TD Waterhouse Investor Services, Inc.
SECURITIES EXCHANGE ACT OF 1934
Release No. 50415 / September 21, 2004
INVESTMENT ADVISERS ACT OF 1940
Release No. 2299 / September 21, 2004
ADMINISTRATIVE PROCEEDING
File No. 3-11669
In the Matter of TD WATERHOUSE INVESTOR SERVICES, INC., Respondent. |
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ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND A CEASE-AND-DESIST ORDER PURSUANT TO SECTION 15(b)(4) OF THE SECURITIES EXCHANGE ACT OF 1934 AND SECTION 203(k) OF THE INVESTMENT ADVISERS ACT OF 1940 AS TO TD WATERHOUSE INVESTOR SERVICES, INC. |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 15(b)(4) of the Securities Exchange Act of 1934 ("Exchange Act") and Section 203(k) of the Investment Advisers Act of 1940 ("Advisers Act").
II.
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the "Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over it and the subject matter of these proceedings, Respondent consents to the entry of this Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order Pursuant to Section 15(b)(4) of the Securities Exchange Act of 1934 and Section 203(k) of the Investment Advisers Act of 1940 ("Order"), as set forth below.
III.
On the basis of this Order and Respondent's Offer, the Commission finds1 that
Nature of Proceeding
1. TD Waterhouse Investor Services, Inc. ("TDW"), a registered broker-dealer, gave undisclosed cash compensation to three independent investment advisers, Kiely Financial Services, Inc. ("Kiely Financial"), Rudney Associates, Inc. ("Rudney Associates"), and Brandt, Kelly & Simmons, LLC ("BKS") (collectively "the Advisers"), to encourage the Advisers to direct their clients' brokerage business to TDW.
2. TDW's payments to the Advisers created potential conflicts of interest between the Advisers and their clients. By receiving compensation from TDW, each adviser compromised its ability to evaluate independently whether to choose or to keep TDW as its clients' broker. The law required the Advisers to disclose the potential conflicts fully to their clients and in the Advisers' Form ADV. Each of the Advisers' failure to adequately disclose the potential conflicts created by the payments received from TDW violated Sections 206(2) and 207 of the Advisers Act.
3. TDW knew that by offering compensation in exchange for an adviser's business, TDW was creating a potential conflict of interest between the adviser and its clients that the adviser had to disclose. TDW even had written procedures that stated that TDW would ensure that the advisers adequately disclosed the payments.
4. TDW chose to address the potential conflicts created by the payments to the advisers by adopting written procedures that required it to "ensure" that the advisers disclosed the payments in their Forms ADV. TDW, however, failed to follow these procedures in that it did not review all of the Forms ADV of the Advisers to "ensure" that the payments had been adequately disclosed to the Advisers' clients and in the Advisers' Form ADV. Because of this conduct, TDW should have known that it was inducing and was a cause of the Advisers' violations of Sections 206(2) and 207 of the Advisers Act.
Respondent
5. Respondent TDW, headquartered in New York, New York, is a broker-dealer which has been registered with the Commission pursuant to Section 15 of the Exchange Act since 1979, S.E.C. file number 8-23395. TDW is a subsidiary of TD Waterhouse Group, Inc., a large discount brokerage firm that itself is a wholly-owned subsidiary of the Toronto-Dominion Bank. Facts
6. TDW made payments to three investment advisory firms as an incentive for the Advisers' brokerage business. TDW induced Kiely Financial, Rudney Associates, and BKS, none of which adequately disclosed to their clients the $49,500, $20,000, and $7,500, respectively, that they received, to violate the federal securities laws.
TDW's Sales Incentive Payments
7. TDW provides brokerage and other financial services to independent investment advisers and their clients through its investment advisory division, TD Waterhouse Institutional Services ("TDW Institutional"). Approximately 2,500 investment advisers currently use its services.
8. During 2000, TDW Institutional began offering enticements, such as reduced commission rates and fees, free or discounted portfolio management software, and, in a few instances, hard dollar payments to advisers. These enticements, which TDW called "sales incentives," generally were memorialized in a contract between the adviser and TDW in which TDW compensated the adviser for moving its clients' assets to TDW or keeping them there. The compensation payments came directly out of TDW's profit margins on that adviser's clients' brokerage business. To determine how much compensation to provide to a particular adviser, TDW ran a detailed profitability analysis on each adviser's projected business. The size and availability of an adviser's payment depended in part on the size of TDW's profit margin.
9. In these three instances, TDW paid the Advisers in "hard dollars." The payments were effected through direct credits to the Advisers' operating accounts at TDW, and payments were often earmarked for the Advisers' marketing, payroll, or other operating expenses. There was no direct benefit to the Advisers' clients.
TDW's Sales Incentive Agreements with the Advisers
10. TDW and Kiely Financial entered into a sales incentive agreement in which TDW agreed to reward the adviser if the adviser increased its clients' investment in certain mutual funds to specified asset levels. The negotiations between TDW and Kiely Financial began when Kiely Financial's president and sole owner, Dr. Joseph Kiely ("Kiely"), approached a TDW First Vice President of Sales for financial help. After being turned down initially because Kiely Financial's accounts were not profitable enough for TDW to justify any incentive payments, Kiely then asked if there was anything he could do to get the money he wanted, adding, according to an internal TDW e-mail, that he was willing to do "what works for [TDW]."
11. With this new commitment, TDW recalculated its profit margins on Kiely Financial's accounts, assuming that the adviser's clients would increase the amount of money that they invested in certain mutual funds which were profitable for TDW. Based on these new calculations, the parties agreed to a contract which obligated TDW to pay Kiely Financial if its clients' total balance in these mutual funds met or exceeded pre-determined asset levels. Through these agreements, Kiely Financial received five payments from TDW over approximately two years, totaling $49,500 in compensation, which Kiely Financial did not disclose to its clients.
