commissioners Stein and Piwowar found that:

[R]espondents were negligent by failing to fully and fairly disclose conflicts of interest to their clients. 

Based upon our independent review of the record, we find that TRG and Robare violated Section 206(2) of the Investment Advisers Act of 1940 and that Jones caused the violations of Section 206(2). We also find that Respondents violated Section 207 of the Advisers Act by filing Forms ADV with material misrepresentations or omissions. Given these violations, we find that it is in the public interest to impose a cease-and-desist order on Respondents and to order each of them to pay a $50,000 civil money penalty. 

Page 2 of the  SEC Opinion.

Reliance On Compliance Counsel Defense

A key aspect of this case was the Respondents' reliance  upon the advice of compliance consultants, and whether said reliance was justifiable and served to demonstrate a lack of intent to engage in misconduct. Chair White and Commissioners Stein and Piwowar largely rejected ALJ Grimes' finding that Respondents had demonstrated that they had justifiably relied upon the advice of independent consultants, and, accordingly, that reliance precluded the creation of scienter evidencing an intention to engage in the underlying conduct in a negligent, reckless, or willful manner. As such, in stark contrast to ALJ Grimes' rationale, we have this in part [Ed: footnotes omitted]:

Neither Respondents nor the law judge cite any case recognizing a defense of reliance on compliance consultants. And even were such a defense available on grounds analogous to a reliance on counsel defense, we find that Respondents cannot establish it. To establish a defense of reliance on counsel, a defendant must demonstrate "that he made complete disclosure to counsel, sought advice as to the legality of his conduct, received advice that his conduct was legal, and relied on that advice in good faith." No evidence exists that TRG specifically sought or received advice from Triad about how to disclose the Arrangement to its clients. Indeed, Triad's Chief Compliance Officer-who reviewed TRG's Forms ADV-represented to the Commission in 2013 that Triad was "unaware if the service fees [paid under the Arrangement] were disclosed to the clients of the Robare Group."

As to its compliance consultants, the record also does not contain convincing evidence that TRG specifically sought or received advice from its consultants about how to disclose the Arrangement and relied on that advice in good faith.  Robare's vague references to discussions with consultants do not establish that TRG received and followed advice about the disclosure of the Arrangement. And although TRG received advice about the disclosure of the Arrangement from Renaissance in connection with the December 2011 Form ADV and thereafter, an executive vice president at Renaissance testified that Renaissance did not receive a copy of the 2004 Fidelity agreement until he was interviewed by the Commission in 2014. He further testified that he would typically discuss compensation sources with clients but did not recall discussing the Arrangement with TRG and that Renaissance did not approve TRG's disclosures. TRG and Robare also cite no advice Renaissance gave that explains the continued failure in TRG's Item 14 disclosure to "explain the conflicts of interest, and describe how [TRG] address[ed] the conflicts of interest" as Form ADV directed. 

In any case, TRG and Robare could not reasonably rely on any advice that the disclosures were adequate because they knew their obligations as investment advisers, that they were required to disclose potential conflicts of interest, and that the Arrangement presented such a conflict but was not disclosed. Because of the obvious inadequacy of TRG's disclosure, we find that any reliance by TRG on advice that its disclosure was adequate was not reasonable and thus does not negate our finding of negligence.  

Because TRG and Robare negligently failed to disclose a material conflict of interest, their conduct "operate[d] as a fraud or deceit upon [their] client[s]" and violated Section 206(2).

Fraud and Breach of Fiduciary Duties

In presenting the rationale for imposing a $50,000 penalty, the SEC Opinion states in part that [Ed: footnote omitted]:

Although we do not find that they acted with scienter, Respondents' conduct involved fraud and constituted a fundamental breach of their fiduciary duties to their clients. Respondents' conduct also harmed their clients by depriving them of conflict-free advice. Given the serious nature of the violations of the Advisers Act, a second-tier civil penalty is appropriate to deter future misconduct by Respondents and others. The maximum second-tier penalty for each act or omission is $50,000 for a natural person or $250,000 for an entity. Accordingly, we impose one maximum $50,000 second-tier penalty on each of Robare and Jones and one $50,000 second-tier penalty on TRG. 

