If you have been a regular reader of this Blog, or even if you just browse the Wall Street Journal on occasion, you have undoubtedly noticed the attention being given over the last few weeks to the SEC’s decision increasingly to bring its Enforcement cases before Administrative Law Judges, rather than in federal court. While the SEC has attempted, somewhat inadequately, in most people’s eyes, to explain its rationale for doing so, the generally accepted viewpoint seems to involve the application of Occam’s razor, i.e., that the simplest explanation for something is typically the best: when it goes before an ALJ, the SEC almost always wins.
Emphasis on “almost.” I am very pleased to report the receipt today of an Initial Decision by ALJ James Grimes in a case that we tried in February 2015 in which he dismissed all charges levied by the SEC against my clients: Robare decision
The case was filed against The Robare Group, Ltd. (“TRG”), an SEC-registered investment advisory firm in Houston, Texas, and its two founders and principal owners, Mark Robare and Jack Jones. It concerned the adequacy of certain disclosures, primarily in TRG’s Form ADV, they made regarding potential conflicts of interest arising out of compensation that they received from Fidelity, which served as the custodian for their customers’ assets, when their customers invested in certain non-Fidelity mutual funds. In short, the SEC alleged that the disclosures were not adequate, and that, as a result, Mr. Robare and TRG willfully violated subsections (1) and (2) of Section 206 of the Advisers Act, that Mr. Jones willfully aided and abetted and caused the same violations, and that all three respondents violated Section 207 of the Advisers Act. Respondents, of course, denied the allegations.
In his Initial Decision dated June 4, 2015, Judge Grimes, the ALJ assigned to the case, dismissed all allegations and charges that the SEC brought. In reaching that conclusion, Judge Grimes made several pertinent findings. First, he found that disclosures by advisors to customers and prospective customers may appear in documents other than just Form ADV. As a result, regardless of whether respondents’ Form ADV was adequate or not, if other documents that respondents supplied their customers, which in this instance included a separate disclosure document and a Fidelity customer agreement, among others, did contain adequate disclosures, then there is no violation.
Second, he found that respondents reasonably relied on advice they received over the years from several trusted sources – including consultants as well as the broker-dealer with which they were registered – regarding their disclosures, rebutting the SEC’s insistence that they acted with scienter, recklessly, and negligently. Specifically, and dramatically, Judge Grimes stated the following in denying the scienter charge:
[I]n listening to Mr. Robare and Mr. Jones testify and observing their demeanor under cross-examination, it is difficult to imagine them trying to defraud anyone, let alone their investment clients. They came across as honest and committed to meeting their disclosure requirements. Indeed, their belt-and-suspenders approach to compliance, through which they relied on multiple firms, including [their BD] and [their consulting firm], to ensure the Robare Group was compliant with its disclosure obligations belies any argument that Mr. Robare or Mr. Jones acted with intent to deceive, manipulate, or defraud anyone.
Third, the Judge found that respondents established that they never made any investment decisions on behalf of their customers that were influenced, in any way, by a desire to receive compensation from Fidelity; to the contrary, they made their investment decisions not knowing whether whatever non-Fidelity mutual fund they happened to select would result in them receiving a payment. Moreover, the Judge found persuasive the fact that respondents often deliberately included Fidelity mutual funds in their customer portfolios, even though they knew such mutual funds would not result in them receiving compensation from Fidelity.
Finally, and perhaps most interestingly, Judge Grimes expressly recognized the difficulty that investment advisors experience when trying to determine whether their disclosures are adequate, citing unrebutted testimony from two witnesses respondents produced to the effect that “the Commission’s position as to what constitutes adequate disclosure is a ‘moving target’,” or, similarly, “investment advisors ‘struggle to determine what is sufficient disclosure,’” and that “the reason for this struggle is a lack of clear and consistent guidance.”
The Initial Decision is final unless a party files a petition for review, i.e., an appeal, or a motion to correct manifest error of fact, or if the SEC determines on its own initiative to review the decision.
Attentive readers may have noticed that Judge Grimes has already been the subject of earlier blog posts regarding the SEC’s increased use of Administrative Proceedings. Just days ago, an Order that Judge Grimes entered in another matter received attention from the media because he agreed to the issuance of a subpoena to the SEC to allow the respondent to explore suggestions raised in an article in the Wall Street Journal that a former SEC ALJ had resigned in the face of pressure from the SEC to rule against respondents. Clearly, given his decision in the Robare case completely blowing up the SEC’s theories, Judge Grimes either is feeling no such pressure himself, or, perhaps, he doesn’t care about it. Either way, it is extremely gratifying to know that there is at least one ALJ who is willing to call them as he sees them…which is how this process is supposed to work.
Finally, congratulations to my clients for having the bravery to take this case to a hearing, even knowing the massive statistical hurdle they faced by having the SEC bring it as an Administrative Proceeding, and also given the fact they could have settled for charges much more benign than those the SEC ultimately included in the Order Instituting Proceedings. Let them serve as role models for the industry.