12. TDW and Rudney Associates entered into a sales incentive agreement in which TDW gave Rudney Associates two payments. The negotiations between TDW and Rudney Associates began when Rudney Associates' principal, Eric Rudney ("Rudney"), approached TDW to discuss moving Rudney Associates' clients' accounts to TDW. During these talks, TDW and Rudney also discussed whether TDW could help Rudney Associates with some of the advisory firms' costs.
13. After Rudney Associates moved its client accounts to TDW, TDW agreed to give Rudney Associates a sales incentive, which was memorialized in a letter to Rudney which stated that TDW would provide Rudney Associates with a "one-time payment of $10,000," to be reevaluated annually. TDW agreed to give Rudney Associates the payment after running a profitability analysis on how much revenue and profit Rudney Associates' client brokerage would generate for TDW. The next year, as contemplated in the original agreement, Rudney asked for and received a second $10,000 payment. In total, Rudney Associates received two payments from TDW over approximately a six-month period, totaling $20,000, which Rudney Associates did not disclose to its clients.
14. TDW entered into a sales incentive agreement with BKS in which TDW gave BKS one lump-sum payment. The negotiations between TDW and BKS began when BKS, through its then-80 percent owner Kenneth G. Brandt ("Brandt"), approached TDW to discuss moving BKS's client accounts to TDW. The parties eventually entered into a sales incentive agreement in which TDW agreed to make a one-time, $7,500 payment to BKS, a fact that BKS did not adequately disclose to its clients.
TDW's Policies and Procedures Governing Sales Incentive Agreements
15. TDW recognized that payments to an adviser could create a potential conflict of interest for the adviser. Thus, TDW drafted procedures to govern the payments, which stated that TDW "must ensure that advisors disclose the above payment arrangement on their ADV as required by securities regulators due to the potential conflict of interest."
16. TDW chose to address the potential conflicts created by the payments to the advisers by adopting procedures that required it to "ensure" that the advisers disclosed the payments in their Forms ADV. TDW, however, failed to follow these procedures in that it did not review all of the Forms ADV of the Advisers to "ensure" that the payments had been adequately disclosed to the Advisers' clients and in the Advisers' Form ADV. In fact, in the cases of both Kiely Financial and Rudney Associates, TDW made multiple payments to the adviser without determining whether the adviser had disclosed earlier payments to its clients. A former compliance counsel at TDW who was responsible for verifying disclosure admitted that she did not review each adviser's Form ADV. She merely "spot-checked" advisers' disclosures.
17. In the summer of 2003, TDW instituted new procedures, which dictate that no payments will be made to any third-party vendors on an adviser's behalf, until TDW Institutional's compliance personnel have ensured that the adviser has fully disclosed the potential conflict to its clients. Under the new process, TDW Institutional's compliance department verifies the prospective disclosure before the incentive agreement will be submitted for final executive approval.
Legal Discussion
18. Section 206(2) of the Advisers Act establishes a fiduciary duty for investment advisers to act for the benefit of their clients. Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979). Section 206(2) makes it unlawful for an adviser to engage in any transaction, practice, or course of business that operates as a fraud or deceit upon any client or prospective client. A violation of Section 206(2) may be established by a showing of negligence. SEC v. Steadman, 967 F.2d 636, 643 n.5 (D.C. Cir. 1992). Section 207 of the Advisers Act makes it unlawful for any person to willfully make any untrue statement of a material fact or omit to state any material fact required to be stated in a report filed with the Commission.
19. Receiving compensation from TDW created potential conflicts of interest between the Advisers and their clients. By accepting TDW's payments, the Advisers potentially compromised their ability to independently evaluate whether to recommend that their clients maintain client accounts at or transfer client accounts to TDW. As fiduciaries, the Advisers were obligated to disclose these potential conflicts fully to their clients.
20. TDW recognized that it was creating these potential conflicts of interest, and it chose to address this potential conflict by implementing a policy to "ensure" that the Advisers disclosed these potential conflicts of interest to their clients. However, after creating this policy, TDW did not adequately follow through. TDW did not review all of the Forms ADV of the Advisers to see if the payments had been disclosed. Further, in both the Kiely Financial and the Rudney Associates cases, TDW continued paying the advisers additional sales incentives, despite the fact that TDW had not verified that previous incentives had been disclosed.
21. Moreover, the arrangement with Kiely Financial should have made it clear to TDW that its sales incentive payments were affecting advisers' incentives in ways that could hurt the advisers' clients. Through the negotiations, TDW believed that Kiely was willing to invest his clients' money in ways that would help him receive compensation, not necessarily in ways that would be the best investments for his clients.
22. Accordingly, as a result of the conduct described above, TDW willfully2 induced and was a cause of Kiely Financial's, Rudney Associates', and BKS's violations of Sections 206(2) and 207 of the Advisers Act.
IV.
In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions agreed to in Respondent TDW's Offer.
Accordingly, it is hereby ORDERED:
A. Pursuant to Section 15(b)(4) of the Exchange Act, that Respondent TDW is censured.
B. Pursuant to Section 203(k) of the Advisers Act, that Respondent TDW cease and desist from committing or causing any violations and any future violations of Sections 206(2) and 207 of the Advisers Act;
C. It is further ordered that Respondent shall, within 30 days of the entry of this Order, pay a civil money penalty in the amount of $2,000,000 to the United States Treasury. Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (D) submitted under cover letter that identifies TDW as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Helane L. Morrison, San Francisco District Office, Securities and Exchange Commission, 44 Montgomery Street, Suite 1100, San Francisco, CA 94104.
By the Commission.
Secretary
Endnotes