Page 17 of the  SEC Opinion.

Piwowar Dissent on Civil Penalty

Commissioner Piwowar concurred with the SEC Opinion but not with the imposition of the $50,000 civil penalty. In his dissent as to the imposition of the fine, he explained that:

Section III.B of the opinion lists six factors the Commission considered in deciding both whether to impose a civil penalty on each Respondent and the amount of any such penalty. Of the six factors, only one weighs in favor of imposing civil penalties: the act or omission involved fraud. The other five factors weigh against a civil penalty: there was no harm to others, none of the Respondents was unjustly enriched, none of the Respondents has committed previous violations, there are no other matters as justice may require that would lead one to conclude that civil penalties are appropriate in this matter, and there has been no showing that we need to deter such persons, based on the findings of the administrative law judge and the record before us. . . .

2019 DC Circuit Opinion

The Robare Group, Ltd, et al., Petitioners, v. Securities and Exchange Commission, Respondent (Opinion, United States Court of Appeals for the District of Columbia Circuit, 16-1453 / April 30, 2019) http://brokeandbroker.com/PDF/RobareDCCir180430.pdf
As set forth in the "Syllabus" to the DCCir Opinion:

The Robare Group, an investment adviser, and its principals petition for review of the decision of the Securities and Exchange Commission that they violate Section 206(2) and Section 207 of the Investment Advisers Act, 15 U.S.C. §§ 80b-6(2), 80b-7. They contend that the Commission's findings of inadequate disclosure of financial conflicts of interest over a period of years are not supported by substantial evidence, as shown by the contrary decision of the administrative law judge. Upon review, we hold that the Commission's findings of negligent violations under Section 206(2) are supported by substantial evidence, but the Commission's findings of willful violations under Section 207 based on the same negligent conduct are erroneous as a matter of law. Accordingly, we deny the petition in part, grant the petition in part, and remand the case for the Commission to determine the appropriate remedy for the Section 206(2) violations.

On appeal to DCCir, TRG and its principals argued that they had provided the necessary disclosure and that Enforcement failed to proved that their conduct rose to the level of negligent. In rejecting those arguments, the DCCir Opinion explains in part that:

In sum, the evidence before the Commission demonstrated that TRG and its principals persistently failed to disclose known conflicts of interest arising from the payment arrangement with Fidelity in a manner that would enable their clients to understand the source and nature of the conflicts. As the Commission emphasized, TRG and its principals had the burden under the Advisers Act of showing they provided "full and fair disclosure of all material facts," Decision at 7 (quoting Capital Gains, 375 U.S. at 194), and the evidentiary record permitted the Commission to find they did not carry this burden. Evidence that their clients suffered actual harm was not required. See Capital Gains, 375 U.S. at 195. TRG and its principals cannot, and do not, suggest their payment arrangement with Fidelity was not a material fact of which their clients needed to be fully and fairly informed, nor do they explain how, during the period of years at issue, that material fact was conveyed through TRG's Forms ADV or other means.

Page 13 of the DCCir Opinion

Willfully

Notwithstanding DCCir's affirmation of the negligence findings by the SEC, the Court was persuaded by the Petitioners' arguments that they had not "willfully" omitted material information on TRG's Forms ADV. As dramatically set forth in part, the DCCir distinguishes between conduct that is "negligent" and that which is "willful," and explains that:

This court has yet to address the meaning of "willfully" in Section 207, but the parties agree that the standard set forth in Wonsover v. SEC, 205 F.3d 408, 413-15 (D.C. Cir. 2000), applies here. Pet'rs' Br. 45; Resp't's Br. 44-45. We will therefore assume (without deciding) that the Wonsover standard governs this case. In Wonsover, the petitioner challenged the Commission's definition of "willfully" in Section 15(b)(4) of the Securities Exchange Act of 1934, 15 U.S.C. § 78o(b)(4). Relying on Supreme Court and Circuit precedent, this court observed that "[i]t has been uniformly held that 'willfully' in this context means intentionally committing the act which constitutes the violation," and rejected an interpretation that "the actor [must] also be aware that he is violating one of the Rules or Acts." Wonsover, 205 F.3d at 414 (alterations in original). 

The Commission found that Mark Robare and Jack Jones acted willfully because they "both reviewed each of the Forms ADV before filing" them with the Commission and they "were responsible" for the forms' content. Decision at 15. It is the Commission's position that they "acted intentionally, as opposed to involuntarily" because they "intentionally chose the language contained in the Forms ADV and intentionally filed those Forms." Resp't's Br. 45; see SEC v. K.W. Brown & Co., 555 F. Supp. 2d 1275, 1309-10 (S.D. Fla. 2007). In the Commission's view, neither the principals' "alleged 'good faith mindset'" nor their "subjective belief that their disclosures were proper . . . . is relevant to willfulness." Resp't's Br. 45. This misinterprets Section 207, which does not proscribe willfully completing or filing a Form ADV that turns out to contain a material omission but instead makes it unlawful "willfully to omit . . . any material fact" from a Form ADV. 15 U.S.C. § 80b-7 (emphasis added). 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. 

"Intent and negligence are regarded as mutually exclusive grounds for liability." Harris v. U.S. Dep't of Veterans Affairs, 776 F.3d 907, 916 (D.C. Cir. 2015) (quoting District of Columbia v. Chinn, 839 A.2d 701, 706 (D.C. 2003) (quoting 1 DAN B. DOBBS ET AL., THE LAW OF TORTS § 26 (1st ed. 2001))). "Any given act may be intentional or it may be negligent, but it cannot be both." Id. (quoting 1 DAN B. DOBBS ET AL., THE LAW OF TORTS § 31 (2d ed. 2011)). Intent is defined as acting "with the purpose of producing" a given consequence or "knowing that the consequence is substantially certain to result." RESTATEMENT (THIRD) OF TORTS, supra, § 1. "Extreme recklessness" may constitute "a lesser form of intent." Steadman, 967 F.2d at 641-42; see Marrie v. SEC, 374 F.3d 1196, 1203-06 (D.C. Cir. 2004). Negligence, by contrast, means acting "without having purpose or certainty required for intent" but in a manner that is nevertheless unreasonable. DOBBS ET AL. (2d ed.), supra, § 31; see RESTATEMENT (THIRD) OF TORTS, supra, § 1 cmt. d. 

The Commission did not find that Mark Robare or Jack Jones acted with "scienter" in failing adequately to disclose the payment arrangement with Fidelity on TRG's Forms ADV. Decision at 12 (defining "scienter" as "a mental state embracing intent to deceive, manipulate, or defraud" (quoting Hochfelder, 425 U.S. at 193 n.12)). Instead, the Commission gave "significant weight" to the ALJ's determination that their testimony and demeanor during cross-examination "belied the notion they were 'trying to defraud anyone.'" Id. (quoting Initial Decision at 39). The Commission also found that the record evidence did not "establish that [their] investment decisions on behalf of their clients were influenced by the fees they received from Fidelity." Id. So it did not find Mark Robare or Jack Jones "acted intentionally or recklessly," only that they "acted negligently." Id. Because the Commission found the repeated failures to adequately disclose conflicts of interest on TRG's Forms ADV were no more than negligent for purposes of Section 206(2), the Commission could not rely on the same failures as evidence of "willful[]" conduct for purposes of Section 207. . . .

Pages 16 - 18 of the DCCir Opinion


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